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{
"speaker": "Operator",
"content": "Greetings and welcome to the Ball Corporation Third Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brandon Potthoff, Head of Investor Relations. Thank you, sir. You may begin."
},
{
"speaker": "Brandon Potthoff",
"content": "Thank you, Christine. Good morning, everyone. This is Ball Corporation's conference call regarding the company's third quarter 2024 results. The information provided during this call will contain forward-looking statements. Actual results or outcomes may differ materially from those that may be expressed or implied. We assume no obligation to update any of the forward-looking statements made today. Some factors that could cause the results or outcomes to differ are described in the company's latest Form 10-K, our most recent earnings release and Form 8-K and in other company SEC filings as well as company news releases. If you do not already have our earnings release, it is available on our website at ball.com. Information regarding the use of non-GAAP financial measures may also be found in the Notes section of today's earnings release. In addition, the release includes a summary of non-comparable items as well as a reconciliation of comparable net earnings and diluted earnings per share calculations. References to net sales and comparable operating earnings in today's release and call do not include the company's former aerospace business. Year-to-date net earnings attributable to the corporation and comparable net earnings do include the performance of the company's former aerospace business through the sale date of February 16, 2024. I would now like to turn the call over to our CEO, Dan Fisher."
},
{
"speaker": "Dan Fisher",
"content": "Thank you, Brandon. Today I'm joined on our call by Howard Yu, EVP and CFO. I will provide some brief introductory remarks. Howard will discuss third quarter financial performance and key metrics for 2024. And then we will finish up with closing comments and Q&A. Before I talk about the third quarter, I want to take a moment to recognize our team in Tampa, Florida, who have shown incredible resiliency while dealing with the impact of 2 devastating hurricanes. Our thoughts are with everyone impacted by these terrible storms. We are fortunate that all of our employees are safe and that our Tampa facility avoided major damage and was back up and running quickly. The Ball Foundation supported critical relief efforts by providing monetary donations to organizations with teams actively supporting impacted cities. And in conjunction with customers, we donated over 250,000 cans and bottles of drinking water. Our thoughts remain with the communities impacted by these terrible storms and we will continue to support our employees, customers and communities through our global employee giving program. I would also like to welcome our new colleagues who recently joined Ball following our October 29 acquisition of Alucan Entec, a European extruded aluminum aerosol and bottle technology leader. As the demand for sustainable aluminum packaging continues to grow among customers and consumers, this transaction is a capital-efficient way to add incremental capacity to expand our extruded aluminum aerosol business in Europe, while also allowing us to serve the growing extruded aluminum beverage bottle market and diversify our customer base across the continent. Turning to business performance. We delivered strong third quarter results and year-to-date have returned approximately $1.4 billion to shareholders via share repurchase and dividends as of today's call. Reflecting further on year-to-date 2024 performance, aluminum packaging continues to outperform other substrates across the globe. In EMEA, third quarter volumes remained strong, driven by continued investment by our customers in canned filling across the region. In South America, softer-than-anticipated volume performance was driven by our exposure to Argentina and supply-demand tightness in Brazil. In North America, persistent economic pressure on the end consumer and our exposure to U.S. domestic beer led to softer-than-expected volumes. Our regional performance culminated in Ball's global beverage can shipments being essentially flat year-over-year in the third quarter and up 2% year-to-date. For a complete summary of regional shipments for the third quarter, please refer to today's earnings release. Consistent with our previous commentary and given our customer mix and year-to-date regional volume performance, we now anticipate full year global shipment growth in the low single digits range. Key drivers for our company's performance in 2024 continue to be the benefits of deleveraging, repurchasing shares, improving operational efficiencies and leveraging our well-capitalized plant assets to grow the use of innovative, sustainable aluminum packaging across channels, categories and venues. Based on our current demand trends and the previously mentioned drivers, we are positioned to grow full year comparable diluted EPS mid-single digits plus of 2023 reported comparable diluted EPS of $2.90 per share, generate strong adjusted free cash flow, strengthen our balance sheet and return a value in excess of $1.6 billion to shareholders via share repurchases and dividends in 2024. With that, I'll turn it over to Howard to discuss the quarter and key metrics."
},
{
"speaker": "Howard Yu",
"content": "Thank you, Dan. Turning to our results. Third quarter 2024 comparable diluted earnings per share was $0.91, versus $0.83 in the third quarter of 2023. Third quarter comparable net earnings of $278 million were up 6% year-over-year, primarily due to strong operational performance and price/mix, leading to improved year-over-year performance in North America, EMEA and South America. In addition, we had lower interest expense. In North and Central America, segment comparable operating earnings increased 4% and were in line with our expectations despite a softer U.S. mass beer category and stretched end consumer. Benefits of effective cost management and plant efficiencies across our well-capitalized plant network more than offset for the impact of lower volumes. Our team has done a great job improving operational efficiencies, lowering costs and effectively counter-measuring risk. And in future years, when end customer demand inflects more favorably, we are set up to more profitably serve our customers' growth. In EMEA, overall segment volumes were strong and segment comparable operating earnings increased 24%, matching our expectations entering the quarter. Recent demand trends remain favorable and the business is on track for significant year-over-year comparable operating earnings growth in 2024 driven by improving operational efficiencies and volume growth. In South America, segment comparable operating earnings increased 28%, while segment volumes declined due to continued weakness in Argentina and supply-demand tightness in Brazil late in the quarter. During the third quarter, consumer conditions in Argentina demonstrated some gradual signs of recovery and we continue to monitor the dynamic economic situation in Argentina and potential scenarios that can impact results. In Brazil, strong demand in the month of September outpaced our ability to service that demand. We remain bullish about Brazil and our ability to deliver year-over-year comparable operating earnings and volume improvement as we enter the summer selling season in South America. Looking at the businesses within other, the aerosol business performed well and operating earnings were helped by insurance proceeds received during the quarter. The can plant and beverage packaging, other were in line with our expectations and we continue to see growth opportunities in India. Lastly, while our cups business slightly improved operating earnings year-over-year, the growth of this business has not been at the level we initially expected. And as a result, the company is currently evaluating various options for this business. Moving on to additional key financial metrics and goals for 2024. These reflect very consistent figures to those provided throughout the year. We continue to anticipate year-end 2024 net debt to comparable EBITDA to be below 2.5x. While we are currently at 2.2x at the end of the third quarter, net debt to comparable EBITDA may nudge slightly higher by year-end as the company continues payments of tax due on the gain from the sale of aerospace. 2024 CapEx is on track to be in the range of $650 million, a year-over-year reduction of $400 million and largely driven by carrying capital elated to prior year's projects. We remain on track to achieve our adjusted free cash flow target. Share repurchases are expected to be in excess of $1.4 billion by year-end. Through today's call, we have repurchased approximately $1.2 billion in shares year-to-date. Our 2024 full year effective tax on comparable earnings is expected to be slightly above 21%, largely driven by lower year-over-year R&D tax credits associated with the sale of the company's aerospace business. Relative to the estimated tax payments due on the aerospace sale, we have paid a total of $484 million as of the end of the third quarter and we now expect our total taxes on the transaction to be in the range of $950 million. Full year 2024 interest expense is expected to be in the range of $300 million. Excluding the non-comparable aerospace disposition compensation costs, full year 2024 reported adjusted corporate undistributed costs recorded in other non-reportable are expected to be in the range of $100 million. And last week, Ball's Board declared its quarterly cash dividend. Looking ahead to the rest of 2024, we remain laser-focused on operational excellence, driving efficiency and productivity across our business and cost management and monitoring emerging market volatility. We are committed to maximizing the full potential of our company over the long term. We have executed on de-risking the corporation through debt retirement. We have no significant near-term maturities. The runway is clear for us to activate near-term initiatives to consistently deliver high-quality results and generate compounding shareholder returns. With that, I'll turn it back to Dan."
},
{
"speaker": "Dan Fisher",
"content": "Thanks, Howard. The business is operating well and we have line of sight to growing our 2024 comparable diluted EPS mid-single digit plus. While the consumer backdrop remains volatile, we will remain disciplined and through the strength of our portfolio and the unwavering dedication of our employees, we are confident we will deliver on our commitments laid out at our Investor Day. We are focused on executing our purpose and our promise was certainly on display during the third quarter. By the care and support we have provided our employees, customers and communities, by enabling the greater use of aluminum packaging with our bolt-on aluminum aerosol acquisition and by working together to deliver strong results, operating efficiencies and the consistent return of value to shareholders to ensure we win together over the near and long term. We will strive to deliver innovative aluminum packaging solutions that can lead to a world free from waste and continue down the path to deliver compounding shareholder returns in 2024 and beyond. Shareholder value creation remains our focus. And going forward, we anticipate exceeding 10% per annum diluted comparable EPS growth, including in 2025. Consistent delivery of high-quality results and operational performance, coupled with significant share repurchases for the foreseeable future, in addition to dividends, will drive shareholder value creation. We appreciate the work being done across the organization and extend our well wishes to our employees, customers, suppliers, stakeholders and everyone listening today. Thank you. And with that, Christine, we are ready for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of George Staphos with Bank of America."
},
{
"speaker": "George Staphos",
"content": "I guess the first question I had regards the operational excellence work that you've been doing. And what might you have seen year-to-date, what might we see either in absolute terms or sequentially into 4Q and then into 2025? And what I'm really trying to get is, is there any sort of incremental catalysts that we might be able to see from the cost side given that things are pretty much status quo on the top line both in terms of volume and price/mix?"
},
{
"speaker": "Dan Fisher",
"content": "Yes, George. I think you'll see for the next couple of years a continuance of sort of 2% to 3% of our cost structure, is what we're trying to drive to in terms of an overall goal of productivity. Now there's a chunk of the aluminum that's built in there that's tolled, which you really don't have a great deal of ownership on how to drive productivity there. But the teams are continuing to fill the funnel with projects and build on that. I think the simple way to think about it, George, is we are planning better. By planning better, that results in less conversions and less turnover of label changes. That creates less spoilage and less overtime. And so those fundamental ratios got out of whack during COVID. We've taken some of the higher-cost, less-efficient assets out. So you're seeing that first wave of productivity gains back half of last year and into this year. And then the second half of this year and into next year, the manifestation of really this operational excellence, lean, standardization, continuous improvement. But they're going to come through those primary factors. And a little bit of volume will go a long way in also improving that and improving our leverage flow-through. I think you can see we're making more money on a per can basis through a lot of the actions we've taken. I think we can maintain that, offset inflation, offset merit increases and maybe even margin up a bit more moving forward. In North America specific, my comments are really about getting the volume breeds more tailwind and leverage and it also enables us to step into these efficiency gains where it really shows up in those areas. And then further down the road, it enables you to grow, absent capital investments at the rate we've seen historically. So that's how we're looking at it. And I think you'll start to see the incremental nature of the standardization and the process improvements now and moving forward. But the easier stuff, candidly, not easy in terms of dealing with your people and closures of plants but easier in terms of retiring assets that really weren't fit for purpose for the long term. We're kind of through that wave."
},
{
"speaker": "George Staphos",
"content": "Understood. My next and I'll turn it over. You mentioned that you will be ready for the summer season in Brazil, yet you had some capacity constraints in September. So it sort of begs the obvious question, so how do you manage that? Is there capacity that is mothballed that you can turn back on that will allow you to hit the market in an appropriate way? And then taking a step back, a recurring question topic for Ball is obviously maturity, to put it one way, of mass beer. What can you do with the portfolio as you look out to the next couple of years to either change up your mix or get a higher return if it's required in that mass beer portfolio? Is it, in fact, I realize EVA is something you don't emphasize quite as much. Is that portfolio EVA positive and doing what it needs to do? So South America and mass beer."
},
{
"speaker": "Dan Fisher",
"content": "Yes. Thank you, George. Start with South America. So this is just a function of, obviously, in the second and third quarter, in the summer hemisphere, you are curtailing. So the answer is, it got hotter much faster in Brazil. And so we have uncurtailed the lines and we should have got ahead a little bit of the safety stock build. So you're basically 2 to 3 weeks of not easing into peak season but hitting it full on. And that probably cost us somewhere in the neighborhood of 300 million to 400 million units. So those lines are turned on now. We do have capacity that can help serve that market, so it's really more of a Q3 phenomenon. And so that's been put into place. Obviously, you're running incredibly tight right now to make sure that when demand inflects, the one thing that we're preserving obviously is earnings and we probably managed it a bit too tight in Brazil. But I think we're on our toes moving forward and our partner in that region is doing quite well. And we'll continue to do that during peak season. That's more or less their focus period, generally speaking. And then on the mass beer, it's a great question, right? We've acquired in North America. First of all, historically, why are you there? EVA drives you to profit pools, big profit pools, versus others. Beer also, keep in mind, it's like, if you look at the category, it has declined for 20 years. However, the substrate shift in the cans has more than offset that. And the innovation in those categories have more than offset that. So what we need to be aware of and ensure is we're with the right strategic partners in that category. Some folks are winning and we're with them, but we're also with folks that are not doing well. And so we've already started some elements of rebalancing that portfolio. It does become a bit more challenging because the acquisitions over 30 years have assets right across the street from breweries. So there is some connective tissue there that it's not a quick pivot. At the same time, we've always done a nice job of creating new white spaces, innovating with the winners. We're seeing some of those gains. But given the weakness of the end consumer, you won't start to see that appreciate at a rate that's more visible, I think, in the top line results until you see a little bit more relief to the end consumer by virtue of interest rate cuts and things of that nature. We've been on this particular topic, George, for a handful of years now. I think we're moving in the right direction. We're with the folks that are going to win in this category. And the other blurry line here is, don't just focus on historical beer companies. Focus on beverage companies, alcohol companies. And one of our biggest partners has the fastest-growing RTD, probably the fastest-growing non-alcohol beer and the 2 fastest-growing domestic light beers. So there are elements of winning with the right brands, winning with portfolios, winning with folks that are innovative. All of those factor into that. It's not a quick pivot but it's one that we're encouraged about the direction of flight we're on. Thanks for the question."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Ghansham Panjabi with Baird."
},
{
"speaker": "Ghansham Panjabi",
"content": "I just want to build on your last comments and go back to beverage North America. Can you just give us a bit more color on how the other categories performed, especially some of the premium categories for that segment in this region? And simplistically, what is the catalyst for volumes as we look out to 2025 for this segment? And just as a corollary to that, are you winning your share of new business as it comes up in North America? And if so, how do you measure that?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. So I think first things first, there's probably a macro comment here. I am quite encouraged actually for 2025 on a couple of fronts, right, that have been the drags for the end consumer. One, we finally saw the rate cuts and the manifestation of, I think, the Fed recognizing that folks need more discretionary spending power. I think versus 2019, we've got 8% less discretionary spending power. So I think that's manifesting in the food and beverage categories, there's been a lot more inflation. And so that's really weighing on the end consumer there. So the rate cut starts to help. We've also seen an acceleration of savings here over the last 6 to 8 weeks. I think the uncertainty of the election, it would be nice just to get through that period. So the combination of those 2 things are certainly going to -- when we're talking to all of our customers, they're very encouraged about 2025 on that stage and on that front. So you're going to see in the beer side, in the beer category, in the alcohol category, it is going to be folks that are paying attention to the low end on the price paradigm and on the innovation, high end. And some of our customers have better portfolios to do that than others. And they will lean into that and they will win. And as they get a tailwind of discretionary spending coming back, that category will get better. And so we're bullish on seeing growth next year in that category writ large. And we're -- I think we're with the right folks that are going to do well in that category. And then secondarily, remind me your -- sorry, your second question there, Ghansham."
},
{
"speaker": "Ghansham Panjabi",
"content": "Yes. I was just -- the premium subsegments that you're exposed to in North American bev, how did they perform? And then also you're winning -- are you winning your share of new business in the region?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. I think -- and I think you're hearing this pretty consistently. This year was -- you saw some contractual shift from us to a couple of our competitors. That was done -- 2022 is when that contract was -- that contract shuffle happened. Since then, it's been a really rational marketplace relative to that. And we should grow in line with the market moving forward. We've won business that has offset some of the contractual headwinds we were facing. . I think the issue is, underlying those wins, is then a backdrop of flattish energy this year and beer and then domestic beer on a decline. So the combination of those 2 have kind of muted the wins that we've had. But it's not hard to figure out whether you've won contractually or not. I think the share positioning all year has been a manifestation of mix, category mix, winners and losers within categories and where you sit within those portfolios and categories."
},
{
"speaker": "Ghansham Panjabi",
"content": "Okay. Got it. And then for my second question, maybe for you and Howard as well, just in terms of what is the starting point for base volumes for 2025 that kind of gets you to that 10% plus earnings target that you've outlined or reaffirmed, I should say?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. I mean, we're -- as you know, our process, we are in the throes of it right now. But initial stages say we're in line with the -- our long-term algorithm of that 2% to 3% range for top line. It will be stronger in Europe and South America. We feel like 2025 will be better than the run rate that we're currently experiencing in North America. So we'll have the volume we need and we'll have the backdrop of the efficiency gains we need and we're still holding the line on $650 million -- or in line with D&A in terms of capital investment. So the share repurchasing and then the second half algorithm of the shares we purchased this year are all going to contribute to some really nice tailwinds into '25."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Jeff Zekauskas with JPMorgan."
},
{
"speaker": "Jeffrey Zekauskas",
"content": "I think your restructuring charges ex insurance recovery was a little bit more than $90 million. Is that all related to Santa Cruz in Brazil and the Kent, Washington plant? Or are there any other curtailments or closures that are involved in that charge?"
},
{
"speaker": "Howard Yu",
"content": "Yes, Jeff. I think some of that -- the vast majority of that, I believe, is related to some of these closures that we've had. We've also had a closure in [indiscernible] that is also reflected in some of that number, too. The other component of this, I would say, is around IT and related to -- if you're thinking about it in the context of non-continuing operations related to the sale of aerospace. And so that's a component of that, that you would see in there as well."
},
{
"speaker": "Dan Fisher",
"content": "Jeff, we also took, through the op model restructure, we did take some actions midyear. So there was severance associated with a number of individuals here as we were rightsizing the business post aerospace acquisition."
},
{
"speaker": "Jeffrey Zekauskas",
"content": "And then secondly, when you reflect on your aluminum cups initiative, what do you think are the key reasons that held that initiative back?"
},
{
"speaker": "Dan Fisher",
"content": "I think the biggest -- the 2 biggest things, biggest issue is inflation, weakened consumer, a price point that's unsustainable relative to what people are willing to pay for sustainability. I don't think anybody was anticipating kind of the world we're living in here right now in terms of the inflationary pressures and the reduced discretionary spend of the end consumer. So that was a challenged environment for sure. And then I think the downstream recycling infrastructure that's required is also far more complicated. And we know it pretty well but I think in some of the service industry, airports, travel, transportation, we found that it presented some pretty significant barriers to move quickly, at least on that side of the house."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Arun Viswanathan with RBC."
},
{
"speaker": "Arun Viswanathan",
"content": "I guess first question was, I think there was an $85 million closure charge in the quarter. Is that correct? What was that for in North America and South America?"
},
{
"speaker": "Howard Yu",
"content": "Yes. I think we just answered that question, same to what Jeff was asking, Arun, is the closures associated with the reductions in Kent, some of these other ones that we've done here in North America, as well as the ones that we've done in South America as well. And so I think you're asking fundamentally the same question. And restructure, of course."
},
{
"speaker": "Arun Viswanathan",
"content": "Okay. Great. And then just on the -- it seems like a large amount though but nevertheless, just wondering about the volume progression, how you see that kind of evolving over the next few quarters. I know that you have some of the easier comps in the back half of this year. Those will start dropping off. So do you expect kind of -- how do you kind of expect to make that greater than 10% -- or 10% or greater earnings growth? I know you've laid out some low single-digit growth targets in the past at your Investor Day and so on. But how are you thinking about can growth from here?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. I think the easier comp would only be in Europe for the fourth quarter. Fourth quarter was incredibly strong in South America. There was a little bit -- so a little bit of Argentina too that we'll have to offset there. North America will be a reflection of end consumer health in the fourth quarter, how quickly the rate cuts, and I think the election stabilization there and the people are stopping to save money and spend money, those will all help that. Enter '25, we're feeling confident about all 3 regions. I think we've answered this question as well but bears repeating. 2% to 3% growth, in line with our Analyst Day expectations, led by what we laid out at Analyst Day as well. Europe will continue to grow at a healthy rate. South America will grow at a healthy rate. North America will be kind of in that lower end of the 1% to 3% range based on what we see today. But there's hope coming and optimism coming in North America where they're finally getting after the rate cuts and that's what our end consumers need. So that, coupled with consistency of share buyback, returning value and then you'll get the compound effect of the lower weighted average shares going into 2025. So 2025 will -- should shape up to be a nice year for us."
},
{
"speaker": "Howard Yu",
"content": "Yes. I think, Arun, maybe just to piggyback on that, what we did outline during Investor Day is that we're on this journey to reduce costs on a gross basis of $500 million over the next several years. And so -- and you've heard us talking about the traction that we're getting here in 2024. And I would expect that we would continue on this journey as we're just starting it really. And so 2025, '26 and '27, all of those. And so as Dan indicated, we have a very high level of confidence in being able to deliver the 10-plus percent EPS next year."
},
{
"speaker": "Arun Viswanathan",
"content": "And just real quickly on the footprint. I know that you guys have obviously closed some plants, as you noted. Is that kind of come full circle? We've been hearing that utilization rates for your system may be in the low 90s. So would that require more closures, or do you feel pretty good about where you are with the footprint?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. We feel good about the footprint at this point."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Anthony Pettinari with Citi."
},
{
"speaker": "Anthony Pettinari",
"content": "Just maybe piggybacking on that last question. Given the strength in EMEA, can you talk about what your operating rate in Europe is? And then just in terms of the ability to meet, I think, 3% to 5% growth long term that you outlined at the Analyst Day, how long can you go before maybe some debottlenecking projects or maybe even possibly greenfield? Can you just kind of talk about the system and your ability to meet demand there?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. In Europe, I don't -- Anthony, we don't see a need for an additional greenfield in Europe, I think Mainland Europe for the next 2 to 3 years. That's sort of our planning period that we're looking at. We did build, as you know, 2 new facilities that have ability or run rate to add lines. And so we'll maximize that. We'll also maximize, to your point, where we can speed up lines and add process equipment and debottleneck and all of the things that you're familiar with. The one caveat will be that EMEA region, there are areas that are growing even at a faster rate. And -- but they're a little bit more volatile markets, so you have a bit more patience there, places like Egypt, places like Turkey, India is in that mix. So I would caveat or pull those regions out of my initial comments. But all of what we're talking about here is in the envelope of our spending capital at D&A. We can do all of what we need to, to help grow specifically Europe and South America at those outsized growth rates. I think we spent the capital we needed to in North America. So we're -- the team is laser-focused on ensuring that we're returning value to shareholders and enabling the investments in the areas that are going to give us the greatest payback."
},
{
"speaker": "Howard Yu",
"content": "Maybe one more thing to add there, Anthony, I would say, on the substrate shift, Europe is still relatively early in that journey. And so we're seeing a good lift and we will continue to see that. I think the substrate shift is something less than 32% as we speak today. And so there's plenty of runway there as well."
},
{
"speaker": "Anthony Pettinari",
"content": "Okay. That's very helpful. And then just a quick question on kind of the consumer weakness that you've seen in North America. You've talked about kind of standard sizes versus specialty sizes versus super specialty, I think at the Analyst Day, cups were kind of included in that super specialty category. And obviously, it's been a bit weaker. I'm just wondering, when you look at kind of the broader portfolio, are you seeing kind of a mix down in North America between specialty cans and 12-ounce where you're more likely to sell a 6-pack of a 12-ounce standard can and some of those higher ASP products in specialty sizes are not growing as fast or maybe you're kind of losing some mix there? And is that impacting the overall profitability of the business, or is that cutting it maybe a little bit too finely?"
},
{
"speaker": "Dan Fisher",
"content": "I think, Anthony, it's cutting it a bit too finely. But you are on to something here and I'll just draw this out a bit. So you look at energy specifically, right and you look at the end consumer for energy categories and where they consume those products, they shop at a C-store channel. And many of these individuals are in construction or they're in the service industry. And overwhelmingly, the majority of these consumers are Hispanic. The Hispanic unemployment rate is nearly 6%. And so when we talk to our energy customers, they're telling us that the interest rates and that particular category in that channel have been impacted. Those are overwhelmingly specialty cans in that category but they're not -- they're the less special variety. So it's 16 ounce, right? And so we -- that's what's happening within the energy category right now. So that starts to relieve itself, interest rate cuts and a couple of other things. So that's why I'm more bullish about moving into 2025 with some tailwinds in and around that. But you do have to slice it down to a pretty discrete level to kind of parcel out can size, channel, customer, regional aspects to it. Specialty is still special and it's still tight. It's just like the general malaise, I think, of the end consumer is what we're experiencing right now across all categories and all can sizes."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Stefan Diaz with Morgan Stanley."
},
{
"speaker": "Stefan Diaz",
"content": "Maybe to start and piggybacking off George's question around South America. Can you tell us what the volume number was in Brazil and maybe what you think the market grew in the quarter? I understand it's a seasonably slow period there. And maybe additionally, if you could speak to the profitability upside versus Street expectations, despite the volume headwinds you faced in the quarter. Is that more operational excellence? Or was there potentially some more end shipments in the quarter? If you could just dig into that a little bit, that would be helpful."
},
{
"speaker": "Dan Fisher",
"content": "Yes. Thanks. Nearly double-digit growth in South America and Brazil, specifically, sorry. And we were flat to slightly down and I think we left about 3% to 4% of growth on the table by not matching our production with demand. Our primary strategic partner did not win in the quarter. But we expect them to do well in the fourth quarter and the first quarter, which is, of course, their peak season, which you referenced. And then I would say it wasn't actually end mix. Typically, as you know, we make those ends in a very favorable tax jurisdiction. So that mix can increase or decrement profitability as a result of that mix but we're shipping less ends actually. This is all improved performance and really appreciate the team with regards to that down in South America. So hopefully, continued margin benefits through our focus on operations with a little bit of a tailwind there in South America bodes well for us. I think we'll certainly make more money in Q4. And then it's -- for us, it's the culmination really of the countries outside of Brazil that will dictate whether we're growing or we're not. We'll certainly grow for the year and grow in line with expectations that we've laid out. But whether we grow mid-single digits or closer to low single digits, I think it will be all indicative of what happens in Paraguay, Uruguay, Peru, Chile and Argentina and that recovery there."
},
{
"speaker": "Stefan Diaz",
"content": "Great. And then I'm glad to hear that everybody is okay in the Tampa region following the storm there. That said, with the 2 storms in the Southeast, do you believe that they had any impact on North American volume in the quarter?"
},
{
"speaker": "Dan Fisher",
"content": "No, I don't. I think we lost almost 2 full days, 3 days of production. But that, like you said, in a shoulder period. This would have contributed to some missed volume and probably a bridge items worth of -- had it been June, July, August time period. But we were able to -- we were able to source those customers largely from our other regional assets there. And thanks for the well wishes."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Leithead with Barclays."
},
{
"speaker": "Michael Leithead",
"content": "First question on South America. Can you help us better understand the impact of Argentina on segment volumes? If I heard you correctly, Brazil was flattish. So is Argentina down something like double the segment average? And then relatedly, how are you assessing your presence or footprint in Argentina just given all the uncertainty and volatility there?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. For the full year, what we're anticipating right now is -- and this would include the fourth quarter, somewhere between 500 million to 600 million units of decrement year-over-year due to Argentina volumes when you compare it to 2023. And the third quarter was approximately 270 million that Argentina was down, in the third quarter versus the prior year. So as it relates to Argentina, I'll give you, Argentina is really good when it's good and its' not so good when it's not. Having said that, we've been there the last -- 30 years ago, we stayed in that market and it's grown significantly and the can does really well there. And our 2 most important strategic partners in South America are there. They're going to continue to be there and they want us to be there to support them. Having said all that, we're eyes wide open. I think Howard and I went down in April, met with the central bank, met with the Vice President, met with the Secretary of Commerce. Everything they laid out at that time, they're executing against. So we're seeing currency controls easing. We're seeing inflation at sort of the lowest levels. Howard, I'd ask you to weigh in."
},
{
"speaker": "Howard Yu",
"content": "Yes, I think that's right. I think, if anything, it's incrementally a little bit better. And so that gives us, I think, some optimism overall as it relates to their policies taking hold and even being able to repatriate funds and things of that nature. I think that the banking system is improving a little bit there as well in the increment. And so I think that we expect 2025 to continue on that progress path. And as Dan said, this is -- Argentina has historically been a very profitable area. That all said, we do recognize that the volumes down in Argentina in the third quarter were in excess of 30%. That being said, we don't see as much of a profit impact this year as we did last year when these policies and the initial shock associated with that, those churns had happened. So overall, I think we're going to be watchful and mindful and doing a lot of scenario planning, which is what we do. But we feel as though the long-term prospects still remain quite favorable for us in Argentina."
},
{
"speaker": "Michael Leithead",
"content": "Great. That's sounds super helpful. And then secondly, can you talk a bit more about what the Alucan acquisition brings to your existing extruded aluminum business? And are there other aerosol or adjacent opportunities in the M&A pipeline still out there for you guys?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. Well, I think first things first, it's -- one of the facilities was actually part of our original investment in this space. And so we've actually run the plant in Spain, some of our employees have. So we know it well and we know the customer base very, very well. They also built a new facility in Belgium. So we're stepping into a footprint that will enable us to grow incrementally without having to build a greenfield facility. And that is a business that has been growing mid-single digits, high single digits. Very encouraging. And so we were faced with a number of capital allocation decisions and this was just uniquely presented. The individual who was the owner is retiring. And so you know this, anything in M&A, it all looks good on paper but you have to have a buyer and a seller and this was -- we were the right owner for it. And yes, we're excited to welcome these folks on board. So that came nicely and there are other opportunities within the space. It's pretty fragmented. And so we -- where there's an opportunity and there's a buyer and seller, I mean this is -- these are really nice bolt-ons for us and fits well within our capital allocation structure and we continue to return value to our shareholders. So all the stars lined on this one and so hopefully, there are more of those out there."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Josh Spector with UBS."
},
{
"speaker": "Joshua Spector",
"content": "I apologize if I missed this but I wanted to ask specifically on the 4Q EPS expectations. So last call, you talked about fourth quarter being up maybe about a 10% kind of normal growth. You reiterated your mid-single-digit growth for the year. So that's, at the low end, that could mean that EPS is flat or maybe even slightly down. So can you just clarify what your expectation is for the quarter?"
},
{
"speaker": "Howard Yu",
"content": "Yes, Josh, what I would say is that we did have a little bit of improvement in Q3. We had our insurance proceeds. I think we outlined that in our prepared comments as well that came in associated with the Verona fire. And so that was probably $0.02 that was pulled into Q3 based on timing. So that comes out of Q4. That said, I think that the expectation is that Q4 will continue to increment upwards as it relates to EPS. And as we said, that would probably be a mid-single digit, mid-single-digit plus range as well to get us for the full year in that range."
},
{
"speaker": "Joshua Spector",
"content": "Okay. That's helpful. And I wanted to go back to one of the earlier questions, just on the cost savings and efficiency. Just you talked about scenario planning. I guess if we're scenario planning for next year and saying maybe there's a scenario where volumes are more flattish versus up low single, what kind of cost efficiencies or earnings could you see in that scenario from what's in your control and what you're doing today?"
},
{
"speaker": "Howard Yu",
"content": "What I would say, Josh, is that we're focused in on controlling what we can and making sure that this operational efficiency standardization journey that we're on continues to move forward and we get that -- we continue to gain traction. That all said, as Dan outlined, we're in the throes of our annual process as we look at 2025. And so we'll have some more prepared comments for you with our Q4 earnings."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Edlain Rodriguez with Mizuho."
},
{
"speaker": "Edlain Rodriguez",
"content": "I mean just a quick observation on Argentina. Are people really drinking less because of this tough economic conditions? Because you would think they would want to forget the problems. And so I guess, like not everyone is like my friends down there. So a little surprising there to see volume down so much because of the economic conditions. So if you go into Europe then, again, we've been seeing like a nice recovery there. Like would you attribute that to improving end consumer demand? Or is that just like restocking, easier comps? Like what's really driving that strength overall?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. Good. So I think if you get outside of Buenos Aires, yes, dramatically less spending power in Argentina, people are drinking a lot less. Obviously -- we were just down there last week, by the way. So significantly different consumption profile than 1 year ago. And then secondarily, in EMEA, there has been 2 things that have happened this year that have been better than we anticipated coming into the year. One, the pricing of our customers have been a bit more aggressive. Now at the same point in Europe, there's a bit more control by the retailers on what you can pass through in terms of price. So there's been conscious effort by a number of our customers to go get share. Number 2, there has been relief on energy. So relatively speaking, folks in Europe don't have as much discretionary spend power as they did in '19, before the energy spikes. However, they've got relatively more in their pocket, right, than they did certainly at this time 1 year ago. So those 2 things contributed. The destocking, restocking event that you're characterizing, that will be a Q4 impact, not as much of a Q3. So what you've seen through the first 9 months are real. Maybe a bit of improvement in Q1. That was ahead of true demand because I think they lowered the inventory levels too much in Q4 of last year. So you would have seen that come through in Q1 more than you would have seen it at this point. And then it should be a relatively easier comp in Q4 because of this phenomenon that you characterized."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Phil Ng with Jefferies."
},
{
"speaker": "John Dunigan",
"content": "Dan, Howard, this is John Dunigan, on for Phil. Appreciate all the detail, guys. I just wanted to first touch on the cups business. I mean you said you're looking at strategic alternatives. I mean, is there anything else that you're really looking to explore outside a potential sale? Is there more investment or acquisitions to bolster up the business or anything along those lines?"
},
{
"speaker": "Howard Yu",
"content": "Yes. John, well, let me say first that no formal or firm decision has been made. But as we think about that business, it's just we're losing probably in the magnitude of $40 million this year and that can't continue. And so we'll look at various different options, whether that means rightsizing that business going forward. Again, as you outlined, maybe some sort of joint venture or third-party interaction there that can maybe focus more on that business. And then obviously, thinking through whether or not we wind that down. So all of those things are in play. But certainly something that we need to address here in the short term."
},
{
"speaker": "Dan Fisher",
"content": "I would not think in terms of additional capital, either via acquisition or putting it into the business."
},
{
"speaker": "John Dunigan",
"content": "Got it. I appreciate that. And then on South America, I know we've talked about it a lot. I mean, you guys said you started up just maybe a couple of weeks, few weeks behind a normal schedule and hotter weather came in. Is that something that you guys can catch up on? I mean I know you're running full out now and it seems like the summer is good but 3% to 4% maybe lost in 3Q, is that able to be recaptured in the summer selling season in 4Q, 1Q time? And then as you're thinking about the region, going into maybe next year and beyond, already running full out, is that a region that you see needing more capacity as your primary customer grows? Is it something where you can maybe pull some of the assets that you had in Argentina to help supply the Brazilian market? Maybe just what are your thoughts on this."
},
{
"speaker": "Dan Fisher",
"content": "No, I think you're thinking about it the right way. Simply put, in all of our businesses during the winter period or this low period, you're always curtailing, you're always doing maintenance work. I think you were still -- let's be honest, we were still kind of chasing the bottom of volumes in South America. It feels like we're inflecting positively now. And so it's a reframing of stocking levels, when you do your maintenance, pulling it up further earlier. So you can manage this, I think, more effectively. There's more capacity to run as opposed to curtail. We were laser-focused on driving the bottom line. And when you see a surge that's weather related to this magnitude, now, you've missed it in the third quarter, we're running, to your point, we're running our assets in Chile and Argentina and other places where we might have a bit more excess capacity to catch up. So I think we'll be better prepared for it next year in a more stable top line environment, which is really encouraging. But you kind of missed that shoulder season onetime benefit there."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Roxland with Truist."
},
{
"speaker": "Michael Roxland",
"content": "Just 2 quick ones for me. Just can you -- Dan, can you go through the cadence of shipments in North America during the quarter? And where do October shipments stand in North America at present?"
},
{
"speaker": "Dan Fisher",
"content": "Yes. It was -- I would say August was okay and then things started to really slow September time frame. And as we're heading into -- right now, I think it's a continuance of that. You can see that reflected in the scanner data. But 2 things will have to happen. It's usually a 60-, 90-day impact for those interest rate cuts to flow through, #1. And #2, I think you've seen this as well. It's -- people are saving at a pretty high rate right now. And I think we got to get through next week and hopefully, there's some stabilization there. And those 2 things should help to inflect. Like I said, our customers are pretty darn encouraged about 2025, a little bit more stabilization, inflation stabilizing, interest rate cuts. But I think we're still in a level of uncertainty here as I sit here and talk to you today about Q4."
},
{
"speaker": "Michael Roxland",
"content": "Got it. And then just one quick follow-up on the strategic customer realignment mentioned earlier. Obviously, a lot of things to consider, particularly given where your plants are situated. But also to me and correct me if I'm wrong, it sounds like you're still focused on beer. I mean is there any way to really diversify more into other end-markets? Or is the strategy really just trying to realign with brands that are winning in beer?"
},
{
"speaker": "Dan Fisher",
"content": "Well, we're with the brands that are winning in beer, overwhelmingly, right? It's -- there's been -- I mean, we're with all the brewers and the company that's winning the most, we've got a dramatically significant share of that position. And then I think within -- we don't look at it, I would say, Michael, as beer anymore. We look at it as alcohol. So the folks that have the best portfolio, best alcohol portfolios, we're with them. Can you reposition? Of course. I would just reiterate this. Historically, the margin in the beer space have been far better than any of the other. So you might get the growth but the diversification historically, would have come at a cost. And so the other thing about beer, just to remind everyone, it's like we weren't declining because we were taking substrate. So if you still believe that a substrate shift is there and it's going to happen, then it's not a bad place to be. But making those calculations and prognosticating, it's different now because beer now has a 70% share of aluminum -- or aluminum has a 70% share of beer. But there's still opportunities. There was another glass closure just announced this week. So I think you've got to be really thoughtful about the mix. Generally speaking, we are very thoughtful about the mix and who's winning and we generally have those, the more innovative folks, the acquirers. I think the demise of beer is a little bit overdone given the backdrop of that substrate shift. So beer in general, yes, has been declining for 20 years but it hasn't within our portfolio. And I think the end consumer softness has a lot more to do with this than the beer decline. So that's what I would posit. And Christine, we're done here and very much appreciate everybody's questions and certainly hope that everyone has a good holiday and our folks remain safe. And we'll talk to you again after the year. Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day."
}
] |
ball | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Greetings, and welcome to the Ball Corporation Second Quarter 2024 Earnings Conference Call [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brandon Potthoff, Director of Investor Relations. Thank you, sir. You may begin."
},
{
"speaker": "Brandon Potthoff",
"content": "Thank you, Christine. Good morning, everyone. This is Ball Corporation's conference call regarding the company's second quarter 2024 results. The information provided during this call will contain forward-looking statements. Actual results or outcomes may differ materially from those that may be expressed or implied. Some factors that could cause the results or outcomes to differ are in the company's latest 10-K and other company SEC filings as well as company news releases. If you do not already have our earnings release, it is available on our Web site at ball.com. Information regarding the use of non-GAAP financial measures may also be found in the notes section of today's earnings release. In addition, the release includes a summary of noncomparable items as well as a reconciliation of comparable net earnings and diluted earnings per share calculations. References to net sales and comparable operating earnings in today's release and call do not include the company's former Aerospace business. Year-to-date net earnings attributable to the corporation and comparable net earnings do include the performance of the company's former Aerospace business through the sale date of February 16, 2024. I would now like to turn the call over to Dan Fisher, CEO."
},
{
"speaker": "Dan Fisher",
"content": "Thank you, Brandon. Today, I'm joined on our call by Howard Yu, EVP and CFO. I will provide some brief introductory remarks. Howard will discuss second quarter financial performance and key metrics for 2024. And and then we will finish up with closing comments and Q&A. We remain laser focused on creating a better, more sustainable world. During the quarter, Ball was included in the FTSE4Good Index Series, which is designed to measure the performance of companies demonstrating strong environmental, social and governance practices. This highlights our unwavering commitment towards a more circular future. Across our global organization, our employees continue to demonstrate our values in the areas of recycling, education and STEM manufacturing and disaster relief and preparedness as evidenced by our recent global volunteer month impact. During the month of April, our employees contributed over 3,100 volunteer hours across 17 countries. Thank you to our 16,000 colleagues that continue to demonstrate that we care. Under the themes that we work and we win, our team delivered strong second quarter results. Global beverage can, global extruded aluminum aerosol shipments, increased 2.8% and 5.6% in the quarter, respectively. In addition, we executed on our share repurchase plans and have returned approximately $925 million to shareholders via share repurchases and dividends as of today's call. Reflecting further on year-to-date 2024 performance, aluminum packaging continues to outperform other substrates across the globe. In North America and EMEA, second quarter volumes exceeded our internal expectations. In South America, softer than anticipated volume performance was driven by our exposure to Argentina. For a complete summary of regional shipments for the second quarter, please refer to today's earnings release. Consistent with our previous commentary and given our customer mix and incorporating second quarter and year-to-date regional volume performance, we continue to anticipate full year global shipments to grow in the low to mid single digits range. Key drivers for our company's performance in 2024 continue to be the benefits of deleveraging, repurchasing shares, improving operational efficiencies and leveraging our well capitalized plant assets to grow the use of innovative, sustainable aluminum packaging across channels, categories and venues. Based on our current demand trends and the previously mentioned drivers, we are positioned to grow comparable diluted EPS mid single digits plus of 2023 reported comparable diluted EPS of $2.90 per share, generate strong adjusted free cash flow, strengthen our balance sheet and now expect return of value in excess of $1.6 billion to shareholders via share repurchases and dividends in 2024. With that, I'll turn it over to Howard."
},
{
"speaker": "Howard Yu",
"content": "Thank you, Dan. Turning to our results. Second quarter 2024 comparable diluted earnings per share was $0.74 versus $0.61 in the second quarter of 2023. Second quarter sales were influenced by the pass through of lower aluminum prices as well as lower volumes in South America, offset by increased volumes in North America and EMEA as well as favorable price/mix in South America. Second quarter comparable net earnings of $232 million were up year-over-year, primarily due to strong operational performance, including improved year-over-year performance in North America, EMEA and South America, lower corporate undistributed costs and lower interest expense. In North America, segment comparable operating earnings exceeded our expectations and offset year-over-year headwinds associated with the US beer brand disruption. Benefits of effective cost management and plant efficiencies across our well capitalized plant network will continue to support incremental volume growth. We continue to anticipate year-over-year earnings improvement during the second half of 2024, driven by improving operational efficiencies, lowering cost and effectively managing risk. In EMEA, overall segment volumes were up stronger than anticipated. Recent demand trends remain favorable and the business continues to be poised for year-over-year comparable operating earnings growth throughout the remainder of 2024, driven by improving operational efficiencies and volume growth. In South America, our segment volumes decreased 3.2%, following a strong first quarter where volumes increased 26.3%. During the second quarter, consumer conditions in Argentina deteriorated further, though we appear to be beyond the most difficult comparisons given the timing of Argentina's 2023 slowdown. Despite these challenges, strong demand in Brazil of mid single digit volume growth and our customer mix continue to drive our business. We continue to monitor the dynamic economic situation in Argentina and potential scenarios that could impact results. We remain optimistic about Brazil and our ability to deliver sequential earnings and volume improvement as we enter the summer selling season in South America. Moving on to additional key financial metrics and goals for 2024. Very consistent figures to those provided during our first quarter earnings call and June Investor Day commentary. We continue to anticipate year end 2024 net debt to comparable EBITDA to be below 2.5 times. While we are currently at 2.3 times at the end of the second quarter, net debt to comparable EBITDA may nudge slightly higher by the end of the year as the company continues payments of taxes due on the gain from the sale of the aerospace. 2024 CapEx is targeted to be in the range of $650 million, a year-over-year reduction of $400 million and largely driven by carrying capital related to prior year's projects. We are on track to achieve our adjusted free cash flow target. And share repurchases are expected to be in excess of $1.4 billion by year end. Through today's call, we have repurchased approximately $800 million in shares year-to-date. Our 2024 full year effective tax rate on comparable earnings is expected to be approximately 21%, largely driven by lower year-over-year R&D tax credit associated with the sale of the company's aerospace business. Relative to the estimated tax payments due on the aerospace sale, the first payment was made during the second quarter and the remainder of the approximately $1 billion in taxes due will be paid throughout the second half of 2024. Full year 2024 interest expense is expected to be in the range of $300 million. Excluding the noncomparable aerospace disposition compensation costs, full year 2024 reported adjusted corporate undistributed costs recorded in other non-reportable are expected to be in the range of $90 million. And last week, Ball's Board declared a quarterly cash dividend. Looking ahead to the rest of 2024, we remain laser focused on operational excellence, driving efficiency and productivity across our business, cost management and monitoring emerging market volatility. We are committed to maximizing the full potential of our company over the long term. We have executed on derisking the corporation through recent debt retirements and we have no significant near-term maturities. The runway is clear for us to activate near term initiatives to consistently deliver high quality results and generate compounding shareholder returns. With that, I'll turn it back to Dan."
},
{
"speaker": "Dan Fisher",
"content": "Thanks, Howard. The business is operating well. And as we look forward to the second half of the year, we continue to anticipate growing our 2024 comparable diluted EPS mid single digits plus. While the consumer backdrop remains volatile due to the strength of our portfolio and the unwavering dedication of our employees, we are confident we will deliver on our 2024 guidance and long term commitments laid out at our June Investor Day. Looking ahead, we are focused on executing our enterprise wide strategy to advance sustainable aluminum packaging solutions on a global scale by accelerating our pathway to carbon neutral and unlocking additional value from within the organization by driving continuous process improvement through operational excellence. Together, we will strive to deliver innovative aluminum packaging solutions that can lead to a world free from waste and embark on a path to deliver compounding shareholder returns in 2024 and beyond. As we communicated at our June Investor Day, shareholder value creation is our focus. Going forward, we anticipate 10% plus per annum diluted EPS growth, consistent delivery of high quality results and operational performance, coupled with significant share repurchases for the foreseeable future. In addition to returning value to shareholders via dividends we’ll drive shareholder value creation. We appreciate the work being done across the organization and extend our well wishes to our employees, customers, suppliers, stakeholders and everyone listening today. Thank you. And with that, Christine, we are ready for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Ghansham Panjabi with Baird."
},
{
"speaker": "Ghansham Panjabi",
"content": "I guess first off on 6.5% growth in the EMEA segment for 2Q. I think you mentioned it came in above your internal expectations. If you could just give us a bit more color on that, what drove that specifically? And then also how do you see that evolving into the back half of the year?"
},
{
"speaker": "Dan Fisher",
"content": "I think a little bit of it. As we were transitioning out of Q1 into Q2, we were starting to see some relief, some inflation relief. So the end consumer was strengthening in pockets and couple that with a little bit more aggressive pricing by some of the customers that I would consider that we're in a more of a partnership relationship than just a customer supplier relationship. And so we benefited a bit from mix. I think this is something going on over here consistently now and I was saying it all year, it's like winners and losers or if you're a little ahead of the market, a little below, it probably has more to do with mix region by region right now than it does with winning or losing contracts in many respects. And we have the opposite mix in Europe that we do in the US where we have a heavier CSP -- heavier energy portfolio over there than when you contrast that to our North America, which is heavier on the beer side. And so we benefited from it in Europe. We anticipated some good pull through on the euro competition. It's interesting. We were actually ahead in Europe and there was some pretty crummy weather in the Nordics, in the UK and Ireland and places like that, and it's ahead of the holiday season, which can really give you a bit more of a tailwind. So it was a surprise on multiple fronts, incremental surprised, not a significant surprise. We continue to -- and you've heard us say this, we continue to be very bullish on Europe over the medium and long term just because I think the can has a lot of runway there. But some nice signs that folks are fighting for some volume there probably -- maybe even more so than they're doing in places like North America, and we benefited from mix there and expect to continue to do well there for the balance of the year and in the foreseeable future."
},
{
"speaker": "Ghansham Panjabi",
"content": "And then for beverage, North America, Central America, how did that sort of break out between US, Canada versus, let's say, Mexico and some of the other regions down there? And then just holistically then, as you think about your portfolio and the new products that the industry has introduced to higher price point items, et cetera, in context of consumer affordability. So as you kind of think about the weakness you're still seeing in portions of the North American business. How is that propagating, is it still at the low end or is it starting to permeate towards the middle consumer and the high end as well?"
},
{
"speaker": "Dan Fisher",
"content": "It is -- I mean in the US, I think the US is different than the rest of the world. It's a pretty stark contrast. You even see it in one of the major brewers, they're growing at the high end brand and they're growing at the low end brand. It's kind of the premium light beer segment, that's the one that folks are trading down from. But we've seen this now Ghansham, for like 18 months. It's like we've been living this and that's kind of -- candidly, that's why we've been adjusting our cost structure, we've been doing different things with the operating model. You see things like slower growth in -- you see things like slower growth at the energy drink level. This is signs that you see this in the past, this is when you're kind of touching the bottom end of kind of these recessionary points and the health of the end consumer. So we're operating in that environment. We're still growing and we're making more money. So that all feels good. If you get a little -- if you get an interest rate cut, you're potentially in September and a little bit more clarity on the election, all of those things tend to translate into a bit more optimism probably from us and our competitors based on where we are, because to your point, I don't see a lot more downside on the end consumer. We've been living it though for about 18 months. So we've seen the trade downs and then we've seen the less frequent purchases. And I think what you're also hearing as a result of that is from our customers and from certain categories in certain segments, they're going to have to address that via different pricing mechanisms to drive volume. So I think we're kind of -- we're in a good spot relative to that, believe it or not versus how we've been operating in the last 18 months as an industry. So I'm a bit more encouraged than pessimistic."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of George Staphos with Bank of America."
},
{
"speaker": "George Staphos",
"content": "I just want to pick up my first question, piggy back on topic Ghansham raised. So at this juncture, are your customers talking about doing more incremental net promotion price reduction, et cetera [indiscernible] variable end market, or do they see kind of the next way to grow out of this really on innovation? And kind of the context, if we go back not quite 10 years ago but sort of post Rexam, especially in alcohol, there was a lack of volume growth and it was innovation that drove growth, at least in part. At this juncture, innovation comes at a higher price. Is this the wrong time to drive innovation? So really the only way to deal with this to drop price and raise promotion, how are your customers thinking about that? And what are you doing to help them in that evaluation?"
},
{
"speaker": "Dan Fisher",
"content": "So this breaks down -- in the US -- this is a US phenomenon, probably more than any other region that I see. At the high end, that's where the innovation is going, okay? So if you look at beer, in particular, the high end of the brands, folks are -- they're spending more on advertising and they're innovating more there because people are willing to pay for it. At the low end, it is a value put. And so if you look at the largest brewer in North America, you'll see they have two brands that are growing disproportionately to the rest. One is squarely on the higher end of the end consumer and one is squarely on the low end of the end consumer. Now the big middle portion, that is sort of the premium light beer, that is the one that will have to be priced differently. So innovation will continue to get pushed. It will get pushed into new categories and it will get pushed into higher end brand categories that already exist. And then you've got to be competitive on the low end of those ranges, maybe even more so than historically. And in the middle, that's where folks that are doing well in the marketplace, whether it's on the CSD side or on the alcohol side, they are playing the CPI game really well, they are playing the branding game very well, they're playing the discount and the revenue models really well and brand superiority starts to show up. The real integrity of the brand and the value of the brand shows up now, as you well know, after covering this for many years. So I think that's how we're looking at and we're helping them in every -- listen, we can help you with innovation and we can use our fleet of assets to help you really layer in lower costs in terms of the supply chain and the agility to deliver. So there are ways that we can use the economies of scale that we have to work both sides of that equation. And then what's left for the customer to figure out is how they play some of these major brands and what the brand value is and how they're going to price that to drive volume. And I think that's what will be coming around more so than anything here in the next six months. Some thinking in and around that, that will be more growth oriented. And then with the backdrop of the end consumer, is it enough to drive the volume? My belief is, it will at least maintain the stable position that we've been operating under, and it could be a slight uptick. Hope that was helpful. It is different than Rexam. It is different than post Rexam. I will tell you that. You're on to that. Yes, it's definitely different conversations. But you've got to fight with innovation even on the high end brands and you've got to be incredibly focused and diligent on supply chain efficiencies on the low end. So that is -- with just more intentionality on both ends of it."
},
{
"speaker": "George Staphos",
"content": "So what does that mean for your mix as you layer those two or three or pull those two or three levers that your customers do into the back half of the year, what are you seeing in terms of volume trends to start 3Q? And how do you feel about the plant network overall as it exists relative to those trends as you see them?"
},
{
"speaker": "Dan Fisher",
"content": "I think there's an aspect here where mix will matter in the short term. So there won't be -- you'll be thinking about, there's a minor October reset but it will be more in the February -- January, February retail reset, where you see some more innovation and some more introductions in and around that, and around the Super Bowl, that's typically what happens in North America. Our fleet cost average is lowering a lot of the decisions we made in terms of the fixed cost of our plans. We're seeing the benefits in our new operating model, we're laser focused on efficiency and operational excellence. We're seeing those benefits. We're running -- freight cost is better, our warehousing footprint smaller. So there's a lot of supply chain efficiencies that we're benefiting from. You'll see more of it as volumes grow. So I feel like we're having the right conversations with our customers, they're seeing that, our Net Promoter Score continues to rise. And so I know that the conversations we're having and the efforts that we're making are resonating with the customers. We're seeing some benefits of that. But in the immediate short term, your customer base matters now more than any time and we've benefited from who our customers are here this year in particular in North America."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Jeff Zekauskas, JPMorgan."
},
{
"speaker": "Jeff Zekauskas",
"content": "So over the past few years, Ball has increased its capacity in North America. And then what it did is, it reduced it to become more efficient. If you compare your North American capacity today to what it was in 2019, has it changed very much?"
},
{
"speaker": "Dan Fisher",
"content": "Yes, we have more capacity. We're selling more. We have more capacity and there's additional envelope and room for us to grow capacity further."
},
{
"speaker": "Jeff Zekauskas",
"content": "And in terms of the volume that you experienced in the Americas in the second quarte, was the beer market down and the consumer soft drink market for you up?"
},
{
"speaker": "Dan Fisher",
"content": "That's correct. Our customer portfolio on the CSD side was a benefit to us."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Josh Spector with UBS."
},
{
"speaker": "Josh Spector",
"content": "I was wondering if you could square kind of your short term view here around growth versus your long-term view. And just given kind of some of the outperformance here in 2Q, do you think you could start to see, call it, high single digit to 10% plus growth in EPS in the second half, considering you're starting to face some easier comps, or do you need a more favorable backdrop to really drive more of that?"
},
{
"speaker": "Dan Fisher",
"content": "Just one thing, I would say, we did have a fairly significant -- I'll let Howard describe Q3. I would say Q4 and moving forward, your comment is correct. Q3, there's an anomaly, I'll let him describe that for you."
},
{
"speaker": "Howard Yu",
"content": "Yes, that's right, Josh. We did have -- on the R&D tax credit side, we had a pretty meaningful impact in Q3 of last year. This was associated with the aerospace business and so those to the tune of nearly $40 million. And so obviously, that will make for the comps in Q3 to be a bit more challenging. But as Dan said, I think going into the fourth quarter and certainly beyond, we've said that we'd achieved 10%-plus EPS in 2025 and each year after that."
},
{
"speaker": "Dan Fisher",
"content": "And in Q3, just to reiterate, if you take out the onetime benefit, then yes, we're operating at 10%-plus EPS moving forward."
},
{
"speaker": "Howard Yu",
"content": "And I think just even despite the tax credit, I think that we will be up as it relates to third quarter EPS. And so that $40 million or nearly $40 million is a pretty meaningful impact. But despite that we’ll still be up year-over-year."
},
{
"speaker": "Josh Spector",
"content": "I just wanted to follow up on specifically inventory in beer in North America. I don't know if you have any visibility around your customer levels of where things are at in terms of days or cases? And if there is more promotional activity, is that a big pull forward for you or do you think inventories probably stay leaner for longer?"
},
{
"speaker": "Dan Fisher",
"content": "I think our inventories are going to be a bit stronger moving forward, will lift a little. They're a bit too low. As you recall and this going back to Q1, we helped one of our beer partners significantly in Q1. So we kind of overshipped in one and now we're operating at lower inventory levels. So it's a rebalancing because of that for us that will settle out by the end of the year. And then I'm encouraged about kind of the trajectory of flight on a couple of the beer brands in particular. So yes, I'd say it's yet to be determined. But for us, in particular, no, we will still have some uplift in the second half of the year because we were operating so low in the first half because of some unique anomalies with uni negotiations and things like this."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Arun Viswanathan with RBC."
},
{
"speaker": "Arun Viswanathan",
"content": "Good to see the results. So I guess just a couple of questions on South America. So obviously, some challenging conditions in Argentina, some volatility down there. Do you still expect a very robust second half in your South America business, especially Q4? And what gives you that visibility? I mean, I guess, again, there is a lot of volatility on there, but are there any specific drivers that you'd point to?"
},
{
"speaker": "Dan Fisher",
"content": "We've got really good ones. First of all, thank you. I hope you're doing well. The only thing we've got out here in Denver is two or three forest fires happening. So if you hear us coughing that's all coming from. So the second quarter, let me -- let’s just set the stage for the second quarter and what happened in Brazil and particularly. So in 2023, in the second quarter, the third largest brewery filed for bankruptcy and they didn't participate much in the market. They had a good showing this second quarter. And so when you're looking at comps year-over-year, we were stronger last year than we were this year because that entrant didn't participate. But year-to-date, we're up 10%-plus because our partners are winning disproportionately overall in the market, and they have been for a year plus. And so much of our business is tied to a couple of folks who we have a lot of conversations with and we're encouraged about a couple of underlying themes, right? We've talked about the can continuing to gain back share. About two years ago, we saw returnable glass gain share 6 to 7 points, I believe, of substrate share, which always happens in an inflationary environment. There's a quick repositioning of that, that's now coming back solely but surely. So we picked up a couple points of can share in the Brazil market, which is meaningful once you get to peak season, which, of course, second quarter is the least. And then Chile had a rough winter period, one of the coldest on record. So that will rebound. Our Paraguay business is doing very well. Peru is doing well. And then it just boils down to Argentina. So I think we have line of sight into over -- what the overall majority of our business, and we're encouraged about the back half trajectory. And in Argentina, the volumes are still going to show a degradation over the back half of the year from a comp perspective because volumes really didn't start to slow down until this quarter and a little bit of the first quarter. But what happened this time a year ago in Argentina is there was a lot of regulatory, monetary and fiscal policy that was eating into our margins like taxes holding on to receivables for a longer period of time. So the margin comparability will be pretty flat year-over-year in Argentina until you see some improved conditions there but the volumes will still show a little bit of a decline. And rough order of magnitude, the decline for Argentina is roughly a 1% volume decline for Ball year-over-year. So it's meaningful on the volume line. It's not as meaningful on the earnings line moving forward. And then as the end consumer starts to gain a bit of strength down there, which we're starting to see early signs of it that will start to come back and we'll lever up nicely. So feeling good about the second half in South America, a lots going on in that region, as you said, but the fundamentals of the macro environment in our biggest country that we participate in continues to be buoyed by really good fiscal discipline, inflation continuing to monitor to the lower end of even what the central banks are proposing. So we're feeling good about that and we feel like we're coming off of some less favorable environments in Chile and Argentina. So let's see how we get on but the next six to 12 months should be improved in both of those areas."
},
{
"speaker": "Arun Viswanathan",
"content": "And then maybe if I could just ask a follow-up. So I appreciate the long term comment on greater than 10% or 10% or better EPS growth. In our models, it seems like we're modeling kind of mid single digit or better EBIT growth in '25 and the rest is coming from lower interest expense and share buyback. Assuming that's correct, are you saying that you're able to maintain that level of growth in '25 and beyond. So are you kind of implying that you will continue to buy back stock and pull on some other levers other than just volume in order to the feedback level of EPS growth. Maybe you can just elaborate on what gives you the confidence that you'll continue to maintain that greater than 10% EPS growth rate?"
},
{
"speaker": "Dan Fisher",
"content": "I'll just make one high-level comment, and then I'll have Howard chime in. And so if you go back to our Investor Day, and I probably didn't do a great job of pointing this out. But what we laid out, and we have a high degree of confidence in is probably somewhere closer to the 13% to 15% range as opposed to the 10% plus, and it's coming from exactly what you described a steady diet of us staying within our $650 million capital envelope and expanding operating cash flow by managing our earnings and managing our working capital with a real intention and focus. And so we don't need a whole lot of growth to do that. It's a much more repeatable model. And I think we're encouraged by the trajectory of growth with the rebound in the end consumer here hopefully happening in the next 12 months. There's probably more upside than not, Howard, what did I miss?"
},
{
"speaker": "Howard Yu",
"content": "think that's right. And Arun, we are committed to buying back shares. I mean we're increasing how much we're buying back even this year. We've talked about it in the context of over $1.4 billion that we'll get through and essentially since mid-February, since the sale of Aerospace. And so obviously, that will have a meaningful impact on the share count going into next year and we'll continue to do that as well. The other thing I think to point out and we talked about during the Investor Day is the cost savings, gross cost savings that we're going to be undertaking. We've seen great traction. You're seeing some of that readout even in the numbers this quarter. You saw some of that in the first quarter as well. And you'll continue to see that well into 2024 and into 2025. And so there's no reason to expect that we're going to deliver anything less than 10%-plus, and probably ahead of that for the next couple of years, for sure, on the EPS side."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Roxland with Truist."
},
{
"speaker": "Mike Roxland",
"content": "On this call and in some prior calls and also on the recent Investor Day, you mentioned improving plant efficiency, centralizing best practices, standardizing them, documenting processes, ensuring that all your facilities are sort of benchmarked with one another. How far along are you in that process right now? And if we think two to three years from now, what do you think this standardization, focus on cost takeout efficiency, what do you think it can add to the business in terms of dollars and profit?"
},
{
"speaker": "Dan Fisher",
"content": "Yes, I'd say we're early innings. And I think what this will allow us to do is consistently deliver against our 2 times growth percentage algorithm by gaining more productivity and efficiency in the plants and translating that into less capital required on the assets to grow into that, which historically has been a pretty big preventer of us from not achieving the 2 and 1. So translating that into dollars, I could tell you that's -- in theory, that's the strength for what we're doing. We're seeing it thus far and that should be fairly meaningful. I mean a 2 and 1 off of 2% to 3% growth over the next three years versus the 1.5 to 1, that's roughly the order of magnitude that we're trying to to fill the gap in, if that helps, Mike."
},
{
"speaker": "Mike Roxland",
"content": "And then just one quick question in terms…"
},
{
"speaker": "Dan Fisher",
"content": "It's meaningful. I don't have a $1 per thousand number or cent per can number, but it is meaningful in terms of our ability to deliver organically higher end of that 2 to 1 range."
},
{
"speaker": "Howard Yu",
"content": "And I think we've laid out that of the $500 million of gross savings, I mean, we're going to have a meaningful part of that will be front end loaded here in 2024 and 2025. But certainly, going into '26, '27 and beyond, as we aspire to be a best-in-class manufacturer, we will continue to see efficiencies there. I mean, as Dan said, we're early innings but we're putting up runs. And so that's a good thing to see as it relates to the corporation and what we're doing operationally."
},
{
"speaker": "Mike Roxland",
"content": "So if you're still in early innings that means that you got this particular -- I mean, what's your time frame in terms of having everything standardized? In two years, three years, when do you think everything should be on par with one another?"
},
{
"speaker": "Dan Fisher",
"content": "Yes, I would give us somewhere in that two to three year range is what [indiscernible] myself are talking about, and it won't be 100% standardized, but 80%. And the reason I say that, you know this business is we got 40-year-old plants, we've got brand new plant. So we're not going to recapitalize to standardize everything. But the performance, the meeting cadence the S&OPs, all of that should look and feel like you're walking into a Ball plant everywhere in the world."
},
{
"speaker": "Mike Roxland",
"content": "And then just one quick question. Obviously, you've now lapped the problem child product at this point. But it seems like Bud Light is now number three after Modelo Especial and Michelob ULTRA. So that really seems to be a more function for at least, as I can tell, a function of shelf space reset. So two part question. One, to the extent you can comment, has any of that decline been offset by gains in Michelob ULTRA? And two, do you think that Bud Light will ultimately regain some shelf space in the fall or the early winters as you noted when it occurs?"
},
{
"speaker": "Dan Fisher",
"content": "So two brands are growing within their portfolio. You mentioned one, the other one is, I believe, Busch Light. And so both of those are growing nicely. And so yes, they are filling some of the brands -- the portfolio whole. I'm encouraged by promotional activity in both those brands. And I think anything that Bud Light comes back and recovers is great, but they've got two real winners within that portfolio that they're leaning heavily into. And I think that's more probably the route that that wins and it also speaks to sort of brands on the different ends of the end consumer spectrum as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Leithead with Barclays."
},
{
"speaker": "Mike Leithead",
"content": "First, just on aerosol. The business saw a nice, I think, 6% volume growth. I guess my understanding was this overall market is still a bit soft. So is there some competitive share gains, is it a mix with your extruded bottles? Just if you could help unpack that a bit, that would be helpful."
},
{
"speaker": "Dan Fisher",
"content": "No, the market is growing probably half that rate globally, a little bit more than that. The advantage that we've got is strategically is our plants are able to produce bottles that have higher recycled content and we also make the alloys with the highest recycled content in the industry. And so the environmental and the sustainability message to somebody like a Unilever or a buyer store, they have a big packaging carbon issue. So if they could move into aluminum out of other substrates and we have the highest recycled content, we are winning disproportionately because of that. Not on price. In fact, it probably costs a bit more. But the light-weighting of the bottle on the less alloys, steel versus aluminum continues to be a positive trend. So there's a lot going into it. And we're very well positioned in the strategic partners and innovative partners and sustainability leads in that area. And we're bullish about that business moving forward because of the moat that we've created there."
},
{
"speaker": "Mike Leithead",
"content": "And then I wanted to circle back to the US. Dan, you've given a lot of really helpful color around the different product category dynamics. But I want to circle back, I'm not sure if I heard in the answer to Ghansham's question earlier. But in 2Q, how did your US business for Ball perform relative to, say, the overall segment up one?"
},
{
"speaker": "Dan Fisher",
"content": "I think it's in line. It's actually the US was driving it more so than anything. Keep in mind, our Mexican business, if you -- 80% of it is products that go north. And it's one major brewer and they did well, that category didn't do great, but they did well. But everything was more or less in line, favorable CSD, flat energy, a decline in domestic beer, uplift in the imported beer. We participated in all those and net-net-net. Some of our customers within certain categories did a little better, so we did a little better. That's probably how it would shake it out."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Edlain Rodriguez with Mizuho. Our next question comes from Anthony Pettinari with Citi."
},
{
"speaker": "Bryan Burgmeier",
"content": "This is actually Bryan Burgmeier on for Anthony. Maybe just a question on ‘24 EPS guidance, and I apologize if I missed this. Just thinking about kind of the magnitude of strong 2Q results, some modest tailwinds from lower interest expense, more share repurchases. It seems like there's maybe a tiny bit of upside to the full year guide versus your previous outlook. Is it South America and Argentina that makes you feel like reiterating is most prudent right now, so I know you reiterated volume growth expectations. So I'm just trying to kind of rectify the two different points."
},
{
"speaker": "Dan Fisher",
"content": "Honestly, we're looking at the same thing you are. More constructive on the plus side of our guide. And when I hear the entire competitive landscape and our entire customer landscape, all saying similar things that we’re going to be delivered despite a little bit more volatile second half given the election, et cetera. I've been encouraged every month this year by the performance of the business and our commitment to doing the things that we can control, and those are going to continue. And then we have benefited a bit from mix in North America. Does that continue? I suspect it will. So yes, we're leaning to the plus side of that algorithm for sure."
},
{
"speaker": "Bryan Burgmeier",
"content": "And last question for me, and then I can turn it over. Just can you comment maybe European can shipments versus underlying consumption growth in the region? Do you think that the industry maybe did a little bit of restocking this year or are brewers maybe ordering ahead for the summer? Just any color on maybe shipments versus consumption in Europe."
},
{
"speaker": "Dan Fisher",
"content": "The destocking and restocking event that happened sort of December and then January and February. So Q1 had a little bit of that favorability in it. But what we've seen is this is actual consumption that's happening, a more aggressive pricing environment in some instances. I think if you talk to anybody in our industry, everybody is tight. We're getting very close to can allocation scenarios. So this is 100% consumption at this point, benefit from the euro, benefit maybe from the Olympics, but more of a benefit from just inflation dissipating in a different return of value equation by our customers needing to price differently. So all of that's been a healthy dynamic in Europe and fingers crossed that continues here for the foreseeable future. We do have some can share that's also helping in pockets of the EU, specifically the UK, they continue to move more into cans. So there's some different dynamics that are unique to each country and each category in each geography. But overall, yes, I'm really pleased with our performance in Europe and constructive on Europe at large right now."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Phil Ng with Jefferies."
},
{
"speaker": "Phil Ng",
"content": "Pretty encouraging to see Brazil still up mid single digits. Argentina has been [problematic], it’s a little noise in general just all the movement. How would you like us to think about the back half? And certainly, you had outsized earnings last year from some mix dynamics in Brazil in the fourth quarter. So just kind of give us a little more color on do you have enough levers for your volumes to be up in South America given the weakness in Argentina, and then your ability to kind of drive earnings in the back half in South America as well?"
},
{
"speaker": "Dan Fisher",
"content": "There's an opportunity. I think Q3 will have still some volume decrement because of Argentina. Q4 will return to growth. But the earnings were already being impacted, Phil, in Argentina in Q3 because of some of the taxes that were being levied on, especially metal coming in from Brazil into Argentina dollars going out. There was a lot of currency controls put in place. So our margins -- our volumes held in, but our margins took a fairly significant hit and then further hit in Q4. So from a margin standpoint, you should see growth in the second half of the year. aAnd volumes will be flattish to slightly up with a negative tailwind still fairly significant in Q3 from Argentina, I think in the neighborhood of 500 million cans."
},
{
"speaker": "Phil Ng",
"content": "So on balance on earnings is kind of muted is how I should think about it for Argentina [Multiple Speakers] margins might be better at budget…"
},
{
"speaker": "Dan Fisher",
"content": "You're right. From this point forward, it's muted. And here's what's going on in Argentina too. So for the last two months, they've got inflation down in the 4% range, and that was their target. What has also happened is there's been price fixing, there's a weak end consumer. This is the weakest the end consumer spend but they've accomplished all of their monetary and financial goals of lessening inflation. And so we're starting to see some easing in that country and then it's going to be employment based and sort of a return to a more stable end consumer there. But it’s -- I'm not an economist, but I'd say that they've kind of driven this thing where they wanted to and now I'm encouraged that we move up from here. It won't happen overnight but at least they've gotten us to a place that they were attempting to do in October and November of last year."
},
{
"speaker": "Phil Ng",
"content": "I mean, I think certainly, there are some concerns coming into the quarter that mass beer in the US would be a drag, and you obviously put up really strong results in that segment in North America. If I heard you correctly, Dan, you sound a little more upbeat on the plus side of your mid single digit type growth. Does a lot of that come from North America or is it more Europe, some of the other segments, just because you're lapping that tough ABI comp, right, and you still put up 1% volume growth in 2Q. It sounds like your customers are promoting a little bit. Is that enthusiasm more on North America? And then are you expecting volumes perhaps to pick up a little bit in the back half?"
},
{
"speaker": "Dan Fisher",
"content": "I think every one of our business units, every one of our regions will make more money year-over-year in the third quarter. So there may be a little bit more weighting to your point. Actually, I think it's going to be more representative of a Q4 lift than a Q3 lift, just we've got such low inventory levels and really tight there in North America that you'll see some pickup on absorption more likely in Q4. But yes, leaning to the plus and as you know, this is -- a big portion of this is about mix and who wins in the third quarter. And I'm encouraged that premium light beer, domestic light beer, they're going to have to do something on pricing there. It's been a pretty similar tape, right Phil, for the last several quarters and so I think different behavioral patterns will have to kick in at some point."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Chris Parkinson with Wolfe Research."
},
{
"speaker": "Chris Parkinson",
"content": "You hit on this a little bit, but I'd like to dive in a little bit more on the Brazilian market. Can you just talk about -- the last couple of years have been obviously pretty choppy, especially coming out of COVID. And there have been some substrate market shifts, obviously, changing and evolving consumer behaviors. Can you just kind of give us an update on where you think we are not only for the back half but where you think will ultimately be for '25, '26 as well as your competitive positioning?"
},
{
"speaker": "Dan Fisher",
"content": "So for -- I would say -- you're almost at a point where you can take COVID out of the equation. I think what happened in '23 -- so just '23 to '24 first half of the year, let me walk you through a comparative, right, for Brazil. In Brazil, the third largest brewery had a blowout 2023 first quarter, which we don't participate with. They filed for bankruptcy in Q2 of 2023. So they did virtually nothing in that quarter. So when you're looking at comps depending on who's with who and the mix trajectory in that category portfolio that there was volatility in one, we were up 26% in 1. So we benefited from that comp one. We didn't benefit from it as much in 2. But Q3, Q4 and Q1 of '23 and '24, the behemoth that we're with did well in the market. We continue to think that they will do well in the market based on innovation, based on share, based on their long term positioning. We're the number two player in the entire South America. They have been doing well as well. So I'm encouraged by the second half and I'm encouraged the economy in Brazil and the GDP is what really matters most at this point, to answer your follow-on question for '25 and '26, I think they have things going in the right direction, moderate-to-low inflation, employment continuing to improve, no sudden movements in terms of fiscal or monetary policy, all of that has a positive tailwind. And then the only thing that really comes out of COVID would be the substrate shift from glass into cans, and we're early innings on that. So we picked up probably 2 points of the 7 points that were lost and we expect to continue to pick up more of that in the back half of '25 and into '26. And then for us, our exposure to Argentina will be meaningful if there's abrupt recovery in Argentina in '25 and '26, that will -- obviously, we'll get 100% of that. So I'm constructive on the outlook. I think it will be at the higher end of our longer term growth algorithm based on the underlying conditions. And then Brazil, I think, starts to normalize a bit more. And it will be about mix but it will be less so about mix than what you saw in Q1 and Q2."
},
{
"speaker": "Chris Parkinson",
"content": "And just a real quick one, not once but twice. I tried to get a beer after a round of golf in New York, and I was handed to a Ball aluminum cup and it's something people haven't really been discussing for quite some time, but they're starting to pop up a lot. And so I was just kind of curious what's the latest and greatest there in terms of your thought of trajectory? I mean it seems like it was kind of a thing and then it wasn't but now it's clear that you're making some additional strides. I'm just kind of curious on that front."
},
{
"speaker": "Dan Fisher",
"content": "You do find it at places like that. I think ultimately, the backdrop, if you've got a weakened consumer and it's going to impact the volume on a project like that. And so we continue to gain traction but it's not near what we thought it would be two or three years ago. And so that's probably all I'll say about that for now. And we'll do one more question, Christine."
},
{
"speaker": "Operator",
"content": "Our final question comes from the line of Stefan Diaz with Morgan Stanley."
},
{
"speaker": "Stefan Diaz",
"content": "I hope everybody is doing well. In the release for Europe, you mentioned seasonal and sustainability trends should improve demand throughout the year. Does this mean you're expecting mid single digit volume growth for the second half as comps look favorable? And then maybe sort of following up on Bryan's question, considering can shipments seems like they were ahead of scanner for the latest quarter, are you worried about any potential destocking like we saw late in 2023?"
},
{
"speaker": "Dan Fisher",
"content": "I don't anticipate destocking for us, all of this stuff is like competitor and customer centric, right, on the destocking and stocking issues, nowhere near what you would have seen in '22 or '23. So I'm less concerned. Obviously, if volume were to fall off significantly, which we don't foresee or we're not anticipating, I might have to revisit that comment. But at this point, we've got incredibly low inventory levels. We're hand to mouth in Europe. We're in the throes of increasing our stacking in South America and then in North America, where we've got, like I said, historically low inventory levels that we'll need to manage that up over the second half of the year. So I'm encouraged and not concerned about that topic in particular. I get the question but for us, it's not as meaningful."
},
{
"speaker": "Stefan Diaz",
"content": "And then given strong volume results in the past couple of quarters, I was just wondering if you could remind us if you still have any capacity curtailed within your network. And if so, maybe what do you need to see to bring that back online? And then maybe if you could also just quickly comment on what you think utilizations are by region?"
},
{
"speaker": "Dan Fisher",
"content": "You always have curtailments in South America this time of the year. We have very few, if any, curtailments in North America or Europe. Absolutely none in Europe right now. And the only thing that we would be curtailing would be one can size fits in North America at times. So all of that's good. The industry is in a really healthy position, probably high 80s, if I look at the annual projection, high 80s in Brazil, low to mid-90s in Europe and then low 90s in the US, which means you got excess capacity in shoulder season and you don't have any in peak season. And so it's in a good spot."
},
{
"speaker": "Operator",
"content": "I would now like to turn the floor back over to management for closing comments."
},
{
"speaker": "Dan Fisher",
"content": "Thanks. Again, really appreciate our 16,000 employees. We had a flood and we've got some fires going on, and hope everybody remains safe and takes care of one another and look forward to talking with you all here at the end of the third quarter. So thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day."
}
] |
ball | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Greetings, and welcome to the Ball Corporation First Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded."
},
{
"speaker": "",
"content": "It is now my pleasure to introduce your host, Brandon Potthoff, Investor Relations for Ball Corporation. Thank you, sir. You may begin."
},
{
"speaker": "Brandon Potthoff",
"content": "Thanks, Christine."
},
{
"speaker": "",
"content": "Good morning, everyone. This is Ball Corporation's conference call regarding the company's first quarter 2024 results. The information provided during this call will contain forward-looking statements. Actual results or outcomes may differ materially from those that may be expressed or implied. Some factors that could cause the results or outcomes to differ are in the company's latest 10-K and other company SEC filings as well as company news releases. If you do not already have the earnings release, it is available on our website at ball.com."
},
{
"speaker": "",
"content": "Information regarding the use of non-GAAP financial measures may also be found in the notes section of today's earnings release. In addition, the release includes a summary of noncomparable items as well as a reconciliation of comparable net earnings and diluted earnings per share calculations. References to net sales and comparable operating earnings in today's release and call do not include the company's former aerospace business, year-over-year net earnings attributable to the corporation and comparable net earnings do include performance of the company's former aerospace business through the sale date of February 16, 2024."
},
{
"speaker": "",
"content": "I would now like to turn the call over to Dan Fisher, CEO."
},
{
"speaker": "Daniel Fisher",
"content": "Thank you, Brandon."
},
{
"speaker": "",
"content": "Before we discuss Ball's strong earnings and improved volume performance, I would like to thank all of the Ball team members that worked tirelessly to achieve the successful aerospace business sale on February 16, 2024."
},
{
"speaker": "",
"content": "Sale proceeds were immediately put to work to reduce our leverage, strengthen our balance sheet and return value to shareholders. In addition, I would also like to share that Ann Scott has announced her retirement as Head of Investor Relations after 37 years with the company. Just this week, Ann's first grandchild, Isabella Ann, arrived safely into the world. Needless to say, we all know what Ann will be doing in retirement, babysitting, golf and being a lifetime Ball cheerleader. Ann will provide behind-the-scenes support to Ball through the end of the year. So as she winds down her time as a full-time employee, feel free to extend your well wishes via her Ball e-mail."
},
{
"speaker": "",
"content": "As you can tell from our call introduction today, our Investor Relations succession plan has been activated with Brandon taking the lead as the head of the department. Congratulations to Ann and her family on the new grand baby and her well-earned retirement and for your support of Brandon and Miranda as they take the next steps in their careers at Ball."
},
{
"speaker": "",
"content": "Today, I'm joined on our call by Howard Yu, EVP and CFO. I will provide some brief introductory remarks. Howard will discuss the first quarter financial performance and key metrics for 2024 and then we will finish up with closing comments and Q&A."
},
{
"speaker": "",
"content": "Our team delivered strong first quarter results following the successful and earlier-than-anticipated sale of the aerospace business during the quarter. Global beverage can shipments increased 3.7% in the quarter, and we immediately executed our plans to deploy sale proceeds to deleverage and initiate a large multiyear share repurchase program."
},
{
"speaker": "",
"content": "Reflecting further on year-to-date 2024 performance, aluminum packaging continues to outperform other substrates across the globe. In North America and EMEA, first quarter volumes exceeded our internal expectations as customers pulled forward volume in preparation for the summer selling season, following notable fourth quarter 2023 destocking."
},
{
"speaker": "",
"content": "In South America, strong volume performance driven by our customer mix and warm weather continued in Brazil. For a complete summary of regional shipments for the first quarter, please refer to today's earnings release. Given seasonality, our customer mix and incorporating first quarter regional volume performance, we anticipate full year global shipments to grow in the low to mid-single digits range."
},
{
"speaker": "",
"content": "Key drivers in 2024 are the benefits of deleveraging, repurchasing shares, improving operational efficiencies and fixed cost absorption, and leveraging our well-capitalized plant assets to grow the use of innovative, sustainable aluminum packaging across channels, categories and venues. In addition, to further actions to strengthen the balance sheet and reduce long-term liabilities."
},
{
"speaker": "",
"content": "Based on our current demand trends and the previously mentioned drivers, we are positioned to grow comparable diluted EPS mid-single digits plus off 2023 reported comparable EPS of $2.90 per share, generate strong free cash flow, strengthen our balance sheet and return of value in the range of $1.5 billion to shareholders via share repurchases and dividends in 2024. We look forward to showcasing our team and unveiling our future operating model and long-term growth plans at our biannual Investor Day scheduled for June 18 in New York City at the New York Stock Exchange."
},
{
"speaker": "",
"content": "With that, I'll turn it over to Howard."
},
{
"speaker": "Howard Yu",
"content": "Thank you, Dan."
},
{
"speaker": "",
"content": "Turning to our results. First quarter 2024 comparable diluted earnings per share was $0.68 versus $0.69 in the first quarter of 2023. First quarter sales decreased slightly due to the pass-through of lower aluminum prices and lower volumes in North America, offset by the pass-through of inflationary costs and increased volumes in South America."
},
{
"speaker": "",
"content": "First quarter comparable net earnings of $217 million were flat year-over-year, primarily due to improved year-over-year performance in North America, EMEA and South America, offset by lower year-over-year results in nonreportable other, which were driven by improved comparable operating earnings in our aluminum aerosol business, being more than offset by noncomparable SG&A costs associated with the aerospace sale and higher year-over-year undistributed costs, which are detailed in footnote 2 of today's release."
},
{
"speaker": "",
"content": "In North America, segment earnings exceeded our expectations and offset notable year-over-year headwinds associated with the U.S. beer brand disruption and the favorable benefits of the virtual power purchase agreement termination. The earlier-than-anticipated closure of Kent plant, which permanently ceased production during the first quarter also aided results and supply-demand balance across our system. Benefits of effective cost management and plant efficiencies across our well-capitalized plant network will support incremental volume growth without spending incremental growth capital. We continue to anticipate sequential earnings improvement during the seasonal summer quarters, driven by modest volume improvement, improved fixed cost absorption and effectively managing risk."
},
{
"speaker": "",
"content": "In EMEA, the business continues to navigate varying consumer end demand conditions, particularly in Egypt. Overall, segment volumes were up slightly in the quarter following notable destocking by certain customers in late 2023. In recent weeks, demand trends have remained favorable, and the business continues to be poised for year-over-year comparable earnings growth in 2024, oriented largely to the second half and driven by volume and mix."
},
{
"speaker": "",
"content": "In South America, our segment volumes increased 26.3% in the first quarter, driven by strong demand in Brazil and our customer mix. The Brazilian can market was up 18% in the first quarter. We continue to monitor the dynamic economic situation in Argentina and potential scenarios that could impact results. We remain optimistic about Brazil and our ability to deliver sequential earnings and volume improvement as we exit the summer selling season in South America."
},
{
"speaker": "",
"content": "Additionally, in the first quarter of 2024 and up through the February 16 date of sale, our former aerospace business made $27 million of comparable operating earnings, which is included in the comparable net earnings of $217 million that I referenced earlier."
},
{
"speaker": "",
"content": "Moving on to additional key financial metrics and goals for 2024. We now anticipate year-end 2024 net debt to comparable EBITDA to below 2.5x. While we are currently at 2.2x at the end of the first quarter, net debt to comparable EBITDA will nudge slightly higher by year-end as the company starts payments of tax due on the gain of the sale of aerospace."
},
{
"speaker": "",
"content": "2024 CapEx is targeted to be in the range of $650 million, a year-over-year reduction of $400 million and largely driven by carry-in capital related to prior year's projects. We are on track to achieve our free cash flow target. Share repurchases are expected to be in the range of $1.3 billion by year-end. Through today's call, we have repurchased approximately $350 million in shares year-to-date, and earlier this week, the Board increased the share repurchase authorization to 40 million shares. The new authorization replaces all prior authorizations. This increased authorization will enable meaningful share repurchases during 2024 and beyond."
},
{
"speaker": "",
"content": "Our 2024 full year effective tax rate on comparable earnings is expected to be approximately 21%, largely driven by lower year-over-year R&D tax credit associated with the sale of the company's aerospace business. Relative to the estimated tax payments due on aerospace sale, the approximate $1 billion taxes due will be paid throughout the remainder of 2024. Full year 2024 interest expense is expected to be in the range of $320 million. Excluding the non-comparable aerospace disposition compensation costs, full year 2024 reported adjusted corporate undistributed costs recorded in other nonreportable are still expected to be in the range of $85 million. And earlier this week, Ball's Board declared its quarterly cash dividend."
},
{
"speaker": "",
"content": "Looking ahead to the rest of 2024, we remain laser-focused on operational excellence, driving efficiency and productivity across our business and cost management and monitoring emerging market volatility. We are committed to maximizing the full potential of our company over the long term. We have executed on derisking the corporation through recent debt retirements, and we have no significant near-term maturities. The runway is clear for us to activate near-term initiatives to consistently deliver high-quality results and generate compounding shareholder returns."
},
{
"speaker": "",
"content": "With that, I'll turn it back to Dan."
},
{
"speaker": "Daniel Fisher",
"content": "Thanks, Howard."
},
{
"speaker": "",
"content": "Given the strong start to the year in 2024, we anticipate growing our comparable diluted EPS mid-single digits plus by offsetting the divestiture through growth in our aluminum packaging operations, interest income, lower interest expense and the benefit of a lower share count."
},
{
"speaker": "",
"content": "Looking ahead, we are focused on executing our enterprise-wide strategy to advance sustainable aluminum packaging solutions on a global scale by accelerating our pathway to carbon neutral and unlocking additional value from within the organization by driving continuous process improvement and operational excellence. Together, we will strive to deliver innovative aluminum packaging solutions that can lead to a world free from waste and embark on a path to deliver compounding shareholder returns in 2024 and beyond."
},
{
"speaker": "",
"content": "We very much appreciate the work being done across the organization and extend our well wishes to our employees, customers, suppliers, stakeholders and everyone listening today. Thank you."
},
{
"speaker": "",
"content": "And with that, Christine, we are ready for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Ghansham Panjabi with Baird."
},
{
"speaker": "Ghansham Panjabi",
"content": "First off, obviously, congrats to Ann, a huge resource for all of us and more importantly, a real class act and also our congrats to Brandon and Miranda also."
},
{
"speaker": "Daniel Fisher",
"content": "Thank you for that."
},
{
"speaker": "Ghansham Panjabi",
"content": "Yes. So I guess, maybe, Dan, you could start off with just the updated thoughts on the outlook by the various regions. And obviously, there's lots of issues with comparability and customer issues and so on and so forth. So what is the market -- what do the markets feel like at this point?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes, good question. I think South America, we saw the strength in the fourth quarter carried over in the first quarter, and our partner did kind of won today in the market down there. So a really good start to the year. I think as it relates to Brazil, I think that economy continues to incrementally improve. We took a little bit of the refill glass back that we've talked about, we lost over 18 months and sort of that higher inflationary environment. So that's positive. So that's inflecting in the right direction. I think we'll probably increment higher this year versus our outlook in Brazil. And then Argentina is hanging in there. Howard and I were down there about 4 weeks ago. They're having a good crop. They'll get the proceeds from selling those agricultural commodities around the world here in the next couple -- couple of months, and then that should unlock some of their FX policies, which will certainly benefit us and derisk the balance sheet in that part of the world."
},
{
"speaker": "",
"content": "Yes. So we're seeing growth. We're seeing slightly ahead in South America, writ large, that's the only country that's probably flattish to a little negative versus our going-in assumptions were -- was Chile, but it's really negligible in the grand scheme. As you know, it's really all about Brazil. And that's in a really good spot."
},
{
"speaker": "",
"content": "Europe, we saw growth ahead of what we anticipated. A couple of things are working in a favorable manner versus where we entered the year in terms of our assumptions. Number one, there was more destocking, I think, in Q4 across Pan-Europe and so I think some inventory levels got to a better position and look a lot closer to where they were heading into -- or prior to COVID. And then we're starting to see some pickup in the beer section in particular. So folks are going for volume a bit more than even we anticipated heading into the year in Europe. So that outlook looks great."
},
{
"speaker": "",
"content": "And then the watch out, of course, is going to be what happens in -- what happens in the Middle East and how that influences energy prices and the end consumer. But all the underlying parameters are slightly ahead of what we assumed heading into the year. So we're encouraged. Let's see how we get on in peak season."
},
{
"speaker": "",
"content": "And then Q1, I think, is the most challenging to architect and explain because of the year-over-year comparability. But the pull forward into -- from Q2 into Q1 for us had a lot to do with one major brewer that was dealing with labor negotiations. And so we had to build some safety stock to potentially navigate some challenges there. So think in the area of $15 million to $20 million was pulled in from Q2 into Q1 versus our original assumptions. The balance of it, though, Ghansham, is you're really starting to see all of the structural changes and effects that we've made over the last 18 months. So we've rightsized operations, but more importantly, we've taken the higher cost facilities out. And so as you get volume running against a more productive and efficient portfolio, you're starting to see those benefits."
},
{
"speaker": "",
"content": "So the timing impact, probably about $15 million, $20 million out of 2 into 1 overwhelmingly for 1 customer. And so for us, we -- our shipments are reflected at a much -- at a slightly higher rate in the underlying scanner data. And then within our portfolio -- within our portfolio, some of our customers won in their areas, CSD in particular, beer is soft, writ large versus, I think, what we even expected heading into the year. So mix is going to play a pivotal role, I think, within the industry and player by player. And right now, we're encouraged by the mix that we have. So it's still going to boil down to Q2 and Q3. Our customers are still going to go for volume and peak season and a great start to the year and slightly improved performance across the world is great, and let's see how we get on in the next 6 months."
},
{
"speaker": "Ghansham Panjabi",
"content": "Okay. Very comprehensive. And for the second question, it's really two parts. One is just a clarification. In Note A, you called out $17 million of corporate interest income. What does that refer to first off? And then second, the $5.5 billion or so of net proceeds from the sale it looks like net debt is down $3.8 billion sequentially, a couple of hundred million for share buybacks. And I see the working capital, but I'm still having a tough time reconciling to that $5.5 billion or $6 billion. Can you help with that also?"
},
{
"speaker": "Daniel Fisher",
"content": "Sure."
},
{
"speaker": "Howard Yu",
"content": "Yes. So maybe -- Ghansham, this is Howard. I'd say that the interest income is specifically just related to the cash that we got on hand. So we got almost $5.5 billion -- or over $5.5 billion. And so that plays into the increased interest income associated with that. As it relates to..."
},
{
"speaker": "Ghansham Panjabi",
"content": "Is that included in EBITDA, sorry to interrupt, but..."
},
{
"speaker": "Daniel Fisher",
"content": "Yes, yes."
},
{
"speaker": "Howard Yu",
"content": "Yes. In the corporate line, that's right."
},
{
"speaker": "Ghansham Panjabi",
"content": "Sorry, go ahead."
},
{
"speaker": "Howard Yu",
"content": "Yes. And then as it relates to debt, yes, we anticipate that we would have paid down about $2.8 billion. Remember, the initial thoughts that we had in the quarter was that aerospace was being closed sometime after March 15. And so there was a European -- Euro-denominated debt that came due in the middle of March. And so we paid that down. So you couple that with the $2 billion that we referenced earlier around proceeds and where that would go. And so that's why you see the $2.8 billion debt retirement as well as knocking out some of the short-term debt and revolver and things like that, that we had. Clearly, with the cash on hand, we were going to go ahead and neutralize some of that interest expense as well."
},
{
"speaker": "",
"content": "And then we have talked about a $2 billion share repurchase over the next couple of years. I think we said that we were initially targeting about 2 -- $1 billion of share repurchase here in 2024. Given the timing of the sale, we're a little bit ahead of that. And so now what we said is that we're going to target about $1.3 billion worth of share buybacks here in 2024, consistent with the authorization that was approved by the Board earlier this week as well and the 40 million shares to be repurchased."
},
{
"speaker": "",
"content": "So -- and then everything else consistently, the CapEx, we anticipate that that's going to be about $650 million in the year, consistent with what we said. I think our interest expense at around $320 million is probably about $10 million better than we had originally indicated, and you're seeing that flow in as it relates to early timing as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Anthony Pettinari with Citi."
},
{
"speaker": "Anthony Pettinari",
"content": "Congratulations to Ann and to Brandon and Miranda. I think I can't say enough good things about Ann and the job that she's done over the years. So congratulations."
},
{
"speaker": "",
"content": "Just looking at North America, I think if you back out the energy benefit from last year, EBIT was up almost 25% on kind of flattish or down volumes. You talked about the fixed cost reductions from plant closures. I'm just wondering if there's anything more than that or any kind of finer point you can put on that in terms of the cost that you've been able to take out as sort of the operational performance within North America?"
},
{
"speaker": "Daniel Fisher",
"content": "I will take a shot at this and then ask Howard to just -- I think it's twofold. Yes, it's the fixed cost absorption. Straight line from the immediacy of the closure of the facilities and its improved performance across the portfolio. I think we've commented on this before. Probably versus 5 years ago, we've lost a couple of points, potentially 3 points of efficiency across our portfolio of assets in North America, and now we're gaining on that. So you're seeing the combination of the fixed cost benefits of the plant closures and the higher-cost facilities, coupled with the fact that we're running better. So a lot of folks that are now 2 or 3 years enroll in a number of these plants and they're performing better. So I think it's the combination of those two things. But one-offs, no. I mean, there were some -- there's always a few that are positive, and there's always a few that are negative. So I think it's really the underlying performance of the facilities in the region. They're doing a really nice job."
},
{
"speaker": "Anthony Pettinari",
"content": "Got it. Got it. And then in South America, you had a great result with volumes up, I think, 26%, but EBIT up 10%. Can you talk about any kind of price cost dynamics in South America or the lag in -- the EBIT growth kind of lagging a bit. Is that Argentina related? Or just help us reconcile that?"
},
{
"speaker": "Howard Yu",
"content": "Yes. Sure, Anthony. Let me go ahead and take a shot at that one there. I think South America was in its peak season. And so the way we think about it was -- and we talked about it in the Q4 earnings as well, Brazil was performing very well in that quarter as well. So really, you got to think about it in the context of the entire season and some of the mix and timing will change. And so if you think about what we said in Q4, the performance we had in Q4 in South America, we had about low single-digit growth of something around 2%, 2.5% growth and operating earnings was up 60%. And so coupling that with the performance here in the quarter at 26% volume growth and then 10% operating earnings. If you look at it holistically for both those quarters, we're up about 12% and over 40% as it relates to operating earnings. And so that's the way we think about it. Mix as it relates to cans and ends, those things will obviously play into this particularly in South America, and we're seeing that overall. So I think of it more in the context of the overall busy season for them and how successful it's been holistically."
},
{
"speaker": "Daniel Fisher",
"content": "In the simplest way, we've talked about this for years and years and years and you've heard us talk about. And can and end shipments, right? So we ship more ends in the fourth quarter than we did in the first quarter. So the balance of the entirety of the portfolio, really, that's where the volatility lies in terms of leverage, deleverage. It's not isolated within the quarter. You kind of have to look at it throughout the entirety of peak season. And that's the overwhelming gist of it. So we're happy with the leverage fall through with over the 6-month period."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Arun Viswanathan with RBC."
},
{
"speaker": "Arun Viswanathan",
"content": "Just wanted to get your thoughts on how volumes in North America should evolve now that you're anniversary-ing the Bud Light situation. We've also heard of some share shifts within the industry. So yes, maybe you can just kind of give us your thoughts and if there's any category discussion that would be helpful or promotional kind of view as well."
},
{
"speaker": "Daniel Fisher",
"content": "Yes. So we've spoken about, and I think it's well known within the industry that there was a share shift one brewer to the tune of approximately 2 billion units, that's already happened. That's in our numbers. So we lost the 2 billion and multiple competitors picked that up and incremented up. And we've got line of sight to fill that hole this year. If you go back to previous call and the assumptions we laid into North America for 2024, we thought we'd be negative obviously, in the first quarter, not only for the lapping the major brewer disruption, but the dislocation of this volume. And then we would -- which we've already won a couple of big chunks of business, and you will start to see that flow in, in the back half of the year. So that's where we geared toward flat in North America. So last -- the 2 billion pick up, roughly a similar amount and you'll inflect in the back half of the year with volume. Obviously, the size of that volume and the mix of that volume now plays out within the next couple of quarters, but you should still see increments of volume lift here out through the balance of the year in North America."
},
{
"speaker": "",
"content": "We think the industry is in that 1% to 2% growth range. Beer is a little softer, CSD is a little better. Mix will matter. Energy continues to grow. Mix will matter in promotional activity in peak season and the health of the end consumer, that's going to play out and determine whether it's 1%, 2%, a little north of that, a little south of it. But for us, we're really comfortable regardless of whether we're growing flat to down a little to up a little. We've got really good line of sight into the operating earnings and the cash generation of the business."
},
{
"speaker": "Arun Viswanathan",
"content": "Great. And then we've obviously seen some volatility on the aluminum price side. Maybe you can just comment on how that would impact you going forward? I mean I'm not sure if your customers -- I think they have some hedging programs in place, but would that also impact demand levels if they opt to push price to cover some of that inflation? And especially in Europe, I guess, I'm just curious if there would be any potential headwinds from metal premium pass-through? Or -- and how would you kind of characterize that in the context of -- it sounds like Europe is getting better from a supply-demand standpoint?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes. I think it's probably much ado about nothing at this point. We're coming off of incredibly low aluminum prices right now in a historical context. That seems to be the preferred package. There's a shift toward that in a number of parts of Europe. I guess the watch out is what's happening in the Middle East, right? I mean is that going to inflect significantly energy prices. Some mills and some aluminum is protected because it's nuclear power or it's tied up with other energy sources that aren't fed out of that part of the world, but it's certainly something that would impact the end consumer, not our customers' behavior patterns at this time. We're not having any conversations that would give us pause or concern. In fact, it's just the opposite at this point. They're more aggressively going in and working on taking share. and are using the can to do that."
},
{
"speaker": "",
"content": "So I think it's a watch out. It always is, but what we're seeing right now is not of a concern. And overwhelmingly, what everybody has learned, to your hedging question in particular, I think folks got caught a little upside down over the last 2 to 3 years in some instances. And I think they paid a lot more attention to hedge strategy and kind of protecting where they are. If they locked in hedges, they'd be locking in those hedges at kind of all-time low levels. So I'm a little bit more encouraged by the structure of the industry and the behavioral patterns. And then obviously, the watch out is what's going on in the Middle East and does that have any impact."
},
{
"speaker": "Arun Viswanathan",
"content": "Great. And congrats again to Ann and Brandon as well. Definitely, we'll miss speaking with her and getting her perspective."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of George Staphos with Bank of America."
},
{
"speaker": "George Staphos",
"content": "Thanks for the details. Everyone said it, but I'd like to as well. Just Ann congratulations, first on your grand baby, but also for being such a resource to all of us over the last number of years, you are the legend in the industry. And congratulations to Brandon and Carmen on their increased responsibilities. Okay. So in terms of operations, Dan, you had mentioned that you're still trying to claw back that 2% to 3% operating efficiency loss over the last few years. Where do you stand in that regard? Forgetting about the actual plant closure benefits. What do you -- where do you stand in terms of that recovery? And can you give us a 1 or 2 kind of for instance, in terms of how that lean or benchmarking is showing up on a day-to-day basis?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes. We've got, George, latest numbers that I've seen. We picked up probably 1% of the 3% we've got back. And it's showing -- where it's showing up, principally, it's showing up in reduced over time. It's showing up in spoilage. The older assets that were retired, I would say, have contributed 80% of that improvement, okay? So there's still -- I think we've just scratched the surface on getting to the other 2%, 2.5%, if you will, across the existing portfolio of new assets."
},
{
"speaker": "",
"content": "So we still have a bit of runway. I mean, you could -- that's a meaningful number on when you apply it to roughly 50 billion units. And so we're in early innings. But as you know, volume to manifest in order for those efficiencies to show up, and we're inflecting here over the back half of the year. So we're counting on continued improvement. We'll talk more about this at our Investor Day and how we're structured in terms of the operating model, and we can point to this in, I think, more granularity than we've talked about historically. But I would say roughly, we've shuttered the facilities to pick up 1% of the 3%. And now we've got to work on the remaining assets that are in place to continue to grow into that too, and we're early innings on getting it, but it is showing up incrementally."
},
{
"speaker": "George Staphos",
"content": "Okay. I mean, I guess, we'll talk about it in June, but a pushback could be, okay, well, you got 1 point because you shut a facility and then the remaining 2 or 3 is going to be tougher to get at because it's got to come from ongoing. So do you have any comment on that? That would be great, if not, we can stay with the June."
},
{
"speaker": "Daniel Fisher",
"content": "Yes. I would say no, that's not true. It's going to be easier because this is roughly 1,200 new employees that are 3 years of service in and they're learning how to make cans. And so this is incremental in terms of the learning curve. This is not different than at any point in time when we talk about an 18-month, 24-month ramp-up on facilities. I think about it in that context. So if we focus, we maintain -- we don't have attrition at the levels that you did, obviously, during COVID. We will gain on this and we will gain on this in a pretty methodical and pragmatic and a very prescriptive manner. So I'm encouraged that we will get this back here over the next 18 to 24 months."
},
{
"speaker": "George Staphos",
"content": "Next question. So in Brazil and sort of piggybacking on what Anthony had teed up. Was there any sort of operating issues in terms of the lack of profit leverage versus the volume leverage? Again, I know you said we should look at it holistically. Were there -- did you lose any share to your knowledge with any customers recognizing in a quarter where you're growing 18% or whatever the number might have been depending on the customer or the market, the answer is probably no. But any operating issues that we should take away? Any customer loss issues or if things were very much as expected in the quarter in South America and in Brazil?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes. Thanks. So Brazil grew at 18%, we grew at 26%. So no, we didn't lose anything. In fact, you could say we incremented share positions. If this is 100%, George, just to be clear, it is end sales that were heavier mix in the fourth quarter versus the first quarter. And so that's what it is. So we shouldn't have been up 60% earnings on 2% growth in the fourth quarter. So if you kind of mix that end issue, which we've talked about forever in a day, it's just lumpy, and it's incredibly profitable because of the tax jurisdictions down there. It's like -- that's it. Yes, nothing fundamental. It's not Argentina. It's not anything that -- it's no pricing mechanisms and contracts, All of that's really stable. It's just fundamentally to end float between 4 and 1."
},
{
"speaker": "George Staphos",
"content": "Understood. My last two ones quick. Number one, just piggyback again on the aluminum question, recognizing it's a watch out, but not something you're terribly concerned about. I know over the last couple of years, 3 years, you've probably been working on supply chain, clearly, with a lot of this inventory now showing up -- or a lot of this aluminum showing up in inventory and warehouse that might not be able to be used because of the sanctions. What are the risks and how are you planning against it that if there is some sort of mill disruption somewhere around the world that we don't see some spike, some tightening in an aluminum therefore can sheet, what are your thoughts there and how you're planning against that?"
},
{
"speaker": "",
"content": "And then last, can you just give us a little bit more color on the payout that was related to the aerospace sales? Again, congratulations. It was obviously a favorable valuation. But kind of what went into that number? Congratulations on 1Q."
},
{
"speaker": "Daniel Fisher",
"content": "Thank you very much. So we've learned a lot. This may be a little long-winded answer in terms of our price cost and managing the risk, managing tariffs, managing sanctions as it relates to your inventory supply. We've gotten a lot better at this since the tariffs were put in place in 2016. We've got 21 different metal programs. So metal that would be of concern on sanctions, we're really not shipping it to countries where that's even in conversation. So it will be going to places that it can be used, where there's trade relations with those countries that may have some concerning trade routes or unintended consequences for what -- exactly what you described."
},
{
"speaker": "",
"content": "So we're managing those. We've derisked that over the last handful of years, and we've gotten -- we've gotten pretty good at that, understanding what's going on relative to those conversations and how we get out ahead of it. So I'm -- it's less of an issue. I agree. I mean, 4 or 5 years ago, we spent in an inordinate amount of time on things just like that because it wasn't in the ethos, it wasn't in our management patterns and our cadence of conversations, in our S&OP process. But I think it's pretty well under control, not to say that the world is not going to change here suddenly, and we need to manage it. But I would put this in the category of very low risk for us at this point in terms of just how we're managing our portfolio."
},
{
"speaker": "",
"content": "And then I'll let Howard weigh in on some of the proceeds comments again."
},
{
"speaker": "Howard Yu",
"content": "Sure. So I think, first and foremost, George, that is a noncomparable compensation component associated with the aerospace sale. Part of the variable performance-based compensation plan for Ball employees. I think the way we think of it is the magnitude of the impact of this disposition causes the expense to be not normal. And so we've recognized approximately a $4.7 billion gain on this disposition which is unprecedented, of course, and not likely to ever recur. And so for that reason, we're treating that as a noncomparable compensation component associated with that."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Edlain Rodriguez with Mizuho."
},
{
"speaker": "Edlain Rodriguez",
"content": "Again congrats to Brandon and Miranda and Ann, we're going to miss you. Quick one on Europe. Clearly, a better start to the year, better than expected. But are you seeing any fundamental improvement in terms of consumer spending improving? Because everything else we hear about you about -- like things were improving quite a bit. Like what was the surprise, what are you seeing there?"
},
{
"speaker": "Daniel Fisher",
"content": "Great. Yes. So I think it's twofold. I wouldn't say end consumers are spending more. I would say the relative inflation versus payroll mechanism and then the promotional activity for our customers is impacting and influencing volume. And the other piece is the -- I think there was an unwind to an unnatural inventory level by retailers, by our customers at the end of Q4. And so they built that up a little bit. So it's probably half of Q4 to Q1, if you will, inventory stocking, getting back to a more normalized baseline. And then some -- really some more aggressive behaviors from the customers. across Europe that has enabled a little bit more volume. It's not incredibly exciting, but it's better than we anticipated heading into the year."
},
{
"speaker": "",
"content": "But I wouldn't say there's more spend by going into these categories, I would say it's a little bit substrate shift, little bit favorable category, the can certainly winning versus the other substrates. That gap has widened probably more in Europe than in any other region relative to the trade-offs from glass and plastic into cans. So we're the beneficiary of that, but I wouldn't chalk it up to -- there's a lot more spend happening. I think we're the beneficiaries of the mix."
},
{
"speaker": "Edlain Rodriguez",
"content": "Okay. Makes sense. And another one, in terms of like the share repurchase, I mean then, like how do you balance the pace of that share repurchase? Like with your commitment to buy back shares versus like a higher and higher share price. I mean, of course, it's a high-class problem to have, but how do you balance the pace of that?"
},
{
"speaker": "Howard Yu",
"content": "Yes, Edlain, I think we're committed to getting back to it. I mean we had, I think, had a pause for a few years as it relates to share buyback, and I think that we've consistently heard from our shareholders as well that returning that in some measurable fashion and on a consistent basis is important. And so we're just starting in this program, right? I think we've mentioned that we bought about $350 million worth of shares here. And we'll be thoughtful, clearly, as to how the stock price is going. And even as it relates to what vehicles we use to buy back some of that share. We do have a long history of utilizing different instruments. I mean the 10b-18 when the blackout is not there and the 10b-51 when the blackout is there, and then we'll look at things like smaller ASRs as well if the volatility and the economics work for us."
},
{
"speaker": "",
"content": "And so we're looking at all those things holistically in conjunction with the board and we're being thoughtful about them. What we do believe that for this year, we'll spend about $1.3 billion worth of share buyback. Combined with our dividend policy, that will return about $1.5 billion back to the shareholders."
},
{
"speaker": "Daniel Fisher",
"content": "And then relative to elevated stock price. I mean we're very comfortable in buying back our shares at this level still, that's absolutely something that we talk to our finance committee and our board with and we model things internally. And yes, we're very comfortable returning value back to our shareholders right now at these levels and even elevated above this. So -- but it's definitely something that we'll look at. But where the stock is, even trading up today, it's like we're very comfortable buying back shares at this level. So it's a great question. And it's, hey, let's see how we get on here over the next 3 to 6 months, but I think we owe it to return value back to our shareholders at the levels that we're talking about for the foreseeable future. And it's just a good -- it's a really good mechanism in behavior return value if we're generating more free cash flow, generating more earnings, we have plenty of dry powder to do things as they present themselves in terms of bolt-on M&A, et cetera. So I think we can do all of it. And that's kind of how we're looking at it at this point."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Adam Samuelson with Goldman Sachs."
},
{
"speaker": "Adam Samuelson",
"content": "Let me extend also my congratulations to Ann on her retirement and addition to the family. Maybe I wanted to come back to the cash flow side first. Maybe, Howard, I just want to clarify, you bought that -- you talked about $2.8 billion of debt in the quarter. I believe that was higher than what had been initially kind of targeted, maybe there's some timing component to that. Did you also reduce the factoring programs on receivables? Or is that a cash outflow that is still yet to occur is obviously a lot of moving pieces on the balance sheet, I'm trying to make sure we understand what has happened and what has not in the cash..."
},
{
"speaker": "Howard Yu",
"content": "Yes, Yes, no problem, Adam. So yes, we did retire $2.8 billion of debt that was -- we had talked about it from an apples-and-apples standpoint of about $2 billion, but recognizing that, that was anticipating the sale of aerospace sometime after the March 15 date. March 15, we had to do about EUR 750 million denominated debt that was retired. And so that equates to the essentially additional USD 800 million of that gets us to the $2.8 billion in the quarter. ."
},
{
"speaker": "",
"content": "As it relates to factoring, given the cash that we had on hand, we did move forward with the factoring in a meaningful way. We still -- we probably did more of the unwinding here in the first quarter than we would anticipate for the full year. And so that was to the tune probably about $1.1 billion. But by year-end, we're going to stay with our goal -- specified goal and target of unwinding about $0.5 billion of AR factoring by the end of this year. So you'll see that going a little bit the other way throughout the course of this year as we have a $1 billion tax payment that we're going to have to make here in second half -- or actually in second quarter and through the second half as well."
},
{
"speaker": "Adam Samuelson",
"content": "Okay. That's very helpful. And if I could maybe just follow up as we maybe take a step back because there's a lot of moving pieces within comparable EPS growth off the $2.90 last year that obviously had aerospace earnings in it. You pay off debt, there's interest income, reduced factoring expense, share repurchase, tax rate inches up. Maybe if we step back and we think about the 3 core beverage can kind of operating units, globally, Dan, you talked about low to mid-single-digit volume growth, what should we think about the operating profit growth in those core business units off that level of growth? Obviously, in the first quarter, especially North America, had some -- had some favorability, but help us think about what that core operating leverage to look like with that kind of volume growth this year?"
},
{
"speaker": "Howard Yu",
"content": "I would say overall, Adam, that we anticipate operating leverage to continue on here, and you'll see that. What we've said as it contextualizes EPS as we've said, hey, mid-single-digit plus on a year-over-year basis. We've said that the aerospace sale would essentially be neutral for us on an EPS standpoint, given the operating earnings loss associated with aerospace, but the pickup associated with the -- with the additional cash, whether it be interest income, reduction in interest expenses, we've retired debt. And as we go ahead and improve on some of these factoring programs. So we've said that for the full year, the EPS would be neutral associated with the aerospace sales. Think of it in the context of a 2x leverage. And so that's the way we think of it within the P&L. And so that's consistent with what we've modeled. That's consistent with what we're going to see here through the duration of 2024."
},
{
"speaker": "Daniel Fisher",
"content": "Yes. I think for the core beverage business, if you -- it's significantly higher than the historical 2x leverage if you were to back out the nearly $40 million of onetime purchase power agreement. So it's still in excess of the 2x leverage. I think somewhere in the neighborhood of $100 million of operating earnings we're going to get out of the beverage business and an improved result year-over-year and that obviously has the lapping of the $40 million -- $30 million, $40 million onetime benefit."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Phil Ng with Jefferies."
},
{
"speaker": "Philip Ng",
"content": "Congrats on the strong quarter. And like everyone else, I wanted to thank Ann for all her help over the years, and congratulations to Brandon and Miranda as well. I guess my first question is really the free cash flow power of the business, certainly noisy with the aerospace sale this year. Can it be helpful, Howard, perhaps to give us a little more perspective on how you think about CapEx as we look out to 2025 and beyond, maybe 2026? It's been a big growth CapEx cycle. So just give us a little more context on how to think about that, the free cash flow and certainly a high-class problem to have, but how should we think about buyback as well? Pretty steady dose every quarter, more opportunistic if the pullback? Just kind of give us a little playbook and how you're thinking about the pace of buybacks."
},
{
"speaker": "Howard Yu",
"content": "Yes. So sure, Phil. Let me go ahead and get into that a little bit. As it relates to free cash flow, I mean, I think the way to think of it is, say, we're anchoring to a normalized free cash flow in the $900 million to $1 billion range, right? That excludes some of the impact of the factoring unwind, and we talked about that in the context of about $0.5 billion, right? So -- and I think that we can see that going forward on a consistent basis. Dan has talked about the operating cash generation of this business and how rich that is. And so we believe that that's going to help fuel the share buyback even into years that you specified."
},
{
"speaker": "",
"content": "As it relates to CapEx, I mean, the way we think about it here is getting CapEx in the ballpark of GAAP D&A on a consistent basis. I recognize that over the last few years, that CapEx had been a little bit outgrown. And so we're returning back to that discipline of getting CapEx into the D&A envelope. And we think that, that's going to happen here for the next few years as well."
},
{
"speaker": "",
"content": "As it relates to share buyback, look, as Dan said, I mean, we feel good about the price that it's at and we'll continue to buy if there is any, for any reason at all, reason for us to be a little bit more opportunistic because of the prices, then we'll look at that as well. And so I think that we have those full optionality. I think the greater point here to know is that we're going to return to a consistent buying back of shares, something that we had paused on for a few years here, and we'll do that here in 2024. We'll do that here in 2025. And no reason to think that we wouldn't do that going forward beyond that."
},
{
"speaker": "Daniel Fisher",
"content": "Yes, Phil, I would say -- I would -- in the simplest manner, we are running our business, the expectation of running our business enterprise-wide is that net income equals free cash flow. So as I don't want you to think about locking us in at $900 million of free cash flow. As our margins expand, we will mitigate the working capital build associated with the growth. And if you're in that 2%, 3%, 4%, you should be able to manage that. We got room to do that. We spend that GAAP D&A levels and some years it will be less, some years it might be a bit more. But this -- we should be generating a steady diet of free cash flow and returning that back to our shareholders consistently. To your point, there may be some opportunities with a pullback where we can do some more. But I think you should be locking in that you're going to get an overwhelming majority of that free cash flow coming back to you in the form of dividends and share buybacks, over $1 billion share buybacks for the foreseeable future."
},
{
"speaker": "Philip Ng",
"content": "Okay. That's great. And Dan, you gave a little more perspective on Europe. It sounds like still kind of a choppy environment, but good to see some restocking. How are your customers gearing up for the busy summer months. Certainly, there's big -- some big sporting events like the Olympics and the Euros and stuff of that nature. Are they gearing up for that? And then I think on your prepared remarks, you made some comment about perhaps Europe's recovery would be more back half-weighted. Give us a little more perspective why perhaps the back half is a little better than the front half?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes. Entering the year, it was really the comments were more macro related and end consumer and the strength of the end consumer. We got the benefit of the restock and a little bit more favorable behavior by our customers kind of pushing volume. But we thought that there would be a natural tendency for inflation to come back and for the regasification projects that come online. So there would be more room for optimism in the second half of the year, and that's really what we heard from our customers as well."
},
{
"speaker": "",
"content": "Your point about the Euro Cup certainly is helpful. I'm more -- I get more excited about the soccer \"football\" drinking behaviors than I do about the Olympics drinking behaviors. So that generally moves the needle a lot more than the Olympics, if you will. So that will be helpful, and we've certainly heard that from -- especially our larger beer customers and elements of Western Europe. So yes, it's really macro related. And I think a lot of those things are still playing out in a more favorable manner with the watch out being what happens in the Middle East as it relates to energy prices and how does that impact the end consumer. But we're encouraged."
},
{
"speaker": "",
"content": "Nothing contractual is coming online. It's incredibly stable. This is just -- and we're starting to see increments of better pricing behaviors, a little stronger end consumer, substrate shift continues to manifest in a favorable manner for us, especially as it relates to glass moving into cans. So a bunch of small things kind of add up to a more improved outlook in the second half of the year. And we haven't seen anything that would influence or impact that to the negative, if anything, may be an increment higher."
},
{
"speaker": "Philip Ng",
"content": "Got it. And then just one more for me. On North America, if I heard you correctly, you had some pull forward earnings from 2Q to 1Q. Do you still expect North America earnings to be up year-over-year in 2Q. And then give us a little update. I think there's been some movement in North America as well with the shelf space reset on the beer side. And one of your larger peer customers, I believe, is still dealing with some ongoing labor issues, I think, down in Texas. Any update on that front and how you're kind of managing that?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes, I'll let -- Howard, why don't you cover the earnings, and I'll get back over to the union issues."
},
{
"speaker": "Howard Yu",
"content": "Yes. I think that's right, Phil. I do think that year-over-year earnings will still increment upwards here in the second quarter despite some of the pull-in from Q2 to Q1. I think as Dan said, it's probably $10 million or $15 million that improved the first quarter. But despite that, we still anticipate that we'll have some reasonable growth as it relates to operating earnings in the second quarter as well."
},
{
"speaker": "Daniel Fisher",
"content": "Yes. I think the shelf resets have been communicated really well from -- there's been a couple of folks that have won disproportionately, and we anticipated that in our numbers. So nothing's moved up, down or sideways. I would say, even with -- even with the shelf reset, I think the beer category is down. So I think it's less about the category reset, and it's more about beer and how they get on with promotional activity in the peak season, are they going to drive value -- excuse me, volume."
},
{
"speaker": "",
"content": "And then, yes, we're connected with our plants in Texas with that particular brewer. They're doing a really nice job of managing it right now, but it's still ongoing. It hasn't been resolved, but we're certainly working with our partner to make sure that we're running what we can, and it's being effectively managed. And I think this is a bit of the way of the world right now as it relates to some of the strength of the unions, broadly speaking, and kind of the manufacturing base. So we had to also work with another major brewer in the quarter to work toward mitigating any supply chain shifts and -- so I think we're all coming to a realization that this is probably par for the course moving forward, and everybody is getting aligned to have more thoughtful conversations in and around when these contracts come up across the industry and making sure that collectively throughout the system, we can manage them."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Pamela Kaufman with Morgan Stanley."
},
{
"speaker": "Stefan Diaz",
"content": "This is actually Stefan Diaz sitting in for Pam. And just to echo my colleagues, congratulations to Ann and Brandon and Miranda for the increased responsibility. Now that the aerospace deal is closed and proceeds are in hand. Can you give any details around the potential innovation investments?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes. It's a good question. So we're always -- I guess we have an underlying thought process that we're always investing. There's a combination of R&D that transition that hopefully in the commercial innovation projects. And I think you'll hear this from just about everyone that the opportunity set for us is different by region, but innovation as it relates to getting a constructive package and vehicle that can really attack, if you will, plastic. And the big linchpin there is going to be resealability. And I think there's a lot in that area that's being worked on and it's being worked on by everyone in the industry and all of our customers. So that -- those will be the big unlocks."
},
{
"speaker": "",
"content": "And then there's some pretty interesting stuff that's going to be coming out as it relates to new products. And it's also -- these are also applications that benefit substrate shift. I think that's the real focus of innovation more so than a unique graphic depiction, et cetera. It's like can you have a package that is easily transferable into whatever the benefits of the other substrate are, and can you offset those and then you've got a far more circular and a better, I think, sustainable package that gets supplant that. And so that's where that focus is."
},
{
"speaker": "",
"content": "And then in terms of new products, there's a lot -- there's a lot that's happening in the CSD space. There's a lot happening, better health, lower calorie, lower sugar, that's all real. And then very creative outlooks as it relates to alcohol categories, new alcohol categories and then substrate application for us. That's where the innovation is. But I would say nothing that would be incrementally different in terms of our spend behavior just because we have a stronger balance sheet. These are things that we're working on and working on with our partners. And as it makes sense and as it can be commercialized at scale, we're generally the right person, right company to do that. And so that's how we're looking at innovation right now."
},
{
"speaker": "Stefan Diaz",
"content": "Great. And then I believe your initial volume guide was for low single digits globally, and now you expect low single digit to mid-single digits. Is the raise at the top end based on strong 1Q? Or do you expect better demand throughout the year now? And maybe what do you need to see to hit the top end of that guide?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes. Peak season dependent. Just to be abundantly transparent. I mean if I'm talking about 3.4% growth versus 3.3%, I think the 3.3% starts to look like mid-range versus -- so I would say we got out ahead of the gate. We had favorable mix in South America. We're a little ahead in Europe. Scanner data is a little behind in North America. So the balance of that seems like net-net-net, that's a little favorable. Until we get through peak season on 70% of our business, I think I've ranged it appropriately. And regardless of whether it's low single digits or mid-single digits, you're going to see cash flow generation, EPS mid-single digit plus share buyback to the tune of nearly $1.3 billion. So we're really confident in the underlying performance and behavior of the business. Let's see how peak season gets on."
},
{
"speaker": "Stefan Diaz",
"content": "Great. And maybe if I could sneak one more quick one in here. Can you just go through how April trends are benchmarking versus your expectations?"
},
{
"speaker": "Daniel Fisher",
"content": "Yes, April is largely in line, a little softer than March, but in line with our expectation. And as you know, Easter fell a week different last year than it did this year. And so that plays into it a bit. So it's -- I think it's there or thereabouts. And it really -- a couple of weeks before Memorial Day is when things really start to pick up. So it's really the back half of the second quarter where it's most meaningful."
},
{
"speaker": "",
"content": "Christine, that will be the last question. I think we're a couple of minutes over."
},
{
"speaker": "Operator",
"content": "This ends the question-and-answer session. I would now like to turn the floor back over to management for closing comments."
},
{
"speaker": "Daniel Fisher",
"content": "Yes. Thanks. I just -- just a quick reminder, June 18, New York Stock Exchange is our Investor Day. Again, I'd like to thank Ann for her incredible service to the company and certainly echo all the very nice comments toward Brandon and Miranda. And thanks to all of our employees. We look forward to talking to you again at the end of the next quarter, if not before at Investor Day. Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day."
}
] |
bax | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning, ladies and gentlemen, and welcome to Baxter International's Fourth Quarter 2024 Earnings Conference Call. Your lines will remain in a listen-only mode until the question-and-answer segment of today's call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time. I would now like to turn the call over to Ms. Clare Trachtman, Senior Vice President, Chief Investor Relations Officer at Baxter International. Ms. Trachtman, you may now begin."
},
{
"speaker": "Clare Trachtman",
"content": "Good morning and welcome to our fourth quarter 2024 earnings conference call. Joining me today are Brent Shafer, Baxter's Chair and Interim Chief Executive Officer; Joel Grade, Baxter's Executive Vice President and Chief Financial Officer; and Heather Knight, Baxter's newly appointed Chief Operating Officer. On the call this morning, we will be discussing Baxter's fourth quarter and full year 2024 results, along with our financial outlook for the first quarter and full year 2025. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the first quarter and full year 2025, the anticipated impact of our strategic actions, the potential impact of various regulatory and operational matters and the macroeconomic environment on our results of operations contain forward-looking statements that involve risks and uncertainties. And of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of certain non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in the accompanying investor presentation and available in our earnings release issued this morning, which are both available on our website. As a reminder, continuing operations excludes Baxter's Kidney Care business and Baxter's former BioPharma Solutions business, which are both reported as discontinued operations. During the Q&A session this morning, Brent, Heather, Joel and I will be available to address questions. Questions on our results and outlook will be addressed by me and Joel. Now I'd like to turn the call over to Brent. Brent?"
},
{
"speaker": "Brent Shafer",
"content": "Thank you, Claire, and good morning, everyone. I appreciate you joining us. As you know, I recently stepped into the role of Chair and Interim CEO at Baxter. Joe Almeida led the business through a period of significant evolution over his nine year tenure, and we're sincerely grateful for his dedication to the company. One of the Board's top priorities, of course, is the identification of a permanent CEO. The Board is actively engaged in the search process with a supportive leading firm, evaluating both internal and external candidates. We're moving expeditiously, but most importantly, we're taking a rigorous approach to ensure we identify the right candidate to lead Baxter into the future. During the transition period, I'm committed to helping ensure we remain focused on a crisp execution of our priorities and delivering strong, consistent results. I'm pleased to be working with the entire leadership team on these shared goals. We're continuing to move the company forward into a new era. And as recently announced, we closed the sale of Vantive on Jan 31, 2025. This significant milestone was the final step of three strategic actions outlined in January of 2023 to transform the business. You'll recall these actions included the implementation of a new verticalized operating model. As a Director and in my role as Interim CEO, I can confirm that this segment-driven approach has created increased focus and execution related benefits, bringing greater clarity and agility to how we pursue opportunities globally. And as part of our transformation efforts, we completed the divestiture of Baxter's non-core BioPharma solutions business in 2023. Since joining Baxter's Board in 2022, I've observed and supported these shifts in the company's strategic direction, and I'm extremely proud of the hard work and dedication of our teams to reach this stage. These actions have positioned Baxter to accelerate innovation for patients and customers, and to drive profitable growth for our shareholders. Later in this call, Joel will provide details on our quarterly and full year performance as well as our outlook for 2025. As you have seen in this morning's release, we finished 2024 on a high note, beating our fourth quarter guidance for continuing operations on both the top and bottom lines. And we're starting 2025 building on this positive momentum. During this interim period, I'll be working closely with Heather, Joel and the rest of Baxter's strong leadership team to ensure we maintain that momentum. I've been very impressed by what I've experienced in the last few weeks, an engaged, talented, highly-motivated team that is squarely focused on Baxter's mission to save and sustain lives, a truly collaborative spirit and an intense focus on delivering on our commitments. This includes initiatives focused on innovation and profitable growth to enhance performance, deliver increased value and to better serve the needs of our patients and customers. To support these efforts and as we've shared earlier this month, we've instituted a new Chief Operating Officer position as a next step in leveraging the potential of our vertical operating model. We're fortunate to have Heather Knight stepped into this role as COO. Heather brings extensive experience and a proven track record to this position after a successful tenure, as head of our largest segment, Medical Products & Therapies, among other key leadership roles at Baxter and prior large health care companies. She'll be leading day-to-day operations across our three segments, encompassing global commercial operations, R&D, supply chain and medical and regulatory affairs. Her leadership will be critical as we navigate the next phase of growth. Now, I'd like to turn it over to Heather to share her perspectives. Heather?"
},
{
"speaker": "Heather Knight",
"content": "Thank you, Brent, and good morning, everyone. I'm very pleased to be joining today's call. I look forward to building upon, what we've achieved to date and helping to launch a new chapter of accelerated performance for the company. As Brent mentioned over the last two years, I've had the privilege of leading Medical Products & Therapies or MPT, which is Baxter's largest segment with over $5 billion in sales and operations spanning the globe. During this time, I spearheaded numerous vital initiatives with the support of my talented colleagues, including the recent successful launch of our Novum IQ infusion pump platform in The United States. As the leader of MPT, I also helped oversee the North Cove recovery efforts following Hurricane Helene. Given the essential nature of the products that are manufactured in North Cove, we spared no expense in our efforts to help address product supply for patients and customers, including importing products from Baxter sites globally. Thanks to the incredible dedication and resilience of the North Cove and broader Baxter teams, we were able to restart production on eight of the site's 10 manufacturing lines in the fourth quarter. Our final two manufacturing lines came online in January, and I'm very proud to report that we are now producing at pre-hurricane levels. This is just another critical milestone in our recovery, as we continue to work to replenish inventory and support our customers and patients' needs. Additionally, I've served as the lead interface to many of our key customers, and have been deeply involved in successfully renegotiating the recent renewals of select U.S. GPO contracts, helping to ensure we continue to meet our customers' needs, while also delivering positive movement in pricing. As COO, I'm excited to build upon my deep knowledge and understanding of our markets and operations to enhance collaboration across our segments and create a more holistic Baxter experience for our customers and the patients they serve. I'm confident that, by harnessing our combined strength and expertise, we can unlock significant value and accelerate our efforts to drive customer-inspired innovation for all of our stakeholders. I look forward to partnering with Brent, Joel and the entire Baxter team, as we work to achieve our strategic objectives and deliver exceptional results. I'll now turn it over to Joel to discuss our financial performance in more detail. Joel?"
},
{
"speaker": "Joel Grade",
"content": "Thanks, Heather, and good morning, everyone. I'm happy to be joining the call this morning to provide some additional details on Baxter's fourth quarter and full year 2024 financial performance, as well as commentary on our financial outlook for 2025. As Brent mentioned, we're very pleased with our fourth quarter results and how we ended the year. Our results came in ahead of our prior guidance on both the top and bottom lines, driven by better-than-expected sales and solid operational performance. Fourth quarter 2024 global sales from continuing operations of $2.75 billion increased 1% on a reported basis and 2% on a constant-currency basis, and compared favorably to our previous guidance, which calls for sales to decline in low single-digits. Outperformance in the quarter was broad-based and reflected positive sales across most of our product additions. As expected during the fourth quarter, Hurricane Helene negatively impacted our sales by approximately $110 million or approximately 400 basis points. Although the overall magnitude is less than the previously anticipated approximately $150 million, given the company's swift recovery efforts. For the full year, Baxter reported sales from continued operations at $10.6 billion, increasing 3% on both the reported and constant-currency basis. Hurricane Helene negatively impacted growth for the full year by just over 100 basis points. On the bottom-line, fourth quarter adjusted earnings per share from continuing operations were $0.58 and came in ahead of our prior guidance of $0.50 to $0.53 per share driven by the favorable top-line results and solid operational performance. In addition, our tax rate came in favorable to our expectations, which offset a negative impact from foreign exchange. On a year-over-year basis, adjusted earnings per share from continuing operations declined 11% in the quarter, primarily due to the negative impact of Hurricane Helene on our results. For the full year, adjusted earnings per share from continuing operations totaled $1.89 per share and increased 11% over the prior year, reflecting solid underlying operational performance and a benefit from non-operational items, including lower interest expense and tax rate. Now I walk through our results of our reportable segments. Commentary regarding sales growth will reflect growth at constant-currency rates. Sales in our Medical Products & Therapies, or MPT segment were $1.3 billion, increasing 1% in the quarter and coming in favorable to expectations. Full year 2024 sales totaled $5.2 billion, advancing 5% and ahead of the prior guidance of 2% to 3% growth. Adjusting for the impact of Julian, MPT sales growth in the quarter would have been approximately 9% and approximately 7% for the full year. Within MPT, fourth quarter sales from our Infusion Therapies & Technologies division totaled $1 billion and decreased 1%. Sales in the quarter benefited from significant growth for our U.S. Infusion Systems portfolio, as the rollout of our Novum IQ pump platform continues to build momentum, with orders coming in from both new and existing customers. Nutrition sales in the quarter advanced double-digits globally, reflecting strength in The U.S. as we continue to build out our alternate sites portfolio. Finally, as anticipated, IV Solutions declined in the quarter due to the impact of Hurricane Helene. Q4 sales in Advanced Surgery totaled $292 million and grew 6% globally. Results in the quarter reflected solid demand and positive pricing for our portfolio of hemostats and sealants across the globe. MPT's adjusted operating margin for the quarter was 16.5% coming in better-than-expected due to the sales outperformance. Margins declined year-over-year, primarily reflecting the impact of the hurricane. In Healthcare Systems & Technologies or HST, sales in the quarter were in line with expectations and totaled $784 million, decreasing 1%. Full year 2024 sales totaled $3 billion and declined 2%. Within the HST segment, sales in the quarter for our Care & Connectivity Solutions or CCS Division were $504 million, advancing 3% globally. Performance in the quarter was driven by 9% growth in The U.S. for CCS, due to continued momentum in our Patient Support Systems or PSS business, which once again delivered strong growth and reflected a benefit from competitive wins in both our Med Surg and ICU product lines, as well as upgrades for existing customers. Total U.S. capital orders for CCS rose 9% in the quarter and increased 15% for the full year. We are exiting the year with a healthy backlog and strong funnel and look to build upon this momentum over the course of 2025. Performance for this division was partially offset by weaker sales outside The U.S., reflecting a difficult comparison to the prior year period, which saw growth of 12% as well as softness in both China and France in the current year. Frontline care sales in the quarter were $280 million and declined 8%. Consistent with commentary over the course of this year, performance in the quarter was impacted by the backlog reductions, which positively contributed to sales in the prior year period. Results in the quarter also reflected the impact of certain market exits and supply constraints, which collectively impacted sales by approximately $15 million in the quarter. We expect the supply constraints that impacted the fourth quarter to be largely resolved for most products in the first quarter of 2025. We believe that performance for this division will also benefit from stabilization of the primary care market over the course of 2025, as well as the launch of several new products in the second half of this year, that are expected to contribute to positive performance for FLC in 2025 and beyond. FLC fourth quarter adjusted operating margins of 18. 5% increased sequentially, considering the trend of sequential margin improvements. Margins declined year-over-year, primarily reflecting higher investments. Moving on to our Pharmaceuticals segment. Sales in the quarter came in favorable to expectations and totaled $643 million, increasing 8%. Full year 2024 sales were $2.4 billion advancing to 7%. Fourth quarter sales within Injectables & Anesthesia of $383 million grew 8%. Performance in the quarter reflected mid-teens growth in our Specialty Injectables portfolio and anticipated rebound from the third quarter, which was impacted by the timing of some orders. Growth is driven by strong demand for U.S. pre-mixed products and the continued rollout of new products as well as the benefit from targeted sales and marketing initiatives that have been implemented. As expected, lower sales of inhaled anesthesia, which declined at mid single-digits slightly tempered overall performance for the injectables and anesthesia. Within drug compounding, continued demand for services resulted in strong growth of 9% for the quarter. Pharmaceuticals adjusted operating margins were 15.9% for the quarter, increasing 600 basis points sequentially. Adjusted operating margins decreased 370 basis points compared to the prior year, reflecting the impact from the MSA entered into following the BPS sale and increased operating expenses to support the new and upcoming launches. Pharmaceuticals team remains focused on expanding margins through improved mix, stabilizing the anesthesia business, driving cost improvements, compounding business and executing our margin improvement initiatives in integrated supply chain. Other sales, which represents sales not allocated to the segment and primarily includes sales of products and services provided directly through certain of our manufacturing facilities were $12 million in the quarter and totaled $67 million for full year 2024. Before moving on to the rest of the P&L results, I wanted to make some comments regarding our continued operations reporting going forward. As mentioned last quarter, due to the change of moving Kidney Care business results to discontinued operations, corporate costs that have previously been allocated to the Kidney Care segment that would not convey with the Kidney Care business in the sale are now reported in unallocated corporate costs. As we previously commented, we plan to offset a large portion of these expenses in 2025, through incomes we receive for Vantive under the transition services agreements or TSAs as well as cost containment initiatives the company is already in the process of undertaking. Our goal remains to fully offset the impact of these stranded costs and the loss of TSA income by the end of 2027. Fourth quarter adjusted gross margin from continuing operations was 44.5%, coming in favorable to expectations and reflecting a sequential improvement of 80 basis points. On a year-over-year basis, adjusted gross margins declined slightly by 10 basis points, driven primarily by the impact of Hurricane Helene, higher spend within such a manufacturing plant to support product growth, as well as the impact of the manufacturing supply agreements following the sale of EPS. Positive contributors to margin in the quarter were ongoing benefits from our margin improvement programs within our integrated supply chain network, as well as favorable product mix and pricing initiatives in select markets. Adjusted gross margin from continuing operations for the year totaled 43.5%. Fourth quarter adjusted SG&A from continuing operations totaled $679 million or $24.7 million, as a percentage of sales, an increase of 190 basis points from the prior year period, as we continue to make select investments to support our growth objectives and new product launches. This increase also included approximately $30 million of select discrete items that are not expected to repeat, including increased employee health care expenses, due to high cost medical claims incurred during the quarter, fees associated with our tax optimization program and phasing of stock compensation expenses. These higher expenses were offset by benefit from lower stranded costs. Full year 2024 adjusted SG&A totaled $2.66 billion and represented 25% of sales. Adjusted R&D spending from continued operations in the quarter totaled $131 million and represented 4.8% as a percentage of sales, an increase of 10 basis points compared to the prior year period, and reflects our continued investments in advancing new products across the portfolio and bringing innovation to patients across our segments. 2024 full year adjusted R&D totaled $510 million or 4.8% as a percent of sales. These factors resulted in an adjusted operating margin of 15.2% on a continuing operations basis, coming in favorable expectations and improving 70 basis points sequentially. Compared to the prior year, adjusted operating margins from continued operations decreased 190 basis points, driven by the factors I just discussed, as well as the unfavorable impact from foreign exchange. Full year 2024 adjusted operating margin from continuing operations was approximately $1.5 billion or 13.9% of sales. Net interest expense from continuing operations totaled $90 million in the quarter, an increase of $18 million versus the prior year period, reflecting lower interest income. For the full year, net interest expense totaled $341 million, decreasing $98 million and reflecting the benefit of our debt repayment initiatives. Adjusted other non-operating income totaled $4 million in the quarter compared to income of $10 million in the prior year period. For the full year, adjusted other non-operating income totaled $38 million compared to $5 million of income in the prior year period, primarily reflecting lower foreign exchange losses. The continuing operations adjusted tax rate for the quarter was 10.8% and came in lower-than-expected. For the full year, the continuing operations tax rate was 17.5%. Both the full year and fourth quarter tax rates reflect the benefit of initiatives we have undertaken to optimize our global tax rate. And as previously mentioned, adjusted earnings from continuing operations were $0.58 per share for the quarter and decreased 11% versus the prior year. Positive contributions to earnings include improved commercial performance for new product launches and positive pricing. In the quarter, these drivers were offset by the negative impact of Hurricane Helene, which we estimate impacted our results by approximately $0.10 per share, and an unfavorable impact from foreign exchange and interest expense of approximately $0.06 per share. Full year 2024 adjusted earnings per share from continued operations totaled $1.89 per share, an increase of 11% as compared to the prior year period. Let me conclude my remarks by discussing our outlook for the full year 2025 and the first quarter of 2025, including some key assumptions underpinning the guidance. All guidance provided excludes the impact of Kidney Care discontinued operations. For full year 2025, Baxter expects total sales growth of 5% to 6% on a reported basis. This guidance includes an approximate 200 basis points negative impact from foreign exchange based on current rates, as well as approximately $345 million of anticipated MSA revenues from Vantive. Operationally, Baxter expects sales to grow 4% to 5%. This guidance excludes the impact of foreign exchange, MSA revenues and the planned exit of IV Solutions from China as the company continues to focus on driving profitable growth. The negative impact from exiting the IV Solutions business in China is approximately 50 basis points to growth. Operational sales guidance for the full year by reportable segment is as follows. For MPT, we expect sales to increase approximately five percent, driven by continued momentum with our Novum IQ launch, the benefit of positive pricing in The U.S. and other underlying business momentum. This guidance excludes the impact of exiting the IV Solutions market in China, which is estimated to impact sales growth by 120 basis points. Sales in our HST segment are expected to increase approximately 3% and is expected to be balanced across both CCS and FLC. We expect pharmaceutical to increase approximately 5% to 6%, driven by mid single-digits growth in both specialty injectables and drug compounding. Now turning to our outlook for other P&L line items. As previously shared, we expect full year adjusted operating margin from continued operations to total approximately 16.5% and includes TSA income of approximately $125 million. We expect our non operating expenses, which include net interest expense and other income and expense to total between $250 million to $270 million. On a continued operations basis, we anticipate a full year tax rate of approximately 19.5%. We expect our diluted shares count to average approximately $550 million shares for the year, which does not contemplate any share repurchases. Based on all these factors, we now anticipate full year adjusted earnings on a continued operations basis of $2.45 to $2.55 per diluted share. This outlook includes an estimated negative impact of approximately $0.03 per share from foreign exchange based on current rates. A couple of other quick comments I'd like to make regarding our outlook for 2025. First, I'd point out that our current guidance includes a slight impact from tariffs enacted in China, but does not reflect any impact from potential tariffs that are contemplated for Mexico and Canada, given the validity of the situation and potential for further delays implementation and possible exemptions. Second, in 2024, costs that have previously been allocated to Kidney Care that did not convey with the discontinued operations presentation were reported in unallocated corporate costs. Starting in 2025, these costs will be allocated to the three segments along with related TSA income. Specific to the first quarter of 2025, we expect continued operational sales growth of approximately 3% to 4%, on a reported basis, and approximately 4% on an operational basis. For the first quarter, foreign exchange is expected to negatively impact the top-line by more than 200 basis points and MSA revenues are expected to total approximately $60 million. The China IoT Solutions exit is expected to impact top-line growth by approximately 60 basis points in the first quarter. On a continuing operations basis, we expect adjusted earnings per share of $0.47 to $0.50 per share. This guidance reflects the impact of closing Vantive on January 31st, which negatively impacted earnings per share by approximately $0.04 in the quarter, as compared to the closing of the sale on December 31, and we've been able to close on that date. With that, we can now open up the call for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] I would like to remind the participants that this call is being recorded and a digital replay will be available on the Baxter International website for sixty days at www.baxter.com. Thank you. Your first question comes from the line of Robbie Marcus with JPMorgan. Please go ahead."
},
{
"speaker": "Robert Marcus",
"content": "Great. Good morning and thank you for taking the questions. Two from me. First, Joel, how should we think about with all the moving pieces on the top and bottom-line, the cadence for 2025? Sure."
},
{
"speaker": "Joel Grade",
"content": "Good morning, Robert. Thanks for the question. So I'll start on the sales line. And as you know, we normally have some ramp in our business over the course of the year, but there's a couple of things I'd call out this year specifically. First and foremost is, in the -- I'd say the first quarter, we're taking somewhat more conservative approach in the sense that we're still recovering from the hurricane. And so, we've given ourselves a little bit of, I'd say, conservatism to see how that all plays out. So I'd say, despite what should be relatively easier comp with HST, certainly there's going to be an element of assets built into the first quarter from a conservatism standpoint. I would say, the other thing I would call out over the course of the year is that, in the fourth quarter, we do anticipate that being a larger quarter in the sense that obviously we're comparing up against the impact from Helene. So those are couple of things that I'd probably call out from a cadence perspective on the top. From an earnings perspective of the OI, yes, I think the main thing I'd call out there is that we do anticipate a continued ramp over the course of the year, mostly driven by the impact of our stranded cost work that will be kicking in and continue improvements over the course of the year. Obviously, that's what we've already started to do, but obviously that will continue to build over the course of the year. And so, therefore you can expect some ramp from earnings perspective for that reason."
},
{
"speaker": "Robert Marcus",
"content": "Great. Maybe a quick follow-up. The HST business especially frontline care was still negative growth this quarter. What's the latest you're seeing there, the confidence you could turn it around in 2025 and your level of visibility to it? Thanks."
},
{
"speaker": "Joel Grade",
"content": "Yes. So I'd say a couple of things there. I mean, first of all, we are anticipating a stabilization of the Primary Care markets, and we certainly have seen some of that, and are starting to see that even as we head into the first quarter. So, I think that obviously had a substantial decline in 2024. And so, from that perspective, I think the stabilization of that market is an important piece of this. Yes, certainly, as you know, we do anniversary some difficult comps over the course of the year, for example, things like some of the government orders, some of the things that were against, some of the stimulus packages, some of the spending things in the backlog, we're up against in 2024 versus 2023. We don't have those headwinds to the extent that we did, obviously as we ended the 2025. So I think that's another important piece of this. And then I think some of the things we called out in the prepared remarks around some of the things of supply constraints, I think that, we're looking to resolve that I think Q1 of this year. And so, I think generally speaking, some of the impacts that we had last year, we won't be up against in the same way this year. And in addition to that, in a little bit of longer-term perspective, we do have some interesting new product launches that are coming out with the older practice certainly more later in the year than '26. But that's sort of reasons we feel confident in that. I know you asked about that, Steve, but just from the perspective of CCS as well. One of the other differences this year versus last year was, as you recall, we ended the last year with an order book that actually had quite a bit of softness in it and had an impact in the early part of the year last year. As we talked about in the second half of this year, our order book in CCS has remained quite strong, particularly in PSS U.S. And so, we ended this year with certainly a lot better momentum in that business as well. So I think the combination of those things, Robert, give us a perspective on how why we think there's a good opportunity for some recovery this year, I think, at HST overall."
},
{
"speaker": "Robert Marcus",
"content": "Appreciate it. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of David Roman with Goldman Sachs. Please go ahead."
},
{
"speaker": "David Roman",
"content": "Thank you. Good morning, everybody. Heather, congratulations on the new role. I'm looking forward to working with you in this capacity. And Claire, thank you and the finance team for the extensive financial information here. Super helpful as we look at the company post Vantive. For my first question. The past several years for Baxter have been characterized by exogenous events like Hurricane Helene, elevated inflationary pressures, the transition with the Hill Rom deal and the strategic actions you've taken with BPS and Vantiv. Can you help us think about the direction of the company from here and how you're thinking about strategic priorities and maybe at the same time give us a flavor for how that fits into the profiling characteristics if you go to the CEO search?"
},
{
"speaker": "Joel Grade",
"content": "Absolutely. I'll start and then Brent can add anything, and he'd like to on the second piece of that. Obviously, Dave, you're right. There certainly has been a lot going on here at Baxter. But what I would say, first of all, this company has done an amazing job of working through these transformational efforts here over the last couple of years and really set us up in a good place for this company moving forward. And so, how do I think about priorities for the company? And again, certainly, we'll roll on this Capital Markets Day sometime after the CEO has been named. But we're starting. I would say, it starts with customer inspired innovation. These are things that we as a company want to make sure that we are driving innovative products and opportunities, obviously, inspired by our customers. We're certainly going to have a focus on targeted markets. I would say, it's one of the kind of the grow of the growers. How do we find those opportunities where we can actually invest our capital in places that ultimately going to drive growth for the organization? I'd say, the third thing really I think about it is how do we optimize the structure of our company, obviously with the sale of the Kidney business, optimizing both our cost structure from a standard certain cost perspective, but also optimizing our supply chain and some of the things that allow us to take advantage of some of the more simple supply chain opportunity without having to have our whole deliveries of the Kidney business. So that's the third thing. I'd say fourth is really around this concept of commercial excellence and how do we drive consistent execution as a company as a key focus. The last I'd say is really around disciplined capital allocation, those things that allow us to both focus on driving growth, both organically and again in a folded tuck-in way inorganically, but that also balance with returning value to shareholders. So I would call those things really out as how to think about our company moving forward. And again, I'll turn it over to Brent in terms of just how does that really fit into the process of the CEO search. Brent?"
},
{
"speaker": "Brent Shafer",
"content": "I'd just add, in this transition period, certainly, I'm looking for stability, predictable, consistent, strong results. And by Joel, I give tremendous credit to this organization for all the things they have worked through, many of them very complex projects, time-consuming, et cetera. So directionally starting to move the organization to more of an emphasis on growth, both through innovation and through commercial execution is in the short-term moves we can make that accelerate progress in the company. And as far as CEO search and how we're looking at that at the Board level, that work is already underway. And as you can imagine, there's a pretty good profile of Baxter's portfolio, where we are at this point in time. So the experience that we're looking for would be appropriate with the company's situation and opportunities in front of us. So the fact that candidates need to have that experience and a vision that can lead the company forward to its next chapter. And having been here and now been on the board and just working with this management team, I just think there is phenomenal opportunity here because so much heavy lifting has been done over the last few years to streamline and to put this new vertical organization in place, which I think is a real winner honestly. It's a great opportunity."
},
{
"speaker": "David Roman",
"content": "Thank you. And maybe just a quick follow-up on the financial side. Joel, can you walk us through the post Vantive sale capital structure of the company and maybe update us on target leverage ratios and the timeframe to achieve that?"
},
{
"speaker": "Joel Grade",
"content": "Yes, absolutely. So maybe I'll start with the leverage ratio. Certainly, what we've talked about, we're continuing to be committed to is a target leverage ratio around 3x net debt-to-EBITDA. And I think that is a level that gives us again, this opportunity to both balance strategic investments as a company and as well, again, return value to shareholders in a way that I think balances on our capital structure. We anticipate being able to achieve that term of leverage by the end of 2025. We'll certainly have it sometime in the later part of the second half of the year. Feel good about that. Obviously, since the deal closed with Vantive, we paid down nearly $3 billion of debt. The first part of it was taking out our delayed raw turbo that we had taken out earlier in 2024. And then, we also paid off a portion of $1 billion with 2026 term loan that was actually our highest coupon debt. So I guess I would say, between that work and our continued efforts in terms of driving free cash flow out of the organization, I feel comfortable with the fact that we're heading towards that target. That will allow us to really to be to adjust our capital allocation priorities from what's been mostly paying down debt to those areas that would allow us to get to get continued investments in driving organic growth, continued opportunities for folding tuck in opportunities, will that make sense? And the opportunity to restart the buyback program. Certainly, initially, the offset option dilution and I'd say opportunistically from there."
},
{
"speaker": "David Roman",
"content": "Terrific. Thanks so much."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Matt Miksic with Barclays. Please go ahead."
},
{
"speaker": "Matt Miksic",
"content": "Great. Thanks so much for taking the questions. Congrats on a nice end to this busy, busy year. So I wanted to follow-up on some of the comments you've made on new product investments and product pipeline. If you could talk a little bit about, which business lines those -- which you'd highlight and then maybe timing, as to when we might start to see some of the benefits of these investments? And then, I have one follow-up."
},
{
"speaker": "Joel Grade",
"content": "Sure. So really, let me start with the fact that, it's really across our portfolio where we actually have really some innovation happening here. And certainly, I would start with Heather's business and FLC. Obviously, the Novum pump has been a resounding success. It's a differentiated product that, again, has got a great customer response. The launch has gone extremely well. Obviously, we got a partial year of that growth last year in 2024, we'll have a full year of that growth heading forward here in 2025. So certainly Novum is obviously a huge, key part of our innovation and again really a great success story. Certainly in pharma, one of the things that you heard from us talk about Pharma is our need and our opportunity to continue to accelerate with new product launches in pharma. This past year, we launched nearly 10 and we anticipate another double-digits year heading into 2025. That is something we should expect from us to continue to do. And while there's not necessarily one large molecule that you can tie something to, that level of activity is something that we are committed to and we have a great pipeline of opportunities ahead of us. I would tell you that, the effect of that, you see the growth we've had in our pharma business and so you're seeing the impact of some of that that's already happened and we anticipate as we head into next year, again another solid year from Pharma in terms of their innovation as well. From an HST perspective..."
},
{
"speaker": "Matt Miksic",
"content": "Great. Yes. That's super helpful. The one other comment I wanted to make is maybe a follow-up on, Robbie's, on HST. Just the environment for sort of capital and some of the patient support devices and other things that you're selling, fleets and beds, et cetera, that you're selling in hospitals, just maybe a general comment on that environment, demand cycles, sector trends, anything that can help us gauge where that business is going? Thanks so much."
},
{
"speaker": "Joel Grade",
"content": "Yes, absolutely. Thanks for the question. Yes, so I would say generally speaking, the capital environment is quite good. I think, as we talk about this year, our capital orders particularly in PSS in The U.S., especially in the second half of the year, have actually been very consistent. And over year-over-year, we've had about a 15% growth in those orders, which obviously, there's a timing element in terms of when the orders turn into cash or turned into a sale. But we certainly headed this next year with some good momentum, and we expect to continue to build on that momentum as we head into 2025. So I would say, generally speaking, the capital environment is quite good, both from, I'd say, the monitoring the patient monitoring devices as well as from a beds perspective. Obviously, we've had continued success with our Progressive Plus model as well. So I think overall the environment is healthy. We're encouraged by some of the competitive wins that, we've had in those areas. As I said, we're anticipating some new products coming up that will benefit us as we get to go to that area as we have in 2020."
},
{
"speaker": "Brent Shafer",
"content": "This is Brent. I just had a comment here. I believe from what I've seen, there has been a significant improvement in the commercial organization in The U.S. particularly, in those categories. And so I think we're seeing the benefit of upgrades made in that area and real rigor around the commercial processes there. So a credit to those teams."
},
{
"speaker": "Matt Miksic",
"content": "Excellent. I appreciate the color."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Vijay Kumar with Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "Hi, guys. Good morning and thank you for taking my question. Joel, maybe my first question on TSA and margins here. I know the optics, these are apples-to-oranges comparison rate, but the year on year, it does look margins were up 250 basis points. So if you can just break that down, right? What is TSA? How much of this was stranded costs, which were there in fiscal 'twenty four and that's going away? What is pricing elements here? And did the China IV fluid exit, is that a headwind or a tailwind to margins?"
},
{
"speaker": "Joel Grade",
"content": "Okay. Thanks for the question, Vijay. Let me start with, I guess, I think the easiest way to bridge our what ended the year at 13.9% to our target that we've talked about and guided to a 16.5%. I think the way to think about that is that, if you take the 13.9% and you add about 40 basis points for the 2024 impact of Helene, and then you add about 220 basis points of what would be a the stranded cost impact, and then you think about 100 basis points, what I'm going to call operational improvements as we head into 2025, those are things like light pricing, particularly in The U.S. in our MPT business. Those are things like product mix. One of the things that we talked about is the improvement of our injectables portfolio, the higher growth in our advanced surgery, the improvement in HST, all of our mix elements that add to are positive there. We talked about some of the leverage from that we get from volume growth. And so, I think -- again obviously some of the things we talked about new product launches, that's where you get that 100 points of benefit. And obviously, we're reinvesting some of that, but that's a key element of it. And then, there's two elements of the stranded cost and the MSA is that are in the opposite direction. So there's 40 basis points, I'll call the net impact of stranded cost that hasn't yet been addressed in 2025 and about a 60 basis point impact of dilution from MSA revenues that are obviously generating lower margin, low single-digit margin from a gross profit perspective. So that really is the bridge. And so that takes you from the 13.9% to the 16.5%. So hopefully that gives you some perspective on that. Can you repeat your second question?"
},
{
"speaker": "Vijay Kumar",
"content": "No, that was extremely helpful, Joel. But my second one was on, if I look at the performance in the quarter, it looks like the beat was just more than the headwinds from Hurricane Helene coming in slightly better than expectations, right? Can you quantify what the headwind from Helene was in the quarter? And what drove the hurricane impact? It looks like pumps was very strong. So maybe some commentary around pump performance?"
},
{
"speaker": "Brent Shafer",
"content": "Yes. I'll start with the quarter, but then I'll pass it over to Heather to talk a little bit about the performance of the IVS and pumps in the quarter. Obviously, the headwinds for Helene, was 100 basis points in the quarter."
},
{
"speaker": "Heather Knight",
"content": "Yes, about $110 million on the top-line and $0.1 on the bottom-line."
},
{
"speaker": "Brent Shafer",
"content": "But obviously, the great news on that is, actually we over-performed in terms of the recovery time, in terms of offsetting some of that. I don't know, maybe Heather, I'll give over to you to talk a little bit about some of that."
},
{
"speaker": "Heather Knight",
"content": "Sure. Hi, Vijay. Good morning. Nice to hear from you. So we did better in Q4 with the swift recovery of our Northcove site, thanks to the great work of our team. So about $45 million better on IV Solutions as a result of the swift recovery that we had out of that location. So we did see strength across our infusion therapies business and the infusion pump platform in particular in the fourth quarter. So I'll say, we're very happy with the launch of Novum IQ and where we are. The teams are doing a great job driving this new platform. If you recall, Baxter placed a pretty big bet to internally develop a brand new to market and novel infusion pump platform both with the hardware, software and digital platform and we're seeing it pay off. So our infusion business grew 50% last year in 2024, and we're expecting another great year this year in 2025. And it's not only important, because we get the revenue from the hardware and software, but also because we get to pull through very consistent revenue over the life of that pump. So share capture, competitive gains are really important. And customer satisfaction right now is very high, both on the implementation of the pump as well as the EMR integration with the new platform. And this was developed in collaboration with our customers. Again, we're starting to see the benefit of that. We took multiple points of market share last year in 2024, and we're expecting to see more of the same more competitive gains in 2025. And then, we have some new complementary digital suites that are now launching that will be a great complement to this launch midyear in 2024 that we released. So I'll tell you, I'm pretty excited about where we are in this new chapter, the new pace, momentum that we're building around the Novum platform. And IVs are stable. We've gone through the GPO resign, and are in line with our expectations, if not slightly better than we expected. So we're expecting a great rebound in 2025 and certainly really appreciate our customer support during the recovery of Hurricane Helane, and hats off to the Baxter team for the fast recovery. But thanks for the question today."
},
{
"speaker": "Brent Shafer",
"content": "Yes. This is Brent. I'd just like to recognize Heather and her team and really all the folks who worked on North Cove recovery. It's hard to explain it in a financial setting, but the work to deal with the disaster situation, to work through that effectively, bring the plant back up and really look after the community at the same time. It's just world-class response by the folks who were involved. And I personally want to thank them all, especially Heather."
},
{
"speaker": "Vijay Kumar",
"content": "Thank you. Very helpful answers."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Travis Steed with Bank of America Securities. Please go ahead."
},
{
"speaker": "Travis Steed",
"content": "Hi, thanks. I'll follow-up a question on the saline side and obviously a great job on the fast recovery. I think it went better than most expected. I was just thinking about how you think about the book of saline business kind of before and after the hurricane. Did you see customers add a second source and how you're kind of thinking about the share of that? And then I had a follow-up question on free cash flow."
},
{
"speaker": "Heather Knight",
"content": "Yes. Thanks for the question, Travis. So as I mentioned to Vijay, I mean, our expectations are in line or even slightly better. I think because of the flat fast recovery that we had quite honestly out of North Cove, we're not seeing as many customers take on a second particular because as we mentioned we're at pre-hurricane levels started at this point. So, new U.S. GPO contract is particular stated on January 1st and February 1st. So now that we've fully recovered, most customers are still committed to their remaining compliance and minimum committed volumes that they've given to Baxter. So, we're pleased with the response and our customers sticking with Baxter during this time. We know the fourth quarter wasn't easy for them, but we proved to them the resiliency that we have and the investments, quite honestly, that we've made over the last few years and our global network and activating that during Helene certainly helped and relieved some of the pressure. So we think that that's pretty unique to Baxter and the hundreds of millions that we've invested in our platform and IV solutions due to the critical nature that they play in health care. Again, in line are slightly better and are working closely with our customers to make sure that they can resume normal clinical practice as they've had and patients can get the critical solutions that they need."
},
{
"speaker": "Travis Steed",
"content": "Great. That's helpful. And then, I did want to ask on free cash flow generation. I know there's a lot of adjustments this quarter. How should we think about some of these adjustments going forward? When do you think you can kind of get back to kind of 80% free cash flow conversion? I don't think you gave a guidance for free cash flow next year. I'm curious how you're thinking about that. And then the Frontline Care write down, any more color on that? I don't know, if that's kind of a change in the growth expectations for that business long-term."
},
{
"speaker": "Joel Grade",
"content": "Yes. Thanks, Travis. So on free cash flow, the way I would think about that is that, we have talked about the fact that we want to have an 80% conversion of net earnings free cash flow. And I expect that to be, generally speaking, what we'll do in the course of the year with one caveat to that. And that is in the first quarter, we're anticipating some negative impacts from think about it this way, it's two things from working capital perspective. Number one is some of the expenses we incurred in Q4 related to Hurricane Helene actually going to be paid in Q1. And then secondly, there's going to be some level of restock from an inventory perspective that's going to have a negative drag on cash. So I would think about that number for this year as somewhere more like in the low 70s, but that is mostly impacted by the first quarter, and I anticipate a much more normal cash conversion in the second few quarters of the year and obviously going forward. We'll hopefully continue to improve that as we go forward. Regarding the write down of Frontline Care, the way I would look at that, Travis, is we do a once a year review of our goodwill and other tangible as it relates to those assets. And 2024 was obviously an impactful year from an FLC perspective. So I guess I'd characterize it more as an impact to 2024 on the model than I would any type of overarching concern about the growth prospects going forward."
},
{
"speaker": "Travis Steed",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Lawrence Biegelsen with Wells Fargo. Please go ahead."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Good morning. Thanks for taking the questions and congrats on the nice finish to the year here. Brent, I was hoping to ask you two questions. First, David earlier in the call talked about the challenges Baxter's had in recent years. How do you think about the pros and cons of an external versus internal candidate for CEO bringing in fresh perspective versus someone who kind of already knows Baxter? I have one follow-up for you."
},
{
"speaker": "Brent Shafer",
"content": "I mean, that's the big question, I guess. And the Board is very focused on that because there are pros and cons to either solution. Obviously, an internal candidate knows all the details of the business, how it runs, how it operates? An external one can bring a fresh perspective, but they have to ramp-up quickly to try to catch that same level of knowledge, which takes a while, especially in a complex business. So I can just tell you that, it is a full Board activity. The Board is very focused on this. And though they would like to move as quickly as possible, the general sense is, it's more important to get the right fit for the company, at this point in time than it is to necessarily be quick. So I hope that gives you a little flavor for it."
},
{
"speaker": "Lawrence Biegelsen",
"content": "That does. Thank you. Secondly, Brent, how did you evaluate the guidance as interim CEO? And how do you think about the process for the permanent CEO to re-evaluate it? You know that, just to be candid, you know the investors typically think a new CEO will come in and want to put his or her stamp on the guidance, may want to change investment priorities and things like that. How did you think about that? Thanks for taking the question."
},
{
"speaker": "Brent Shafer",
"content": "How do I think it, coming in as an interim, you mean?"
},
{
"speaker": "Lawrence Biegelsen",
"content": "Yes, I mean, is there a risk the new CEO comes in and says, we need to invest more and changes the guidance?"
},
{
"speaker": "Brent Shafer",
"content": "Yes. I think at a Board level, seen the three year look at the business and are aware of the details and the drivers. And being on board now and in the business, I feel good. I feel like there are solid plans in place. Of course, when you have another person at the helm and I'm interim leader, so my focus is really on executing the plans that are in place. Another person may put a different filter on it, but the general situation around our markets and our offerings are known very well in the business. So anything -- anyone coming in would be building on that. I guess that's all I can assume. It's kind of a hard question to answer because it depends."
},
{
"speaker": "Joel Grade",
"content": "I think the one thing I would just give Brent the opportunity and he's talked about it. I would just reiterate the fact that this is a great opportunity for someone to come in and I guess Brent has a perspective on that and maybe could share that as well. But I think as we talked about some of the key strategic initiatives that have done over these last three years, there's really last couple of years, there's a really nice opportunity for someone to come in here and take a company that really I think is actually set up well for success. And so, I don't know if Brent is a good company."
},
{
"speaker": "Brent Shafer",
"content": "Yes, I'll comment a little bit about that. I mean, the organization, as you know, has been consumed with a lot of project work, very tough, detailed work working through these separations, the spins. And there is a real energy in the organization to turn now to growth and innovation. And so, you can feel it. You really can. That is a real opportunity here. There are good leaders ready to move it forward. And I think whoever comes into the role that is the key piece to drive is that, profitable growth from the base that's been done now, because a lot of clean-up has been done."
},
{
"speaker": "Lawrence Biegelsen",
"content": "All right. Very helpful. Thank you for taking the questions."
},
{
"speaker": "Operator",
"content": "The next question comes from the line of Danielle Antalffy with UBS. Please go ahead."
},
{
"speaker": "Danielle Antalffy",
"content": "Hi. Good morning, everyone. Thank you so much for taking the question. And, Heather, excited to work with you. Just a quick question. Actually, Larry's question is a good segue into Brent and Joel and Heather. Just as we look to 2025 and sort of some of the pipeline drivers specific to 2025 and maybe even 2026. I know you guys talked about, like, 10 product launches in pharma, for example. But any color you can give on sizing these and what we as analysts and investors can look forward to over the next 12 to 24 months? And that's all. Thanks so much."
},
{
"speaker": "Joel Grade",
"content": "Sure. I'll start and others can chime in as they like. So I guess, I'll start with what I call a few of the kind of key drivers as we think about our guidance in 2025 and the year ahead of us. Number one, we continue to have strong growth in MPT. I think, obviously, as we mentioned a little earlier, the full year of the Novum launches, again, we're really excited about that. Advanced surgery, we're anticipating good single-digits growth there. And our clinical nutrition business was actually kind of an interesting notice and started to get the penetration into the ASC space. So we've seen some nice growth there and anticipate that continuing into the next year as well as the impact of GPO pricing. That's a strong element in that business. We talked a little earlier about the recovery of HST and the continued momentum on the capital side of the particular PSS in The U.S. as well as the stabilization of FLC. We talked about pharma, as sort of the key of the innovations of new product launches and the mix improvement there of injectables relative to compounding, I'd say, even stabilization on the anesthesia side. I think that's really on the top-line. And then the drivers of the line that I talked about here, again, some of the GPO pricing, the new product launches, the mix, continued improvements in our ISC, our supply chain with our margin improvement programs and volume leverage. And then, over the course of the year, continued impact from driving out some of the stranded costs that we've talked about here. So I think those are really the things to look forward to. And then, from a new product launch perspective, just in general, again, a renewed focus on that and accelerated focus there. So some impact in the ways I talked about '25, but also sets up for some impact beyond that."
},
{
"speaker": "Heather Knight",
"content": "I'll chime in. Yes, I'm looking forward to working with you too. This is Heather. So some things that I'm excited about, I mean, the pump platform, as I mentioned, is something that we will continue to build on and we have additional launches to support Novum IQ and a gateway now that can work across our entire portfolio. So really excited about that and a connected ecosystem in the hospital, which is going to help clinical decision support and more personalized patient care. I mean, that's something that was the original thesis of the Hillrom acquisition and we're starting to really see good pilots and momentum with our customers on that. HST is going to be introducing some new products. They've got launches coming out throughout 2025 and early 2026. We're still seeing great momentum on Progressive Plus and PFS, so that continues to pay good dividends and taking market share there. And then, Pharma is hitting a really exciting cadence of new product launches, getting into more complex molecules, 10 to 12 launches a year that are really going to help buoy. And as Joel mentioned, the margins of that business, they're really focused on that, and when they hit this innovation cycle that they're on right now. So those are some of the things that I'm personally excited about. And then he mentioned alternate site. We made investments two years ago in alternate site in The United States and we are starting to see dividends paid there in the nutrition portfolio with some small tuck-ins licensing and distribution deals that we did in MPT and those are starting to bear fruit. So that momentum in The U.S. will continue. So those are just a few things that I'm personally excited about. So when I talk about a new rhythm, a new pace and momentum that's building, we're definitely starting to see that across the portfolio and those investments that we made bearing fruit now moving into 2025 and 2026. Thanks for the question."
},
{
"speaker": "Brent Shafer",
"content": "Yes. Thanks, Heather. This is Brent. I'd just add to that. I sort of referred to it, but really starting right now, we're putting the emphasis on accelerating time to market innovation development. So that is an area of very strong focus right now is how to speed up that whole innovation cycle, and get product solutions to market faster. So that will be ongoing work. Thanks for your questions."
},
{
"speaker": "Danielle Antalffy",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, those are all the questions the time allows us to take. Therefore, that concludes today's question and answer session and today's conference call. We thank you for your participation. You may now disconnect."
}
] |
bax | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, ladies and gentlemen, and welcome to Baxter International's Third Quarter 2024 Earnings Conference Call. Your lines will remain in a listen-only mode until the question-and-answer segment of today's call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time. I would now like to turn the call over to Ms. Clare Trachtman, Senior Vice President, Chief Investor Relations Officer at Baxter International. Ms. Trachtman, you may now begin."
},
{
"speaker": "Clare Trachtman",
"content": "Good morning and welcome to our third quarter 2024 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Joel Grade, Baxter's Executive Vice President and Chief Financial Officer. On the call this morning, we will be discussing Baxter's third quarter 2024 results, along with our financial outlook for the fourth quarter and full year 2024. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the fourth quarter, full year 2024 and 2025, the status and anticipated timing and impact of our ongoing strategic actions, including the proposed Kidney Care sale and cost savings initiatives. Regulatory matters and the macroeconomic environment on our results of operations contain forward-looking statements that involve risks and uncertainties, and of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of certain non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in the accompanying investor presentation and also available in our earnings release issued this morning, which are both available on our website. Please note, following the announcement of Baxter's pending sale of our Kidney Care business to Carlyle, the Kidney Care business met the conditions to be reported as a discontinued operation. Accordingly, the Kidney Care business is now reported in discontinued operations and the company's prior period results have been adjusted to reflect the discontinued operations presentation. Restated historical results reflecting the Kidney Care segment as a discontinued operation for the prior six quarters can be found on Baxter's website in the Investor Relations section. Discontinued operations for 2023 also include Baxter's former BioPharma Solutions or BPS business, which was divested at the end of the third quarter of 2023. Current and prior year periods now reflect the continuing operations of Baxter's Medical Products & Therapies, Healthcare Systems & Technologies and Pharmaceuticals segment. Now I'd like to turn the call over to Joe. Joe?"
},
{
"speaker": "Joe Almeida",
"content": "Thank you, Clare, and good morning, everyone. We appreciate you taking the time to join us today. I will start with a brief update on the hurricane recovery progress at our North Cove, North Carolina facility, followed by some comments regarding our third quarter performance. Joel will provide a closer look at our third quarter results and our outlook for the remainder of the year. We will also share some preliminary thoughts regarding our financial outlook following the completion of the pending sale of the Kidney Care business. Then as always, we'll take your questions. As you know, Hurricane Helene caused unprecedented devastation in Western North Carolina in the closing days of September. This region is home to Baxter's North Cove manufacturing facility, the largest plant in our global network and a critical source of IV and peritoneal dialysis fluids for the US market. I want to first recognize the amazing tireless work of our North Cove team, who have helped rapidly advance the ongoing site recovery efforts, while also navigating the storm's personal toll. Our heart goes out to the entire community and we are so proud of what our colleagues across the Baxter network are accomplishing daily to help return the site to normal operations. In just six weeks, the North Cove team has devoted more than 1 million hours collectively to restoring operations. This dedication was evidenced last week as our highest throughput IV solutions line in North Cove was able to restart production. We also expect to restart a second IV solutions manufacturing line in the coming week. Together, these two lines represent their peak operation approximately 50% of the site's total production. These key milestones were achieved ahead of our original expectations. However, I want to emphasize that in coordination with FDA, the earliest that new North Cove product could start to ship is in late November and more hard work remains as we return the plant to full production. Throughout this effort, our focus has remained squarely on our customers and their patients and our employees. And to this end, we have not spared any resource to ensure the needs of these key stakeholders are prioritized. Parallel to our North Cove recovery efforts, we have activated nine sites across our global manufacturing network to help increase available US inventory to serve our patients and customers and we work to bring North Cove fully back online. As we have shared previously, we anticipate restarting North Cove production in phases by the end of the year and our current expectation is that all lines in North Cove will have resumed production before the end of this year. Throughout this journey, our North Cove and global teams have demonstrated an unwavering commitment to Baxter's life sustaining mission. I also want to express our gratitude to ASPR, FDA and the State of North Carolina and HHS among other federal state and local entities for their steadfast support. And we deeply appreciate the patience and partnership of our customers as recovery efforts continue. We will continue providing updates through baxter.com on planned recovery supply continuity and how Baxter is making a difference for its employees in the community. Now turning to our third quarter performance. Given the pending sale of our Kidney Care business, current and prior period results for this business are now reported as discontinued operations. As Clare mentioned, restated historical results can be found on Baxter's website. For today's discussion, we will be focusing our commentary on total company performance in the third quarter, which includes the impact of Kidney Care in both the current and prior periods, but excludes the impact of the BioPharma Solutions Business, which moved to discontinued operations in the third quarter of 2023. On that basis, total company third quarter 2024 sales grew 4% on both a reported and constant currency basis, in line with our prior guidance. All of our Baxter segments increased year-over-year on both a reported and constant currency basis. As always, we benefit from our focus on essential healthcare needs combined with the diversity and durability of our portfolio. In Q3, strength in our Medical Products & Therapies and Kidney Care segments helped offset softness in the Healthcare Systems & Technologies and Pharmaceutical segments. On the bottom line, total company adjusted earnings per share was continuing and discontinued operations totaled $0.80 ahead of our guidance range of $0.77 per share to $0.79 per share. Performance was fueled by top line strength, continued improvements in integrated supply chain efficiency and disciplined management of operating expenses. Taking a closer look by segment, I will begin with the businesses that will comprise the new Baxter following the pending Kidney Care sale. Medical Products & Therapies led all segments with 7% growth at both reported and constant currency rates, filled by positive demand across the portfolio. I particularly want to highlight the strong uptake of our Novum IQ platform in the US including our large volume pump and syringe pump both between those IQ safety software. The new platform is well recognized across the market as advancing pump connectivity, intelligence infusion therapy and we foresee sustained positive momentum, both through existing customer upgrades and competitive conversions. Performance in the segment also benefited from strength globally in our Advanced Surgery division. Our Healthcare Systems & Technologies or HST segment grew 1% at both reported constant currency rates. Growth was driven by strong US performance in the Care & Connectivity Solutions division, particularly for our patient support systems products, which increased low double-digits in the quarter. This growth was partially offset by decline in US Frontline Care sales largely reflecting the ongoing dynamics impacting US Primary Care market, which we have discussed previously, plus a difficult comparison to the prior year period, which reflected the benefit from backlog reduction efforts. Softness in international Care & Connectivity Solutions also muted overall HST growth as lower sales in China and France impact performance in the quarter. We fully recognize the need to drive continued improvement in the growth profile for both the Frontline Care division and HST as a whole. Our current expectation is that the US Primary Care market begins to stabilize over the coming year. In addition, we are keenly focused on enhancing performance through innovation and launch new products to augment growth in both FLC and the broader HST segment. We have several new products scheduled to launch in 2025 and beyond that we believe will contribute to improved performance for this segment over time. Sales in our Pharmaceutical segment increased 1% on both the reported and constant currency basis. Double-digit growth in drug compounding was partially offset by high single-digit decline in our Injectables & Anesthesia division. Sales of Injectables & Anesthesia were impacted by phasing of selected sales into the fourth quarter, combined with supply constraints impacting international sales. While the performance in the quarter was disappointing, we believe the weakness is temporary and we have already observed a course correction to start the fourth quarter. At the same time, the injectable sales force continues to enhance its new product launch capabilities and remain focused on successfully driving the commercial launch of several new injectables in 2024 and beyond. Now shifting to our Kidney Care segment, which will be known as Vantive following its separation from Baxter. This segment grew 4% on a reported basis and 5% at constant currency driven by both demand and pricing for acute therapies and peritoneal dialysis products. These results reflect positive momentum as the segment prepares to operate as a separate entity. Progress on the pending sale to Carlyle continues with the process well underway. We continue to expect the sale to close in late 2024 or early 2025, subject to receipt of regulatory approvals and other customary conditions. As you know, this sale represents a key milestone across the three pillar strategic transformation we announced in January 2023. These steps also included the realignment of our operating model and the divestiture of our non-core BioPharma Solutions contract manufacturing business, both of which were executed over the course of last year. Taken together, these three transformational actions have been uniformly focused on enhancing value for all stakeholders and are powering our ongoing transformation. In addition, we remain committed to crisp execution of several initiatives across the enterprise, focused on enhancing the efficiency of our operations, heightening the productivity of research and development and offsetting the impact from stranded costs that result from the pending sale of Kidney Care. Post the separation of Kidney Care, we continue to expect our business can deliver 4% to 5% top line growth and achieve an adjusted operating margin of 16.5% in 2025 with annual operating margin expansion thereafter. I'm excited about what we have accomplished to-date, while also recognizing there's still more to do. Our progress as always is due entirely to the hard work and commitment of our Baxter colleagues globally. Whether these efforts involve restoring our North Cove facility, powering our ongoing transformation or delivering on our goals in countless other ways, our colleagues are motivated by unparalleled dedication to advancing Baxter's mission to save and sustain lives. I salute this extraordinary team today and every day. Now I will pass it to Joel, who will provide more detail on our third quarter, our outlook for the balance of the year and our trajectory following the pending Kidney Care divestiture. Joel?"
},
{
"speaker": "Joel Grade",
"content": "Thanks, Joe, and good morning, everyone. Before I begin, I would like to reiterate Joe's remarks regarding the presentation of our financial results for the third quarter. Beginning this quarter, the Kidney Care business is now reported as discontinued operations. The company's prior period results have been adjusted to reflect the discontinued operations presentation and historical restated schedules are available on our website. For comparability purposes to previously issued guidance, commentary surrounding our third quarter performance will be provided on both a total company and continuing operations basis. Now turning to some specific comments regarding the quarter. As Joe mentioned, in general, we're pleased with our third quarter results, which came in line with our expectations on the top line and compared favorably to our previously issued guidance on the top line. Excluding the effect of BPS sales in the prior year period, third quarter 2024 global total company sales of $3.85 billion increased 4% on both reported and constant currency basis. Performance in the quarter reflected better than expected sales in infusion therapies, product therapies, drug compounding and US patient support systems, which more than offset softness in Injectables & Anesthesia and HST. Sales from continuing operations increased 4% on both a constant currency and reported basis with all segments contributing to growth. On the bottom line, total company adjusted earnings including continuing operations and discontinued operations were $0.80 per share, ahead of our prior guidance of $0.77 per share to $0.79 per share. Earnings growth in the quarter was driven by operational performance and lower interest expense as compared to the prior year period. Adjusted earnings from continuing operations, which excludes Kidney Care and BPS from both periods totaled $0.49 per share and increased 14% compared to the prior year. Now I'll walk through our results by reportable segments. Commentary regarding sales growth reflects growth at constant currency rates. Sales in our Medical Products & Therapies or MPT segment were $1.3 billion increasing 7% and coming in ahead of expectations. Within MPT, third quarter sales from our Infusion Therapies & Technologies division totaled $1.1 billion and increased 7%. Sales in the quarter benefited from significant growth for our US Infusion Systems portfolio as the rollout of our Novum IQ pump platform continues to build momentum with orders coming in from both new and existing customers. US Infusion Systems sales in the quarter also benefited from strong customer demand for our Spectrum pump. IV Solutions internationally continued to deliver solid performance driven by favorable pricing and underlying volume demand. Mid-single-digit growth in nutrition globally also contributed to ITT performance in the quarter. Sales in Advanced Surgery totaled $272 million and grew 7% globally. Results in the quarter reflect demand for our portfolio of hemostat and sealants as well as favorable pricing. Strong sales and operational performance in MPT resulted in adjusted operating margin of 20% for the quarter, which represented an improvement of 50 basis points year-over-year and 200 basis points sequentially. For our Healthcare Systems & Technologies or HST segment, sales in the quarter were $752 million and increased 1%. Within the HST segment, sales in our Care & Connectivity Solutions or CCS division were $456 million growing 3%. Performance in the quarter was driven by continued strength in our US Patient Support Systems or PSS business, which delivered double-digit growth. Orders for US PSS capital increased mid-teens in the quarter driven by existing accounts and competitive wins. Performance was partially offset by a weaker sales outside of the US driven by softness in China due to ongoing government policy initiatives and the delay in the release of stimulus funding. In addition, sales in Western Europe declined on a year-over-year basis due to certain market exits and weaker demand due to delayed government funding. While year-to-date, we have seen strong order growth for our care, communications and connectivity business, sales performance has been impacted by the timing of installations as many of our hospital customers are delaying installs to future periods. Our backlog is strong and we have a very low cancellation rate for this business. And as such, we see many of these installs phasing into 2025. Finally, sales for our Global Surgical Solutions or GSS business declined as compared to the prior year period due to ongoing supply constraints, which the company continues to quickly work to remediate and expects to be largely resolved by the end of the year. Frontline Care sales in the quarter were $296 million and declined 2%. Growth in the quarter continue to be impacted by a difficult comparison in the prior year as backlog reductions positively contributed to growth in the prior year period. Performance in the quarter was also impacted by ongoing softness in the Primary Care market. We have been in close contact with our distributor partners, who have also acknowledged the challenging market dynamics in US Primary Care market. Our current assumption is that the market begins to stabilize over the course of 2025. Notably, HST recognized significant expansion in operating margins during the quarter driven by improved operational efficiency. HST third quarter adjusted operating margins of 18.1% increased 260 basis points year-over-year and 210 basis points sequentially. Moving on to Pharmaceuticals. Sales in this segment were $588 million, increasing 1%. Sales within Injectables & Anesthesia declined high-single-digits. Performance in the quarter reflected a mid-single-digit decline in our injectables portfolio driven by a difficult comparison to the prior year period, which benefited from a competitor being out of the market. In addition, sales in the quarter were impacted by some orders shifting to the fourth quarter and the delay of an anticipated new product launch. Supply constraints outside of the United States also impacted performance in the quarter. Lower sales in Injectables & Anesthesia continue to weigh our performance and declined mid-teens in the quarter. As Joe mentioned, we have seen sales rebound in this business to start the fourth quarter. In addition, the injectables team continues to enhance its new product launch playbook, given the volume of new products this team is targeting to launch over the coming months and years. Within Drug Compounding, strong demand for services continued in the quarter, resulting in double-digit growth. Given lower sales in Injectables & Anesthesia in the quarter, Pharmaceuticals margins declined both year-over-year and sequentially. Pharmaceuticals adjusted operating margins were 9.9% for the quarter. The Pharmaceuticals team is keenly focused on expanding margins through improved mix with injectables growth accelerating, taking action to stabilize the anesthesia business, driving cost improvements in the compounding business and executing on margin improvement initiatives in the integrated supply chain. Sales in the quarter for our Kidney Care segment totaled $1.2 billion, increasing 5%. Within Kidney Care, global sales for chronic therapies were $952 million, increasing 5%. Strong PD growth in the quarter was partially offset by the expected negative impact from certain product and market exits in our in-center HD business. Sales in our Acute Therapies business were $203 million, representing growth of 9% driven by strong demand in the United States. Other sales, which represent sales not allocated to a segment and primarily includes sales of products and services provided directly through certain of our manufacturing facilities were $17 million and increased 12% during the quarter. Before moving on to the rest of the P&L results, I wanted to make some comments regarding our continuing operations results. Given the reporting change moving Kidney Care business results to discontinued operations, corporate costs that had previously been allocated to the Kidney Care segment and will not convey with the Kidney Care business and the pending sale are now reported in unallocated corporate costs. These stranded costs negatively impacted Baxter's results in the quarter and prior periods but are expected to be mostly offset in 2025 through income to be received from Vantive under transition service agreements or TSAs as well as cost containment initiatives the company is in process of undertaking. As we previously stated, we currently expect to fully offset the impact of these stranded costs and loss of TSA income by the end of 2027. Third quarter total company adjusted gross margin, including discontinued operations from Kidney Care was 42.5% and represented an increase of 80 basis points over the prior year. The year-over-year expansion in gross margin primarily reflects the continued efficiencies within our integrated supply chain network as well as pricing initiatives in select markets. Overall, product mix partially offset margin expansion in the quarter. Adjusted gross margin from continuing operations totaled 43.7% and declined 110 basis points versus the prior year period driven by mix in the quarter and the impact of the contract manufacturing agreement we entered into following the sale of BPS. Adjusted SG&A, including discontinued operations from Kidney Care, totaled $871 million or 22.6% as a percentage of sales, an increase of 50 basis points from the prior year period as we continue to make select investments to support our growth objectives and new product launches. Adjusted SG&A from continuing operations totaled $665 million or 24.6% as a percentage of sales, an increase of 20 basis points versus the prior year. This increase is partially offset in another P&L line item referred to as other operating income and expense, which reflects income the company has received from TSAs entered into following the BPS sales. Total adjusted R&D spending in the quarter, including discontinued operations for Kidney Care, totaled $169 million and represented 4.4% as a percentage of sales, an increase of 10 basis points compared to the prior year period and reflects our continued investments in advancing new products across the portfolio and bringing innovation to patients across our segments. Adjusted R&D from continuing operations totaled $129 million or 4.8% as a percentage of sales and decreased 20 basis points versus prior year. These factors resulted in an adjusted operating margin of 15.6%, inclusive of discontinued operations, an increase of 40 basis points versus the prior year driven by the factors of both as well as the favorable impact from foreign exchange. Adjusted operating margin from continuing operations totaled 14.5% and reflects an approximate $55 million headwind for stranded costs, which negatively impacted operating margin by 240 basis points in the quarter. 2024 year-to-date continuing operations adjusted operating margins reflect approximately $200 million or 250 basis points of negative impact on stranded costs. Net interest expense totaled $88 million in the quarter, a decrease of $40 million versus the prior year period driven by debt repayments completed with the proceeds from our BPS divestiture. Adjusted other nonoperating income totaled $9 million in the quarter compared to income of $7 million in the prior year period. Adjusted other nonoperating income from continuing operations totaled $1 million in the quarter compared to income of $12 million in the prior year. The total company adjusted tax rate for the quarter, including discontinued operations from Kidney Care was 13.8%, decreasing 100 basis points as compared to the prior year and came in slightly lower than expectations. The year-over-year decrease is primarily driven by changes in earnings mix and incremental R&D tax credit benefits in the US versus the prior year. And as previously mentioned, total adjusted earnings were $0.80 per share for the quarter and increased 18% versus the prior year primarily driven by improved commercial performance and a reduction in interest expense. Adjusted earnings from continuing operations totaled $0.49 per share, increasing 14% versus the prior period and reflected an $0.11 per share headwind related to stranded costs. Year-to-date adjusted earnings from continuing operations totaled $1.31 per share, increasing 25% versus the prior period and reflecting an approximate $0.30 per share headwind related to stranded costs. Let me conclude my remarks by discussing our outlook for the fourth quarter and full year 2024, including some key assumptions underpinning the guidance. First, given the unprecedented impact of Hurricane Helene on the company's North Cove operations and related production. We have adjusted our full year 2024 financial outlook to reflect the estimated impact of the hurricane on our fourth quarter results. We expect the effects from the hurricane to negatively impact total company fourth quarter sales by approximately $200 million, including an estimated $40 million to $50 million impact on Kidney Care sales and approximately $150 million to $160 million impact on MPT sales. Total company adjusted earnings per share, including discontinued operations, are expected to be negatively impacted by $0.15 per share to $0.20 per share. In addition, all guidance provided on a total company basis includes the impact of Kidney Care discontinued operations and excludes the impact of BPS discontinued operations. Based on these factors, for full year 2024, Baxter now expects total sales growth of 1% to 2% on a reported and approximately 2% on a constant currency basis, reflecting the 100 plus basis point negative top line impact from Hurricane Helene. On a continuing operations basis, Baxter expects sales growth of approximately 2% on both reported and constant currency basis, inclusive of an approximately 150 basis points negative impact from Hurricane Helene. Constant currency sales guidance for the full year of our reportable segments is as follows. For MPT, we now expect sales to increase 2% to 3%, reflecting a 300 plus basis point negative impact from Hurricane Helene. Sales in our HST segment are now expected to decline low-single-digits, reflecting year-to-date results and the continued slow market recovery in US Primary Care. We continue to expect Pharmaceuticals to increase approximately 7%, which reflects the phasing of some Injectables & Anesthesia sales in the fourth quarter and better than expected sales in Drug Compounding. For Kidney Care, we now expect sales growth of approximately 2%, inclusive of an approximate 100 basis point headwind from Hurricane Helene. This compares favorably to prior guidance and reflects the underlying momentum of this business. Now turning to our outlook for other P&L line items. We continue to expect full year adjusted operating margin to increase by more than 50 basis points in 2024, inclusive of an approximate 50 basis point headwind to full year adjusted operating margin from Hurricane Helene. On a continuing operations basis, Baxter expects adjusted operating margins to decline 90 to 100 basis points. The headwind from stranded costs is expected to impact full year 2024 adjusted operating margin by approximately 250 basis points. Full year 2023 adjusted operating margins of 14.7% reflected approximately 300 basis point negative impact from stranded costs. We expect our nonoperating expenses, which include net interest expense and other income expense to total approximately $320 million in aggregate during 2024 or approximately $300 million on a continuing operations basis. We now anticipate a total company's full year adjusted tax rate of approximately 22%. On a continuing operations basis, we anticipate a full year tax rate of approximately 18.5%. We expect our diluted share count to average 511 million shares for the year. Based on all these factors, we now anticipate full year total company adjusted earnings, excluding special items and inclusive of discontinued operations of $2.90 per diluted share to $2.94 per diluted share. This guidance reflects the $0.15 per share to $0.20 per share headwind from Hurricane Helene. Additionally, given that the Kidney Care business met the criteria to be classified as a discontinued operation in the quarter, US GAAP guidance requires the company to cease the reporting of certain depreciation and amortization on Kidney Care assets. This accounting change is a full year benefit of approximately $0.10 per share, which will be reflected in adjusted discontinued operations. On a continuing operations basis, we expect full year adjusted earnings per share before special items of $1.81 to $1.84 per share, reflecting the negative impact from Hurricane Helene and an approximate $0.42 per share headwind from stranded costs. 2023 full year continuing operations adjusted earnings per share of $1.70 reflected approximately $0.48 per share headwind from stranded costs. Specific to the fourth quarter of 2024, we expect total company and continuing operation sales to decline low-single-digits on both reported and constant currency basis. This guidance is inclusive of a 500 basis point negative headwind from Hurricane Helene. We expect total company adjusted earnings, excluding special items and inclusive of discontinued operations of $0.77 per diluted share to $0.81 per diluted share. This outlook reflects a headwind of $0.15 per share to $0.20 per share related to the hurricane and an approximately $0.08 per share depreciation benefit. On a continuing operations basis, we expect adjusted earnings per share before special items of $0.50 per share to $0.53 per share, reflecting the negative impact from Hurricane Helene and an approximately $0.12 per share headwind for stranded costs. With that, we can now open up the call for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. We are now open for questions. [Operator Instructions] And your first question comes from the line of Travis Steed, Bank of America Securities. Please go ahead."
},
{
"speaker": "Travis Steed",
"content": "Hey, everybody. Can you hear me okay?"
},
{
"speaker": "Clare Trachtman",
"content": "Yes."
},
{
"speaker": "Joe Almeida",
"content": "Yes, we can, Travis."
},
{
"speaker": "Travis Steed",
"content": "All right. Great. I had two questions. I'll just go ahead and ask them a little upfront. One, I wanted to ask on HS&T in the quarter, a little bit light versus the Street. So I wanted to make sure what you're seeing in that business versus expectations this quarter and the confidence that the Primary Care market is going to improve under '25. And the second question I'll ask is on 2025. What do you assume for the hurricane impact on 2025? And how do you still get the confidence to reiterate the guidance of 4% to 5% and 16.5% on the margin, given the hurricanes and what you're seeing in HS&T at the moment. Thank you."
},
{
"speaker": "Joe Almeida",
"content": "Thank you, Travis. Listen, let me start with US PSS. This was the biggest concern in the first quarter and throughout the year, a lot of questions. That business has grown now low-double-digits. We actually converted some really key competitive accounts. We see as not only stabilize, but start to gain market share. The team went through a lot of transformation. And I think it's getting to the point that it's really, really competitive. And the market share gain demonstrates our superiority in our product lines. Second, when I think about the orders coming in for that, we have a very healthy pipeline of orders coming into that. So about 20% growth at the moment on the pipeline. And the operational issues in PSS are all resolved. We have made a transition between two plants, and we see that going well. Care communications, we see a very healthy 14% growth in orders. That business had suffered from some delays in installation that we've seen mainly because hospital volumes are healthy, and those are an indicator that hospitals need a break to take rooms down so we can install our equipment. But the orders are in the book and the postponement of some of this installations will come into first quarter of next year and beyond. So let's focus on FLC because FLC is the core of your question in terms of we see the US Primary Care market weakness. That weakness and softness has been demonstrated by our distributors, which actually destocked some of our products throughout this year. And but we see that starting to stabilize and we see that normalize into 2025. So if I look outside the US as the third piece of this puzzle, China and France has shown weakness in their orders with capital being postponed. And so you know capital outside the US is much more prevalent for this business than in the US. And we also exit low margin business, which also shows some comp issues. Going in 2025 US PSS continued the momentum, good order levels. Surgical solutions is stabilizing from 2023 to '24 with significant growth in '23, showing some level of negative growth in '24 due to the very significant growth in '23. We go back into growth in '25. FLC, easier comps. We have significant amount of new products being launched. The supply constraints will be all but resolved, most of them resolved into the fourth quarter and is stabilized into 2025. So overall, we see the business fully recovering from most of the operational issues that we had and stabilization of the Primary Care market, which has been the biggest derailer for FLC in 2024. Let me talk about start I start 2025 and Joel take it from there. The way we see 2025, Helene is going to impact mostly Q4 of 2024. We may see some impact in the first quarter of 2025. As we announced, all lines will be producing product by the end of this year. We give priority to the highest demand and the one most critically medically needed on the market. So our one liter bags coming out of the plant, which is almost 50% of its production, will be fully operational going into 2025 and the other lines to follow. So we see this first quarter a slight impact because of that. But then I turn into a significant improvement that we made in pumps, not only we are growing, above the competitors who recently announced, but we are actually seeing significant competitive conversions, which have helped us that hence you see the growth of our business in the third quarter of 7%. That is driven significantly by pumps and sets. So I will tell you that we see great growth of 50% in 2024 and to continue significant growth in 2025. So that gives us a really good view of how our business will offset some of the Helene impact in the first quarter. HST normalizing and pharma as a fluky quarter that we had really goes back to above mid-single-digit growth mostly with injectables being driven by new products. Joel?"
},
{
"speaker": "Joel Grade",
"content": "Yes. Thanks, Joe. And Travis, I'd add a couple of things here to this related to our confidence in 2025. Number one, we are certainly anticipating continued positive impact from pricing as we've talked about heading into the next year. And then certainly, in addition to what Joe just talked about, that doesn't change. We also continue to expect positive impact from ISC, the continued MIPs and again continued to drive efficiencies that we have from the growth that we're expecting next year. So that's a second part of the positive. Third is just what I'll call the benefit of expense leverage from the growth that we're anticipating having. I think again with the growth that we're anticipating in the businesses, we're certainly expecting leverage growth from that standpoint. And then finally, there is some headwind impact of the MSAs that we've called out before, but the work that we're doing in terms of cost attainment is to eliminate stranded costs, the TSA income that we're anticipating. And I guess I'd say in addition, there's some onetime issues this year that we had that were not expected to repeat next year. So all-in-all, the idea that we essentially reaffirming our confidence in the 4% to 5% from a top line perspective and the 16.5& from the bottom line."
},
{
"speaker": "Travis Steed",
"content": "Thanks so much."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Robbie Marcus, JPMorgan. Your line is open."
},
{
"speaker": "Robert Marcus",
"content": "Great. Good morning and thank you very much for taking the questions. Maybe to follow-up on Travis' question. I wanted to ask about the '25 guidance. It seems like there'll be a little bit of impact going into at least first quarter of next year. So I guess what gives you the confidence to be able to reiterate 16.5%? And do you view that as sort of a target you should be able to reach or in more like historical Baxter guidance philosophy, is that a margin that you should be able to exceed? And then I'll just throw part two of the question since it might be a longer answer. Maybe walk us through some of the initiatives you're taking to offset the stranded cost and over time the lost TSAs to be able to grow underlying operating margin expansion while offsetting some of the declining income from Vantive. Thanks a lot."
},
{
"speaker": "Joel Grade",
"content": "Yes. Thanks, Robbie. It's Joel. I think a couple of things. First of all, I guess what I would say that 16.5% was set as what we believe was a good anchoring point for the organization in terms of how we see it, again, post separation, again, both from as we've talked about here from a growth standpoint, from a margin standpoint, again, both on the gross margin and then obviously that one all the way to the OI line. I think the -- it also was, if you remember, almost a kind of a starting point for what we said would be continued margin expansion over the longer-term horizon. And so again I just would reiterate the fact that, as Joe said, we are expecting some impact, but relatively minimal in the first quarter relative to Helene impact. And then all the things we've talked about in terms of just reiterating pricing, ISC, MIP opportunities leverage on expenses, which we continue to anticipate gaining. And so I think if you think about what how do we see our company post separation, that was the amount that we would anchor the company on for us to continue to build on over the next years to come. I think the some of the actions we're taking, certainly, if you think about these things as the what we call the elimination of stranded costs. One of the things we've talked about is this idea that we have a very dense distribution center network in the United States today because of our Kidney business. With the home deliveries of that business, we have a large number of distribution centers in the US. That ultimately will be something that we will rationalize down significantly based on our new business. This improves not only our operational efficiency. It improves our inventory management. There's a whole set of things from that perspective. We've talked about essentially the size of ensuring we are rightsized as an organization to support the size of the business going forward. And so as we plan for that, we'll certainly be taking those type of actions. And then if you think about some of TSAs, obviously, we've talked about the fact that we're anticipating TSA income in particular in 2025 to offset some of those expenses. But obviously, we are anticipating that, that's not something that will last over a multiyear time period. And so therefore, we're planning carefully on activities to ensure that as those start to fall off, we're ahead of the game and that we have the opportunity to eliminate the stranded costs, which, as we've said, we're planning to do by the end of 2027. So I'll pause there. Is there anything else?"
},
{
"speaker": "Robert Marcus",
"content": "No, that's it. I appreciate the insight. Thanks."
},
{
"speaker": "Joel Grade",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We have a question from Pito Chickering, Deutsche Bank. Please go ahead."
},
{
"speaker": "Pito Chickering",
"content": "Hey, good morning. I guess two questions here. So the first one is, like a few months ago, like IV solutions was viewed as a commodity product. In a few weeks, after the facility was shut down, hospitals and GPOs were in a full-fledged panic mode and asking for governments to nationalize companies to solve this problem. So huge congrats to your team for solving what could have been a nightmare for the country. As you look back at sort of at what happened, do you begin to spread out manufacturing among other facilities to reduce this risk in the future? And we're talking to customers that couldn't do surgeries due to bag of IV. Do you think that it's going to lead to a new recognition and increased pricing due to importance of IV bags within the health care system or is it more of a headwind as hospitals look to diversify their suppliers to multiple manufacturers?"
},
{
"speaker": "Joe Almeida",
"content": "Pito, good morning. The recognition by Baxter has been a long coming. We recognize this is not a commodity. Commodity is defined by something that is readily available and where the barriers to entry are very low. We have invested over $0.5 billion in that facility since 2016 to date with highly automated. And our recovery and the time that we are recovering is very fast compared to what some of the competitors would have experienced themselves. So they spoke on our behalf. We never did. We are much faster than they are in recovery. This shows that not only we have the ability to come back fast after a devastating event. We are producing product as we speak today, by the way, to have a worldwide network of plants that can actually bring products into this country, cross registered at lightning speed. And that is the difference between us and our competitors. Our competitors have capacity constraints every place in Europe and other parts of the world. We are able to have capacity in other parts to bring together the plant in North Cove and augment the market even faster. So we have, of course, we have some lessons learned. We're going to get even better at this, but we have facilities in Spain, UK, Canada, Mexico, Brazil, Colombia, Australia, China, just to give you few names -- a few places that allow Baxter to bring products back. Our people have done a wonderful job and Baxter is an example why this product is not a commodity. I don't want to get into pricing. What I want to tell you is that what we have invested and how we do things is what made us come back so fast and having products being produced as we speak out of that plant."
},
{
"speaker": "Pito Chickering",
"content": "Okay. Great. And then a follow-up question on 2025. Fourth quarter sales are impacted by the $200 million split between Kidney and Medical Products & Therapies. Because distributors and providers that are drawdown on inventories to supply patients when North Cove is offline, as you think about the first quarter of '25, shouldn't we get back the bulk of the $150 million to $160 million back from IV as you restock the inventory channel? Just looking at the revenue guidance for next year, it's implying revenue growth of less than $500 million. And I'm wondering why that $150 million to $160 million sort of loss in the fourth quarter didn't sort of recover next year so that revenue growth may be sort of conservative."
},
{
"speaker": "Joe Almeida",
"content": "Yes. Pito, if you think about something similar that happened to us in the past was Maria. So I think there is -- we have not factored that in the calculus yet because we need to get certainty that all lines are producing at pre-Helene volumes. But of course, you're going to have, you have a destocked situation, not only in Baxter's inventory, but also in the market. And I fully expect us to be producing 24/7 for many, many, many months trying to restock the market and trying to get things back at the level they were before and furthermore, also offer some alternatives for people to stock things that they need that they have not stocked in the past. So I think I see potential upside on that area, but we need to get our lines all fully up to speed, and then we go from there. But I find that as an opportunity that we have not explored yet fully."
},
{
"speaker": "Pito Chickering",
"content": "Great. Thanks so much."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Vijay Kumar, Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "Hey, guys. Good morning and thanks for taking my question. Joe, maybe off of those comments you just made, right? What is the right framework for fiscal '25 guidance? Is the 4% to 5% organic growth coming off of a lower base? And if I understood you correctly, you're not assuming the $150 million of the IV fluid shortage impact to come back next year, right? Are those lost revenues or should they come back to Baxter? I'm just trying to see what is the conservatism being baked into this guidance."
},
{
"speaker": "Joel Grade",
"content": "Yes. Vijay, I guess what I would say is that, I mean, so and as Joe talked about, again, the revenue ramp again in the year, there's going to be some potential impact that we've talked about here in the first quarter. But again we're certainly comfortable holding our guidance of the 4% to 5%."
},
{
"speaker": "Joe Almeida",
"content": "So I'll add, Vijay, what are the builders for this of 4% to 5%, okay? So first is in the very beginning of the quarter, of course, we have an impact of the plants coming up to speed. But as I said in the previous question to Pito was specifically, we will see a destocking and then a restocking and that balances out the rest of the year. So the first thing is you may see a dislocation of growth just because what comes in the first couple of months of that early in the year, picking up towards the end of the year, first of all. Second of all, the product launch that we have primarily in the three businesses. We have five remarkable product launches coming out at HST. We have several molecules that are slated for 2025, coming off a significant amount of launches in 2024 and our pharma team getting much more accustomed to a large number of product launches. And our pump, which is doing extraordinarily well in 2025, in 2024, following 2025 just to underscore, again, 50% growth in 2024 with significant potential for growth in 2025. So those are the main drivers then of the top line. Bottom line will be mostly driven by the drop through of this innovation. When you start restocking the market with IV solutions, those have disproportional better margins that go into the business. Thirdly is the efforts that we already started in 2024 is offsetting the stranded costs that we start to come in to -- which will offset the difference between our TSAs and our cost of doing the TSAs. So the strength of our conviction today at the moment are on the top line buildup I just told you and also the ability to offset that and the manufacturing cost reductions that continue like clockwork come in every single year is slightly better than we planned."
},
{
"speaker": "Vijay Kumar",
"content": "Understood. And maybe my second one for Joel. When you look at the operating margins in the third quarter, 14.5%, it's down optically I think 90 basis points year-on-year on a comparable basis. Is that like an apples-to-apples comparison, Joel? Any cost allocation which makes the comparison hard? And the reason I'm asking is when you look at the 16.5% for next year, that's a 200 basis points jump off. Are there the bridge to that 16.5% and any implications on free cash flows and guidance, excuse me, dividend policy? Is Baxter committing to hold the dividend yield? Thank you."
},
{
"speaker": "Joel Grade",
"content": "Yes. So thanks, Vijay. I think there are a couple of things here. First of all, again, one of the things that we've talked about previously is the difficulty of comparison, if you will, between what you'd see on a continuing operations basis and next year. Recall, please, that the continuing operations in the fourth quarter includes stranded cost that is essentially was previously allocated to kidney, but now is actually sitting in, I think, what we call unallocated corporate cost. And in 2024, that does not yet show the impact of some of our cost outwork. And so if you look as we head into 2025, that 16.5% still clearly represents the opportunities that we're taking on the things that Joe just talked about in the previous question. But in addition to that, starting the work on receiving TSA income against our expenses, starting the work of our cost-containment measures that we're already starting to take this year that will start to impact next year. And so I guess that's the way I would think about this thing. Again it's not necessarily a comparison that you can make based on what we have on a continuing ops basis here versus the 16.5% next year."
},
{
"speaker": "Vijay Kumar",
"content": "Sorry, on the dividends?"
},
{
"speaker": "Joel Grade",
"content": "Yes. And from a free cash flow standpoint, I think, just kind of a couple of comments on this year, obviously, this year has been a choppy year from a free cash flow standpoint. We continue to have separation-related costs that are impacting this as well as, I'd call, some discrete items we've had in the first -- particularly the first half of the year. We do have seasonality in our cash flows that happens as we head into the second half of the year. And we certainly anticipate, as usual, some continued seasonal positive impact as we head into the fourth quarter. The one thing I would remind you also of those is that we do now have some cash flow impacts that were that are occurring from North Cove. And so while there is a -- we will have some insurance proceeds that will be coming back as an offset to that. There will be some impact from both the fourth quarter and heading into next year from a cash flow perspective for North Cove. But again, our cash flow as we head into next year, we anticipate continued leverage from an expense perspective, continued benefits from the improved working capital. And again just a generally beneficial perspective from the proceeds of the Kidney Care sales. And obviously as we head into the second part of the year, we've targeted again three times leverage by the end of the year. Again, with a combination of free cash flow, the proceeds of Kidney, we're certainly anticipating being on track for our cash flow forecast in the second half of the year."
},
{
"speaker": "Clare Trachtman",
"content": "And with respect to the dividend, do you want to comment on the dividend too as well then?"
},
{
"speaker": "Joel Grade",
"content": "Yes. So from a dividend perspective, obviously, we are anticipating, as we've said, resetting our dividend from the perspective of essentially resizing it, if you will, based on the new size of our organization. We are committed to a dividend and we obviously will be coming out with that shortly here as it relates to what the sizing of it will be."
},
{
"speaker": "Vijay Kumar",
"content": "Understood. Thanks guys."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Joanne Wuensch from Citi. Please go ahead."
},
{
"speaker": "Joanne Wuensch",
"content": "Good morning and thank you for taking the question. I'll put them both right upfront. I'd love to get your view on what you're seeing in China and with that, the discussion of the week, the potential for tariffs and the impact. And then as a secondary question, just anything you could add on what you're seeing in new uptake of your Novum pump and expectations for next year. Thank you."
},
{
"speaker": "Joe Almeida",
"content": "In China specifically, Joanne, China post Vantive for Baxter is going to be with some of the exits that we're having right now, less than 2% of our sales. So the impact for us is quite small despite the fact we had some impact this quarter for HST in the VBP. But it's remarkably different, the new Baxter versus the old Baxter. So the tariffs that we're talking about here would be very much related to raw materials, will be chips that we still buy there and other things that will impact the industry in general. But we do not make specifically products in China for the US as Baxter. Even today with Vantive, with the renal business, we don't have that. Post Vantive, we will not have that. And with the reduction in sales volume and some exits, we're going to be very much not exposed to future VBPs at the level that you see in the industry, first of all. And let me give you some context. I think your question about the Novum update is that it's going extremely well. The market share growth, we, usually in the past, used to gain about 1% market share every year just by Rule of Thumb. We are seeing 2% to 2.5% by the end of this year. And we're going to continue to accelerate that. The acceptance of the pump has been significant. And we're very happy how the team has launched the product. It's one of the best launches that I've seen in my career. Kudos to Heather Knight and her team. We've seen significant uptick in interest, not only the large water pump but also the syringe pump. The syringe pump actually market share growth is actually double that taken from incumbents today who in the past have supplemented our spectrum by not having the syringe availability today because we have it. We're going back to the accounts and actually gaining those back."
},
{
"speaker": "Joel Grade",
"content": "Yes. And I would just add to that. Our infusion hardware is actually up 50% this year and that's on top of actually a significant growth in the prior year as well to that point. So that's certainly been a strength of the business that we anticipate continuing on as we head into 2025."
},
{
"speaker": "Joanne Wuensch",
"content": "Excellent. Thank you very much."
},
{
"speaker": "Joe Almeida",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Larry Biegelsen, Wells Fargo. Please go ahead."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Good morning. Thanks for fitting me in. Hey, Joel, obviously people have been trying to figure out the 16.5% for next year. Should we be taking kind of you have the year-to-date continuing ops operating margin of 13.4%. Should we be adding back the stranded costs on Slide 19 to get to kind of a 15.9% year-to-date because the TSAs will offset that? Is there any way to kind of help us understand what the year-to-date? What the '24 kind of underlying number is to bridge that 16.5%? And secondly, the nonoperating expense, I think you said $300 million for continuing ops in 2024. Any color on how much lower those could be next year? Thanks."
},
{
"speaker": "Joel Grade",
"content": "So Larry, first of all, I'll start with the first one. The 16.5%, again, I don't mean to sound unhelpful here, but the bridge between our fourth quarter continuing ops and the 16.5% is really complicated. Our whole purpose of setting the 16.5% out there was to give people something to really anchor on in terms of what our company looks like post separation. And I think the, again, the cost that we're seeing in the continuing ops basis, again, really is impacted significantly, as you said, by the stranded costs. That does not reflect any TSA income in 2024 and does not reflect any impact of cost containment measures in 2024. Now again, we are taking cost containment measures now that will impact '25, but you're just not seeing that in the results in 2024. And so that comparison, again, I wish I could give you a better answer on that bridge, but the 16.5% is really designed to be an anchoring point for our continued build going forward."
},
{
"speaker": "Clare Trachtman",
"content": "Larry, just one thing I'll add. I did include the stranded cost by quarter in our earnings presentation that's available on our website. So you'll be, there's a slide within the deck. So you'll be able to go and see what that impact is on a quarterly basis, both for 2023 by quarter and then for the first three quarters of 2024 as well. So that is available."
},
{
"speaker": "Lawrence Biegelsen",
"content": "And the non-op expense, Joel, how should we think about that next year, how much lower than the 300?"
},
{
"speaker": "Joel Grade",
"content": "Yes. I guess I'd say at this point, Larry, there's not -- we don't anticipate something materially different from that perspective, again, obviously, other than size proportionate to the organization."
},
{
"speaker": "Lawrence Biegelsen",
"content": "All right. Thanks so much."
},
{
"speaker": "Clare Trachtman",
"content": "We will see some reduction, Larry, obviously, because we do plan, obviously, to utilize the proceeds from Kidney Care towards debt repayment. So we should see some benefit within our interest expense. But obviously, on the other income expense line, that's something we'll have to look at as well. So premature right now, but I'd say we do expect interest expense to come down a little bit next year."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Got it. Thank you, Clare."
},
{
"speaker": "Operator",
"content": "We have a question from David Roman of Goldman Sachs. Please go ahead."
},
{
"speaker": "David Roman",
"content": "Excuse me. Thank you. Good morning, everybody. I wanted to come back a little bit to the revenue outlook on the 4% to 5%. And maybe if you can contextualize the bridge from kind of 2Q and 3Q of '24 where you grew 4%-ish in the Baxter business ex-Kidney Care from because those are probably be your two kind of normalized quarters this year, given the HST issues in 1Q and the IV dynamics in Q4. So as you go from the 4% to the 4% to 5%, what specifically changes next year that would give you an opportunity to see an acceleration? Because you're already seeing good price. You talked about 50% growth in hardware. Maybe just help us understand what are the levers to get from 2Q, 3Q this year up back into the mid or higher end of the range?"
},
{
"speaker": "Joe Almeida",
"content": "Other than compounding growth that you're going to see for the pump hardware sets and going back perhaps to IV pricing and other things that you're going to see that we already had to count on is basically HST getting to normality in primarily FLC. We're seeing the normality already in the US for PSS. And so we expect to see our Frontline Care business under HST to go back to a normal growth pace that had before normalized for the growth in '23 driven by the backlog catch-up and the impact of that in '24 plus the softness that we had in some operational issues. So that going back to normal is the main driver. So you have that level there. And that is our level of confidence that our operational issues will be behind us mostly by the end of the fourth quarter then the normalization of the Primary Care market and the resolution of some of the OUS softness that we saw primarily in the third quarter related to France and China."
},
{
"speaker": "David Roman",
"content": "All right. Got it. Very helpful. And then maybe just a follow-up on the capital allocation side. I think on a year-to-date basis, you've been growing SG&A and R&D in dollars to reinvest for future growth. But as you look into the fourth quarter, you're able to offset almost all of the IV impact through strength in the business elsewhere and maybe some proactive measures you're taking down the P&L. So how can you help us think about the trajectory of internal capital allocation around different spending levels, what that trends in Q4 and how we should think about that into next year?"
},
{
"speaker": "Joel Grade",
"content": "Yes. David, thanks for the question. Look, I think the -- as you said, we are making some continued level of investment in our business in order to facilitate some of the growth that we're talking about, which is what you've seen throughout the course of this year. But I think as we think about going forward, again, we are anticipating both the continued allocation of resources to R&D and that we again anticipate continued modest growth in that area, but also gaining leverage in some of the things that we're doing from an SG&A perspective. Again, as we work through our cost-containment measures and stranded costs, as we do head into next year, we are anticipating some level of leverage out of our growth that we anticipate on our SG&A line in particular. So I think that's the way I would say it again. Innovation is going to be a big part of our story going forward. And the continued investment in R&D will reflect that. But again, you should expect some leverage out of the SG&A line as we go into next year."
},
{
"speaker": "David Roman",
"content": "Got it. Thanks so much."
},
{
"speaker": "Operator",
"content": "Due to the constraints of time, we will close the Q&A session here. I would like to thank our speakers for today's presentation and also thank you all for joining us. This concludes today's conference call. Enjoy the rest of your day. You may now disconnect."
}
] |
bax | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, ladies and gentlemen, and welcome to Baxter International's Second Quarter 2024 Earnings Conference Call. Your lines will remain in a listen-only mode until the question-and-answer segment of today's call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time. I would now like to turn the call over to Ms. Clare Trachtman, Senior Vice President, Chief Investor Relations Officer at Baxter International. Ms. Trachtman, you may begin."
},
{
"speaker": "Clare Trachtman",
"content": "Good morning, and welcome to our second quarter 2024 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Joel Grade, Baxter's Executive Vice President and Chief Financial Officer. On the call this morning, we will be discussing Baxter's second quarter 2024 results, along with our financial outlook for the third quarter and full year 2024. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the third quarter and full year 2024, the status and anticipated timing of our ongoing strategic actions, including the proposed Kidney Care separation and the potential impact of our recent pricing actions, regulatory matters and the macroeconomic environment on our results of operations contain forward-looking statements that involve risks and uncertainties, and of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in the accompanying investor presentation and also available in our earnings release issued this morning, which are both available on our website. Now, I'd like to turn the call over to Joe. Joe?"
},
{
"speaker": "Joe Almeida",
"content": "Thank you, Clare, and good morning, everyone. Thank you for joining us. Our second quarter 2024 results reflect the continued progress and momentum of our ongoing strategic transformation. Our performance in the quarter was strong, reinforcing the benefits of our redesigned operating model fueled by the commitment and hard work of our outstanding Baxter team. I will start the call today with some brief commentary on our strong second quarter performance before turning the call over to Joel to provide more detail on our results as well as our outlook for the rest of the year. Then, as always, we open up to your questions. As you saw in this morning's earnings release, Baxter's second quarter results exceeded our previously issued guidance on both the top- and bottom-line. This performance further enhances our confidence in our ability to continue executing against our strategic priorities and build upon this underlying momentum. As such, we have increased our full year sales outlook and adjusted EPS guidance accordingly. Our second quarter performance provides further evidence that the steps we have taken to-date to centralize and streamline our operating model are yielding results. These actions allow for improved visibility both externally and internally to our markets as well as increased accountability for our segment leaders. These benefits, coupled with enhanced operational rigor, have enabled our teams to better identify opportunities to accelerate innovation to drive growth and expand margins. Turning to some of the highlights from the quarter. Second quarter sales from continuing operations grew 3% on a reported basis and 4% at a constant currency rates. As a reminder, continuing operations exclude the impact of our BioPharma Solutions business, BPS, which we divested at the close of the third quarter of 2023, in line with our strategic transformation roadmap. Sales growth was broad-based with all four Baxter segments delivering growth above our expectations, reflecting positive demand and improved pricing for products across much of the portfolio. On the bottom-line, adjusted earnings per share from continuing operations were $0.68. These results were driven by our top-line performance combined with our continued emphasis on operational efficiency across the company with ongoing contributions from our integrated supply chain network. Our strong operational performance more than offset a negative impact from foreign exchange and a higher-than-expected tax rate in the quarter. Now, looking at performance by segment. Medical Products and Therapies, or MPT, delivered second quarter sales growth of 4% at reported rates and 5% at constant currency rates. Growth was fueled by demand across the segment and results included first US sales of our leading-edge Novum IQ large volume pump with Dose IQ Safety Software. Customer interest is high for the Novum platform, including both large volume and syringe pumps with their ability to advance connectivity and intelligent infusion therapy. These pumps are already live and in use at multiple sites, making a difference for caregivers and the patients they serve. We have a healthy funnel of opportunities and anticipate continued strong steady uptick from Novum across the balance of 2024 and beyond through the upgrades of existing customers and conversions of new customers. Our Pharmaceuticals segment grew 9% at reported rates and 11% at constant currency rates. Performance was driven by double-digit growth in our specialty injectables portfolio, reflecting the recent launches of a range of new differentiated injectables as well as significant growth in our Drug Compounding business. Growth in this segment was partially offset by lower sales of inhaled anesthetics. Healthcare Systems and Technologies, or HST, performance advanced to 1% at both reported and constant rates. Our Care and Connectivity Solutions division delivered mid-single-digit growth, reflecting positive market demand and strong [US-capped] (ph) orders, which increased meaningfully both sequentially and year-over-year. Growth in the quarter was partially offset by an expected decline in the Front Line Care division, primarily due to a difficult comparison to the prior-year period and continued softness in the US primary care market. Overall, HST results in the quarter benefited from the operational improvements that we are in process of implementing to enhance ongoing performance. As we discussed last quarter, we expect to see these efforts continue to yield positive results as 2024 continues and going forward. Finally, Kidney Care was flat year-over-year at reported rates and grew 3% at constant currency rates. Performance continues to be fueled by demand for our acute therapies portfolio plus a strong growth for peritoneal dialysis products due to positive volume and pricing globally. Growth was partially offset by an expected decline in sales of in-center hemodialysis products due to select product and market exits. Looking ahead, we remain confident and excited about the future of our company and our potential to continue to accelerate sales growth, expand our margins, and drive innovation that we'll deliver benefits to our customers, shareholders and many other stakeholder communities. As you all know, we launched our strategic transformation in January of 2023 to recast Baxter as a more simplified, more agile and more focused company, passionate in its commitment to operational excellence and better-positioned to accelerate growth through customer-inspired innovation. Among the elements central to our plan was the separation of the Kidney Care business from Baxter in order to provide both companies with improved strategic clarity and greater flexibility to pursue their unique investment priorities. We are continuing to make steady progress toward the separation, and while the ultimate pathway has not yet been determined, we currently expect the separation will occur in late 2024 or early 2025. With the separation of Kidney Care, we have a unique opportunity to redefine ourselves while also remaining firmly grounded in what has powered our success for nearly a century: our life-sustaining mission, our focus on essential healthcare, our commitment to innovation, and at the heart of it all, our employees, whose unparalleled dedication turns our aspirations into impact. Together, we are united, energized and eager to take Baxter into a future of sustained healthcare leadership. With that, I will pass it over to Joel to provide more detail on our results for the quarter and outlook for the balance of the year."
},
{
"speaker": "Joel Grade",
"content": "Thanks, Joe, and good morning, everyone. As Joe mentioned, we are pleased with our second quarter results, which came in ahead of our expectations and further reinforce our goal of consistently meeting and exceeding our financial objectives. Second quarter 2024 global sales of $3.8 billion increased 3% on a reported basis and 4% on a constant currency basis, and as mentioned, compared favorably to our previously issued guidance. Outperformance in the quarter benefited from better-than-expected sales in many product categories and particularly in patient support systems, infusion therapies, peritoneal dialysis and drug compounding. As compared to the prior-year period, sales, excluding Kidney Care, increased approximately 5% on a constant currency basis. On the bottom-line, adjusted earnings from continuing operations totaled $0.68 per share, increasing 24% versus the prior-year period and ahead of our prior guidance of $0.65 to $0.67 per share. Results in the quarter were driven by strong operational performance with continued momentum commercially, partially offset by a negative impact from non-operational items totaling $0.05 per share due to foreign exchange and a higher-than-anticipated tax rate. Now, I'll walk through our results by reportable segments. Commentary regarding sales growth will reflect growth at constant currency rates. Sales in our Medical Products and Therapies, or MPT, segment were $1.3 billion, increasing 5%. Within MPT, second quarter sales from our Infusion Therapies and Technologies division totaled $1 billion and increased 5%. Sales in the quarter benefited from strong growth internationally across the division, particularly for our IV solutions and infusion systems products, which benefited from both volume and pricing gains. Solid demand for nutrition globally also contributed to growth in the quarter. Sales from Advanced Surgery totaled $277 million and grew 4%, reflecting solid growth internationally. For our Healthcare Systems and Technologies, or HST, segment, sales in the quarter were $748 million and increased 1%, coming in ahead of our expectations. Within the HST segment, sales in our Care and Connectivity Solutions, or CCS, division were $452 million, growing 4%. Performance rebounded in the quarter, driven by significant growth in orders, both sequentially and year-over-year for our CCS products. As Joe mentioned, the actions we are taking to enhance our operational rigor and improve execution are yielding results. These factors contributed to orders growth across our CCS division of more than 40% compared to the prior year and over 60% sequentially. Results in the quarter included upgrades to both existing customers and competitive gains within our patient support systems business. We are very encouraged by the growth of orders in the US this quarter, which will be phased in over the course of the second half of this year and into 2025. Overall, we believe the initiatives we are implementing to improve commercial execution will continue to lead to improved performance, both in the second half of this year and beyond. Front Line Care sales in the quarter were $296 million, declining 4%, in line with our expectations and represented a double-digit improvement sequentially. Growth in the quarter continued to be impacted by a difficult comparison to the prior year as backlog reductions positively contributed to growth in the prior-year period. Performance in the quarter was also impacted by ongoing softness in the primary care market, which negatively impacted growth in both our connected monitoring and intelligence diagnostics product portfolios. The timing and release of government orders in the US also impacted growth in the quarter. We expect this division to return to growth in the second half of the year as growth for products in other settings such as cardiology and acute is anticipated to more than offset the continued softness in primary care and lower government orders. The anniversary of the prior-year impact from the backlog reduction will also benefit performance in the second half of the year. Moving on to Pharmaceuticals. Sales in this segment were $602 million, increasing 11%. Performance in the quarter reflect double-digit growth in our US injectables portfolio, driven by new product launches as well as strong demand for services from our Drug Compounding portfolio internationally, which has benefited from supply constraints for certain customers that are expected to ease in the second half of the year. Performance in the quarter was partially offset by lower sales in inhaled anesthetics globally. Sales in the quarter for our Kidney Care segment totaled $1.1 billion, increasing 3%. Within Kidney Care, global sales for Chronic Therapies were $917 million, increasing 1%. Strong PD growth in the quarter was partially offset by the expected negative impact from certain product and market exits in our in-center HD business as well as lower sales in China due to government procurement initiatives. We estimate that these items negatively impacted sales by just over $50 million in the quarter. Sales in our Acute Therapies business were $201 million, representing growth of 9%, driven by strong demand and competitive conversions in the United States. Other sales, which represent sales not allocated to a segment and primarily includes sales of products and services provided directly to certain of our manufacturing facilities, were $22 million and declined 5% during the quarter. Now, moving on to the rest of the P&L. Our adjusted gross margin totaled 41.2% and represented an increase of 80 basis points over the prior year. The year-over-year improvement in gross margin primarily reflects the strong operational efficiencies we are realizing within our integrated supply chain network, resulting from execution of the margin improvement programs we were implementing and the anniversary of the negative margin impacts from inflationary pressures that drove higher cost of goods sold in the prior-year period. Pricing initiatives in select markets also positively contributed to margin improvement in the quarter. Product mix and foreign exchange partially offset margin expansion in the quarter. Adjusted SG&A totaled $873 million, or $22.9 million as a percentage of sales, an increase of 10 basis points from the prior-year period as we are making select investments to support our growth objectives and new product launches. SG&A leverage is expected to continue to improve as sales ramp over the course of the year. Adjusted R&D spend in the quarter totaled $175 million and represented 4.6% as a percentage of sales, an increase of 10 basis points compared to the prior-year period and reflects our continued investments in advancing new products across the portfolio and bringing innovation to patients across our segments. These factors resulted in an adjusted operating margin of 13.7%, an increase of 50 basis points versus prior year, driven by the factors above, which more than offset a negative impact on operating margins of approximately 70 basis points due to foreign exchange. Net interest expense totaled $85 million in the quarter, a decrease of $39 million versus the prior-year period, driven by debt repayments in the fourth quarter of 2023 associated with the proceeds of our BPS divestiture. We plan to continue to repay debt in 2024, consistent with our stated capital allocation priorities. During July, Baxter finalized a bank finance bridge loan in the form of a delayed draw term loan, or DTTL, in lieu of a public bond financing with a total size of $2.05 billion. The DTTL provides certainty of ability to fund debt maturities coming due in the fourth quarter in the event we haven't completed the Kidney Care separation by that time. We expect to utilize proceeds from the separation to repay the loan if outstanding. We felt this was a better option as compared to bond financing given the more temporary nature of the cash need and the high cost of issuing new term debt in current markets. Adjusted other non-operating income totaled $20 million in the quarter compared to an expense of $22 million in the prior-year period, which included losses on both foreign exchange and marketable securities. The adjusted tax rate for the quarter of 23.9% came in higher than expectations and increased as compared to the prior-year tax rate of 17.8%. The year-over-year increase is primarily driven by the geographic mix of earnings, decreased utilization of foreign tax credits in the current year period and a non-recurring foreign tax incentive in the prior-year period. And as previously mentioned, adjusted earnings from continuing operations totaled $0.68 per share and increased 24% versus the prior year, primarily driven by improved commercial performance and a reduction in interest expense, offset by the impact of foreign exchange and a higher tax rate. Let me conclude my remarks by discussing our outlook for the third quarter and full year 2024, including some key assumptions underpinning the guidance. For full year 2024, Baxter now expects total sales growth of approximately 3% on both reported and constant currency basis, which is an increase from prior guidance of 2% to 3% on a constant currency basis. This increase reflects the outperformance we realized in the second quarter and continued momentum for our businesses. Constant-currency sales guidance for the full year by reportable segment is as follows: For MPT, we now expect sales growth of approximately 5%. This is an increase from the prior guidance of 4% to 5% and reflects the outperformance year-to-date and continued momentum for our Novum platform. Sales in our Healthcare Systems and Technologies segment are expected to be approximately flat to the prior year, consistent with prior guidance. This guidance reflects improved performance in the second half of the year, but also assumes the installation of some CCS orders are phased to 2025. In addition, our guidance assumes FLC performance also improves in the second half of the year, but that both primary care and government orders decline in 2024, neither of which we believe represent market share losses. We expect both the primary care market and orders from the government will improve in 2025. We now expect Pharmaceuticals sales growth of approximately 7%, which compares favorably to prior guidance of 6% to 7% and reflects the strong start to the year and continued momentum for our new product launches as well as increased contribution from Drug Compounding. The contribution from Drug Compounding is expected to meaningfully slow in the second half of the year as supply constraints for certain hospital customers ease and the business focuses on driving more profitable growth. Collectively, sales for these three remaining Baxter segments are now expected to increase approximately 4% in 2024 and exit the second half of the year at the higher end of our prior expectation of 4% to 5%. For Kidney Care, we now expect sales growth of 1% to 2% as compared to 2023. This also compares favorably to prior guidance and reflects the underlying momentum of this business. Now, turning to our outlook for other P&L line items. We continue to expect adjusted operating margin to increase by more than 50 basis points in 2024. We expect our non-operating expenses, which include net interest expense and other income and expense to total approximately $330 million in aggregate during 2024. We now anticipate a full year adjusted tax rate of approximately 23%. We expect our diluted share count to average 511 million shares for the year. Based on all these factors, we now anticipate full year adjusted earnings, excluding special items, of $2.93 to $3.01 per diluted share, which also compares favorably to prior guidance of $2.88 to $2.98 per diluted share and reflects the outperformance we realized in the second quarter and expect for the remainder of the year and includes an incremental headwind from non-operational items totaling approximately $0.02 per share. Specific to the third quarter of 2024, we expect global sales growth of 3% to 4% on a reported basis and 4% to 5% on a constant currency basis. And we expect adjusted earnings, excluding special items, of $0.77 to $0.79 per diluted share. With that, we can now open up the call for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Robbie Marcus of JPMorgan. Your question, please?"
},
{
"speaker": "Robbie Marcus",
"content": "Great. Thanks for taking the questions, and congrats on a nice quarter. Two from me. Wanted to start with the revised guidance. And it looks like it's pretty much going higher from the second quarter beat and then third quarter upside versus the Street. So, you gave a lot of detail, but I was hoping you could just walk us through the underlying drivers and did I get the raise and impact correct? Thanks."
},
{
"speaker": "Joel Grade",
"content": "Hi, good morning, Robbie. It's Joel. Thank you for the questions. Yes, I think certainly, the new guidance is actually starts with the performance we had in Q2. We had a strong operational quarter and obviously, that's part of what's carried through to the rest of the year. What I would just say in general, though, is that our businesses continue to have strong momentum in them. And so, I think when you think about this from a sales perspective, it's the recovery -- continued recovery over the course of the year sequentially in HST. Again, we've raised the guidance for MPT as well from a sales perspective as well as Pharma. And so, I think the -- and all those businesses are going to continue to improve from a sales perspective. So, on the top-line, that's part of the really key driver. From a margin perspective, we continue to expect a positive progress from a pricing standpoint from an ISC standpoint. I think our margin improvement programs and the continued work there are also a part of obviously what's driving ultimately the bottom-line beat as well. The offset of some of that from an operating margin perspective, we do make -- we're making continued investments in our business from a sales and marketing standpoint, from an R&D perspective, from new product launch perspective. And so, those things continue to impact the opposite direction. As well as we've got an MSA in Pharma that I think you're aware of was related to BPS sales. So that's an offset. And then finally, on the bottom-line from a -- we do have a headwind from an FX and a tax rate perspective. But again, punchline here, continued sales momentum, margin expansion with a couple of the offsets I talked about."
},
{
"speaker": "Robbie Marcus",
"content": "Thanks. And maybe just a quick follow-up here. The HST had a tough first quarter. It looks like it improved sequentially in second quarter. Front Line Care still negative year-over-year. Maybe just speak to the underlying trends you're seeing in the two businesses there and your confidence in a reacceleration and return to a positive growth in the second half of the year? Thanks."
},
{
"speaker": "Joe Almeida",
"content": "Hi, Robbie, good morning. We feel that a great deal of the operational issues are being addressed and behind us. We still are addressing them and will be throughout the 2024 calendar year. Primarily the one involved in one of our plant transfers is being addressed and is in really, really good shape at the moment. I want to make sure that we also have -- our sales force is doing a fantastic job. We did a significant amount of revamping there. So, we see that going well. We also see a very positive trend in capital and the positive trend in capital allows us to have very strong, one of the strongest quarters we ever had in orders, it was the second quarter. So, we see that going extremely well. This is in the CCS business, which is our beds and nurse call systems. FLC, completely different dynamic that has to do with the primary care market that has significant shift during 2024 with big players coming in and out. We believe our market share is still growing in that slightly, but it's very high, and we feel that business is going to come back into normality towards the end of the year, as well as in government orders, which has been very, very low. And the most important factor was the comp versus last year. All in all, I think HST has turned the corner. We see some very interesting dynamics on the market with our product offering gaining ground and stable market share and possibly growing into Q3 and Q4."
},
{
"speaker": "Robbie Marcus",
"content": "Great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Travis Steed of Bank of America Securities is on the line with a question. Please state your question."
},
{
"speaker": "Travis Steed",
"content": "Hey, thanks for taking the question. I wanted to ask about the KidneyCo separation. I think that was new that you added early 2025, so I wanted to ask about that. And does your thinking change at all on spend versus sell? And also noticed an impairment charge on that business. So, wasn't sure if there's anything to kind of read into that impairment charge this quarter."
},
{
"speaker": "Joel Grade",
"content": "So, a couple of things on this. First of all, thanks for the question, Travis. From a timing perspective, again, look, we're continuing to make progress and continue to move forward on a dual path to ensure that we're ready for both of -- from a sale and spin process. And so, we're obviously doing that in a way that's going to maximize our shareholder value for all of our stakeholders. And so, we continue to make solid progress, what I would say. I think the timing difference, again, I just look at it as we've continued to evolve the process and move it forward, again, we're in -- I think we're in a good place from the perspective of both, but the timing has shifted a little bit as we continue to move through the year. And so, our plan is to still continue to get it done by the end of 2024, but it could move into the early part of 2025, which is why we put the guidance out that it did. From a goodwill perspective, the way I would take that is we've had a -- now a process where we actually had bidders put a value into what the goodwill is. And so, as we assess that relative to the obviously the value of the books, there is a negative impact there from a goodwill perspective. I would say this, in the event that there was a sale moving forward, we would be recognizing a gain on that sale. So, there's a little bit of a timing issue from that perspective. But it's just part of a normal process to reassess our goodwill. And now that again, we have an actual kind of what I call market value for that, so to speak, and that's where that came from."
},
{
"speaker": "Travis Steed",
"content": "Great. Thanks a lot. I wanted to ask a follow-up on the margins. So, first of all, the second half total company, you got a couple of hundred basis points second half margin ramp. So, I wanted to ask about the confidence and kind of what's driving that. But also if you think about the segment margins, in the first half of the year, all the margin expansion for the total company was more on the renal side and the core of Baxter business down year-over-year. I wanted to kind of think about how we get confidence that ex the RenalCo longer-term, like the RemainCo Baxter business is going to be expanding margins kind of the 50 basis points or so a year that you've kind of set out in the past?"
},
{
"speaker": "Joel Grade",
"content": "Sure. Let me start by taking what I call some of the drivers of our margin perspective and then I'll get to the second part of your question. Our margin drivers continue to be from a couple of different things. One is, again, our top-line -- obviously, our top-line growth and some of the new product launches that are coming into play, that's both a short-term and something over the longer term, that's going to be a driver from a margin perspective. Pricing, we continue to see upside opportunities from a pricing perspective. In the current year, it's been primarily outside the US. We looked for some of that inside, in the US next year as again some of the GPO contracts take hold, et cetera, et cetera, but -- and we continue to take pricing. ISC continues to be a area where we expand our margins. Again, both the margin improvement programs and just the efficiencies we continue to gain from some of our investments in automation, et cetera, et cetera. And so that's where the kind of the really key drivers and why we feel continued confidence in our ability to actually drive our margins going forward. I think the -- from an ex-Kidney perspective, there's a couple of things that I would just say. Number one, as we move to a vertical structure in this company, we've continued to refine the process of allocations. So, some of this from an ex-Kidney perspective is an impact. Again, as we continue to refine our allocation methodology and you see some of that again impacting where the [indiscernible] Kidney and some of them margins ex-Kidney. The other part to it from -- just as I mentioned in some of my comments in the earlier question, we are continuing to invest in R&D. We are continuing to invest in new product launches and things that ultimately are going to again drive growth that are impacting operating margins in general. So that's the -- did that answer your question?"
},
{
"speaker": "Travis Steed",
"content": "Yeah, thanks a lot. I appreciate that."
},
{
"speaker": "Operator",
"content": "David Roman of Goldman Sachs is on the line with a question. Please state your question."
},
{
"speaker": "David Roman",
"content": "Thank you, and good morning, everybody. I wanted just to start on the revenue outlook for the balance of the year, and recognizing the comment on exiting the year at the higher end of the 4% to 5% on the core Baxter business. But as you look at the sort of guidance that you've provided for Q3 and the balance of the year, I think that implies revenue growth in Q4 below 1%. Can you maybe just help us understand the drivers of the phasing of revenue for the balance of the year? And then, I have one follow-up on the strategic capital allocation side."
},
{
"speaker": "Joel Grade",
"content": "Sure. Thanks for the question. Yeah, the primary driver of some of the movement there in terms of, I'll call, the squeeze math in the fourth quarter is really product mix impacted. It starts with compounding in Pharma. We've had some -- again, that's been a significant driver of some of the upside. In addition, obviously, other parts of the business and that actually starts to slow down in the second half of the year, but in particular in the fourth quarter. And so, I would say that's really one of the key drivers of some of the little bit of the phasing from what you'd call third quarter perspective and again the squeeze math on the fourth quarter."
},
{
"speaker": "David Roman",
"content": "Got it. And then maybe just a follow-up, if you look at kind of the increases in discretionary spending on the SG&A and R&D side, could you maybe go into a little bit more detail about the internal capital allocation priorities? Where those incremental dollars in SG&A and R&D are being deployed? And maybe any early look you can give us into some of the either product launches or geographic expansion initiatives that may come out the other side of these investments?"
},
{
"speaker": "Joe Almeida",
"content": "Good morning, David. How are you?"
},
{
"speaker": "David Roman",
"content": "Hello, Joe. Thank you. Nice to talk to you."
},
{
"speaker": "Joe Almeida",
"content": "Likewise, listen, just adding a bit to Joel's previous answer is compounding, we had a customer in Australia, which had maintenance planned into their hospitals, and we took a great deal of that volume. So, you see their volume dwindling down in the third and fourth quarter, which we knew about it. So, when you do this squeeze method in the fourth quarter, you get what you -- or you get, but primarily driven by that part of the business having a specific event in the first and second quarter. Moving to the capital allocation, our capital allocation, now putting Kidney Care on the side, is driven by innovation. So, what is the highest innovation drivers for the company is going to be in infusion technology. So, we have more investment to do into new categories of pump, more software. We have intelligence software coming out in 2025 with artificial intelligence that attaches to the pump. We also have five new product launches that we're planning the next 12 months for HST, significant ones, really good ones. We need to put the money behind to close the gap in the research and development regulatory affairs as well as the commercial launch. So, that is where we allocate the money, and we have some molecules in Pharmaceuticals. So, you're talking about infusion systems, specifics into PSS and care communications and what we call the injectable specialty drugs, primarily [indiscernible] that we have coming out of one of our facilities. So, all the capital allocation is going into products that have higher margin and higher contribution to the company plus associated to that is the spending that goes along. So, it's a good spending put for good use. We did a lot of work internally to understand the major drivers of shareholder value to be able to achieve that."
},
{
"speaker": "David Roman",
"content": "Very helpful. Thank you for taking the questions."
},
{
"speaker": "Operator",
"content": "Larry Biegelsen of Wells Fargo is on the line with a question. Please state your question."
},
{
"speaker": "Larry Biegelsen",
"content": "Good morning. Thanks for taking the question, and congrats on the nice quarter here. Joel, I was hoping you could just give us a refresher on the key assumptions for Kidney Care sale or spin. The tax basis, how might it look different from the BPS sale? Just the margins for KidneyCo, first half was 10.9%, which is much higher than in prior year. So, when we're trying to estimate the dilution, what should we think about for margins and the stranded cost assumptions and use of proceeds would be helpful. Any color on that? Thanks for taking the question."
},
{
"speaker": "Joel Grade",
"content": "Sure. Thanks for the question. Let me just start with the -- again, a little bit from a margin perspective. Again, our first quarter with Kidney, you'll recall, was -- had some substantial one-time impact that drove that margin that, what I'll call it, disproportionately high level. So, I think as we've talked about Kidney in general, think about that, I think as a high single-digit sort of low double-digit margin profile at this point. And again, that was somewhat inflated though particularly in Q1 will be the way I would answer that question. From a stranded cost perspective, look, this is an area we haven't specifically given that type of guidance yet on it. What I will tell you is that that's one of the key initiatives that I'm driving personally in terms of our ability to again to reduce the dilutive impact on that. And so, I think that's something we're going to -- you'll hear more about as we go forward. But that's really, again, we haven't come out yet and given that type of information. And we have plans really underway and again, we're starting execution of that to get way ahead of it. Certainly, from a sales versus spin perspective, obviously, the overarching goal is to maximize shareholder value. And so, we're going to do what is best in order to accomplish that. And if I weigh the puts and takes on some of that kind of stuff, obviously, all else evaluations being equal, so to speak, there are certain advantages of the sale from the perspective of more cash earlier, from the perspective of valuation, certainly, et cetera, but obviously, there's lots of parts to play in that. And then, from a tax perspective, I guess, to answer your final question, I think I look at that as a part of the overall economics of what we're going to do. I think there's been a lot of questions on tax leakage, et cetera, et cetera, et cetera. But in the end, it really is about economics in terms of what we end up with from a net tax proceeds and again what maximize the shareholder value."
},
{
"speaker": "Larry Biegelsen",
"content": "All right. I'll leave it at that. Thanks for taking the question, guys."
},
{
"speaker": "Joel Grade",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Vijay Kumar of Evercore ISI is on the line with the question. Please state your question."
},
{
"speaker": "Vijay Kumar",
"content": "Hey, guys, thanks for taking my question. Joel, I just want to go back on the fourth quarter, you implied sort of 1% organic. And if I heard you correctly, is the only thing that's changing is Drug Compounding. So, should the exit rates for MPT, HST, KidneyCo they should all be in that sort of annual range rate in the low- to mid-singles for MPT, HST, KidneyCo in the 1% to 2%, and only thing that changes for Q4 is Drug Compounding, is that correct?"
},
{
"speaker": "Joel Grade",
"content": "It's primarily that and some Kidney, but I think the Drug Compounding is the main part of it. We haven't talked about the fact that our ex-Kidney exit rate for the year will be in the 4% to 5% range. So I think the -- but yeah, it's primarily compounding and then some slowdown in Kidney."
},
{
"speaker": "Joe Almeida",
"content": "So Vijay, the Kidney part is primarily driven by value-based procurement in that specific business. So, as we await the inclusion or not, we look at our forecast and we look -- that is the biggest impact that we're going to have in Kidney is VBP. And of course, that associated with Drug Compounding have muted the good growth and results of the rest of the businesses of Baxter."
},
{
"speaker": "Vijay Kumar",
"content": "Understood, Joe. And maybe, Joe, a bigger-picture question for you. If I just go back last 18 months, there's been a lot of moving parts, challenges, a lot of questions raised on, is Baxter losing share. When I look at your order commentary within HS&T in some of the performance in core business, it looks like we're back to 4%-plus. When we look at the sort of the forward trajectory here, right, the implied exit rate, is that 4%-plus organic sustainable? Any one-offs we should be aware of? I know this year we had China VBP and some product exits. Any other noise factors that we need to be aware of as you look at the outlook and your comments on share losses?"
},
{
"speaker": "Joe Almeida",
"content": "Let me start from the beginning -- from the end of your question. On VBP, VBP is a factor in Kidney Care. It is a very muted factor in the rest of Baxter, because our presence in China is quite different. Our Kidney holds the vast majority of profitability in China for Baxter in the product offering as well. So, put that aside now. So, VBP Baxter ex-Kidney is a non-event at the moment. Moving to share. We had a tough first quarter for HST. And that greatly was self-inflicted. We had execution issues, which are behind us, as you could see. We had really good performance in PSS. Our orders are significantly up and we're back on the saddle on that without any hesitation. I see us moving forward into Q3 and Q4 with possibility of share gains in that space due to our offering and our ability to bring Baxter together, okay? We have a great offering that actually underscore our mission to save and sustain lives and that is becoming more clear to hospital customers and IDNs when we present, then we've seen a movement towards Baxter, what called the Baxter accounts. The other portion of the market share, which has been spoken as of lately in some of the other calls is on the pump. Baxter will continue to gain 1% plus, the Novum can get up to 2% of market share points on a yearly basis and hopefully more as we continue to see great opportunities. Baxter has converted some really large and important accounts from the competition with our Novum pump. So, I want to make sure that we are a really strong company competing in the marketplace and we're having some successes, as you can see by our guidance going into Q3 and Q4. And the Q4, just to close the loop on that, is depressed primarily by Kidney Care going into negative growth territory for sales and the reduction into compounded sales."
},
{
"speaker": "Vijay Kumar",
"content": "Fantastic. Thanks guys, and congrats on the execution."
},
{
"speaker": "Joe Almeida",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Danielle Antalffy of UBS is on the line with a question. Please state your question."
},
{
"speaker": "Danielle Antalffy",
"content": "Hey, good morning, everyone. Thank you so much for taking the question. Congrats on a good quarter here. Joe and Joel, I wanted to ask a high-level question, and that was really you've been undertaking a sort of a restructuring over the last few quarters here. I'm just curious about, Joe, where you think you guys are? Have you completely turned the corner? This is obviously quite a good quarter, relatively speaking and even not relatively -- on an absolute basis. So, how do you guys turned the corner? Where -- are there still more areas for improving execution that you see going forward, or are we on the path to more consistent improvement from here? And I'll leave it at that. Thanks so much."
},
{
"speaker": "Joe Almeida",
"content": "Thank you, Danielle. Listen, one of the things I want to underscore has been Baxter's capability bringing together a life-saving portfolio of products. And we have made significant progress in the last two years in our enterprise accounts and how Baxter-connected products now are starting to show to our customers and how interested they are. So, I feel that commercial execution not by segment or division only, but as a company has been very successful as of late, and we're starting to see that coming around. Second thing is now moving down from the sales into the ISC, we have turned the corner. Our colleagues in supply chain and our presidents of the segments have worked very, very closely and have devised and are implementing and executing really good plans in terms of cost optimization. And we can see that in our margins, start to turn the corner and we have made great changes to accomplish that. Going down one level, SG&A is all about what Joel spoke about, is our stranded cost associated with other efficiencies, primarily in G&A. This is where the recipe is for the next 12 to 24 months is to optimize the Baxter shared services organization even further and there's great opportunity there as well as contain and offset the stranded costs, so we can show progressively in the next year, two, three, consistent improvements in operating income margins."
},
{
"speaker": "Danielle Antalffy",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Matt Miksic of Barclays is on the line with a question. Please state your question."
},
{
"speaker": "Matt Miksic",
"content": "Hey, thanks so much, and congrats on a really strong quarter here. I wanted to just touch on a couple of things that I don't know where [indiscernible] framed out yet in the call. One was just, where you are in terms of the pricing resets that you've talked about a fair amount? And then, also just any sense that you can get from the patient support side of the business or call it the capital equipment side of the business that maybe speaks to overall demand in the market that you're seeing around investment in infrastructure and capacity as that's come up a few times this earnings cycle? And again, congrats, and thanks so much for taking the questions."
},
{
"speaker": "Joe Almeida",
"content": "Thank you. As we had previously disclosed, we have negotiated two very large GPO agreements and conversations now have moved to the IDN level. As expected, customers are being thoughtful and thorough about evaluation -- evaluating their options. We believe now with the Novum launch and our ability to provide product, our supply chain resilience, by the way, is second to none. We have proven that over the years and that resonates with our customers tremendously. The association of that and the ability to have a large-volume parenteral pump as well as a syringe pump on a novel platform on the market makes a huge difference. So, I feel optimistic that we're going to close those negotiations in the next four months and be able to move on into 2025 with these things behind us. And by the way, pricing has been a contributor to Baxter, in Q2 2024, was about 100 basis points and expect to be roughly 100 basis points for the full year."
},
{
"speaker": "Joel Grade",
"content": "Yeah. And then I'll just take that from a capital perspective, you'd asked about investments in capacity and other types of things. I mean, I think the way I would think about this obviously is as we contemplate our world post-separation, this certainly is an opportunity from -- to really evaluate the -- I guess I'll call it our overall network. There's a lot of things that are intertwined while Kidney is part of our company and the ability to actually really reevaluate that once again that separation does happen is really going to be a key driver of how we think about our network, how we think about our manufacturing, how we think about our distribution network, et cetera. So again, as we think about our capital spend moving forward, and again, with now the ability to allocate capital, if you will, in a way that's really focused on both -- it allows both companies to where both companies can really focus their capital on their highest priorities. Again, that's really how we're going to think about the way we evaluate our capital investments and our infrastructure moving forward."
},
{
"speaker": "Operator",
"content": "Rick Wise of Stifel is on the line with a question. Please state your question."
},
{
"speaker": "Rick Wise",
"content": "Hi, good morning to you both. Joe, I was just hoping you would expand on your Novum comments. Where are we in the rollout? Is this -- you talked about the positives about high customer interest and the healthy backlog or funnel of orders. Does adoption -- does growth accelerate in the second half and into '25? Is that the right way to think about it? And are you seeing more orders than you were expecting last quarter or sort of in line?"
},
{
"speaker": "Joe Almeida",
"content": "Rick, good morning. We found, as a matter of fact, we have sales of Novum in the second quarter, which we did not expect to have, but we're a little faster in having the product ready for the market. What we've seen is great interest. It plays well for our ability to compete. As you know, Spectrum is a great product, but it does not have a syringe pump. And having a syringe pump makes a huge difference. So, we're very happy with the momentum that we're getting in Novum. We'll been showing that to very large hospital systems and small as well. Our team is very hard at work and we feel confident in the technology. So, we have the ability to take market share. I think that is an important thing. This is about providing our patients and our customers with the best technology on the market, not a re-engineered technology from many, many years ago."
},
{
"speaker": "Rick Wise",
"content": "Got you. And Joel, maybe just one for you. You obviously -- you and Joe highlighted multiple times in multiple ways Front Line Care and your optimism that things improve from here. And I was hoping you'd just dig in a little deeper on the turnaround. So, will patient care and government, is that potentially going to get better? And maybe talk about that transition to cardiology and acute, I think those are two areas you mentioned. What do you need to do to get there and how soon can it have a positive impact? Thank you both."
},
{
"speaker": "Joe Almeida",
"content": "You're welcome. So, Rick, let me break up a little bit, break down FLC for -- or Front Line Care to all listening to the call. Primary care is one segment, one division of that business. We have other divisions such as cardiology and monitoring. Those are going very well. We have no issues in the acute care space. So, let's focus on a specific, the patient, the primary care physician office. We believe this market has two dimensions. One is the amount of backlog we had in 2023 that we're able to catch up and ship and sell and fulfill orders that were outstanding. The second one is the slowdown in churn that we've seen due to several of these large primary care outfits exiting the market and moving. The demand is still there. Primary care demand is still there. We're number one shareholder, gaining a slight share with 80%-plus of market share already. So, we see that coming back because the demand is not going anywhere. The demand is high. So, the churn due to the changes on the market as well as what we saw last year, we're catching up with the backlog. Government orders is a completely different thing altogether. So eventually the government will need to buy the products that are needed for the government. And when that happens, we'll see the orders come in. We are a very large supplier of the government and I feel comfortable that those problems that we've seen in '24 with the decline in primary care, this year will turn the corner in 2025. The business has solid footing, good technology. On the other side of Front Line Care, we have technology that will be launched in early -- in mid-2025 to compete into monitoring and we are very happy with new launches that will happen in the MedSurg monitoring products that we have coming out in mid-2025. So, technology launches will fuel FLC in 2025 as well as the comp between '24 and '25, a re-emerging of the primary care and probably resuming orders with the government."
},
{
"speaker": "Rick Wise",
"content": "That's a great overview. Thanks, Joe."
},
{
"speaker": "Joel Grade",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Pito Chickering of Deutsche Bank is on the line with our final question. Please state your question."
},
{
"speaker": "Pito Chickering",
"content": "Hey, good morning, guys. Nice quarter and thanks for fitting in here. Looking at the infusion pumps, what do you think the market is growing sort of in 2024? And are you guys picking up or losing share this year? And with all the RFPs out for '25 and beyond, do you guys see yourselves as market share gainers or market share maintainers? And then, on the strong pricing gains for infusion that you talked about, as we think about pricing in 2025, should we see an acceleration of this pricing for next year?"
},
{
"speaker": "Joe Almeida",
"content": "Pito, can you repeat the last part of your question on the pricing, please?"
},
{
"speaker": "Pito Chickering",
"content": "Yeah. So, you talked about the 100 basis points of pricing sort of this quarter and that continued in the back half of the year. Should that be accelerating in 2025 as you think about the GPO contracts?"
},
{
"speaker": "Joel Grade",
"content": "Yeah. So, this is Joel. Let me take that. I think the way I would think about that is we talked about some pricing of maybe 100 basis points this year as part of the gain that was again mostly outside the US across our portfolio. We think about that -- it's about that same pricing bump from next year as we think about -- as we move into the GPO contracts that come through and that's primarily US pricing. So, I think that's the way I would interpret that. I don't know I'd call it accelerating necessarily, but I would call it consistent with what our expectations were for this year, heading into next year."
},
{
"speaker": "Joe Almeida",
"content": "And Pito, answering the question on the infusion pump, first of all, we are market share gainers and have been for a long time, just about 100 basis points a year. This will accelerate and is accelerating with Novum we're going to see Q3, Q4 into 2025. So, we find that we have great interest in our pump. I think there is a churn -- a natural churn of the market in terms of number of pumps that need to be replaced and our objective is to be -- in every competitive account with our new technology."
},
{
"speaker": "Pito Chickering",
"content": "And then, a quick follow-up to David's question, not asking for 2025 [indiscernible] the year with revenues growing under sort of 1% with compounding slowing due to competitors' issues lapping. I guess, how should we model revenue growth compounding in the fourth quarter and then what are the headwinds and tailwinds that we should be thinking about for 2025 revenues?"
},
{
"speaker": "Joel Grade",
"content": "Can you just repeat that? So, your phone was going in and out during that question. I apologize. Do you mind repeating that one more time, please?"
},
{
"speaker": "Pito Chickering",
"content": "Oh, yes, -- so apologies. So, a follow-up to David's question just about the fourth quarter revenues. We're exiting the year growing less than 1% with compounding becoming a headwind in the fourth quarter. So, I guess the question number one is, how should we model compounding growth in the fourth quarter? And number two, with the compounding slowing, how should we think about headwinds and tailwinds for 2025 revenue growth?"
},
{
"speaker": "Joel Grade",
"content": "Yeah. I mean, look, I think the main thing here is really we're going to continue to see, again, improvements in HST. So that's where I'm going to start with. In other words, we've seen that over the course of this year as that HST business has continued to accelerate, again, we think there'll be a strong exit rate for that business and that will continue to accelerate into 2025. I think as we talked about from a Pharma perspective, again, compounding is going to be a portion of that, that's going to drag. I don't know that we've specifically guided the actual compounding business, but that is something that is again going to be a continued -- it's slowing, as Joe talked about, for various customer reasons that that's happened. From MPT perspective, again, we continue to believe we've got some really solid momentum going into 2025, certainly coming out of 2024. And then, obviously -- so just to kind of summarize all that, I think the -- while there is a bit of a squeeze math from the -- we talked about the Kidney and the compounding, the reality of it is that we have a 4% to 5% growth of ex-Kidney that we're heading into -- exiting the year with and heading into next year. So that momentum is really strong, again ex-Kidney, and that's the part that we feel really excited about as we head into 2025."
},
{
"speaker": "Joe Almeida",
"content": "Pito, just reinforcing and underscoring, our exit rate is 4% to 5%. We feel comfortable with that. That's what Baxter is taking into 2025 and we tend to think that our business and innovation can drive even further going into '26 and '27."
},
{
"speaker": "Pito Chickering",
"content": "Great. Thanks so much."
},
{
"speaker": "Joe Almeida",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today's conference call with Baxter International. Thank you for participating."
}
] |
bax | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, ladies and gentlemen, and welcome to Baxter International's First Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time."
},
{
"speaker": "",
"content": "I would now like to turn the call over to Ms. Clare Trachtman, Senior Vice President, Chief Investor Relations Officer at Baxter International. Ms. Trachtman, you may begin."
},
{
"speaker": "Clare Trachtman",
"content": "Good morning, and welcome to our first quarter 2024 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Joel Grade, Baxter's Executive Vice President and Chief Financial Officer."
},
{
"speaker": "",
"content": "On the call this morning, we will be discussing Baxter's first quarter 2024 results along with our financial outlook for the second quarter and full year 2024. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the second quarter and full year 2024; new product development, including the potential impact of recent regulatory clearances with status and potential impact of our ongoing strategic and recent pricing actions, business development, regulatory matters and the macroeconomic environment, including commentary on improving supply chain conditions and evolving customer capital spending trends; contain forward-looking statements that involve risks and uncertainties and of course, our actual results could differ materially from our current expectations."
},
{
"speaker": "",
"content": "Please refer to today's press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in the accompanying investor presentation and also available in our earnings release issued this morning, which are both available on our website."
},
{
"speaker": "",
"content": "Now I'd like to turn the call over to Joe. Joe?"
},
{
"speaker": "José Almeida",
"content": "Thank you, Clare, and good morning, everyone. We appreciate you taking the time to join us today. I will begin with an overview of our first quarter results and then provide some updates regarding our ongoing strategic transformation. Joel Grade will follow with a closer look at our financials as well as our outlook for the second quarter and the remainder of the year. Then, as always, we'll open it up to your questions."
},
{
"speaker": "",
"content": "Baxter started the year on a positive note, delivering solid results, which exceeded previously issued guidance on both the top line and bottom line first quarter sales from continuing operations with 2% on a reported basis and 3% at constant currency rates. This compares to our original outlook of approximately 1% reported and 1% to 2% constant currency."
},
{
"speaker": "",
"content": "Overall revenue growth was driven by positive demand and pricing for a broad range of Baxter products. On the bottom line, adjusted earnings per share for continuing operations of $0.65 came in above our prior guidance range of $0.59 to $0.62 per share. This performance was fueled by top line results, combined with our intense focus on driving improved supply chain execution across our manufacturing network."
},
{
"speaker": "",
"content": "Overall, performance is clearly benefiting from the streamlining and strategic clarity afforded by our newly implemented operating model, as we leverage the advantages of improved visibility globally, increased accountability and function of verticalization. Crisp execution of our margin improvement initiatives, along with a more stable macroeconomic backdrop, is driving enhanced performance across our integrated supply chain operations."
},
{
"speaker": "",
"content": "And as always, Baxter benefits from its emphasis on essential health care needs in combination with the diversity and durability of our portfolio. This is clearly affecting our overall performance this quarter as the strength of our results across Medical Products and Therapies, Pharmaceuticals and Kidney Care helped offset underperformance in our Healthcare Systems & Technology segment."
},
{
"speaker": "",
"content": "Taking a closer look at our performance by segment. Medical Products and Therapies, or MPT, delivered first quarter growth of 6% above reported and constant currency rates. Growth was fueled by both pricing and volume gains amid stable market conditions globally."
},
{
"speaker": "",
"content": "We believe we're well positioned to build on our momentum in MPT with the recent U.S. FDA clearance of our leading-edge Novum IQ large volume infusion pump and Dose IQ Safety Software. This integrated platform, which also includes our previously cleared syringe pump, comprises a single connected intelligent system offering a broad range of benefits for nurses, physicians and other clinicians as well as the patients who depend on them."
},
{
"speaker": "",
"content": "Our Novum IQ technology is now available to order in the U.S. as part of our expanding portfolio of connected care solutions. Customers are excited about the Novum platform's ability to advance connectivity and intelligent infusion therapy. And the team is already engaged with many customers interested in this new technology."
},
{
"speaker": "",
"content": "In fact, the large existing Novum syringes Spectrum customer will begin implementing the full Novum platform in the next few months. In just last week, we secured a 100% competitive account conversion to Baxter pumps with a top-tier multistate health system."
},
{
"speaker": "",
"content": "As you may remember, Novum LVP clearance was not factored in our original FY 2024 outlook. Given the time of the approval, we expect the contribution from Novum launch to be more notable in the second half of the year, even as it displaces, to some degree, sales of our Spectrum IQ pump and the outlook we are sharing today reflects this expected benefit along with the outperformance in the first quarter."
},
{
"speaker": "",
"content": "Also in late-breaking MPT news last week, we received FDA approval of an expanded indication for Clinolipid, our mixed oil lipid emulsion that provides a source of calories and essential omega fatty acids for parenteral nutrition patients."
},
{
"speaker": "",
"content": "Clinolipid is now indicated for use in pediatric patients, including preterm and term neonates. This is an example of our continued commitment to meeting the nutritional needs of patients of all ages and is expected to be a positive addition to our nutrition portfolio."
},
{
"speaker": "",
"content": "Our Pharmaceutical segment achieved a growth of 11% in the first quarter at both reported and constant currency rates. Results for the quarter reflect a benefit from our recent new product launches in the U.S., including 5 new injectables in key therapeutic areas, including anti-infective and antihypertensive medications."
},
{
"speaker": "",
"content": "Together, these new product introductions demonstrate our continued focus on innovation and delivering differentiated products that address areas of need with proprietary ready-to-use presentations, they can simplify the preparation process and support patient safety. Our performance in this segment was also strengthened by heightened demand outside the U.S. for our drug compounding services. This overall momentum more than offset declines from inhaled anesthesia products."
},
{
"speaker": "",
"content": "Our Kidney Care segment delivered 3% growth at reported rates and 4% at constant currency. Growth was driven by pricing benefits as well as a strong demand for our Acute Therapies portfolio and steady gains of peritoneal patients in nearly all markets."
},
{
"speaker": "",
"content": "Growth in this business was tempered by the impact from select product and market exits and reduced volumes in China due to government-based procurement initiatives and a lower patient census. As noted, positive results across these 3 segments helped offset disappointing performance in Healthcare Systems & Technologies, or HST, which declined 9% at both reported and constant currency rates. This decline was driven to some extent by order timing as well as operational factors."
},
{
"speaker": "",
"content": "Our new operating model has been vital in helping us isolate underlying challenges affecting this segment. The size of steps are already underway to address and enhance performance in this business and help realize our full opportunity in this space. These include forging a deeper partnership between the commercial and enterprise account teams focused on the value and quality of the broader portfolio."
},
{
"speaker": "",
"content": "Implementing new tools and processes focused on increasing visibility to historical purchases, creating greater differentiation in customer engagement practices and related measures. We expect these steps collectively to improve operational performance for HST, particularly in the second half of the year. I remain excited about HST and the positive contribution it is expected to deliver to the overall Baxter portfolio. The team is working incredibly hard to address this challenge and turnaround performance in this business and I'm grateful for their dedication and efforts."
},
{
"speaker": "",
"content": "Before I pass it to Joel, I will share an update on our proposed Kidney Care separation as we announced in the March 4th 8-K filing, we are now pursuing dual pathways in the proposed separation of this business, including potentially selling the business to a private equity investor."
},
{
"speaker": "",
"content": "The ultimate path forward will be determined consistent with our objective to accelerate performance for both entities and maximize shareholder value. We currently expect the separation to take place in the second half of 2024."
},
{
"speaker": "",
"content": "Looking ahead, I want to express my excitement about Baxter overall trajectory. Our life sustaining mission is as always our North Star and our colleagues around the world making it come alive tenacious focus on execution and operational excellence."
},
{
"speaker": "",
"content": "Our progress against our strategic transformation initiative showcases our ability to deliver on what we set out to accomplish. The benefits are clear in our overall outperformance for the quarter. Our building momentum, our recent innovation milestones and the progress of our proposed Kidney Care separation journey. We will continue to maintain the pace and intensity of our transformation and take the necessary steps so that all of our segments are well positioned to power our performance going forward."
},
{
"speaker": "",
"content": "I will now pass it to Joel to provide more detail on our performance and outlook."
},
{
"speaker": "Joel Grade",
"content": "Thanks, Joe, and good morning, everyone. As Joe mentioned, we are pleased with our first quarter results, which came in ahead of our expectations. First quarter 2024 global sales of $3.6 billion increased 2% on a reported basis and 3% on a constant currency basis, and as mentioned, compared favorably to our previously issued guidance."
},
{
"speaker": "",
"content": "Performance in the quarter benefited from better-than-expected sales across all our product divisions, with the exception of those within our Healthcare Systems & Technologies segment."
},
{
"speaker": "",
"content": "On the bottom line, adjusted earnings from continuing operations totaled $0.65 per share, increasing 33% versus the prior year period and ahead of our prior guidance of $0.59 to $0.62 per share. These results reflect the meaningful operational improvements we are recognizing both commercially as well as within our integrated supply chain network, and these factors drove our outperformance in the quarter."
},
{
"speaker": "",
"content": "Now I'll walk through our results by reportable segments. Commentary regarding sales growth will reflect growth at constant currency rates. Sales in our Medical Products & Therapies, or MPT segment, were $1.2 billion, increasing 6%."
},
{
"speaker": "",
"content": "Within MPT, first quarter sales from our Infusion Therapies & Technologies division totaled $966 million and increased 6%. Sales in the quarter benefited from strong growth internationally across the division, including in our IV solutions, nutrition and infusion systems portfolios. Solid demand in the U.S. for IV solutions also contributed to growth in the quarter."
},
{
"speaker": "",
"content": "Sales in Advanced Surgery totaled $263 million and grew 8%, coming in ahead of expectations, and reflecting strong growth internationally."
},
{
"speaker": "",
"content": "For our Healthcare Systems & Technologies, or HST segment, sales in the quarter were $667 million and declined 9%. Within the HST segment, sales in our Care and Connectivity Solutions, or CCS division were $402 million, declining 7%."
},
{
"speaker": "",
"content": "Performance in the quarter was impacted by several factors, including the phasing of product installations, particularly for care communications, which is expected to accelerate later in the year by the timing of capital orders, which increased mid-single digits in the quarter,, but are expected to ramp more meaningfully over the course of the year."
},
{
"speaker": "",
"content": "By lower rental revenues, which negatively impacted sales by approximately $5 million. And finally, by certain operational challenges, for which the team is in the process of implementing clear plans to improve performance and enhance commercial rigor. Given all these factors, we expect to see significant improvements for CCS in both orders and revenue in the second half of the year, which is similar to the [Audio Gap] we experienced last year in this division."
},
{
"speaker": "",
"content": "Front Line Care sales in the quarter were $265 million, declining 12%."
},
{
"speaker": "",
"content": "Growth in the quarter was impacted by a difficult comparison in the prior year as backlog reductions positively contributed to growth in the prior year period."
},
{
"speaker": "",
"content": "Performance in the quarter was also affected by softness in the primary care market which negatively impacted sales in both our connected monitoring and intelligent diagnostics product portfolios."
},
{
"speaker": "",
"content": "Similar to CCS, we expect performance to meaningfully improve in the second half of the year as market conditions for primary care are anticipated to ease, the pace of customer orders are expected to increase, and we anniversary the prior year impact from the backlog reduction."
},
{
"speaker": "",
"content": "Sales in our Pharmaceuticals segment were $578 million, increasing 11%. Performance in the quarter reflected double-digit growth in both our U.S. and international injectables portfolio, driven by new product launches as well as continued strong demand for services within our drug compounding portfolio internationally."
},
{
"speaker": "",
"content": "Moving on to Kidney Care. Sales in the quarter were $1.1 billion, increasing 4%. Within Kidney Care, global sales for chronic therapies were $888 million, increasing 2%. Solid PD growth in the quarter was partially offset by the negative impact from certain products and market exits in our in-center HD business as well as reduced sales in China due to government procurement initiatives and lower patient census volumes following the pandemic."
},
{
"speaker": "",
"content": "We estimate that these items negatively impacted sales by approximately $50 million in the quarter. Sales in our Acute Therapies business were $214 million, representing growth of 15%, driven by strong demand and competitive wins in the U.S. and solid performance internationally."
},
{
"speaker": "",
"content": "Other sales, which represent sales not allocated to a segment and primarily includes sales of products and services provided directly through certain of our manufacturing facilities, were $16 million and declined 47% during the quarter, in line with our expectations and reflecting reduced demand for certain contract manufacturing volumes."
},
{
"speaker": "",
"content": "Now moving on to the rest of the P&L. Our adjusted gross margin totaled 42.5% and represented an increase of 170 basis points over the prior year and was favorable to our expectations. The year-over-year improvement in gross margin primarily reflects the strong operational efficiencies we are realizing within our integrated supply chain network, resulting from execution of the margin improvement programs we're implementing and the anniversary of the negative margin impacts from inflationary pressures that drove higher cost of goods sold in the prior year period."
},
{
"speaker": "",
"content": "Pricing initiatives in select markets also positively contributed to margin improvement in the quarter. First quarter margins also reflected a benefit from the closure of our dialyzer facility as production in the facility was increased in advance of the closure, resulting in better absorption and lower costs for these dialyzers."
},
{
"speaker": "",
"content": "This benefit is expected to be isolated to the first quarter. Overall product mix in the quarter did partially offset margin expansion in the quarter. Adjusted SG&A totaled $856 million or 23.8% as a percentage of sales consistent with the prior year period as ongoing transformation initiatives to enhance operational efficiencies were offset by higher spend in select investments in sales and marketing initiatives."
},
{
"speaker": "",
"content": "SG&A leverage is expected to improve as sales ramp over the course of the year. Adjusted R&D spending in the quarter totaled $160 million and represented 4.5 as a percentage of sales, similar to the prior year period and reflects our continued investments in advancing new products across the portfolio and bringing innovation to patients across [Audio Gap]."
},
{
"speaker": "",
"content": "These factors resulted in an adjusted operating margin of 14.3%, an increase of 180 basis points versus the prior year. Net interest expense totaled $78 million in the quarter, a decrease of $39 million versus the prior year period, driven by debt repayments in the fourth quarter of 2023 with proceeds from our BPS divestiture."
},
{
"speaker": "",
"content": "We plan to continue to repay debt in 2024, consistent with our stated capital allocation priorities. Adjusted other nonoperating income totaled $7 million in the quarter, compared to income of $2 million in the prior year period. The adjusted tax rate in the quarter was 25.0% compared to 23.1% in the prior year period. The year-over-year increase is primarily driven by a valuation allowance recognized in the quarter."
},
{
"speaker": "",
"content": "And as previously mentioned, adjusted earnings from continuing operations totaled $0.65 per share and increased 33% versus the prior year, primarily driven by commercial performance and operational efficiencies within our integrated supply chain."
},
{
"speaker": "",
"content": "Let me conclude my remarks by discussing our outlook for the second quarter and full year 2024, including some key assumptions underpinning the guidance. For full year 2024, Baxter now expects total sales growth of approximately 2% on a reported basis and 2% to 3% on a constant currency basis, which is an increase from prior guidance of approximately 2% on a constant currency basis."
},
{
"speaker": "Constant currency sales guidance for the full year by reportable segments is as follows",
"content": "For MPT, we expect sales growth of 4% to 5%. This is an increase from the prior guidance of 3% to 4% and reflects the first quarter outperformance and the inclusion of Novum, which is currently expected to contribute an incremental $25 million to infusion pump sales and reflects some cannibalization of prior planned sales of Spectrum."
},
{
"speaker": "",
"content": "Sales in our Healthcare Systems & Technologies segment are expected to be flat to the prior year as compared to previous guidance of approximately 3%. As mentioned earlier, we expect performance to meaningfully improve in the second half of the year, driven by the factors discussed, including timing of installations, order phasing and improved operational execution. We expect pharmaceutical sales growth of 6% to 7%, which compares favorably to prior guidance of 4% to 5% and reflects the strong start to the year and continued momentum for our new product launches."
},
{
"speaker": "",
"content": "Collectively, sales for these Baxter businesses are expected to increase 3% to 4% in 2024. For Kidney Care, we expect sales growth of flat to 1% as compared to 2023. This also compares favorably to prior guidance and reflects the underlying momentum of this business."
},
{
"speaker": "",
"content": "Now turning to our outlook for other P&L line items. We continue to expect adjusted operating margin to increase by at least 50 basis points in 2024. We expect our nonoperating expenses, which include net interest expense and other income and expense, to total approximately $350 million in aggregate during 2024."
},
{
"speaker": "",
"content": "We continue to anticipate a full year adjusted tax rate between 22.0% and 22.5%. We expect our diluted share count to increase slightly and average 511 million shares for the year. Based on all these factors, we now anticipate full year adjusted earnings, excluding special items, of $2.88 to $2.98 per diluted share, which also compares favorably to prior guidance of $2.85 to $2.95 per diluted share and reflects the outperformance we realized in the first quarter."
},
{
"speaker": "",
"content": "Specific to the second quarter of 2024, we expect global sales growth of approximately 1% on a reported basis and 2% to 3% on a constant currency basis. And we expect adjusted earnings, excluding special items, of $0.65 to $0.67 per diluted share."
},
{
"speaker": "",
"content": "With that, we can now open up the call for Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] I would like to remind participants that this call is being recorded, and a digital replay will be available on the Baxter International website for 60 days at www.baxter.com."
},
{
"speaker": "",
"content": "Our first question comes from Vijay Kumar of Evercore ISI."
},
{
"speaker": "Vijay Kumar",
"content": "I guess, my first one is on top line here. When I look at the business here, the Hillrom portion health care tech part of the business underperformed, all other segments came in about right. And Joe, when you think about this exiting fiscal '24, can Baxter get back to like 4% top line, like when does Hillrom normalized? And perhaps talk about what gives you confidence that this business is actually growing? Is there any reason to fear share loss within that part of the business?"
},
{
"speaker": "José Almeida",
"content": "Vijay, we are committing to a 4% -- around 4% exit rate for the year. We see what happened in HST in the first quarter as a postponement of orders and some operational issues that we have, that we're addressing very diligently. We're starting to see good results coming out of it."
},
{
"speaker": "",
"content": "What gives me confidence in the second half of the year for HST is that the orders that we have, have improved in the exit of Q1 into Q2 with a healthy funnel of opportunities over the rest of 2024. We have commercial and operational challenges that we identified and we have very specific action plans in place. We also are executing on the existing backlog and we also saw some typical seasonality."
},
{
"speaker": "",
"content": "The first quarter is always the weakest quarter for HST, and the fourth quarter is the highest quarter for HST. Vis-a-vis 2023, we exit Q4 with 7% growth. So what I want to make sure to our investors that we are -- we will exit Baxter around 4% this year -- 4% to 5%, actually -- 4% to 5%, and we will have a recovery of HST based on their operational results and the good funnel that we have established and we're starting to see."
},
{
"speaker": "",
"content": "This is ex Kidney. I want to make sure that you know. When I talk about Baxter exit 4% to 5% is ex Kidney. So to your question, there's good confidence in exiting the business 4 to 5, good plans in place and starting to see the recovery in HST. This is the headline."
},
{
"speaker": "Vijay Kumar",
"content": "That's helpful comments, Joe. One on maybe margins here. Q1, both gross margins and operating margins came in above. What drove that gross margins? Are we seeing benefits of cost actions or is this any timing element? Are we seeing pricing contribution? Because when I look at the second quarter EPS, it's below 3. So was there any timing element here on that margins?"
},
{
"speaker": "Joel Grade",
"content": "Yes. This is Joel. And so a couple of things on the Q1 margins, I would call out. Number one, the ISC drove a substantial portion of that. We had strong operational efficiencies. We had positive manufacturing variances that flowed through. And so I think just in general, our ISC performance was a strong contributor there."
},
{
"speaker": "",
"content": "Our pricing also had, I'd say, a modest, but partial part of that is well in terms of enhancing our margins. There's a little bit of a mix impact that was offsetting some of that, but I think that's really -- those are some of the really primary drivers in the first quarter. I think from a second quarter standpoint, there's a couple of things I'd just call out there."
},
{
"speaker": "",
"content": "Number 1 is there was some favorability in the first quarter that was related to the closing of our dialyzer facility. And we had production that was increased. So we had better absorption there. And so from a timing standpoint, those -- that benefited the Q1 margins to some extent that you won't see as much in Q2."
},
{
"speaker": "",
"content": "And I think the other thing I would call out in Q2, while we certainly continue to have positive contribution from the IHC, positive contribution from pricing, and in particular, some OUS markets, but we also did have a pharma MSA that was part of our BPS divestiture that has -- is impacting the pharma margins in the second quarter as well. So those are a few of the puts and takes from the Q1, Q2 margins."
},
{
"speaker": "Operator",
"content": "Pito Chickering of Deutsche Bank is on the line with a question."
},
{
"speaker": "Pito Chickering",
"content": "Going back to the softness in Healthcare Systems & Technology, can you give a little more detail on what exactly were the operational factors that impacted the first quarter? And why it should ramp sort of in the back half of the year? And also on the capital orders, I guess, why did those not flow through in the quarter as you guys were expecting?"
},
{
"speaker": "",
"content": "And then finally, kind of why you saw lower rental revenues you're expecting? I guess I'm just trying to understand that the delta and the guidance you're seeing sort of today is down 300 bps for the year versus 3 months ago. And what changed so dramatically?"
},
{
"speaker": "José Almeida",
"content": "I will take the first part of your question and Joel will take the second part of your question. We saw the operational issues were more related to how we were integrating our enterprise accounts and our folks who are every day in the field. We had made significant changes halfway through the quarter but did not catch up fast enough."
},
{
"speaker": "",
"content": "We've been seeing a great deal of larger orders being signed today. As a matter of fact, a couple of them are full conversion -- competitive conversions. We have a very effective and large enterprise account that now is fully integrated with HST. And those were the things that we saw and didn't start in the first quarter, we should have been integrated and done a better job in -- probably in August, September last year."
},
{
"speaker": "",
"content": "We did catch up to that, and we see that better. We also have integrated some of the sales systems with more rigor than we had before, and we are making some changes at the mid-level management in that operation so we can get more rigor in how we sell product. But I have to tell you that we're already seeing the momentum that Baxter brings to HST, the part of the 2 companies and how the connectivity of our, for instance, a new Novum pump and how that works with the beds and the monitors how that makes a difference."
},
{
"speaker": "",
"content": "So that is one part. There were operational issues in frontline care completely different than our CCS business. Front Line Care were related to government orders is slowed down by the government, also primary care issues with the payment system that was got hacked in the first quarter that was a division of United Healthcare that affect the primary care physicians offices, therefore, affect how they're ordering the products and getting paid."
},
{
"speaker": "",
"content": "So that affects us as well. And there is a temporary contraction in the primary care physicians market, which we have very high market share. As a matter of fact, we probably gained share in that business. Instead of losing, we actually have proof that we gained share."
},
{
"speaker": "",
"content": "So we see that as a temporary blips in the Front Line Care. In the CCS business were pure operational issues, a lack of better integration in our key account management or enterprise accounts. So the headline of the answer is, we are executing much better right now. We're starting to see the effect in the CCS. We have converted couple of very large accounts from the competition and our offering of launches from last year, Progressa+ and Centrella CLR with a continuous lateral rotation have done very, very well."
},
{
"speaker": "",
"content": "As a matter of fact, that was the reason why a Midwest system converted from the competition to us. In terms of Front Line Care, we're starting to see the rebound. I think we hit the bottom in the primary care office. And what we saw there in terms of all the things coming together, the payment system and the slowdown of the market and we're starting to see that is starting to pick up."
},
{
"speaker": "",
"content": "So I feel cautiously optimistic that our actions are starting to provide results and Baxter, in general, has a pretty strong portfolio that bringing together, as you could see by the results of the quarter. Now passing on to Joel on the second part of the question on the revenue."
},
{
"speaker": "Joel Grade",
"content": "Yes. I would say your question around the second half of year, why are we not recovering fully all the way to the 3%? I mean, I guess what I would say, the first quarter was a fairly sharp decline relative to expectations. And I think more than anything, it's simply that we're not fully anticipating making that up throughout the rest of the course of the year. Having said that, to Joe's point, we certainly do remain optimistic about the growth prospects in this business."
},
{
"speaker": "",
"content": "We have a number of new product launches that are coming in, they are going to continue to enhance our growth. As Joe pointed out, the improvement in Front Line Care, we had a lot of issues. We had gone through a lot of backlog last year and so there was actually a lot of difficult comparisons in the first half of the year that we're going to be lapping in the second half of the year."
},
{
"speaker": "",
"content": "We certainly expect our orders from CCS to continue to meaningfully accelerate. And as Joe said, we've taken specific actions to ensure that commercially and operationally, we're executing better as we head into the back half of the year."
},
{
"speaker": "",
"content": "So I guess, again, in summary, I don't know we're planning that -- we're not going to be able to make up the entire impact that we had in the first quarter of the year, but we're still confident in how we're moving forward. And I would say this, we started to see some modest improvements even starting in Q2 in that business as well."
},
{
"speaker": "Pito Chickering",
"content": "Okay. And then a follow-up question on the gross margin. Is it just such a key part of the Baxter story here. Can you quantify the impact of the closing of the dialyzer facility in the quarter?"
},
{
"speaker": "",
"content": "Looking at the rest of the gross margin improvement year-over-year, what's the split between the inflationary pressures easing versus increased pricing versus just simple operational efficiencies? And should inventories rolling through the balance sheet on the P&L be a tailwind to margins this year? And any seasonality around that occurring?"
},
{
"speaker": "Clare Trachtman",
"content": "So Pito, I'll take that. There are a lot of questions in there. What I would say is that the key is within our integrated supply chain, a lot of this comes down to the execution on our margin improvement initiatives. They've always been designed to offset inflation."
},
{
"speaker": "",
"content": "So even this year, we do have normal inflationary pressures within our organization, but the MIPs that the team is executing against are more than offsetting that and driving the savings both on a year-over-year basis and relative to our expectations."
},
{
"speaker": "",
"content": "Now in the first quarter, we did benefit from some of the positive and favorable manufacturing variances that Joel was referencing. So within the fourth quarter, we did have better volumes than we had anticipated that did -- so those favorable manufacturing variations rolled off in the first quarter giving us a benefit inclusive of what Joel referenced on Opelika where we were preparing for the closure of that dialyzer facility down in Opelika, Alabama. So that's really what I would say."
},
{
"speaker": "",
"content": "Pricing is a benefit. It's a benefit on a year-over-year basis and it's a benefit relative to our expectations. And this is pricing again across the organization on a net basis. And what we're doing is really outside the U.S., we're looking at those businesses and driving a lot of targeted actions within those markets outside the U.S. So I think this is collective. This is in line with what we said earlier that a lot of our margin improvement this year would be coming from gross margin."
},
{
"speaker": "Operator",
"content": "Larry Biegelsen of Wells Fargo is on the line with a question."
},
{
"speaker": "Larry Biegelsen",
"content": "Joe, there was a lot of strength in Q1 outside of HST, but the guidance implies growth slows in all segments. Why would growth slow so much relative to Q1 in Q2 through Q4 in those other segments? And I had one follow-up."
},
{
"speaker": "Clare Trachtman",
"content": "So Larry, maybe I'll start with that and let folks. I would say most of it -- we did see some strength within our Kidney Care that came in favorable to our expectations. So I think that we are still anticipating that to slow in the second half of the year as we get the impact from some of the government-based pricing initiatives in China. Also just the impact of some of the market exits that we will be incurring for the rest of the year."
},
{
"speaker": "",
"content": "So that's probably one of the biggest differences if I think about kind of the rest of the year. In addition, within our Pharmaceuticals business, we had really strong performance from our hospital pharmacy compounding business outside the U.S. We are continuing -- we have strong demand for that business. But we are also really focused on improving the profitability of that business."
},
{
"speaker": "",
"content": "So as we look at it going forward, being very disciplined about some of the business and demand that we're taking on for that. So I'd say that's probably the other impact. Besides that, I think most of the other businesses really kind of continue to perform in line. But those are the 2 big drivers of what changes between the first half and the second half."
},
{
"speaker": "José Almeida",
"content": "And you'll see a tremendous acceleration for HST, Larry, that is reflective of the pace of the business but also acceleration of some of our actions that we took mid-Q1, that is starting to get effect in Q2. We have accelerated our pump sales."
},
{
"speaker": "",
"content": "We also see tremendous demand for our IV solutions and our nutrition -- IV nutrition doing pretty well. And our Pharmaceutical is doing extremely well with the 5 launches. We put those gains into the forecast, into the guidance going forward. However, we see this -- us seeking profitability ahead of sales growth."
},
{
"speaker": "",
"content": "So we will make some of the decisions to be markets where we can actually improve the bottom line. So it's a combination. You saw what happens. We beat the top. We beat the bottom and we continue to seek for opportunities to hopefully overperform."
},
{
"speaker": "Joel Grade",
"content": "And if I could just add one thing on the kidney piece for a little bit just 1 order of magnitude. That business that we talked about going from flat to 1% from a guidance perspective would be closer to mid-single digits without some of the market exits. So to Clare's point, that is a fairly sizable impact as we head into the remaining part of the year as well on a holdco basis."
},
{
"speaker": "Larry Biegelsen",
"content": "That's helpful. Just one quick follow-up. Joe, on the plan for Kidney Co. spin versus sale, when do you expect to make a decision? And how do you guys think about the pros and cons of the spin versus a sale?"
},
{
"speaker": "José Almeida",
"content": "Larry, we will be separating the business in the second half of 2024. And I don't want to comment at the moment and which option is a better option than the other. We're contemplating both options, and we have said that before that we will maximize shareholder return for the option. So whatever option we choose is going to be one of 2. We will separate first of all. Second, when we separate, we will separate with maximization of shareholder return in mind."
},
{
"speaker": "Operator",
"content": "Robbie Marcus of JPMorgan is on the line with a question."
},
{
"speaker": "Robert Marcus",
"content": "Maybe one on R&D. This is one of the first years in a while that R&D is growing slower than sales. How do you think about your R&D investment and where it's going? And are we just seeing some of the benefits of the Hillrom integration here?"
},
{
"speaker": "José Almeida",
"content": "I want to start by saying that we actually increased R&D in HST, the former Hillrom business, we call HST in Baxter now. We increased R&D there. We are very, very judicious about capital allocation within the business and what put money in R&D. We also have plans in '24, but also in '25 to continue to increase the dollar's value, not as a percentage of sales, the dollar's value that we put there."
},
{
"speaker": "",
"content": "So we have not reduced the dollar value of R&D for '24, we actually increased that. As a percentage, that number may show a slowdown, but it has dollar-wise improved. There's no -- there are no savings that we are requiring from research and development. As a matter of fact, we continue to hire folks."
},
{
"speaker": "",
"content": "We are right now exploring alternate sites for more R&D centers in one in Ireland and another one in the East Coast of the United States, we are actually increasing that. So our objective is to drive our goal to 4% to 5% top line growth with innovation, and that's going to be fueled by R&D."
},
{
"speaker": "",
"content": "You're going to see the Novum, we just had Clinolipid approved in the U.S. for neonate and term babies utilization. We also had -- we have significant pipeline coming in from HST. We have wireless communication device. We have new monitors, new thermometers. We have a significant amount of new technology. So there's no slowing down in R&D. It's the other way around."
},
{
"speaker": "Robert Marcus",
"content": "Great. And maybe one, it doesn't get a lot of attention, but I feel like almost every quarter for the past few years, it keeps driving upside and now it's broken out as drug compounding. Nice high-teens growth here. Kind of same question, following up on Larry, but more specific to the drug compounding."
},
{
"speaker": "",
"content": "How do we think about the trajectory of this business? It's one that keeps growing double digits year in and year out and the expectations it always will slow, but it hasn't yet. So what are your views here on how to think about this for the rest of the year?"
},
{
"speaker": "José Almeida",
"content": "Robbie, we at pharmaceutical relied outside the U.S. in very key markets, the combination of drug compounding and premix and vial pharmaceuticals as well as IV solutions as Baxter provides a full solution to the customers."
},
{
"speaker": "",
"content": "Drug compounding is not an area -- a strategic area for Baxter, but it's strategic in specific markets that we do business. I would look at the performance of injectable pharmaceuticals, which has been -- was 8% this first quarter, we're starting to see the new products really taking shape and helping offset the price erosion headwinds as well as the gross margin that got eroded during the pandemic."
},
{
"speaker": "",
"content": "So I would say to you that I'm always optimistic on the second half of the compounding business volume. It is an opportunity that we have to continue to grow. But it's more important to us to grow the new products that we're launching because for every dollar that we sell of a new molecule or a new launched premix, the gross margin is one of the highest in the company, and it goes between 70% and 85%. So that's the focus."
},
{
"speaker": "",
"content": "Compounding is a good all-around business in Australia, New Zealand, U.K., Canada, Ireland to bring the IV solution volumes and some of the pharmaceuticals, but it's not the driver of the business in pharmaceutical. The new product launches and the volume is."
},
{
"speaker": "Operator",
"content": "Danielle Antalffy of UBS is on the line with a question."
},
{
"speaker": "Danielle Antalffy",
"content": "Congrats on a good start to the year here. I just wanted to ask about Novum. Obviously, that's probably the biggest event that has happened now since we were all asked on the phone together. So just curious what you're seeing. I know it's early days, but with Novum, how much of that is factored into the Q1 outperformance or maybe drove some of the Q1 outperformance and into the higher guide? And just sort of what you're seeing from a competitive dynamic now that you do have Novum out there?"
},
{
"speaker": "José Almeida",
"content": "Thank you for the compliment. Opening the question, it was very nice of you to recognize that, we agree with you. Novum has had no impact in the first quarter. As a matter of fact, that performance is driven by strong volumes all around the MPT portfolio, but Novum."
},
{
"speaker": "",
"content": "So Novum is going to be -- will have an impact on the company in the second half of the year when we start shipping. As we noted in the prepared remarks, we have 2 large accounts that just order the product. One is a full conversion from our competitor, our largest competitor, and we're going to continue to see that as our technology is modern, is new."
},
{
"speaker": "",
"content": "The equipment was designed with a significant amount of productivity built in. It comes with the best drug library on the market. And we're going to continue to have a combination of good alternatives to our customers between SIGMA SPECTRUM and Novum. So we -- as we transition between one technology and the other, we will have customers who will continue to use SIGMA SPECTRUM with our award-winning version 9 of the pump and the ones who will have the need for Novum to go there. But our objective right now is competitive conversions. And I think we can make a significant impact there, some in 2024 and more so in 2025."
},
{
"speaker": "Joel Grade",
"content": "Yes. And if I could just add a couple of things to that. Number one, keep in mind, as Joe talked about, we continue to see really strong performance in our Spectrum pump. And so throughout the course of the year, we've anticipated still strong double-digit growth in Spectrum."
},
{
"speaker": "",
"content": "As we head into the second half of the year, again, we will start rolling out Novum. We talked about them from the prepared remarks, we've anticipated some cannibalization of Spectrum with the Novum rollout, but we've included certainly $25 million in the fourth quarter of the year as an anticipation of incremental impact from the Novum rollup -- rollout and as Joe said, much more heading into 2025."
},
{
"speaker": "Operator",
"content": "Patrick Wood of Morgan Stanley is on the line with a question."
},
{
"speaker": "Patrick Wood",
"content": "Amazing. I'll keep it to one given the amount going on this morning. So thank you for taking it. Pharmaceuticals, obviously, again, very strong growth. I'm just trying to think bigger picture. The drug shortage list is still very high. You've got some onshoring certainly of the syringe side of things. And I think the Civica experiment didn't really work and some of the Indian manufacturers have been having a difficult time."
},
{
"speaker": "",
"content": "I guess what do you see as a long-term opportunity there within that business to keep pushing out ANDAs and potentially either benefit from onshoring or pulling back some capacity and better pricings of the drug shortages? Just curious for the outlook there."
},
{
"speaker": "José Almeida",
"content": "Patrick, we are in an injectable space that is -- it's called a specialty generic. We take ANDAs, and we create premixes. They're very safe, they have good shelf life and they can be deployed to hospitals very quickly. So as we think about drug shortages, we continue to explore drugs that can be put into that format."
},
{
"speaker": "",
"content": "But we have also a different -- we have 2 technologies, one we call Calix, but we have another 1 that we call Viaflo. And the Viaflo technology also allows for premix even better without having to refrigerate for the most part. So our portfolio and Alok Sonig who runs that business has brought in a significant amount of opportunities for us to look at more drugs, more molecules."
},
{
"speaker": "",
"content": "We revamped our portfolio of new molecules that is going into premix and put more relevant ones. So they see the 5 we just launched. We have a really good effect in '24 and '25 for Baxter. That business is launching probably 3 to 4, 5 relevant molecules a year. And between expansion of markets outside the U.S. and the U.S., we will have more than 25 different launches in 2025."
},
{
"speaker": "",
"content": "So we continue to accelerate the innovation, but it's the quality of the innovation. In terms of making the product available, we will continue to invest in the technology. As you know, all GALAXY technology is U.S., base is made here in Illinois, and we have some of our products made in Puerto Rico as well as Ireland, but most onshore. So there should be of a good value proposition for our customers who look for security of supply."
},
{
"speaker": "Operator",
"content": "Travis Steed of Bank of America Securities is on line with a question."
},
{
"speaker": "Travis Steed",
"content": "I wanted to ask some of the segment margins, like Renal margins were really strong this quarter, HST margins were lower. I assume that's the revenue stuff, but I just wanted to make sure any other color you can provide on kind of those segment margins this quarter just given they were kind of way off trend?"
},
{
"speaker": "Joel Grade",
"content": "Yes. Thanks for the question. Yes, you're correct in your assumption on that. And then on the Kidney side in particular, there is a lot of impact on that, and something I referred to you earlier in terms of closing our Opelika plant. So again, in that -- in the first quarter, there was -- I call there's a lot of increased production that drove a fairly significant amount of margin in our Kidney business in Q1 in particular. So I think that's really the main driver of that business that you saw that looked like a bit of an outsized margin. We're certainly not anticipating that to continue in Q2."
},
{
"speaker": "Travis Steed",
"content": "Okay. And then just kind of bigger picture, when you think about the core Baxter business kind of excluding the Renal business, just the opportunity for continued margin expansion. You're getting good margin expansion this year. But just in general, like what are the line of sight that you have? Is it cost rolling off? Is it based on revenue growth acceleration, cost opportunity that you can take out of this business just to kind of keep this margin trajectory and expansion kind of going longer term?"
},
{
"speaker": "Joel Grade",
"content": "Yes. I think it's really a combination of things. First of all, it's the volume, as you said, it is continued opportunities from pricing. As you know, we've had some pricing impact this year. And we've renegotiated some of our contracts with our GPOs as we head into next year. We're anticipating continued favorability from a pricing standpoint."
},
{
"speaker": "",
"content": "We also continue to -- the IFC continues to be an area of strength for us that is going to be positively impacting our margins. I think the continued operations for execution, the operational efficiencies, some of the automation opportunities we've had, we continue to do work from a procurement standpoint and some of the buying opportunities we have both to leverage our scale as well as for risk mitigation, we -- I see continued opportunities in the IFC space."
},
{
"speaker": "",
"content": "And I think the other thing I would say is I've said this before, I'll say it again, we're not going to SG&A are way to prosperity. However, there are areas of opportunity there. For example, we'll be hiring, even starting next week, a person that's going to be leading our global business services."
},
{
"speaker": "",
"content": "That is an opportunity for us to continue to think about how we -- what our operating model is, as opposed to verticalization and how we can leverage some of the -- those opportunities across our organization. So I think, again, I see a variety of ways really up and down our P&L in terms of those type of opportunities to continue to expand our margins."
},
{
"speaker": "Operator",
"content": "Josh Jennings of TD Cowen is on the line with the question."
},
{
"speaker": "Joshua Jennings",
"content": "I was hoping to ask Joe and team just about the geographic expansion initiative for the Hillrom or HST portfolio. Has it taken a little bit longer than Baxter initially thought? Or are there challenges to bring Hillrom technologies into international geographies where Baxter are present and Hillrom didn't? It sounds like some of the international softness was based on government order timing in Q1, but just wanted to get an update there as it was part of the strategic rationale for the Hillrom acquisition."
},
{
"speaker": "José Almeida",
"content": "Yes. We have good performance in Western Europe, we see that, and we see good performance in Latin America as well. So we see that Baxter combination with Hillrom has expanded Hillrom opportunity in those markets. We are making changes in our Asia Pacific organization to bring more focus on capital sales to supplement what Baxter is strong, which is general acute market sales."
},
{
"speaker": "",
"content": "So we're increasing talent in Asia Pacific with some changes we just recently made. And Western Europe continues to be a strong market for us, and we continue to strengthen the group there, Latin America as well. So it has been a positive take on Baxter and Hillrom combined for outside the U.S. One market where things are not as strong is China, but China because specifically Made in China restrictions in VBP is known in the market, but our sales ambitions there were not very great as opposed to the fact that in Latin America, Europe, Middle East and Africa and the rest of Asia Pac, they become very strong, including Australia."
},
{
"speaker": "",
"content": "We're very successful in Australia, just closed some really good deals there. So Baxter brought a lot of talent into that equation, and we continue to strengthen the team with new hires that we're bringing on board."
},
{
"speaker": "Joshua Jennings",
"content": "Understood. And just one follow-up. Wanted to just ask about the Connectivity Solutions technology. It sounds like Novum IQ, the smart beds, they're adding to that connectivity solutions portfolio. But maybe if you could just share with us any pipeline initiatives and how you think they can roll in and then start delivering bigger sales impacts as we move into '25 and 2026?"
},
{
"speaker": "José Almeida",
"content": "We, with Novum IQ, syringe and LVP, large volume parenteral, now we have a suite that connects with Baxter, gateway, overall gateway called Connex. And the Connex brings all these devices to talk to each other. So right now, if you went to our center, our customer experience center in Batesville or in any other place that we have, you would see the pump communicating to devices like Volt, the bed communicating to Volt."
},
{
"speaker": "",
"content": "You see the connectivity. And as it becomes more important to our customers, Baxter has the right solutions for the hospitals. Interestingly speaking that it has to bring productivity improvement to the hospital. The ability to connect by just connecting is table stakes. But what Baxter is seeking is continue to innovate to bring specific solutions to improve productivity in the hospital setting."
},
{
"speaker": "",
"content": "So we -- when we do our -- later this year, we do our Investor Day, we'll be able to bring a demo where you're going to be able to see how these devices will be connecting to each other. But they are very important. And with Novum now, the last piece of this puzzle is complete."
},
{
"speaker": "Operator",
"content": "We have time for one final question. Matt Miksic of Barclays is on the line with our final question."
},
{
"speaker": "Matthew Miksic",
"content": "So I'd love to understand one of the things that a question I get often on Baxter is sort of where is the sort of tall pole in the tent? Where is the sort of significant single growth driver, if there is one? And looking into the end of back half of this year and '25, maybe, Joe or if you could highlight which of the product lines or business lines do you think are going to emerge as something that we're all going to look to, to sort of see lift in growth or lifting leverage into '25?"
},
{
"speaker": "José Almeida",
"content": "Matt, one of the advantages of Baxter, it's diverse portfolio that brings things to a point where acute -- the acute market, we provide significant amount of infrastructure products for those markets, IV solutions, pharmaceuticals, pumps."
},
{
"speaker": "",
"content": "We also have the capital market with beds, monitors. And so when we think about Baxter in general, our -- we have several of -- several drivers of growth. You could see this quarter was a significant amount of growth and it was more than enough to offset some headwinds that we had in HST and HST is going to continue to -- I'm cautiously optimistic about the business."
},
{
"speaker": "",
"content": "And I think we have -- we're back into our cadence of growth for that business. We have innovation of every single part of Baxter. We have significant drivers coming out of pharmaceutical, our injectable pharmaceutical portfolio. Our pump conversion rates will be what's going to make that business grow is going to be competitive conversions to our biggest competitor because we have a product that is new and it fulfills significant market needs."
},
{
"speaker": "",
"content": "We also have, in our HST portfolio, more than 7 significant launches in 2025. So innovation in Baxter is not dependent on 1 or 2 products, it's a wide range of products that derisk the company and put the company in a good solid footing to achieve ex Kidney 4% to 5% growth."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today's conference call with Baxter International. Thank you for participating."
}
] |
bby | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for standing by. Welcome to Best Buy's Fourth Quarter Fiscal 2024 Earnings Conference Call. [Operator Instructions] This call is being recorded for playback and will be available at approximately 1:00 p.m. Eastern Time today. [Operator Instructions]"
},
{
"speaker": "",
"content": "I will now turn the conference call over to Mollie O'Brien, Vice President of Investor Relations."
},
{
"speaker": "Mollie O'Brien",
"content": "Thank you, and good morning, everyone. Joining me on the call today are Corie Barry, our CEO; and Matt Bilunas, our CFO. During the call today, we will be discussing both GAAP and non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful can be found in this morning's earnings release, which is available on our website, investors.bestbuy.com."
},
{
"speaker": "",
"content": "Some of the statements we will make today are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may address the financial condition, business initiatives, growth plans, investments and expected performance of the company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements."
},
{
"speaker": "",
"content": "Please refer to the company's current earnings release and our most recent 10-K and subsequent 10-Qs for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call."
},
{
"speaker": "",
"content": "I will now turn the call over to Corie."
},
{
"speaker": "Corie Barry",
"content": "Good morning, everyone, and thank you for joining us. I'm proud of the performance of our teams across the company as they showed resourcefulness, passion and unwavering focus on our customers this past year. Throughout fiscal '24, we demonstrated strong operational execution as we navigated a pressured CE sales environment. This allowed us to deliver annual profitability at the high end of our original guidance range even though sales came in below our original guidance range. Importantly, we grew our paid membership base and drove customer experience improvements in many areas of our business, particularly in services and delivery."
},
{
"speaker": "",
"content": "For Q4 specifically, we are reporting profitability at the high end of our expectations, with revenue near the middle of our guidance range. Our comparable sales declined 4.8% in the quarter. At the same time, we expanded our gross profit rate 50 basis points from last year due to profitability improvements in our membership program as well as Best Buy Health."
},
{
"speaker": "",
"content": "Excluding the impact of the extra week, we lowered our SG&A expense compared to last year as we tightly controlled expenses and adjusted our labor expense rate with sales fluctuations. As expected, customers were very deal-focused through the holiday season, and the promotional environment overall was in line with our expectations. While shopping patterns more closely resembled historical holiday periods and Black Friday and Cyber Week performances were in line with our expectations, the sales lull in December was even steeper than we had modeled. Then customer demand strengthened considerably and was higher than we expected during the 4 days before Christmas."
},
{
"speaker": "",
"content": "Our Q4 digital sales mix was flat to last year at 38% of total domestic sales. Customer in-store pickup of online orders was also consistent at 44%. We improved our delivery speeds, expanding the percent of ship-to-home online orders delivered in 2 days. We have been very focused on getting our app in the hands of customers. And I'm pleased to say that on Black Friday, it ranked #3 across shopping apps and #4 across all apps on Apple's App Store."
},
{
"speaker": "",
"content": "We ended the quarter and year with 7 million members across our 2-tiered My Best Buy paid memberships. Paid members consistently showed higher levels of interaction with comparatively higher levels of spend at Best Buy and a shift of spend away from competitors. From a financial perspective, membership delivered another quarter of higher-than-expected operating income rate contribution. When you include the changes we made to the free tier and the impact of the midyear changes we made to the paid program benefits, our membership program contributed approximately 45 basis points of enterprise year-over-year operating income rate expansion for the full year."
},
{
"speaker": "",
"content": "And our Best Buy Health business achieved its operating income contribution target of 10 basis points for the year. In addition, we announced strategic partnerships with Advocate Health, Geisinger Health and Mass General Brigham, and our care at home platform is now being used in 8 of the top 20 health systems in the U.S."
},
{
"speaker": "",
"content": "Now I would like to look forward to fiscal '25. We expect this to be a year of increasing industry stabilization. Our strategy is to focus on sharpening our customer experiences and industry positioning while maintaining, if not expanding, our operating income rate on a 52-week basis."
},
{
"speaker": "Therefore, our fiscal '25 priorities are as follows",
"content": "one, invigorate and progress targeted customer experiences; two, drive operational effectiveness and efficiency; three, continue our disciplined approach to capital allocation; and four, explore, pilot and drive incremental revenue streams."
},
{
"speaker": "",
"content": "There's a lot to unpack. I'll start with a discussion about the macro environment, the CE industry and our sales expectations. At the highest level, there have been and continue to be macro pressures impacting retail overall and CE more specifically."
},
{
"speaker": "",
"content": "First, inflation has been slowing, but prices for the basics like food and lodging are still much higher and consumers have to prioritize and make trade-off spend decisions. Second, there is a consumer propensity to spend on services like concerts and vacations in lieu of goods, which has remained sticky even as the prices there too have inflated."
},
{
"speaker": "",
"content": "Third, we have a relatively stagnant housing market. Fourth, CE was a significant recipient of a pull forward of demand during the first 2 years of the pandemic. When consumers need to prioritize the basics that usually does not include the product purchases they recently pulled forward. And lastly, the level of CE product innovation has been lowered during the pandemic and supply chain challenged years."
},
{
"speaker": "",
"content": "It's not so much about each of these individually, but when you stack the five, it has been a heavy weight on the industry. On the positive side, experience tells us that these are all cyclical and transient in nature. And while they are ebbing and flowing, we are optimistic that several indicators will continue to show favorability this year. These include decreasing inflation leading to the lowering of interest rates, continued low unemployment, encouraging trends in consumer confidence and the beginnings of a housing market rebound."
},
{
"speaker": "",
"content": "We remain confident that our industry will grow again after 2 years of declines. This is simply a matter of the timing. Our underlying thesis is consistent. First, we believe that much of the growth during the pandemic was incremental, creating a larger installed base of technology products in consumers' homes."
},
{
"speaker": "",
"content": "Second, we expect to see the benefit of the natural upgrade and replacement cycles for the tech bot early in the pandemic kick in this year and into the next few years. Third, we are returning to a more normalized pace of meaningful innovation after a pause during the pandemic."
},
{
"speaker": "",
"content": "Taking all these factors and considerations into account, we expect fiscal '25 comparable sales to be flat to last year on the high end of our guidance range, down in the first half and up in the second half of the year. The low end of our annual comp sales range is a decline of 3%, reflecting a scenario where the mix of the factors I just discussed results in lower customer demand."
},
{
"speaker": "",
"content": "From a category standpoint, we expect sales in our computing category to improve through the year and show growth for the full year as early replacement and upgrade cycles gain momentum and new products featuring even more AI capabilities are released as we move through the year. We are already beginning to see the improvement as year-over-year comparable sales for laptops turned slightly positive in the fourth quarter and are trending positively so far this quarter."
},
{
"speaker": "",
"content": "At this point in time, we expect revenue for the rest of our product categories to stabilize through the year and be flattish to slightly down for the full year, partially offset by the continued growth of our services revenue."
},
{
"speaker": "",
"content": "Even though overall, we are expecting flattish sales growth for the full year, there are many examples of innovation both already introduced and expected through the year that we believe will drive interest including the Samsung AI-enabled phone we are already seeing materially more demand than we expected, new emerging content for VR/AR devices, Ray-Ban smart glasses, Bose open year headphones, EV universal charging devices and a proliferation of 98-inch screen TVs, to name a few."
},
{
"speaker": "",
"content": "Also, the level of exciting and cool new tech at the Consumer Electronics Show in January felt back to normal. Of course, some of that cool new tech hits the market over the following year while some of it is still a few years from consumer launch."
},
{
"speaker": "",
"content": "Now I would like to provide more details on some of the key initiatives within each of our fiscal '25 priorities to capitalize on that industry stability. As I mentioned, our first priority is to invigorate and progress targeted customer experiences. Our first initiative is to materially elevate personalization. We are focused on providing increasingly personalized, highly relevant and motivational content for our known identified customers. We can attribute roughly 90% of our annual revenue to known customers."
},
{
"speaker": "",
"content": "Let's start with our efforts around our paid membership program. Here, we're creating seamless, tailored experiences for our members based on their unique preferences or context. Our app first member deals experience is a great example of this. Rather than bombarding our members with thousands of great member deals, we focus on the experience on the most relevant offers based on their preferences and observed member data."
},
{
"speaker": "",
"content": "Additionally, we're adding personalization across the membership journey, including in-store at POS, where later this year will include props to provide both sales associates and customers with relevant contextual information about their membership like their savings, rewards, protection plans and offers. We will also include personalized dynamic messaging in our communications to members about their upcoming program renewals. These efforts and more will serve to increase membership engagement and continue to improve retention."
},
{
"speaker": "",
"content": "As we think about our broader known customer base, we are fortunate to have a tremendous amount of first-party customer data for our advanced analytics capabilities to leverage. While we are elevating personalization across our customer interactions, I'm particularly excited about the work we are doing with our app. We are currently testing a personalization-centric version of the app homepage with the stories and actions that matter most to customers, along with critical content and plan to launch to all customers during the second quarter."
},
{
"speaker": "",
"content": "The second initiative is to invest back into our store experience. Our stores are crucial assets that provide customers with differentiated experiences, services and convenient multichannel fulfillment. Customer shopping behavior has evolved in the last 4 years. And this year, we are particularly focused on ensuring we provide the experience that customers expect to have when they take the time to come into our stores."
},
{
"speaker": "",
"content": "As a result, our capital investments for fiscal '25 are concentrated more on existing store updates and refreshes and less on major remodels or store openings. We plan to touch every single store in the chain in some fashion, improving both our merchandising and ease of shopping for customers."
},
{
"speaker": "",
"content": "This includes improving and livening the merchandising presentation given the shift to digital shopping and corresponding lower need to hold as much inventory on the sales floor. It also includes rightsizing a number of categories to ensure we're leveraging the space in the center of our stores in the most exciting, relevant and efficient way possible. For example, we will be removing physical media and updating our mobile digital imaging, computing, tablets and smart home departments."
},
{
"speaker": "",
"content": "We are also excited to partner even more with our vendors this year as it relates to their branded in-store merchandise experiences. The coming innovation, combined with our plan to refresh every store in our fleet, provides much more opportunity for vendor investments in our stores. A few examples I can share at this time include Tesla, LoveSac and Starlink."
},
{
"speaker": "",
"content": "Although we still see opportunities for additional large experienced store remodels, we believe we have a better opportunity to improve existing store experiences at scale in fiscal '25. At the same time, we are planning to open a few additional outlet centers and new formats to continue to test 2 important concepts."
},
{
"speaker": "",
"content": "First, we will open small locations in a couple of out state markets where we have no prior physical presence and our omnichannel sales penetration is low to measure our ability to capture untapped share. Second, we will test our ability to close a large format store and open a small format store nearby, thereby maximizing physical store retention through convenience. These learnings will collectively continue to help us refine our forward-looking store strategy."
},
{
"speaker": "",
"content": "In addition to a great physical experience, we want to ensure our customers receive the expert service interactions they want and Best Buy is known for when they come to our stores. During fiscal '25, we will continue to leverage our multiskilled store associates, but in hundreds of stores we will also add back fully dedicated expertise in key categories like major appliances, home theater and computing."
},
{
"speaker": "",
"content": "Our plan is to deploy some of our most skilled sellers against these categories and double down on category-specific training and certifications for these employees. We know that our selling certifications create a better experience for our customers as our certified employees on average drive nearly 15% higher revenue per transaction and garner higher Net Promoter Scores than a noncertified employee."
},
{
"speaker": "",
"content": "In fact, the third initiative under our drive targeted customer experiences priority is to make sure we are prepared to bring coming innovation to life for customers in ways no one else can. This means we need to be ready to leverage the unique strengths that make us the best place for customers to see new tech and the best partner for vendors to launch NewTek."
},
{
"speaker": "",
"content": "This includes everything from expertly trained associates who can explain the new technology and what it can do for you, the best merchandising presentation both in-store and online, all the way to great trade-in values for customers who use technology. This will be particularly important later this year when more computing products featuring AI are expected to launch."
},
{
"speaker": "",
"content": "As a reminder, we hold 1/3 of the retail market share in both the U.S. computing and television industries, roughly 20% in gaming and well over 10% share in other categories like major appliances. We intend to strengthen our position in these key categories through the initiatives I just outlined as well as pointed marketing spend and sharp pricing."
},
{
"speaker": "",
"content": "Our second key priority for the year is to drive operational effectiveness and efficiency. We have a longstanding commitment to identifying cost reductions and driving efficiencies to help offset inflationary pressures in our business and fund investment capacity for new and existing initiatives."
},
{
"speaker": "",
"content": "Our fiscal '25 initiatives are focused on driving further efficiencies across forward and reverse supply chain, our Geek Squad repair operations and our customer care experience. We will continue to lean heavily on analytics and technology to achieve these efficiencies. This includes leveraging AI safely and effectively."
},
{
"speaker": "",
"content": "Let me provide a few specific examples of how we are leveraging it. One, we're using AI to route our in-home delivery and installation trucks to drive more efficient scheduling and a better customer experience. Two, we are leveraging AI to summarize the main points and follow-ups from each of our customer service calls. It also improves the accuracy of the interaction and data collection while reducing average engagement time by almost 5%."
},
{
"speaker": "",
"content": "To help us enhance our overall tech development effectiveness we are leveraging gen AI code generation and shared resources for our engineers. We are also establishing a digital and technology hub in Bangalore, India, which will give us expanded, more economical access to talent and skills. The hub will open and begin the process of onboarding team members later this year."
},
{
"speaker": "In addition, in fiscal '25, we are taking actions to, one, ensure our resources are directed at the right strategic areas; and two, to rightsize our model based on current operations. These actions will allow us to do the following",
"content": "balance field labor resources to make sure we are providing the optimal experience for customers where they want to shop, redirect corporate resources to make sure we have the necessary assets dedicated to areas like AI and other elements of our strategy and rightsize parts of the business where we expect to see lower volume than we envisioned a few years ago. whether that is the result of lower industry sales or due to decisions we made like evolving our paid membership benefits."
},
{
"speaker": "",
"content": "While we made these decisions during the fourth quarter, which resulted in a restructuring charge that Matt will discuss later, many of the actions will be implemented through the first half of fiscal '25 and we will provide more details as we move through the year."
},
{
"speaker": "",
"content": "Our third key priority for the year is to continue our disciplined approach to capital allocation. This will include striking the appropriate balance of prioritizing areas that best position us for the future while prudently dealing with the near-term uncertainty in the CE industry. There are a few key points that I want to highlight."
},
{
"speaker": "",
"content": "First, as it relates to our capital allocation strategy, our overall approach isn't changing. We still plan to first fund operations and investments in areas necessary to grow our business, and next, return excess free cash flow to shareholders through dividends and share repurchases."
},
{
"speaker": "",
"content": "Second, while our enterprise capital expenditures for fiscal '25 are planned at a similar level to last year, our Domestic segment capital expenditures are expected to decline by approximately $50 million due to the store portfolio investment approach I discussed earlier and lower technology-related expense. This is offset by a year-over-year planned increase in CapEx in Canada to reflect investments for new stores and necessary supply chain automation projects."
},
{
"speaker": "",
"content": "Third, and consistent with our practice over the past several years, we will continue to tightly manage our working capital. Our teams have done a tremendous job managing our inventory in a very uneven sales environment, keeping inventory aligned with our forward-looking sales projections while, at the same time, maintaining as much flexibility as possible. And lastly, this morning, we announced a 2% increase in our quarterly dividend. This represents the 11th straight year of dividend increases and puts our current dividend yield near 5%."
},
{
"speaker": "",
"content": "Our fourth key priority for fiscal '25 is longer term in focus. We will continue to explore opportunities that leverage our scale and capabilities to drive incremental profitable revenue streams over time. The most developed example of this is Best Buy Health, where we are leveraging our expertise and our Geek Squad agents to capitalize on the growing use of technology to help provide health care in the home."
},
{
"speaker": "",
"content": "While still very small in relation to our core business, our fiscal '25 Best Buy Health sales are expected to grow faster than the core business, which, combined with cost synergies from fully integrating acquired companies, are expected to drive another 10 basis points of enterprise operating income rate expansion."
},
{
"speaker": "",
"content": "Another example is our recently announced collaboration with Bell Canada to operate 165 small-format consumer electronics retail stores across Canada. These stores, previously known as The Source, which was a wholly owned subsidiary of Bell Canada, will be rebranded as Best Buy Express. We will provide the CE assortment as well as supply chain, marketing and e-commerce."
},
{
"speaker": "",
"content": "Bell will continue to be the exclusive telecommunication services provider and will also be responsible for the store operating costs and labor components of the partnership. This collaboration will allow us to expand our presence in malls and in smaller and midsized communities across Canada. Best Buy Express stores are expected to roll out during the second half of this year."
},
{
"speaker": "",
"content": "Other examples of opportunities we are pursuing include continuing to build out our business case for Geek Squad as a service and adding vendors to our supply chain partner plus program."
},
{
"speaker": "",
"content": "Before I close and turn the call over to Matt, I wanted to touch on a few of the ways we are being recognized for the support we provide to our employees and communities. From an employee standpoint, I'm proud to share that we continue to maintain industry low turnover rates and our fiscal '24 employee turnover was down on a year-over-year basis."
},
{
"speaker": "",
"content": "To that end, this is our second year as the #1 retailer on the Just Capital List, which evaluates and ranks the largest publicly traded companies in the U.S., in part on how a company invests in its workforce. This year will also mark the fifth anniversary of our caregiver pay benefit. During that time, we've supported 22,000 employees with almost 3 million hours of time away, so they could care for those who matter most."
},
{
"speaker": "",
"content": "We continue to be credited as a leader in sustainability. In Q4, for the 13th year, we were named to the annual Dow Jones Sustainability North America Index. We were also just named for the seventh consecutive year, to the CDP's prestigious Climate A List, which looks at how organizations demonstrate best practices associated with environmental leadership."
},
{
"speaker": "",
"content": "In summary, we are focused and energized about delivering on our purpose to Enrich Lives through Technology in a vibrant, always changing industry. We don't assort tech products just for the sake of technology. We see technology and service of humans. And as the largest CE specialty retailer with our unique range of product assortment and expert services, we deliver that human experience to millions of customers."
},
{
"speaker": "",
"content": "I want to reiterate our fiscal '25 strategy in what we expect to be a year of increasing industry stabilization we are focused on sharpening our customer experiences and industry positioning while maintaining, if not expanding our operating income rate on a 52-week basis. We are putting ourselves in the best position for fiscal '25 and beyond. As our industry returns to growth, we expect to grow our sales and expand our operating income rate."
},
{
"speaker": "",
"content": "I will now turn the call over to Matt for more details on Q4 financial performance and our outlook."
},
{
"speaker": "Matthew Bilunas",
"content": "Good morning, everyone. Before getting into our quarterly results, let me start by sharing a few details on the extra week that occurred in the fourth quarter. We estimate that the extra week added approximately $735 million in enterprise revenue and approximately $0.30 in non-GAAP diluted earnings per share to the quarter. Also as a reminder, revenue from the extra week is excluded from our comparable sales calculation."
},
{
"speaker": "",
"content": "Next, I will share details on the fourth quarter results including the extra week. Enterprise revenue of $14.6 billion declined 4.8% on a comparable basis. Our non-GAAP operating income rate of 5% improved 20 basis points compared to last year and included a 50 basis point improvement in our gross profit rate."
},
{
"speaker": "",
"content": "Non-GAAP SG&A dollars were $30 million higher than last year and increased approximately 30 basis points as a percentage of revenue. Compared to last year, our non-GAAP diluted earnings per share increased 4% to $2.72."
},
{
"speaker": "",
"content": "When viewing our performance compared to our expectations, revenue was near the midpoint of our guidance. As Corie mentioned, our comparable sales trends were not linear, with the more traditional holiday shopping days being our strongest from a growth perspective. Our comparable sales by month were November, down 5%; December, down 2%; and January, down 12%."
},
{
"speaker": "",
"content": "Although our sales were near the midpoint of our guidance, our non-GAAP operating income rate of 5% was at the high end. Our gross profit rate was higher than we expected, primarily driven by a more favorable gross profit rate in our services category, which includes our membership offerings. Our non-GAAP SG&A expense was near the high end of our expectations due to additional incentive compensation."
},
{
"speaker": "",
"content": "Next, I will walk through the details of our fourth quarter results compared to last year. In our Domestic segment, revenue decreased 0.9% to $13.4 billion, driven by a comparable sales decline of 5.1% and was partially offset by approximately $675 million in revenue from the extra week. From a category standpoint, the largest contributors to comparable sales decline in the quarter were home theater, appliances, mobile phones and tablets, which were partially offset by growth in gaming."
},
{
"speaker": "",
"content": "From organic's perspective, the overall blended average selling price of our products was slightly higher than last year. The growth was primarily due to an increased mix of units coming from higher ticket items such as notebooks and TVs, even though the individual ASPs for both of those categories were down year-over-year."
},
{
"speaker": "",
"content": "International revenue of $1.2 billion increased 2.7%, primarily driven by approximately $60 million of revenue from the extra week, which was partially offset by a comparable sales decline of 1.4%. Our domestic gross profit rate increased 60 basis points to 20.4%. The higher gross profit rate was primarily driven by improvements from our membership offerings, which included a higher gross profit rate in our services category."
},
{
"speaker": "",
"content": "In addition, the higher gross profit rate from our Best Buy Health initiatives also contributed to the improved rate. The previous items were partially offset by lower product margin rates."
},
{
"speaker": "",
"content": "Consistent with the third quarter, approximately $20 million of vendor funding qualified to be recognized as an offset to SG&A, which was a reduction to cost of sales last year. We anticipate a similar recognition of this funding in the first half of fiscal '25 or approximately $20 million a quarter."
},
{
"speaker": "",
"content": "Moving to SG&A. Our Domestic non-GAAP SG&A increased $17 million, which was primarily driven by the extra week and higher incentive compensation, which were partially offset by lower store payroll costs and reduced advertising expense. Our International non-GAAP SG&A increased $13 million, which was primarily driven by higher incentive compensation and the extra week."
},
{
"speaker": "",
"content": "In the fourth quarter, as Corie alluded to, we incurred $169 million in restructuring costs. The related actions span multiple areas across our organization and include approximately $65 million for actions that won't be implemented until fiscal '26."
},
{
"speaker": "",
"content": "Moving to the balance sheet. We ended the year with $1.4 billion in cash. Our year-end inventory balance was approximately 4% lower than last year's comparable period, and we continue to feel good about our overall inventory position as well as the health of our inventory."
},
{
"speaker": "",
"content": "During fiscal '24, our total capital expenditures were $795 million versus $930 million in fiscal '23. The largest drivers of the year-over-year decline was a reduction in store-related investments. We also returned $1.1 billion to shareholders through dividends and share repurchases."
},
{
"speaker": "Moving on to our full year fiscal '25 financial guidance, which is the following",
"content": "Enterprise revenue in the range of $41.3 billion to $42.6 billion; Enterprise comparable sales of down 3% to flat; Enterprise non-GAAP operating income rate in the range of 3.9% to 4.1%, which compares to an estimated 4% non-GAAP operating income rate for fiscal '24 on a 52-week basis; a non-GAAP effective income tax rate of approximately 25%; non-GAAP diluted earnings per share of $5.75 to $6.20."
},
{
"speaker": "",
"content": "In addition, we expect capital expenditures of approximately $750 million to $800 million. And lastly, we expect to spend approximately $350 million on share repurchases, which is similar to our fiscal '24 spend."
},
{
"speaker": "",
"content": "Next, I will cover some of the key working assumptions that support our guidance. As our ongoing practice, we will continue to close existing traditional stores during our rigorous review of stores as their leases come up for renewal. In fiscal '24, we closed 24 stores. And in fiscal '25, we expect to close 10 to 15 stores."
},
{
"speaker": "",
"content": "Earlier, Corie provided context on our fiscal '25 top line assumptions. Let me spend more time on the profitability outlook. We expect to drive gross profit rate expansion of 20 to 30 basis points compared to fiscal '24 due to the following actions and initiatives."
},
{
"speaker": "",
"content": "First, continued profitability improvements of our services and membership offerings is expected to provide approximately 45 basis points of gross profit rate expansion. The achievement of this improvement essentially recoups the original investment of our previous Total Tech offering that was scaled nationally in October of 2021."
},
{
"speaker": "",
"content": "The expected rate improvement is due to higher revenue from installation and delivery services, which were previously included benefits of paid membership and a lower cost to serve due to lower expected volume for in-home installation and other related services. The unit volume of these services is still expected to be above pre-pandemic levels but below the elevated levels we experienced when Total Tech members receive them as a benefit at no incremental cost. We also expect Best Buy Health to add a benefit of approximately 10 basis points to our enterprise profit -- gross profit rate on a year-over-year basis."
},
{
"speaker": "",
"content": "Partially offsetting the previous items is approximately 20 basis points expected pressure from a lower profit share on a credit card arrangement. In fiscal '24, our profit share was approximately 1.4% of domestic revenue, consistent with fiscal '23. The expected pressure in fiscal '25 is primarily due to expected increases in net credit losses. This estimate does not include implications from any proposed changes to late fee regulation. We also expect that our product margin rates will experience slight pressure."
},
{
"speaker": "",
"content": "Now moving to our SG&A expectations. The high end of our guidance assumes SG&A dollars are similar to fiscal '24, which includes the following puts and takes. We expect higher incentive compensation as we reset our performance targets for the new year with the high end of our guidance assuming an increase of $40 million compared to fiscal '24. We expect advertising expense to increase by approximately $50 million."
},
{
"speaker": "",
"content": "Partially offsetting previous items is the benefit of 1 less week, which is estimated at approximately $90 million. Store payroll expense is expected to be approximately flat to fiscal '24 as a percentage of sales. Lastly, the low end of our guidance reflects our plans to further reduce our variable expenses to align with sales trends."
},
{
"speaker": "",
"content": "Before I close, let me share a couple of comments specific to the first quarter. We anticipate that our first quarter comparable sales will decline approximately 5%, which aligns with our estimated February performance. We expect our non-GAAP operating income rate to be approximately flat to fiscal '24 first quarter rate of 3.4%."
},
{
"speaker": "",
"content": "We expect our gross profit rate to improve compared to last year, in line with the 20 to 30 basis point improvement we are expecting for the full year. SG&A dollars are expected to decline as a percentage in the low single-digit range with the decrease primarily due to lower store payroll expense."
},
{
"speaker": "",
"content": "I will now turn the call over to operator for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] First question is from the line of Scot Ciccarelli with Truist Securities."
},
{
"speaker": "Scot Ciccarelli",
"content": "This is probably difficult to answer but I'd be interested in any color you might have. When you kind of look at the comp performance and the comp decline, how would you segment it between, let's call it, broader pressures on discretionary spending versus, let's call it, the pull forward of demand that happened during the pandemic? Because we're kind of getting into that kind of 4-year period since the pandemic. Typical life cycle of a lot of your products is 3 to 5 years. Just how are you guys kind of thinking about that? Or is it at all possible to segment that?"
},
{
"speaker": "Corie Barry",
"content": "I wish there was an exact science to this one. That being said, we did try to give you in the prepared remarks a few indicators that we're seeing that say we might be starting to get into that replacement cycle. We talked specifically about laptop units returning to growth in Q4 and that trend continuing here as we head into Q1. That, to me, feels like an early indicator of at least some foray into that replacement cycle."
},
{
"speaker": "",
"content": "Because honestly, really, right now, there isn't any massive current innovation that would spur you to go buy a new laptop. There's a little bit but we're expecting more as the year goes on. And then obviously, that -- the laptop category would be kind of earlier in the realm of replacement cycles that we've talked about."
},
{
"speaker": "",
"content": "So I think you're starting to see some goodness there, Scot, which makes me think a little bit more of the overhang that we're seeing is that kind of combo batter of 5 macro factors that I talked about that continue to weigh on the industry and haven't abated nearly to the pace that I think anyone thought from a macro perspective."
},
{
"speaker": "Scot Ciccarelli",
"content": "That's helpful, Corie. And then one other quick one. Like, you guys talked a bit earlier in the script on personalization. I guess the question is for your kind of category, do you get enough frequency in terms of customer visits to really be able to little leverage that data and the personalization that you're targeting?"
},
{
"speaker": "Corie Barry",
"content": "I think what's important is to differentiate purchase frequency from the frequency of interacting with the brand. And we have the luxury because we do know -- like I said, 90% of our purchasing customers we can identify, we can actually see many behaviors. And people don't just come to us because they want to make a purchase."
},
{
"speaker": "",
"content": "There's a lot of research done in the category. There are repairs done in the category. There are curiosity about upgrades done in the category. And so we do see enough frequency of visits and our ability to understand how the consumer is acting that do allow us to make those personalizations."
},
{
"speaker": "",
"content": "And that's why one of the things that we mentioned and why we try to get really specific examples is in the app, having that personalized front page means we're not just targeting you for what you might purchase next. We're literally trying to figure out your next best action, and that action might just be discovery."
},
{
"speaker": "",
"content": "You might just want to come and scroll through and take a look at what's new or what's coming and educate yourself. And we will gladly help you do that. And so I think the next realm of personalization -- I think personalization often gets lumped in with purchase. And it's for us, in particular, because we really deal with the full life cycle of how people use these products, it's a lot broader than that."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Brian Nagel with Oppenheimer."
},
{
"speaker": "Brian Nagel",
"content": "So I want to start, Corie, bigger picture. You mentioned in your prepared comments, I know we've been talking a while about this AI. We talked about some of the products and then how Best Buy's utilizing AI in its own business model. The question I have is as you're talking now to your vendor partners, maybe going back to CES or before, how much excitement is starting to really build around AI as -- in terms of products that we could see in the relative near term for Best Buy, from a consumer base standpoint?"
},
{
"speaker": "Corie Barry",
"content": "Yes. I will give you my very best qualitative answer here. I think if you followed what happened at the Consumer Electronics Show in January at all, it was, I would argue, the largest foray into how AI will impact our world going forward from here, particularly as it relates to consumer electronics."
},
{
"speaker": "",
"content": "And I think in the coming year, there's enough noise out there that you can get this feel that you're going to start to see the computing side of this really start to take light and make it easier and more seamless for everyone to be able to use tools that will help them be more efficient and effective."
},
{
"speaker": "",
"content": "But the horizon question, and that's how I like to think about it, I like to think about it as the kind of innovation horizon, I think, is really vibrant right now in terms of what AI technology might be able to do. Because it's not just compute. It gets into like how smart can I make the things around me."
},
{
"speaker": "",
"content": "And one of the other things that's really interesting about AI is it actually makes consumer electronics products more human. And so there's this question of how do I make these CE products interact with me more seamlessly?"
},
{
"speaker": "",
"content": "How are the robots that are in my house even smarter because they can triangulate faster and they just get smarter on their own? So my little robot vacuum gets smarter every single time that I use it, right?"
},
{
"speaker": "",
"content": "And so these aren't just innovations in the compute side of things. You're starting to see it in the phone side of things. You're starting to see it and how far can we kind of push the envelope on what consumer electronics can do for you in your home to just make your home life more seamless."
},
{
"speaker": "",
"content": "So I'm not saying it's going to be a revolution overnight, Brian, to be clear. But I do definitely see more excitement and kind of this unlock in how technology can fit even more seamlessly into your life."
},
{
"speaker": "Brian Nagel",
"content": "That's very, very helpful. I appreciate that. And then just a follow-up, unrelated. With regard to the [Technical Difficulty] normalization within the CE category, you talked about through the holiday promotions being, I guess, normal. But the question I have is, are you seeing more nonspecific CE retailers come back to the category now as the overall consumer backdrop normalizes post pandemic?"
},
{
"speaker": "Corie Barry",
"content": "I wouldn't say there's more. I mean, I think when we were headed into holiday, we said this is typically a category that is promotional. It's typically a category that many different partners play in for the holiday because whether or not it blew the doors off, it is always a category that people look for as it relates to holiday. And so I think you always see some players come in and out of the space as it relates to gifting and CE as a gift. And I -- my personal point of view, didn't see more than we would have expected this holiday than any other."
},
{
"speaker": "",
"content": "Obviously, we're always watching the competitive landscape. But I think that's why we're really focused in the coming year on our unique positioning in the CE landscape and the both pre-purchase and then post-purchase offerings that we have that are pretty unique in the marketplace, no matter who enters it."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Michael Lasser with UBS."
},
{
"speaker": "Michael Lasser",
"content": "It's on market share trends. Best Buy has always been very dynamic with its strategy. It's one of the factors that has led to its success that it's been able to change with the market, but it does seem like in the last several years the pace of change with the strategy has increased significantly, whether it comes to membership, store format, the composition of store associates. How do you think this is having an impact on Best Buy's market share especially in light of the fact that if we look at Best Buy sales in the Domestic segment for this year, it's likely that the company is going to be on pace to have sales that are about $2 billion below where they were in 2019."
},
{
"speaker": "Corie Barry",
"content": "Yes. So let me start a little near term and then I'll work my way back to a little bit longer term. You're right, there have been a number of strategic pivots in the model. And to be clear, this is in service of bolstering our position in the market. That is why we are making the changes that we are, and it's also in service of a changing consumer who expects a different experience. So we've said it many times, Michael, and I know you're familiar. There isn't a great single source of share here for consumer electronics because nobody covers all the categories that we do."
},
{
"speaker": "",
"content": "But for the Circana track categories, which represent about 70% of our revenue, we held share in Q4 and for the full year, year-over-year. With the same caveats as I think about the last several years, and this is one we have to try to analyze multiple sources over a longer-term period. We believe we've actually largely held share in the key categories since the beginning of the pandemic."
},
{
"speaker": "",
"content": "Like I said, it is a difficult science because there are so many different sources. But you can imagine, as you started with the question, strategically, we are incredibly focused on those real key categories that are important and underline our strategy to really kind of own that home experience and that CE experience end-to-end for our consumers."
},
{
"speaker": "",
"content": "So we are tracking this carefully, and I can promise you that the changes to the model are not for the fun of it. The changes are definitely in service of different customer expectations and our commitment to hold position in this industry."
},
{
"speaker": "Michael Lasser",
"content": "Got it. My follow-up question is, as we look at our model and make an assessment of what the recovery in consumer electronics retail looks like over the next few years, what is the rule of thumb that we should be using in regards to Best Buy sales versus its operating margin and the amount of leverage that the model will produce in light of all the changes that have been made in the last few years? Is there a rule of thumb that you can give us to guide us on how we should be projecting over the next couple of years?"
},
{
"speaker": "Matthew Bilunas",
"content": "Yes, Michael, I'll take that. I think if I look at just going forward in an ideal setting, when you get past the flat to slightly down year this year, we do expect when you look out into the next number of years that the industry will continue to grow and that we will grow along with it."
},
{
"speaker": "",
"content": "I think it is our expectation that we will continue to grow sales. It's our expectation that we will continue to expand our operating profit rate as we do that. And to your point, part of that is we expect to be able to leverage on SG&A and take advantage of not just all the initiatives that are adding to our improvements over this last year, but also just a good focus on cost control and efficiency."
},
{
"speaker": "",
"content": "And so I think by that center, I'm not going to give you a specific how much does rate improve by every point of comp. But it would be our expectation as we grow a few percentage points, we will be able to expand our rate."
},
{
"speaker": "",
"content": "And I think year-to-year, I think that takes on a little different color as you think about one given year and you move into next year with a different level of operating revenue with a consistent level of cost structure. You can imagine that it does help expand your rate a little bit more as you go from one year to the next."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Seth Sigman with Barclays."
},
{
"speaker": "Seth Sigman",
"content": "I wanted to follow up on the sales outlook. As you think about sales down in the first half, up in the second half, any more views on the role that housing and moving activity plays in that? I think some of our work has suggested that there is an impact, but obviously, it's not the only driver. Innovation and a lot of the other things you talked about makes sense. But I guess, how do you think about housing and what's embedded here in the outlook as you think about the opportunity for improvement?"
},
{
"speaker": "Corie Barry",
"content": "You said it very well. It's not a perfect correlation with our business, the housing market, I mean. But there are definitely pieces of the business that tend to correlate more highly, particularly as you think about appliances, and then somewhat as you kind of creep into television. Those tend to be the areas that are most highly correlated. In the prepared remarks, I talked about that kind of stacked macro pressures on CE."
},
{
"speaker": "",
"content": "And then alluded to the fact that the high end of the range at a flat comp for the year, we're assuming that a few of these in particular start to abate. You're starting to see inflation pull back a bit, that one is important. And also, you are starting to at least see the -- what I'd like to call the green shoots of the housing market maybe start to turn in a bit more positive direction."
},
{
"speaker": "",
"content": "So I would assume that in that -- again, at that top end of the guide that we were talking about, we continue to maybe see a bit of that slow progression of improvement."
},
{
"speaker": "",
"content": "There is nothing that would say we expect changes overnight. There's nothing that would say we expect all of a sudden, it's all sunshine and roses in the housing market. But I think in general, we're starting to see enough of the green shoots that make you feel like, yes, there might be a bit of improvement there that helps buoy at least that part of the business."
},
{
"speaker": "",
"content": "That being said, we also said on the downside scenario at a down 3% comp maybe don't see the level of recovery in any of those macro factors that we talked about. So I think that's why we're prudently trying to create a range that acknowledges we're early in the year and early in, trying to see some of the recovery in some of these more cyclical macro items."
},
{
"speaker": "Seth Sigman",
"content": "Got it. Okay. That's really helpful. And then my follow-up, as you think about online sales growth seem to outpace store comps very slightly but for the first time since 2020. And I appreciate the role that stores and online both play in driving a seamless transaction. But I'm just curious, anything notable that you're seeing as it relates to consumer behavior across the channels? And how does that tie in with your store closure plans?"
},
{
"speaker": "Corie Barry",
"content": "I think we've had a pretty consistent view on the fact that we believe online penetration -- we kind of said we'll first stabilize because it went so high during the pandemic, we knew there'd be some level of pullback. And the last -- I'm going to call it like 18 months have been a little bit more around, where does it stabilize, particularly as a percent of our overall revenue."
},
{
"speaker": "",
"content": "And that, for the last year, has been a little bit more stable year-over-year in terms of penetration of digital sales. But our forward-looking hypothesis has been that at a more normalized pace, we probably continue to see online penetration continues to increase."
},
{
"speaker": "",
"content": "Now you led in with what I want to remind everyone, which is this is not a channel that is taken alone in and of itself. The other interesting fact that we laid out in the prepared remarks is that 44% of what we sell online is still picked up in a store. And that number was consistent year-over-year, even though we're shipping faster and we talked about our ability to ship in 2 days even faster than the year before."
},
{
"speaker": "",
"content": "And so for our model, in particular, there is this really important interplay between the digital sales, even as they keep penetrating, and the convenience and the ability to ubiquitously search online but also go into the store, if I would like to, regardless of where I choose to make the purchase, which is why we are moving at a methodical pace, I would say, in terms of the evolution of our store footprint."
},
{
"speaker": "",
"content": "And that's why I also believe this year, our focus is more on touching as many stores as we can and making sure that, that shopping experience feels good, carefully thinking about what the right portfolio looks like over the longer period. And I think Matt and the team have done a really nice job continuing to make sure we are in the right places at the right time and then testing our way into what we think the right footprint of the future is."
},
{
"speaker": "",
"content": "Because it's just not as easy as, is it stores or is it online? It really is the interplay between the 2 uniquely, I would argue, for us as a consumer electronic specialty retailer."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Katharine McShane with Goldman Sachs."
},
{
"speaker": "Katharine McShane",
"content": "Just back to the comp range, I was wondering how we should think about traffic versus ticket when it comes to the down 3% to flat. It seems like there are some moving parts in ticket, and we just wanted to better understand the dynamic of maybe some pressure on prices versus mix."
},
{
"speaker": "Matthew Bilunas",
"content": "Yes. Sure, Kate. When you think about it in the next year, I think what we've been seeing, if I look just back at last year, we saw our average selling prices be a little more pressured in the -- a little bit in the first part of the year and then it started to stabilize in Q3, and in Q4, in fact, our average selling price was up compared to last year. And some of that was this unit mix that we talked about. As well as we look to next year, we clearly are trying to see both -- some level of ASP stabilization, some unit growth, which is why we've seen such a promotional environment to kind of stimulate the unit side of this equation."
},
{
"speaker": "",
"content": "And so I think it all kind of obviously depends by category. And I think the carriers are at somewhat different phases in their -- where is the right ASP to drive the right type of unit velocity. And so I think probably somewhat, I would guess, next year similar to what we've seen this year. There could be quarters where you see a little ASP pressure, a little bit more coming from units and vice versa. So hard to know exactly by quarter, but it's probably nothing too dissimilar from what we've seen in the last year."
},
{
"speaker": "Katharine McShane",
"content": "Okay. And our second question was just on the usage of your credit cards, if you're seeing anything different. Or did you see anything change in the fourth quarter in terms of frequency or size of transaction?"
},
{
"speaker": "Matthew Bilunas",
"content": "No, nothing really different in terms of usage. It's still an amazing offering for us. We have about 25% of our sales transacted on our card, which has been pretty consistent for the past 5 years. Last year, it was still 1.4% of our domestic sales similar to FY '23. So nothing too different in terms of the usage. And in fact, we still see a continued level of our card being used for external purchases. That's been growing over the last number of years."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Greg Melich with Evercore ISI."
},
{
"speaker": "Gregory Melich",
"content": "I wanted to follow up on membership and services. Could you give us an update there in terms of either household or a number of members or what percentage of services revenues are there and what behavior you're seeing?"
},
{
"speaker": "Corie Barry",
"content": "Yes. We haven't explicitly broken out the percent of services, that is, membership. But we did say we now have 7 million members, and that is compared to 5.8 million at the start of the year. During Q4, we actually signed up 35% more paid members compared to the fourth quarter of last year. So remember that we have a new tier in there. So we have the My Total and the My Best Buy Plus. And so that has driven some growth. And I think it's important to remember, our goal here is to drive engagement and increased share of wallet."
},
{
"speaker": "",
"content": "And what we do is we're doing that across 3 main aspects. You hit on acquisition. But there's also -- we talked on the call about engagement and retention. And I think we're happy because, right now, our paid members continue to interact with the brand more frequently compared to nonmembers."
},
{
"speaker": "",
"content": "And in addition, as we've been analyzing incremental spend that says -- based on data from Circana that indicates that our Total Tech members are shifting their share of wallet to us as well."
},
{
"speaker": "",
"content": "So it's not just about how many of them are using services but it's also about how frequently are they interacting with the brand? And are we keeping them loyal to the Best Buy brand. And I think we're happy, again, with what we're seeing so far there and making good progress. We haven't yet lapped the new rollout. So we still have a little bit of time to understand just how well we're doing in that vein. But right now, we're really happy with our ability to acquire members."
},
{
"speaker": "Matthew Bilunas",
"content": "And maybe just for a little additional context, the services growth you see at 6% in Q4, that growth was driven more by increased revenue collected from our installation business. As Corie mentioned, we've shifted -- we've changed our membership program. So we're seeing more of that revenue growth now come off the installation revenue that we're now collecting because it's no longer part of the benefits of Total Tech."
},
{
"speaker": "",
"content": "And so although we're growing more members, the price point is changing a bit. So you see more growth coming from the insulation business from a dollar perspective than you would have seen in previous quarters."
},
{
"speaker": "Gregory Melich",
"content": "Great. And then my follow-up is on that is really -- I think you mentioned that ad expense or marketing expense will be up $50 million this year. Could you just say what that's on? And I'm curious, are there any efforts to use all -- the data that you're getting, whether it's from your members or just customers in general, to maybe get some revenue from all that data and insight?"
},
{
"speaker": "Matthew Bilunas",
"content": "Sure. I'll start, and then Corie can jump on the last part of the question. I think overall, we're adding about $50 million of advertising expense this year. It's for a number of different things, and I'll give you a couple of items. First, we are expecting a brand relaunch in the back half of this year. So some of this money is used for some additional branding spend that we have. I would say also this is a very unique year in terms of we have things like the Olympics and presidential election. So the inflation on marketing actually comes up in these periods of time, which is part of that increase."
},
{
"speaker": "",
"content": "We are also trying to ensure that we are positioned right across our key categories and making sure we have the right amount of low funnel marketing spend pointed at growing our categories when we need to. So I think it's a collection of those things that I would explain. It all adds up to that $50 million. So again, positioning ourselves for a great stabilization and growth in the future and making sure we're in the market in the right spots."
},
{
"speaker": "Corie Barry",
"content": "And I love the question about data. It's one of the most powerful tools we have in terms of how we reach our customers. And so we have a Best Buy Ads business. That continues to grow top line collections and profitability and it's been outpacing our core business, I think, as you would expect."
},
{
"speaker": "",
"content": "And I think it's important to know, this isn't new for us. I mean, at Best Buy we've had very close partnerships with our vendors for a very long time in terms of our advertising. It has gotten more scientific. It has gotten a lot more personalized. And I think that first-party data that we have is much more powerful than it has ever been historically."
},
{
"speaker": "",
"content": "And obviously, we can also leverage our strong share position in places like even smart TV where we do have established relationships and partnerships with both Amazon on Fire TV and Roku. And so we also have partnerships that allow us to partner on those leading streaming platforms, and we can grow that advertising business and deliver even more value to our vendor partners through some of the partnerships we have uniquely there. So you're right, the data that we have stretches, not only on our own platforms like the app, but stretches into how uniquely we can serve those customers."
},
{
"speaker": "Operator",
"content": "Today's final question will come from the line of Joe Feldman with Telsey Advisory Group."
},
{
"speaker": "Joseph Feldman",
"content": "I want to follow up, can you share a little more color on the store refreshes and what we should expect to see over the course of the year as you do touch up the stores and maybe make them a little more engaging from a merchandising standpoint?"
},
{
"speaker": "Corie Barry",
"content": "Yes, absolutely. Let me start with, to be clear, we're not remodeling every store in the fleet. So I have to be clear there. But what we are doing is taking, I would argue, kind of a stronger position than we ever have to ensure that the shopping experience reflects that kind of excitement and that sparkle that technology brings to life."
},
{
"speaker": "",
"content": "So we've given examples before like some of the investments that we are making in our end caps and those vendor experiences that you see throughout the store, super important positions in the store because they tend to be the most customer facing. And so you're going to see us continue to bring those to life."
},
{
"speaker": "",
"content": "I think you're also going to see us rightsize a number of the categories and that's particular emphasis on that center of the store area because we want that excitement. We want that relevancy. We also want to be efficient for our associates. And so we're moving physical media, updating mobile, digital imaging, computing, tablets and smart home, things that allows us to make that center of the store really feel a bit more vibrant and exciting."
},
{
"speaker": "",
"content": "And so the goal here is not that every single store is going to look like an experience store. The goal though is that every single one has a bit of a refreshed look and feel, has more of those vendor partnership opportunities and has a better ability for our associates to merchandise in a way that makes everything feel kind of full and exciting."
},
{
"speaker": "",
"content": "And with that -- do you have a follow-up, Joe, sorry?"
},
{
"speaker": "Joseph Feldman",
"content": "No, no, no, that's good. We can end it there."
},
{
"speaker": "Corie Barry",
"content": "No, no problem. Thanks for the question. And with that, that was our last question. I want to thank everyone for joining us today during what I know is a very busy earnings season. We look forward to updating you on our results and progress during our next call in May. Have a great day."
},
{
"speaker": "Operator",
"content": "Thank you all for joining today's conference call. You may now disconnect."
}
] |
bby | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for standing by. Welcome to the Best Buy'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 call is being recorded for playback and will be available for -- by approximately 1:00 P.M Eastern Time today. [Operator Instructions] I will now turn the conference call over to Mollie O'Brien, Vice-President of Investor Relations."
},
{
"speaker": "Mollie O'Brien",
"content": "Thank you, and good morning, everyone. Joining me on the call today are Corie Barry, our CEO, and Matt Bilunas, our CFO. During the call today, we will be discussing both GAAP and non-GAAP financial measures, a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these financial measures are useful can be found in this morning's earnings release, which is available on our website, investors.bestbuy.com. Some of the statements we will make today are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may address the financial condition, business initiatives, growth plans, investments and expected performance of the company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current earnings release and our most recent 10-K and subsequent 10-Qs for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the call over to Corie."
},
{
"speaker": "Corie Barry",
"content": "Good morning, everyone, and thank you for joining us. For the third quarter, we are reporting better-than-expected profitability on slightly softer-than-expected revenue. Specifically, we are reporting a comparable sales decline of 6.9%, which is slightly below our outlook for the quarter as consumer demand softened through the quarter. At the same time, we expanded our Q3 gross profit rate 90 basis points from last year due to profitability improvements in our membership program and better product margins. We also lowered our SG&A expense compared to last year as we tightly controlled expenses and adjusted our labor expense rate with sales fluctuations. During the quarter, we grew our paid membership base and drove meaningful improvements in customer satisfaction scores across many of our service offerings, including in-home delivery, in-store services and remote support. Our Q3 results demonstrate our ongoing strong operational execution as we navigate through the sales pressure our industry has been experiencing for the past several quarters. The sales pressure is due to many factors, including the pandemic pull-forward of tech purchases, the shift back into services outside the home like travel and entertainment and inflation. In the more recent macro-environment, consumer demand has been even more uneven and difficult to predict. Based on the sales trends in Q3 and so far in November, we believe it is prudent to lower our revenue outlook for Q4. But despite the lowered sales outlook, the midpoint of our annual EPS guidance is now slightly higher than the midpoint of our original guidance as we entered the year. I want to thank our associates for their resilience and relentless focus on our customers. I continue to be so very proud of the way our teams are managing the business today and preparing for our future. Now, I would like to provide more color on our Q3 performance and holiday plans before passing the call off to Matt for the financial details on the quarter and our outlook. We continue to strategically manage our promotional plan and we're price-competitive in an environment, where consumers are very deal-focused and making spend tradeoffs right for their budget. Consumers are looking for value, and from an industry themes' perspective, we are seeing some trade-down in the television category, but not as much trade-down in other categories. As a result, and as expected, the goal of industry promotions and discounts were above last year and pre-pandemic fiscal '20. Similar to the first half of the year, during Q3, our purchasing customers were relatively consistent in terms of demographics versus last year. As a reminder, we over-index with higher-income consumers, compared to the general population. And we saw the percent of revenue categorized as premium and the percent of purchases over $1,000 remain constant versus last year. We have largely maintained our year-to-date industry share in our Circana, formerly NPD-tracked categories. Against this backdrop, our focus on deepening relationships with customers remains crucial. Our membership program delivered another quarter of growth and improved profitability versus last year. The Q3 contribution to the enterprise operating income rate was larger-than-expected due to the combination of a lower cost to serve and higher paid in-home installation services. For the full year of fiscal '24, we now expect our three-tiered membership program to contribute approximately 35 basis points of Enterprise year-over-year operating income rate expansion. It is still early since we introduced material changes in June, but there are a number of insights I would like to share. One, we continue to increase our paid membership base and now have 6.6 million members. This compares to 5.8 million at the start of the year. During the third quarter, we signed up approximately 35% more new paid members compared to the third quarter of last year, driven by the addition of the new Tier and buoyed by back-to-school and October’s member month events. Two, our paid members continue to interact with the brand and shop more frequently compared to non-members, which is the goal of any membership program. Three, and though it is early and we have not yet lapped the new programs, retention rates are outperforming expectations. Four, My Best Buy Total, which is the evolution of our prior Total tech offer, continues to resonate more strongly in our physical store setting. As a reminder, this tier is $179.99 per year and includes Geek Squad 24/7 tech support via in-store, remote, phone or chat on all your electronics no matter where you purchase them. It also includes up to two years of product protection, including AppleCare Plus on most new Best Buy purchases and includes all the benefits of My Best Buy Plus. And five, our My Best Buy Plus tier is resonating more with the digital customers and appeals to a broader set of customer segments. This is the new tier for customers who want value and access. For $49.99 per year, customers get exclusive prices and access to highly anticipated product releases. They also get free two-day shipping and an extended 60-day return and exchange window on most products. We are still early in the process and are testing different promotional offers to determine what resonates most with consumers as well as continuously improving the digital experience to make it even easier to find deals and benefits. Of course, we also have a free membership tier that enables free shipping for everyone, a great differentiator, especially in the holiday season. During the quarter, we continued to evolve our omnichannel capabilities to support our strategy and make it easy and enjoyable for consumers to get the best tech and premier expert consultation and service when they want it through our online store and in-home experiences. Last month, we introduced Best Buy Drops, which is a new experience only available through the Best Buy app. It gives customers the opportunity to access product releases, limited edition items, launches and deals from a variety of categories. There are multiple drops nearly every week, and they're only available in limited quantities. We are encouraged by the early results as Best Buy Drops is driving both incremental customer app downloads and higher frequency of app visits. We have also seen growth in sales from customers who are getting help from our virtual sales associates. These interactions, which can be via phone, chat or our virtual store, drive much higher conversion rates and average order values than our general dot.com levels. This quarter, we had 140,000 customer interactions by a video chat with associates, specifically out of our virtual store locations. As a reminder, this is a physical store in one of our distribution centers with merchandising and products that are staffed with dedicated associates and no physical customers. We also teamed up with live shopping platform Talk Shop Live, to test a series of online shopping events this month, starring our virtual sales associates. These events feature products from some of our newer categories like beauty and wellness as well as new tech and unique products. Our physical store portfolio is one of our key assets, and the role of our stores is to provide customers with differentiated experiences, services and multichannel fulfillment. At the same time, we need some stores to be more cost and capital efficient to operate. As a reminder, while almost one-third of our domestic sales are online, 43% of those sales were picked up in one of our stores by customers in Q3. And most customers shop us in multiple channels. Consistent with our normal cadence, we have largely completed the changes to our store portfolio for the year, so we can focus on the holiday season with minimal disruption to our physical stores. As we think about next year with the current economic backdrop, we plan to spend more of our capital expenditures refreshing a greater number of our stores and less on large-scale remodels. As such, we have three priorities for our US store fleet in the near term. Number one, we are refreshing our stores with a particular focus on improving enlivening the merchandising presentation given the shift to digital shopping and corresponding lower need to hold as much inventory on the shopping floor. For example, this year, in all our stores, we installed new premium end caps in partnership with key vendors that improve the merchandising in the center of the store. This year, we installed up to 10 of these new end caps per store or roughly one-third of our end caps per store and plan to add more next year as we work to upgrade these crucial locations in our stores. In addition, this year, we rightsized our traditional gaming spaces in roughly half of our stores to allow for the expansion of growing categories like PC gaming and newer offerings such as Greenworks cordless power tools, wellness products like the Oura ring, Epson short throw projectors, e-bikes and scooters and Lovesac home furnishing products. While small, we are seeing promising results in some of these new categories with meaningful market share growth. And as always, we continue to work closely with our vendor partners to add experiences to our stores. For example, LEGO and Therabody invested in new shop-in-shops in all our 35,000 square foot experience stores. In addition, and as you would expect, many of our premium partners are continuously updating their in-store spaces to reflect their latest innovations. We will continue this work next year in all our stores, rightsizing a number of categories to ensure we are leveraging the space in the center of our stores in the most exciting, relevant and efficient way possible. Our second priority is to keep investing in formats we know drive returns. This year, we implemented 8 large format 35,000 square foot experienced store remodels for a total of 54 and will end the year with 23 outlet stores. At this point in time, we plan to implement a minimal number of remodels and outlets next year. And the third priority is to open a few smaller footprint stores to keep testing our hypothesis at physical points of presence matter, and we need less selling square footage and more fulfillment and inventory holding space. In addition, we plan to open a few smaller stores in outstate markets to test the impact of adding new locations and geographies where we have no prior physical presence and our omnichannel sales penetration is low. At the same time, we also continue to close existing traditional stores as a result of our rigorous review of stores as their leases come up for renewal. This year, we have closed 24 stores. Over the past five years, we have closed approximately 100 Best Buy stores, which is a 10% decline in store count during that time frame. And we expect to close roughly 15 to 20 stores per year in the near term. We have been enhancing our supply chain network to support these footprint changes and deliver speed, predictability and choice to our customers. For example, we have worked to optimize our ship-from-store hub footprint to maintain substantial coverage for faster offers and take shipping volume pressure off the majority of the stores to allow them to focus on in-store and pickup experiences. Additionally, we are optimizing our shipping locations to enhance our efficiency and effectiveness while still delivering with speed. And as a result, in Q3, we had the lowest ship from store volume as a percent of total since well before the pandemic, with approximately 62% of e-commerce small packages delivered to customers from automated distribution centers. We also continued to augment our own supply chain through other partners and launched Best Buy on DoorDash marketplace, offering our second scheduled parcel delivery option in addition to Instacart Marketplace. As we have discussed previously, we have made strategic structural changes to our store operating model over the past few years to adjust to the shifts we have seen in customer shopping behavior and our corresponding operational needs. These changes provide more flexibility and have allowed us to flex labor hours with the fluctuations in customer sales, shopping preferences like curbside and traffic. As a result, we kept our labor rates steady as a percent of revenue, even as our sales have declined over the past several quarters. As you can imagine, there is a delicate balance to maintain while we adjust our store operating model as the expert service our associates provide customers is a core competitive advantage. We keep a very close watch on our customer satisfaction trends to make sure we are not negatively impacting the customer experience. Broadly, I am proud that the team is doing this work while driving higher purchasing customer NPS for associate availability, product availability and pricing. We are also committed, of course, to providing a great employee experience through training opportunities and benefits. As we mentioned last quarter, we have now led thousands of our sales associates through a certification process focused on our foundational retail excellence. We are also leveraging technology in our stores more than ever to continue to elevate our customer and employee experiences in more cost-effective ways. A great example is our app built for employees called Solution Sidekick, that provides a guided selling experience consistent across departments, channels and locations. Our employees have embraced solution Sidekick and we can see higher customer NPS when our employees are utilizing the app in their interactions with customers. We are gratified that our employee retention rates continue to outperform the retail industry, particularly in key leadership roles, the vast majority of which we hire internally. Our average tenure, excluding our seasonal workforce, for field employees is just under five years, and our general manager tenure is almost 16 years. This is crucial as we can directly tie tenured experience and training certifications to NPS improvement over time. We have also seen a strong pool of applicants for new associates to supplement our store teams this holiday season. As you all have likely noticed, the holiday shopping season has begun. Since we are preparing for a customer who is very deal focused, we expect shopping patterns will look even more similar to historical holiday periods than they did last year with customer shopping activity concentrated on Black Friday week, Cyber Monday and the last two weeks of December. From an inventory perspective, we expect to have strong product availability across categories this year. We will continue to manage inventory strategically to maximize our ability to flex with customer demand. We are excited about the promotions and deals we have planned for all customers and budgets, including special promotions and early access to deals for our My Best Buy Plus and My Best Buy Total members. We have curated gift list to help everyone find the perfect gift. We also introduced a new resource on bestbuy.com and the Best Buy app called Yes Best Buy Sells That, where customers can find the latest in tech and gifting, like pet tech, baby tech or electric vehicle chargers, all the way to unique products, some shoppers may not know we sell like skin treatments, toys for all ages and electric outdoor power equipment. For added ease of shopping and peace of mind, we've extended both our store hours and our product return policy for the holiday season. And this year, for the first time, we also extended that our shoppers can connect directly with one of our virtual sales experts to get help with their holiday shopping. We're also offering free next-day delivery on thousands of items in addition to convenience store and curbside pickup options. Most orders placed on bestbuy.com or through the Best Buy app are ready for store pickup within one hour. Same-day delivery is also available on most products for a small fee. From a merchandising perspective, we're excited for shoppers to see new innovation in a variety of categories, including AI-powered devices like Microsoft CoPilot and Windows 11 computers, the latest in virtual and mixed reality with Meta Quest 3 or Ray-Ban Meta Smart Glasses, immersive audio with Bose Quiet Comfort ultra-headphones and more, and we can help our holiday shoppers take advantage of this new innovation through our trade-in program, which gives the customer value for their old technology. In addition to great deals for our flagship categories like computing, home theater and gaming, that feature our unique ability to showcase higher-end technologies at great value, we also have an expanded assortment of new and growing categories, including e-transportation, health and wellness and outdoor living. Our e-transportation assortment has more options for people of all ages and skill levels. We have twice as many outdoor cooking brands compared to last year and more than 5,000 health and wellness products, including a lineup of fitness, recovery, beauty, skin care, baby tech and more. As you can likely hear, we are very excited to provide customers an amazing experience this holiday season. Of course, the macro environment remains uncertain with some tailwinds and increasingly more headwinds, all contributing uneven impacts on consumers. The job market remains strong and upper income and older demographics, in particular, continue to benefit from excess savings. Overarchingly, the consumer is still spending. But as we have said before, they are making careful choices and trade-offs right for their households. Given the sustained inflationary pressure on the basics, like food, fuel and lodging and the ongoing preference towards services spending, like restaurants, concert tickets indications. Additional indicators have continued to soften, including declining consumer confidence increasing debt and waning savings, and we saw sales trends soften as we move through the quarter. This environment continues to make it challenging to predict shopping behavior even during the most exciting time of the year. While we are lowering our Q4 sales outlook, we have a wide range to allow for a number of scenarios and the mid- to high end of the range reflects sequential improvement. As we discussed on our last call, there are several factors supporting our belief that our Q4 year-over-year comparable sales can improve. We expect home theater year-over-year performance to improve as we expect to be better positioned with inventory across all price points and budgets than last year. We are starting to see signs of stabilization in our TV units as they grew in Q2 and Q3 and are expected to grow in Q4. We expect performance in our computing category to improve as we build on our position of strength in the premium assortment. Notebook units were flat compared to last year in Q2, down as expected in Q3 and expected to be up slightly in Q4 and we expect to see continued growth in the gaming category as inventory is more readily available and there are strong new software titles. In summary, while the macro and industry backdrop continues to drive volatility, we have a proven track record of navigating well through dynamic and challenging environments, and we will continue to adjust as the macro conditions evolve. And we remain incredibly confident about our future opportunities. After two years of declines, we believe the consumer electronics industry should see more stabilization next year and possibly growth in the back half of the year. While our existing product categories have slightly different timing nuances, we believe they are poised for growth in the coming years, benefiting from a materially larger installed base and the ongoing desire and need to replace technology as it ages. Much of this replacement is spurred by innovation, and in addition, we continue to see several macro trends that should drive opportunities in our business over time, including cloud, augmented reality, expansion of broadband access and, of course, generative AI, where we know our vendor partners are working behind the scenes to create consumer products that optimize this material technology advancement. Our purpose to enrich lives through technology is more relevant today than ever. We're the largest CE specialty retailer. We continue to hold one-third of the market share in both the US computing and television industries and we can commercialize new technology for customers like no one else. With that, I would like to turn the call over to Matt for more details on our third quarter results our fiscal '24 outlook."
},
{
"speaker": "Matt Bilunas",
"content": "Good morning, everyone. Let me start by sharing details on our third quarter results. Enterprise revenue of $9.8 billion declined 6.9% on a comparable basis. Our non-GAAP operating income rate of 3.8% declined 10 basis points compared to last year. Non-GAAP SG&A dollars were $57 million lower than last year, and it increased approximately 100 basis points as a percentage of revenue. Partially offsetting the higher SG&A rate was a 90 basis point improvement in our gross profit rate. Compared to last year, our non-GAAP diluted earnings per share decreased 6.5% to $1.29. When viewing our performance compared to our expectations, we did not see the sequential improvement versus the second quarter that our third quarter outlook assumed. From an enterprise comparable sales phasing perspective, August decline of approximately 6% was our best performing month, with September down 7% and October down 8%. Although our sales were below plan, our non-GAAP operating income rate exceeded our outlook by approximately 40 basis points, which was driven by lower SG&A. The lower-than-expected SG&A was largely driven by tighter expense management in areas such as store payroll and advertising expense as we adjusted plans to account for sales trends. Our gross profit rate was essentially flat to our expectations. Lastly, approximately $20 million of vendor funding qualified to be recognized as an offset to SG&A while our outlook assumed it would have been a reduction of cost of sales. We anticipate similar recognition of this funding in Q4 in the range of $15 million to $20 million. Next, I will walk through the details of our third quarter results compared to last year. In our Domestic segment, revenue decreased 8.2% to $9 billion, driven by a comparable sales decline of 7.3%. From a category standpoint, the largest contributors to the comparable sales decline in the quarter were appliances, computing, home theater and mobile phones, which were partially offset by growth in gaming. From an organic perspective, the overall blended average selling price of our products was essentially flat to last year, which is a slight improvement relative to the past few quarters. In our International segment, revenue decreased 3.4% to $760 million. This decrease was driven by a comparable sales decline of 1.9% and a negative impact of foreign exchange rates. Our Domestic gross profit rate increased 100 basis points to 22.9%. The higher gross profit rate was driven by the following. First, improvement from our membership offerings, which included a higher gross profit rate in our services category. Second, our product margin rates improved versus last year, including a higher level of vendor-supported promotions and the benefit from optimization efforts across multiple areas. And third, lower supply chain costs. Before moving on, I would like to give some additional context on the profit sharing revenue from our credit card arrangement, which performed better than we expected in the third quarter. On a year-over-year basis, the profit share has been approximately flat from a dollar perspective over the course of the year, which has resulted in a slightly positive impact to our gross profit rate. In the fourth quarter, we expect the profit share to come in better than we had expected and once again be very similar to last year from a dollar perspective. As we look to next year, we expect the credit card profit share to be a pressure to our gross profit rate. At this point in time, we expect this pressure to be offset by continued financial improvement from our membership offerings. Moving to SG&A. Our Domestic non-GAAP SG&A declined $58 million with the primary drivers being lower store payroll costs and reduced advertising, which were partially offset by higher incentive compensation. Next, let me touch on our inventory balance. Similar to last year at this time, we continue to feel good about our overall inventory position as well as the health of our inventory. Our quarter-end inventory balance was approximately 4% higher than last year's comparable period. As we noted during last year's third quarter earnings call, approximately $600 million of inventory receipts came in a few days later than we had expected, moving from October into November. Adjusting for that timing shift, this year's ending inventory balance would have been approximately 4% lower than last year's targeted ending balance. Year-to-date, we've returned a total of $873 million to shareholders through dividends of $603 million and share repurchases of $270 million. We now expect share repurchases of approximately $350 million for the year. Let me next share more color on our outlook for the year, starting with our thoughts on the fourth quarter. From a top line perspective, we now expect our fourth quarter comparable sales to be down in the range of 3% to 7%. Our Enterprise comparable sales through the first three weeks of November are near the low end of the fourth quarter range. On the profitability side, we expect our fourth quarter non-GAAP operating income rate to be in the range of 4.7% to 5%, which compares to a rate of 4.8% last year. Our fourth quarter gross profit rate is expected to improve versus last year by approximately 30 basis points. Although favorable to last year, the year-over-year improvement is less than the 90 basis points of expansion we reported for the third quarter. From a sequential standpoint, there are three main items I would highlight that are expected to reduce the rate expansion in the fourth quarter relative to the third quarter. First, although it is still a benefit compared to last year, the changes to our membership offering are less impactful in the larger holiday quarter. Second, product margin rates are expected to be closer to flat to last year in the fourth quarter compared to a benefit in the third quarter. And third, we expect supply chain cost to be a slight pressure in the fourth quarter versus a benefit in the third quarter. From an SG&A standpoint, when comparing to last year, we expect our fourth quarter SG&A as a percentage of sales to be more favorable than our year-to-date trends, which is due in part to the impact of the extra week this year. The range of SG&A implied in the fourth quarter incorporates our normal course of actions to adjust variable expenses under the different revenue scenarios as well as adjustments to incentive compensation align with our expected financial outcomes. As a reminder, we expect the extra week to add approximately $700 million of revenue, which is excluded from our comparable sales and $100 million in SG&A, we still expect it to benefit our full year non-GAAP operating income rate by approximately 10 basis points. Let me provide more details on our full year guidance, which incorporates the color I just shared on the fourth quarter. We now expect the following. Enterprise revenue in the range of $43.1 billion to $43.7 billion, Enterprise comparable sales to decline 6% to 7.5%, Enterprise non-GAAP operating income rate in the range of 4% to 4.1%, non-GAAP diluted earnings per share of $6 to $6.30, non-GAAP effective income tax rate of approximately 24%, and lastly, our interest income is still expected to exceed interest expense this year. Our full year gross profit and SG&A working assumptions remain very similar to what we shared last quarter. And some of the key callouts are the following. We still expect our gross profit rate to improve by approximately 60 basis points compared to fiscal '23. A large driver of the gross profit rate improvement is expected to come from our membership offerings, which includes a higher gross profit rate in our services category. Our membership offerings are now expected to provide approximately 35 basis points of improvement. At the midpoint of our guidance, we expect SG&A as a percentage of sales to increase by approximately 95 basis points compared to last year. We expect higher incentive compensation as we lapped up very low levels last year. The high end of our guidance now assumes incentive compensation increases by approximately $140 million compared to fiscal '23. I will now turn the call over to the operator for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Simeon Gutman of Morgan Stanley. Your line is open."
},
{
"speaker": "Simeon Gutman",
"content": "Good morning, everyone. I wanted to ask a question, as we get into the fourth quarter, it looks like we'll have negative comps, and it will be the third year in a row. As you step back, I think there's logic to this massive pull forward and there is a larger installed base. There should be a replacement cycle. But I wanted to kind of question that. And if it throws any water on this, if there's something else happening here, maybe there is a lack of newness. You mentioned that you didn't lose much share, but thinking about market share as well, but thinking about the cycles and whether we're not -- whether we could be in just a negative industry cycle for a little bit longer."
},
{
"speaker": "Corie Barry",
"content": "Thanks for the question, Simeon. I think we have a few things going on to your point. So if you think about the comments that I had in the macro section, you've got a variety of stacked issues happening. One is absolutely you had pull forward throughout the pandemic. Two is you also have this kind of sustained inflation. And again, it's sustained inflation on the basics that we've been talking about food, fuel and lodging. And so that's pulling people. We also talked about the fact that a lot of spend right now is geared towards the more service type of things like concerts, like trips. Everywhere you look, people are taking more and more vacations. And so you have all of this kind of shift of spend that's happening. I think secondarily, as it relates specifically to the holiday time frame, the other interesting thing is people have also been buying CE a little bit more steadily throughout the year. If you think about CE as more of a need-based item, not just that kind of giftable item, and so I think there's also just been a little bit of a shift in where people are spending. But I think broadly, what we're seeing reflected right now is the kind of culmination of not just pull forward, but all of these other factors that we're seeing from the consumer as they make those trade-offs. And we've been using the words uneven for probably six quarters now, and I think that is what you're seeing in the variety of results from consumers and where they're choosing to spend their dollars."
},
{
"speaker": "Simeon Gutman",
"content": "Maybe the quick follow-up is the Q4, I guess, you're running at the low end. Does it get better because the comparison gets better? Or you're hopeful around how the big holiday sales end up playing out?"
},
{
"speaker": "Matt Bilunas",
"content": "Yeah. I think the comparison certainly gets better. As you think about last year, we were about 3% lower than FY '20 levels. This year, we're lower against FY '20, but the sequential is better in Q4. I think there's still a lot of optimism for holiday. I think there's a lot of great holiday promotions and events. And I think we're trying to temper any expectation on holiday just with the pragmatic view of where the consumer is at right now. And I think you commented on the share. I think we actually -- we say largely held share because it's really hard to actually get a good meaningful number on share, but we feel good about our share position as we go into the holiday period."
},
{
"speaker": "Simeon Gutman",
"content": "Okay. Thanks. Happy Thanksgiving. Good luck."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Chris Horvers of JPMorgan. Your line is open."
},
{
"speaker": "Chris Horvers",
"content": "Thanks, and good morning. So, thanks for the commentary around the credit card headwind that you're thinking about next year being offset by the membership. Can you talk about implicitly what you're assuming as a headwind in that comment, there's a lot of speculation. There's a lot of numbers getting thrown around in the market. And so I just want to try to understand what you're implicitly assuming? And then in addition, what are the other big puts and takes in gross margin as you think about 2024, as you think about initiative spending as well as your health efforts?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. Thanks for the question. For credit card next year, I mean, obviously, there's a number of scenarios we're trying to understand as you think about next year. So we're not really guiding next year now. But when we think about the credit card, that pressure that we expect to see, we believe, will largely be offset by benefits we might see from the membership program and services category expanding a bit more from a gross property perspective. The factors within the credit card, one of the biggest things we're trying to understand is just where do net credit losses go. They're -- at the moment, they're pretty close to where they were pre-pandemic. They were very low levels during the pandemic. And so we've been seeing them grow a little bit. And so the question would be how high did those grow if they do grow into next year and what sort of pressure. The other factor to consider is that, generally speaking, our receivable balance is higher than it used to be over the last several years. And so a higher receivable balance and interest income obviously can offset some of those pressures as well. So those are a couple of the bigger things we're trying to understand as we think about the credit card specifically. And as you mentioned, again, for next year, the other puts and takes, again, we're not guiding next year, but that credit card pressure and the membership benefit is one of the bigger factors we're trying to understand. Another one that I would call out would be -- we know that we're going to likely have to add STI expense back in as we're -- we've lowered the expense this year as we reset STI in the coming year to roughly $85 million that we would likely add back. Clearly, where the industry is a question as well to the extent that sales are flat or up, it helps relieve some of the pressure of some fixed costs. Clearly, the level of pressure matters quite a bit next year. If it's a small increase, small decline, it's less significant than is a bigger decline. So those are some of the bigger factors we're trying to think through as we go into next year."
},
{
"speaker": "Chris Horvers",
"content": "So that's a perfect segue. On the SG&A side, Corie, I know you talked about your NPS scores with purchasing customers and what you're seeing in the store, you've caught what feels like a lot of labor over the past few years or past couple of years. Are there any metrics that you're seeing, whether it's non-purchasing customers, like close rates versus people walking indoor that are concerning to you? And then as you think about '24, given that you've comped negatively for this sustained period, is there just less flexibility to manage the labor component?"
},
{
"speaker": "Corie Barry",
"content": "So I alluded to NPS being one of the factors that we -- you can imagine, there is a broad array of both operational and then more survey-based metrics that we're looking at, everything from how fast can we do an in-store pick, how good is the curbside experience. We specifically talked about and we can see meaningful improvements year-over-year in product availability, in associate availability, in a variety of products and pricing, and those have continuously improved even as this year has gone on. And actually, we can also see some level of improvement in some of those through non-purchasers as well. So we're watching both sides of this and that sequential improvement is happening across both purchasers and non-purchasers. And yes, we're watching close rate too, and the team is doing a really nice job measuring themselves and showing some progress against their close rate expectations as well. So we are -- literally, we have the almost Rubik's cube of operational and customer survey-based metrics so we can assess. I think what the team has done a really amazing job at is your point around flexibility. You talked about do you have less. Interestingly, now we have associates who can opt into and get certified in not just multiple areas of expertise within the store, but they can also get certified for operations roles and sales roles, and they can actually move between stores within their markets. And so we can flex not just against what's the consumer demand at the highest level, we can actually flex within a market depending on how and where people are choosing to shop. So I can even use an example like in the last week, we've seen a lot more people opting into in-store pickup and curbside and needing a bit more ship from store, and we can quickly then shift some of that labor into those areas, while still trying to strike the balance. We also talked about even moving some of the ship from store out of stores using those automated facilities so that when we do have labor in the stores, it's more customer-facing. It's facing more some of these key areas where we're trying to deliver these experiences. So not perfect and certainly not going to be perfect every single day at every single location, but we really are working hard, and I give the team a great deal of credit for every day monitoring both the experiences and the operational metrics that will tell us whether or not we're delivering."
},
{
"speaker": "Chris Horvers",
"content": "Got it. Have a great Thanksgiving."
},
{
"speaker": "Corie Barry",
"content": "Thanks, you too."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Peter Keith of Piper Sandler. Your line is open."
},
{
"speaker": "Peter Keith",
"content": "Hey, thanks. Good morning everyone. Happy holidays. Nice to see the membership program changes coming a bit more accretive than initially guided. Could you help us unpack that a little bit in terms of the drivers, if it's just removing the free installation or maybe that middle tier is trending a little more profitable than you thought. Maybe curious on what the uptick is from?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. The main drivers of the improvement from a rate perspective are -- there's basically four main areas. The first is the point change to the three My Best Buy program. The second would be just the growth in paid members over time and the recognition of those annual fees. The changes we made to the total tech program, moving it to Total, mainly came through with lowering the cost to fulfill as we removed the free installation that also was part of the 35 basis points, and the resumption of appliance at home theater installation, paid insulation is the other part of the number. The main drivers of it coming better than our expectations are around higher-than-expected paid installation volumes and then also lower-than-expected Best Buy claims and lower Apple premiums than we had expected."
},
{
"speaker": "Peter Keith",
"content": "Okay. That's helpful, Matt. And then -- and Corie, I guess everyone is very curious on product innovation and understanding we're kind of in this air pocket with very little innovation. But I'm curious are there any little green shoots that you're seeing in stores, maybe smaller products that we're not thinking about that give us some optimism that newness can drive sales?"
},
{
"speaker": "Corie Barry",
"content": "Yeah. I actually -- I mean, I might be biased, but I think there's a lot of green shoots that are out there. And you're right, back to the -- one of the first questions, definitely what has also caused the pullback in CE, and I didn't hit it, to begin with, I'll hit it now, is just a bit of a lack of innovation when everyone was trying so hard to produce as much as possible or pull back as hard as possible, we just haven't seen it. Now we are starting to see a little bit of that turn toward innovation. What we can see, even in TVs, we can see there's a lot more interest in those large screen sizes. We can see growth in the like 77-inch plus kind of categories where people want to get that newness. We actually have double the amount of SKUs in the 97-inch and above TV category, which I know sounds insane, but those are really interesting things to people from a true entertaining at home perspective. In majors, there's a brand-new washer/dryer combo unit from GE, so you can both do the washing and the drying in one unit, which is a really interesting innovation for people like me who might want to do two loads at once, full time and get through it all. In gaming, you can see there's really good availability of consoles, with some really interesting new titles that are driving some demand, some handheld gaming from ASUS and Lenovo. Those are great. And then there's kind of some smaller just interesting things. We talked about the Meta Quest 3, the Meta Ray-Ban sunglasses and not only can you capture pictures but has audio built in. And then I think there's lots of just really small fun giftable things, right? There's everything from the automated bird feeder to the automated litter box and everything in between. So what's cool and the reason a little tongue in cheek, we mentioned the Best Buy sells that is there are actually a ton of really interesting fun consumer technology devices. And to your point, they're kind of small, but they're starting to lead the way into what I think will be more meaningful cycles as we head into the back half of next year. As you think about, we mentioned generative AI and products and importantly, chips that geared toward running those kind of large language processing models. And you can imagine that will extend not just into computing, but into other areas. And we can't always talk about everything that we can see on the horizon, but we definitely can see some interesting products as our vendors, as you all know, are just as incented to stimulate demand as we are."
},
{
"speaker": "Peter Keith",
"content": "Very good. Good luck with the holiday season."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Mike Baker of D.A. Davidson. Your line is open."
},
{
"speaker": "Mike Baker",
"content": "Okay. Great. Thank you. And this was sort of touched on, but the promotional activity, I think you said it's up. Where is it versus plan? Do you expect it to get more promotional as we get through the holiday season? And you said this year, it will be more traditional, i.e., Black Friday, Cyber Monday, the last few weeks, et cetera. Can you remind us how the holiday played out last year?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. I think strategically -- I think we've done a really good job of managing our promotional plan overall. I think the promotions in terms of the discounts and mix of promotions are up versus last year, and in many cases, up compared to where they were pre-pandemic. Again, it hasn't necessarily manifested in our pressure on our product margin rates because we're still receiving a good amount of funding from our vendors to help stimulate the sales that you would expect us to want to do. I think as you look about the holiday season, I think we are expecting the holiday to be a very sales-driven event. Consumers are looking for deals, and they're looking for value. And because of that, we believe it will look probably more closely to like it was pre-pandemic, where people are gravitating towards the big sale events around Thanksgiving and Cyber Monday and a couple of weeks before Christmas. So a pretty similar cadence to what we saw in FY '20, although in FY '20, we did -- didn't have as much pull forward into October as we likely still have in this current year. So a more similar cadence to promotional events. I would expect holiday always to be promotional, and we are well positioned to be promotional and still maintain a great profitable story for our investors. So overall, I think we're in a great spot."
},
{
"speaker": "Corie Barry",
"content": "And just to be explicit, what we actually had said, the promo environment was as expected. It was in line with our expectations in Q3. And you can imagine we're kind of taking -- what we're seeing and pushing that into Q4, but it hasn't been wildly outside our expectations."
},
{
"speaker": "Mike Baker",
"content": "Got it. Okay. Thank you. If I could ask one more, and maybe you can't answer this, but you did talk a lot about some crowding out in that kind of dynamic with the higher inflation. Well, now all of a sudden, the inflation concern is turning to deflation concern. Asking you to look into your crystal ball, how that could impact your sales results next year if the inflation goes away and we're more in a deflationary environment?"
},
{
"speaker": "Corie Barry",
"content": "Yeah. I mean we've been pretty consistent as we've talked about the effects of inflation. We've been pretty consistent in saying, where it's putting pressure on the consumer is because it's in those key basic areas of need, fuel, food, lodging, consumables like the stuff you just kind of need every single day. And that's what's been eating into a lot of that pent-up savings, especially for some of the lower income demographics. And so if you start to get into a world where you see more disinflation in some of those areas, then as you would expect, you start to free up some of that share of wallet for potentially getting back into goods or some of the kind of higher ticket purchases. And so we're watching that carefully. Right now, still very elevated versus especially pre-pandemic, slowing down, and to your point, people start to talk about it, which over time, I think, could present some opportunity for people to move back into the goods space, also, of course, depending on how elevated that spend remains around services and things like vacations and spending outside the home."
},
{
"speaker": "Mike Baker",
"content": "Yeah. Makes perfect sense. Okay. Thank you. Appreciate the color."
},
{
"speaker": "Corie Barry",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Steven Zaccone of Citi. Your line is open."
},
{
"speaker": "Steven Zaccone",
"content": "Great. Good morning. Thanks very much for taking my question. I wanted to ask a question on average selling prices. So it sounds like it was flat, slight improvement. What drove that improvement on a sequential basis by category? And then as you think about the fourth quarter, can you talk about your outlook for units versus ASPs?"
},
{
"speaker": "Matt Bilunas",
"content": "Yeah. I -- we'll get into the by category improvement to ASPs. Generally speaking, we are starting to, I would say, lap some of the ASP reduction. We've been seeing ASPs slowly get lower, also the last number of quarters. I think we're starting to lap some of that deflation in that average selling price, if you will. So I think it's probably as much as that as people are gravitating to in some cases, we mentioned that TV is an area of trade down that we are actually seeing. And so those do tend to lower your ASPs because it's a big ticket item. And as we start to lap that, I think you're starting to see some relief on the ASP sequentially. Again, I think in certain areas, so in terms of like Q4, clearly, we've been seeing unit pressure overall, but there are some areas where some of our bigger categories we are expecting the units to improve. We're expecting TV units to increase. We're expecting to see improvements in notebook units as well. So it's a little bit varied, but those are some of the bigger ones."
},
{
"speaker": "Steven Zaccone",
"content": "Okay. Great. Thanks. And then Corie, I had a question. Just thinking about next year, I think you alluded to more stabilization and the potential for growth in the back half. I guess I was curious, how do you see the recovery playing out? We're waiting for the tech refresh cycle. But if the overall promotional environment stays challenging, how do you think about the recovery from market share position or maybe if the consumer is willing to trade down, how are you positioned to outpace the industry overall?"
},
{
"speaker": "Corie Barry",
"content": "So if I think about how the last year has played out, this industry has largely been in a very promotional stance for over the last year. We've been pretty consistent in saying promos are back to, if not greater, than FY '20 levels. So this is not a new phenomenon for us. So even as we head into next year, we're lapping that. And even in that environment where you've seen that level of promotionality, as Matt said, we've sustained our share position. So I think the team has done a beautiful job positioning us well in a very promotional environment. And I wouldn't be surprised to see that environment continue into the first part of next year. And again, we're lapping that kind of similar environment last year. So it's not a huge change in trajectory for us. I think what starts to make the back half, in our view, potentially more interesting next year is really a function of the innovation cycles. And we can start to see a line of sight toward even read a little bit about, especially on some of the computing and processing side, devices that might start to feed into that as we head into the back half of next year. And back to Peter's earlier question, we can start to see on the horizon, some of that newness and innovation really on the docket as you head into the back half and into holiday for next year as everyone again, it's pretty incented to want to bring some vitality back to the industry."
},
{
"speaker": "Steven Zaccone",
"content": "Thanks very much for the detail. Have a nice Thanksgiving."
},
{
"speaker": "Corie Barry",
"content": "Yeah. Thanks. You too."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Jonathan Matuszewski of Jefferies. Your line is open."
},
{
"speaker": "Jonathan Matuszewski",
"content": "Great. Thanks for taking my question. First one is on the competitive landscape. So you held market share in 3Q, and that's consistent with your comments in the first half. Obviously, you guys have superior customer service and assortment. So what's driving the success among competitors in the industry, who you're tracking who are taking share? Is it purely a function of price? And how is that informing your pricing strategy over the next couple of quarters?"
},
{
"speaker": "Corie Barry",
"content": "Again, I'm probably biased, but I don't think it's purely a function of price. I think we've been very clear, we have to be price competitive, and that is one of the base tentpoles of our strategy. And that said, we also, I think, have a team that has a proven track record of very adept promotional planning around key drive times, whether that's some of the secondary holidays or whether it's the main holiday that we're headed into. So I kind of think of price as the like primary tentpole. But in order to differentiate, I think what we're doubling down on is what we do, that is different than anyone else just given who we are. We are agnostic to the customer. So we don't care what the operating system is or who makes the hardware. We're there for the customer to help them to build on that. We have what we like to call human-enabled services. So we can help you in the store. We can consult for you in your home. We can repair. We can take back. We can trade in. You can buy open box. You can go to an outlet. Like, we just have the huge end-to-end variety of solutions all the way from inspire to support, so that's the kind of second differentiator for us. And then third, I think we're building on those things with a unique membership program with unique offers that reach out to our members with a membership program that's based on the things that we uniquely do well. And then fourth, I have to give major credit to our vendor partners as well, even though we're in a little bit of a slower innovation cycle, they remain closely committed to our success, which means we do have everything from the most new beautiful 98-inch TV that's out on the floor, all the way to those opening price point Chromebooks or opening price point televisions that might be right for you at a value play. And I think our ability to showcase those high and new experience as well as all the way through the rest of the assortment really is that last differentiating piece for us."
},
{
"speaker": "Jonathan Matuszewski",
"content": "That's great color. Thanks so much. And then a quick follow-up on Best Buy Health. You've had some exciting announcements on that side of the business in terms of partnerships in the industry. At the Investor Day, I think you called out expectations for that to grow at a CAGR of an impressive 40% over the next couple of years. Is that business at scale to switch from kind of dilution to accretion in terms of the overall enterprise next year? Any thoughts there would be helpful."
},
{
"speaker": "Corie Barry",
"content": "Yeah. So we remain really excited about the Health business, and we were pretty clear that we had pulled the FY '25 targets on the whole or as the macro backdrop has changed. And so we are, of course, working behind the scenes to really fortify that business for the future. And I know someone had asked earlier as we think about the puts and takes for next year, we would continue to expect Health to become more accretive, and we laid that out as kind of our structural thesis at our Investor Day. And that part of the thesis remains true for us. And while it still is relatively small at this point, we are seeing some nice uptick, particularly in that kind of care-at-home side of things, where we've announced partnerships with Geisinger and with Atrium Health as we think about how we can use our unique Geek Squad assets as well as the unique product assortment that we have to help deliver care at home. So again, relatively small, but the team is doing a nice job continuing to ensure that, that part of the business is accretive and grows over time."
},
{
"speaker": "Jonathan Matuszewski",
"content": "Thanks so much."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Steven Forbes of Guggenheim. Your line is open."
},
{
"speaker": "Steven Forbes",
"content": "Good morning, Corie, Matt."
},
{
"speaker": "Corie Barry",
"content": "Good morning."
},
{
"speaker": "Steven Forbes",
"content": "Matt, you briefly mentioned 15 to 20 basis points of vendor funding being recorded in expenses. Curious if you can maybe give us a little more color there? And then any sort of different way of thinking about how vendor funding maybe supports the margin outlook for 2024? Or are you changing the 2024 margin color of being able to hold margin in a flat sales environment, any update there?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. Yeah. So first of all, it was $15 million to $20 million of impact on net basis points, just to make sure I'm clear. And that would carry on as you get into next quarter Q4 and the first part of next year. And this is strictly a geography. There is no change to the overall financial statements, if you will, just moving as a cost -- offsetting a cost of sales to offsetting SG&A. Essentially, we get any number of types of vendor funding for a number of different things. And when we can actually be more specific with the funding, matching and offsetting the specific cost, we then record that as an offset to SG&A versus offsetting cost of sales. So that's specifically what's happened. And it's just -- it's part of the funding that we get not all of it, obviously. And so we would expect that to continue. To your second question, as you look at next year, at this point, we're not guiding next year, but we would expect product margins to be somewhat of a neutral impact to next year. Overall, we don't, at this point, see a lot of material changes either way. We have a very strong relationship with our vendors, and they are obviously as interested in us in stimulating sales and showcasing their products and innovations that they have. So at this point, we don't see any change to that as we look into next year."
},
{
"speaker": "Corie Barry",
"content": "Matt hit on this, but I want to underscore, the way in which our vendors participate with us varies as you would expect, depending on what we're seeing in the macro. Sometimes that shows up as more promotional partnership. But a lot of times, that shows up in very different ways it can be in how we think about specialized labor, it can be in store experiences like we mentioned on the call, it can be in our Best Buy ads business or in supply chain fulfillment or in services. And I think what's important is our overall level of invested support has grown in the aggregate even as we compare it to pre-pandemic levels. And I think that is the part that for us as important is how can we be the very best partner to our vendors as we collectively want to bring, especially some of this newer innovation to market."
},
{
"speaker": "Steven Forbes",
"content": "Thank you, Corie and Matt. Maybe just a quick follow-up for you, Corie. Any updated thoughts on maybe some of your newer growth initiatives such as device life cycle management, really just trying to think through whether the current sort of operating performance or challenges that are out there are impacting the investments you plan to put behind some of these initiatives? Or whether that's still sort of a growth sort of plan for next year?"
},
{
"speaker": "Corie Barry",
"content": "Yeah. As it relates -- you hit on specifically device life cycle management, I'm maybe going to take it up one level and that is, we've talked about Geek Squad as a service, because it can be everything from device cycle management, which is newer side of this, but also just providing service on behalf of vendors as you think about being an Apple authorized service provider or some of our Best Buy business offerings where we actually use our service profile to go out and do installations writ large. What's nice about an initiative like this is it doesn't require, especially in the earlier stages, much incremental investment. We already have Geek Squad City, which is a very large facility, well staffed with trained experts who we can leverage some of their capacities in order to deliver on something like device life cycle management. Now then we can make decisions as something like that ramps. We didn't mention it this quarter because in Q4, honestly, it's not the biggest front and center area of focus. But you can also imagine behind the scenes, if there are other ways for us to leverage our existing expertise and capacity. Those are very interesting strategic initiatives for us. And we remain excited about this one. We remain excited about the pipeline that we're seeing in this one. And obviously, I think you can expect that we will update you with more clarity as it develops. So with that, I think that -- thank you. I think that is our last question, and I want to thank you all for joining us today. Thank you for the nice wishes. I hope you all also have a wonderful holiday, and we look forward to updating you all on our results and progress during our next call in February. Thank you, and have a great day."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. You may now disconnect."
}
] |
bby | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for standing by. Welcome to the Best Buy'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 call is being recorded for playback and will be available by approximately 1:00 p.m. Eastern Time today. [Operator Instructions] I will now turn the conference call over to Mollie O'Brien, Vice President of Investor Relations."
},
{
"speaker": "Mollie O'Brien",
"content": "Thank you, and good morning, everyone. Joining me on the call today are Corie Barry, our CEO; and Matt Bilunas, our CFO. During the call today, we will be discussing both GAAP and non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful can be found in this morning's earnings release which is available on our website, investors.bestbuy.com. Some of the statements we will make today are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may address the financial condition, business initiatives, growth plans, investments, and expected performance of the company and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current earnings release and our most current 10-K and subsequent 10-Qs for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the call over to Corie."
},
{
"speaker": "Corie Barry",
"content": "Good morning, everyone, and thank you so much for joining us. Today we are reporting better-than-expected Q2 financial results. Our comparable sales came in at the high end of our guidance and profitability was better than expected. These results continue to demonstrate our strong operational execution as we balance our reaction to the current industry sales pressure with our ongoing strategic investments. As expected, our year-over-year comparable sales performance improved from the 10% decline we reported last quarter. For the second quarter, comparable sales were down 6.2%. We expanded our Q2 gross profit rate 110 basis points from last year due to better product margins and profitability improvements in our membership program. We kept our SG&A expenses flat while absorbing higher incentive compensation expenses than we recorded last year. Our industry continues to experience lower consumer demand due to the pandemic pull-forward of tech purchases and the shift back into services spend outside the home like travel and entertainment. In addition, of course, persistent inflation has impacted spending decisions for a substantial part of the population. I continue to be incredibly proud of the way our teams are managing the business today and preparing for our future in light of the industry pressure and ongoing uncertain macro conditions. We strategically managed our promotional plan and we're price-competitive in an environment where consumers are very deal focused and the level of industry promotions and discounts were above last year and often and above pre-pandemic fiscal '20. In the first half of the year, our purchasing, customer behavior has remained relatively consistent in terms of demographics and the percent of purchases categorized as premium. Our inventory at the end of the quarter was down compared to last year in line with our sales decline as the team continues to manage inventory strategically targeting approximately 60 days of forward supply. Our customer satisfaction with product availability has been improving over the past few years and is now the highest it has been since the start of the pandemic. I would note that while we were not a perfect inventory levels last year, we were more rightsized than many and are not lapping the kind of clearance pressure that other retailers experienced. We continue to make it easy and enjoyable for consumers to get the best tech and premier expert service when they want it through our online store and in-home experiences. Almost one-third of our domestic revenue came from our digital assets including our mobile app. We have made considerable improvements to our app customer experience and the percent of our online sales coming through the app has doubled in just the last three years to more than 20% of our online revenue. We are pleased to see higher app usage overall as our app customers engage three times more often than customers engaging with us on other digital platforms. Our Buy Online Pickup In Store percent of online sales continues to be just over 40%, considering the speed of our delivery with almost 60% of packages delivered within two days, we believe the consistency of our high rate of instore pickup by our customers truly underscores the importance of the combination of our digital and physical locations. In addition, our focus on providing customers with expertise and support continues to be highlighted by material improvements and satisfaction scores for our in-store and in-home tech services as well as our home delivery experience. In fact, our remote support services, where we have the ability to remotely access and fixed your computer while you're at home has the highest NPS of all our experiences and continues to increase. These are all services we can provide at scale that no one else can. Our tech services play a material role in our unique membership program that is driving increased customer engagements and increased share of wallet. As we would expect, paid members also report much higher customer satisfaction than nonmembers. During the quarter, we successfully launched significant changes to our program designed to give customers more freedom to choose a membership that fits their technology needs, budget, and lifestyle. In addition, we wanted to build in more flexibility and drive a lower cost to serve than our previous Total Tech program. We now offer three tears; My Best Buy, My Best Buy Plus, and My Best Buy Total. It is of course very early as we only launched the new programs on June 27th, but we are seeing indicators that the program changes are driving many of the results we expect it, including an uptick in year-over-year growth of overall paid membership sign-ups. For example, My Best Buy Total, which is the evolution of our prior Total Tech offer continues to resonate more strongly in our physical stores setting. As a reminder, this tier is $179.99 per year and includes Geek Squad 24/7 tech support via in-store remote phone or chat on all your electronics, no matter where you purchase them. It also includes two years of product protection, including AppleCare Plus on most new Best Buy purchases. In addition, it includes all the benefits included in My Best Buy Plus. And as a reminder, My Best Buy Plus is a new membership tier built for customers who want value and access. For $49.99 per year, customers get exclusive prices and access to highly-anticipated product releases. They also get free two-day shipping and an extended 60-day return in exchange window on most products. In the first several weeks since launch, this plan is resonating more with digital customers and appeals to a broader set of customer segments across more product categories than My Best Buy Total, and its predecessor, Total Tech. We are still very early in the process and are testing different promotional offers to determine what resonates most with consumers and continuously improving the digital experience to make it even easier to find deals and benefits. Lastly, our My Best Buy tier remains our free plan built for customers who want convenience. It includes free shipping with no minimum purchase and other benefits associated with a member account like online access to purchase history, order tracking, and fast checkout. At the beginning of the year, we added the free shipping benefit and phased out the points-based rewards benefit for non-credit card holders. As a reminder, our credit card holders still have the option to earn 5% back in rewards or choose 12 months, 18 months, or even 24 months of 0% interest-rate financing depending on the product category. The customer metrics continue to validate our decisions to change our free tier and our customer enrollments have remained steady. In addition, the financial impact has been better than we originally modeled. For fiscal '24, we now expect our three-tiered membership program to contribute at least 25 basis points of Enterprise Year-over-Year operating income rate expansion, which is consistent with what we have seen in the first half of the year. During the quarter, we continue to make progress on our journey to evolve our omnichannel capability. We want to ensure we maintain a leading position in an increasingly digital age and evolving retail landscape. This means our portfolio of stores needs to provide customers with differentiated experiences and multichannel fulfillment. At the same time, we need them to be more cost and capital-efficient to operate while remaining a great place to work. We are on track to deliver the fiscal '24 physical store plans we announced at the beginning of the year. These include closing 20 to 30 stores, implementing eight large-format 35,000-square-foot Experience Store remodels, and expanding our outlet stores from 19 to around 25. In addition, of course, we are continuing to refresh our stores. For fiscal '24, we are particularly focused on improving the merchandising presentation given the shift to digital shopping and corresponding lower need to hold as much inventory on the shopping floor. For example, in all our stores, we are installing new premium end-caps in partnership with key vendors that will improve the merchandising in the center of the store. These new end-caps have that product and vendor story on the front with the inventory tucked in on the sides. Importantly, it allows us to have a great demo or presentation, even if we are displaying potentially less in-store inventory than we historically have. This also allows for a much better merchandising experience for products that we have deemed more at risk for shrink and have decided to hold inventory in a more secure location off the sales floor. We invested in digital tools that allow the customer to quickly scan and pick up this inventory in a matter of minutes through our prioritized pick process. This minimizes shrink, prioritizes the customer experience, and drives a much more efficient employee process. In addition, in about half our stores we are rightsizing our traditional gaming and digital imaging spaces to allow for the expansion of growing categories like PC gaming and newer offerings such as green works cordless power tools, wellness products like the Oura Ring, Epson short throw-projectors, e-bikes and scooters, and Lovesac home furnishing products. While small, we are seeing promising results in some of these new categories with meaningful market-share growth. As it relates to the operating model in our stores, we are continuing to drive our evolution based on two overarching goals. First, we needed to more efficiently allocate our labor cost considering the higher online sales have resulted in a decline in physical store traffic and sales. Our customers and their expectations and behaviors have changed dramatically and incredibly quickly. We have been working hard to balance the amount of labor hours necessary to deliver the best experience possible for our customers and employees. In our roles and the associated hourly pay are the same and we have had to make some difficult but strategic decisions to give us the ability to flex our labor spend appropriately. As we mentioned last quarter, with our most recent changes, we were able to add approximately 2 million additional hours for customer-facing sales associates into our staffing plan for the year and we saw improvements in our associate availability NPS metric in the second quarter as a result. Because of these structural changes, we have driven more than 100 basis points of rate improvement in domestic store labor expense as a percent of revenue compared to fiscal '20. Additionally, we have been successful in keeping our labor rates steady as a percent of revenue, even as our sales have declined over the past several quarters. Second, we need to provide our employees flexibility, predictability, and opportunities to gain more skills. We have been investing in tools and employee development programs that increase their flexibility within and across stores. As you would expect, we are also focused on leveraging existing and emerging technology to drive better customer and employee experiences across channels. We are gratified that our employee retention rates continue to outperform the retail industry, particularly in key leadership roles. The vast majority of which we hire internally. Our retail workforce has led through significant change over the past four years. I could not be more proud of how our teams have adapted to the changing environment. But all that change, while necessary can be hard and disruptive for any team. We are pleased to be headed into a period of stability from an operating model perspective and we are now laser-focused on ensuring foundational retail excellence. As such, during Q2, we led thousands of employees, including more than 80% of our sales associates through a certification process, focused on our baseline expectations for interacting with customers, our selling model, and product category proficiency. This is just Phase 1 and we will continue to invest in training hours for subsequent phases of the program to make sure we are driving the interactions and outcomes, we believe are the best for our customers and our business. As I mentioned earlier, we are working hard to balance our response to current industry conditions with our need to invest in our future. It has long been part of our cultural DNA to drive cost efficiencies and expense reductions in order to offset pressures and fund investments and this year is no different. In fiscal '24, we are driving benefits from optimization efforts across multiple areas, including reverse supply chain, large product fulfillment, and our omnichannel operations. This includes leveraging technology and rapidly evolving AI. For example, in customer care, our virtual agents are now answering 40% of customer questions via chat without a human agent and with high satisfaction levels. We are continuing to add capabilities and are creating additional employee and customer-facing virtual agents that will simplify our most complex interactions like technology support services, while also delivering key insights from our customer care centers back into the enterprise. We are also testing new state-of-the-art routing capabilities to optimize our in-home operations, reducing cost-of-service and improving the availability and wait time of delivery and installation appointments for our customers. As we think about our growth strategies, we believe we can leverage our scale and capabilities to drive incremental profitable revenue streams. In this vein, we are exploring Geek Squad as a service opportunities with several large companies, including Accenture, Intel, and Lenovo as we have created differentiated B2C and B2B services capability. Device lifecycle management is a specific example of the service we can provide to others and necessity for all companies, device lifecycle management refers to the process of providing tech devices like phones and laptops to employees. This is not a core competency for most companies and the recent hybridization of work has made it even more complicated. We are already supporting a number of firms as their sole device lifecycle management partner providing end-to-end support of these company-provided devices, including procurement, provisioning, deployment, repair, and end-of-life. This is just one example of our ability to leverage our data and assets and adds to the growth we're already seeing in areas like Best Buy Ads and Partner Plus. Before my closing remarks, I also want to take a moment to recognize our Geek Squad teams for their work with our communities. For more than 15 years, they have been sharing and teaching their tech expertise and skills to prepare the next generation for the future workforce. This summer, we welcomed more than 2,000 kids and teens at nearly 40 Geek Squad Academy camps across the country. These camps give participants the opportunity to learn skills on everything from coding, game design, digital music, and more. More importantly, they help young people build self-confidence, spark creativity, and discover how technology can benefit them in their educational pursuits in future careers. I am incredibly proud of all our Geek Squad agents and volunteers for their work this summer inspiring thousands of young minds through tech. As we enter the second half of the year and look forward to the holiday season, we are both proud pragmatic, and optimistic. Of course, the macro-environment remains uncertain with a number of tailwinds and headwinds soon including the October resumption of student loan payments, all of which results in uneven impacts on consumers. Overarchingly, we believe that the consumer is in a good place. But as we have said, they are making careful choices and trade-offs right for their household. During last conference call, we noted that we were preparing for a number of scenarios within our annual guidance range, and we believed our sales were aligning closer to the midpoint of the annual comparable sales guidance. We knew it would be a challenging year for the industry and we are halfway through the year and narrowing our outlook largely as expected. As Matt will discuss in more detail, we are updating our comparable sales guidance accordingly. We now expect comparable sales to decline in the range of 4.5% to 6%. This compares to our previous range of down 3% to down 6%. At the same time, we are narrowing our profitability ranges effectively raising the midpoint of our previous annual guidance for non-GAAP operating income rate and earnings per share. We continue to expect that this year will be the low point in tech demand after two years of sales declines. Tech is a bigger part of all our lives, both in our homes and in our businesses than ever, and we believe next year the consumer electronics industry should see stabilization and possibly growth driven by the natural upgrade and replacement cycles for the tech bought early in the pandemic and the normalization of tech innovation. Let me say a few words about the fourth quarter specifically. For context, we reported a comparable sales decline of 10% for fiscal '23 and roughly 8% for the first half of this year. We are guiding a Q3 year-over-year comparable sales decline that are similar to or a little better than the 6.2% decline we just reported for Q2. Our full-year guidance implies a wide range for Q4 comparable sales of down 3% to slightly positive. There are a number of factors supporting our belief that our Q4 year-over-year comparable sales will improve and could potentially turn positive. We expect growth in-home theater as we expect to be better-positioned with inventory across all price points and budget spends last year. We are starting to see signs of stabilization in our home theater business. For example, TV sales trends improved in Q2 and units returned to growth. We expect performance in our computing category to improve as we build-on our position of strength in the premium assortment will not exactly linear. We are also starting to see signs of stabilization in this category as Q2 laptop sales trends improved materially and units were flat to last year. We expect to see continued growth in the gaming category as inventory is more readily available and there is a promising slate of new software titles expected to be released in the back half of the year. We are planning for potential growth in the mobile phone category as we expect inventory to be less constrained than last year and expect to drive growth in our unlocked phones business. Our hypothesis regarding the holiday season is that the consumer largely returns to pre-pandemic behavior. By this, we mean that they will be looking for great deals and convenience and traffic will be weighted toward promotional events. We have an excellent team and strong omnichannel assets that thrive in such an environment. In summary, while the macro and industry backdrop continue to drive volatility as we move through the year, we have a proven track record of navigating well through dynamic and challenging environments and we will continue to adjust as the macro conditions evolve and we remain incredibly excited about our future opportunities. While our existing product categories have slightly different timing nuances, in general, we believe they are poised for growth in the coming years. In addition, we continue to see several macro trends that should drive opportunities in our business over time, including cloud, augmented reality, expansion of broadband access, and of course generative AI where we know our vendor partners are working behind the scenes to create consumer products that optimize this material technology advancement. As the largest CE specialty retailer with one-third of the U.S. computing and television market share, we can commercialize new technology for customers like no one else can. And with that, I would like to turn the call over to Matt for some more details on our second quarter results and our fiscal '24 outlook."
},
{
"speaker": "Matt Bilunas",
"content": "Good morning, everyone. Let me start by sharing details on our second quarter results. Enterprise revenue of $9.6 billion declined 6.2% on a comparable basis. Our non-GAAP operating income rates of 3.8% declined 30 basis points compared to last year. Non-GAAP SG&A dollars were essentially flat to last year and increased approximately 140 basis points as a percentage of revenue. Partially offsetting the higher SG&A rate was 110 basis-point improvement in our gross profit rate. Compared to last year, our non-GAAP-diluted earnings per share of $1.22 decreased $0.32 or 21%, with approximately half of the decrease due to a higher effective tax rate. When viewing our performance versus our expectations entering the quarter, our revenue was at the high end of the range we provided. Our non-GAAP operating income exceeded our expectations due to a higher gross profit rate driven by a number of areas including lower cost to serve our membership offerings, higher profit-sharing revenue from our private-label credit card arrangement, and lower supply-chain costs. Next, I will walk through the details on our second-quarter results compared to last year. From an Enterprise comparable sales phasing perspective, June's decline of approximately 5% was our best performing month on a year-over-year basis with May and July both down approximately 7%. As we've started Q3, our estimated comparable sales decline in the first four weeks of August was approximately 6%. In our Domestic segment, revenue decreased 7.1% to $8.9 million driven by a comparable sales decline of 6.3%. From a category standpoint, the largest contributors to the comparable sales decline in the quarter were appliances, home theater, computing, and mobile phones, which were partially offset by growth in gaming. From an organic perspective, consistent with the past several quarters, our overall blended average selling price declined in the low-single digits as a percentage versus last year. In our International segment, revenue decreased 8.8% to $693 million. This decrease was driven by a comparable sales decline of 5.4% and the negative impact of foreign exchange rates. Our Domestic gross profit rate increased 110 basis points to 23.1%, a higher gross profit rate was driven by the following. First, our product margin rates improved versus last year. The better product margin rates included a higher level of vendor-supported promotions, and the benefits from optimization efforts across multiple areas. Second, improvement from our membership offerings, which included a higher gross profit rate in our services category. And third, an improved gross profit rate from our health initiatives. Domestic non-GAAP SG&A dollars were flat to last year as higher incentive compensation was largely offset by reduced store payroll costs. Moving next to capital expenditures where we still expect to spend approximately $850 million this year. This reflects a reduction of $80 million compared to last year with lower store-related investments being the primary driver of the reduced spend. Year-to-date, we have returned a total of $560 million to shareholders through dividends of $402 million and share repurchases of $158 million. We expect to continue share repurchases throughout fiscal '24 with the level of share repurchases being slightly higher in the second half of the year compared to the first half. As I referenced earlier, our non-GAAP effective tax rate of 26.6% was higher than the 16.7% rate last year. The lower effective tax rate last year it was primarily due to the resolution of certain discrete tax matters. Now, I would like to discuss our fiscal '24 outlook. As Corie mentioned, we are lowering the high end of our full-year revenue outlook to our previous midpoint while keeping the low end of our revenue guidance unchanged. At the same time, we are narrowing our non-GAAP LOI rate and EPS ranges in a way that raises the midpoint of our previous annual guidance for those items. Let me provide more details on our guidance and working assumptions starting with revenue. We expect Enterprise revenue in the range of $43.8 billion to $44.5 billion. Enterprise comparable sales decline of 4.5% to 6%. Moving on to our full-year profitability guidance, which is Enterprise non-GAAP operating income rate in the range of 3.9% to 4.1% and non-GAAP diluted earnings per share of $6.40. Our outlook remains unchanged for a non-GAAP effective income tax of approximately 24.5% and for interest and income to exceed interest expense this year. As a reminder, the fourth quarter of fiscal '24 contains an extra week. We expect this extra week to add approximately $700 million of revenue, which is excluded from our comparable sales and $100 million of SG&A. We still expect it to benefit our full-year non-GAAP operating income rate by approximately 10 basis points. Next, I will review our full-year gross profit and SG&A working assumptions. We now expect our full-year gross profit rate to improve by approximately 60 basis points compared to fiscal '23 which compares to our prior outlook of 40 basis points to 70 basis points of expansion. The primary drivers of the rate expansion include the following. First, improvement from our membership offerings, which includes a higher gross profit rate in our services category. Our membership offerings are now expected to provide at least 25 basis points of improvement. Second, higher product margin rates, which includes the benefits from our optimization efforts across multiple areas, any higher level of vendor-supported promotions. And third, our health initiatives is also expected to improve our gross profit rate. Lastly, we expect the profit-sharing from our private-label credit card to have a relatively neutral impact to our annual gross profit rate compared to last year. The profit-sharing has provided a slight benefit to our gross profit rate in the first half of the year, which is expected to turn to a slight pressure in the second half of the year. Now, moving to our SG&A expectations. At the midpoint of our guidance, we expect SG&A as a percentage of sales to increase approximately 100 basis points compared to last year. We expect higher incentive compensation, as we lapped the very low levels last year. The high-end of our guidance now assumes incentive compensation increases by approximately $185 million compared to fiscal '23. We continue to expect store payroll and advertising expenses to be approximately flat to fiscal '23 as a percentage of sales. As it relates specifically to the third quarter, we expect our comparable sales to be slightly better than the negative 6.2% we reported for the second quarter. On the profitability side, we expect our non-GAAP operating income rate to be approximately 3.4%. This would represent a decline of approximately 50 basis points versus last year with the contributions from SG&A and gross profit, pretty similar to what we saw in the second quarter. Lastly, I'll share some color on what our guidance implies for the fourth quarter. As Corie discussed, we are planning for multiple revenue scenarios that range from a comparable sales decline of approximately 3% to slightly positive. Our Q4 gross profit rate is expected to improve versus last year, but not at the same level as we are expecting for the full year. SG&A as a percentage of sales is expected to be more favorable than our full-year outlook, which is primarily due to the extra week and the more favorable revenue outlook. I will now turn the call over to the operator for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And your first question comes from the line of Scot Ciccarelli from Truist. Your line is open."
},
{
"speaker": "Scot Ciccarelli",
"content": "Scot Ciccarelli. Good morning, guys. Corie, you mentioned some of the newer technology kind of waiting in the wings with AI and stuff. Can you give the group, any kind of flavor for some of the technologies like generically that you guys are thinking about that could potentially drive improvement in sales trends?"
},
{
"speaker": "Corie Barry",
"content": "Yes, maybe in this, we were talking about computing specifically, and maybe I'll give just a little bit more color there. I mean I think what we're seeing broadly is that computing innovations and the refresh cycles are getting shorter and they are accelerating and we continue to see people using all of their devices more often and far more like a computing processing intensive. And these are really specific activities and you can see both whether you're using it at home, and you're seeing a lot more streaming, or whether using it at work and you're starting to want to leverage some of these more advanced technologies. Obviously, like, for example, Microsoft pre-pandemic focused on dual screen and that was kind of something we had talked about for a while, but they quickly pivoted some of their developments within their Windows OS to address consumer productivity where all of us, we're kind of struggling to make sure we're as productive as possible on multiple devices, a lot of that enhancement went into productivity and I think the emergence of AI is at the heart of many of these innovations. I think in this case, in this example, it centers around the Windows copilot on Windows 11, which brings ChatGPT and AI innovations in the cloud applications within that Windows Office Suite within PowerPoint, Outlook, Excel. And I think what we're expecting will happen and I alluded to it on the call is obviously you're going to have likely at some points here different generation of technology that's going to have more intensively leverage the capabilities that are necessary to run these AI models. I think that's one example. We talk about this often, Scot. It's hard for us always to know exactly what that new horizon of technology is going to be, but this is one that probably has some of the broadest implications for all of our collective productivity."
},
{
"speaker": "Scot Ciccarelli",
"content": "Yes, understood. And then thank you for that. And then the second question is the expectation for slight improvement in comp despite a little bit more difficult comparison. Is that really driven by you have more events in the third quarter than the second quarter as we revert to pre-pandemic kind of behavior?"
},
{
"speaker": "Matt Bilunas",
"content": "No, I think for Q4 specifically, I think as we think about improvement of trends for Q3 and then in Q4, I think we are obviously encouraged by a little bit by back to school. Back to school has been slightly better than we expected as we get into Q3. When you think about Q3 compared to FY '20, it actually has slightly higher growth than what we saw in -- expecting slightly higher growth in Q3 compared to Q2. Q3 compared to '20 has a little bit more holiday sales pulled in. So we are expecting that to continue compared to where pre-pandemic was, but maybe not to the same extent of pull-forward that we've seen in the last few years, so I think we're encouraged by the trends as we leave Q2 if you think about what happened in Q2, we actually saw some stabilization in our business, we saw actually laptop units turned to flat in Q2 in terms of that business and TV units were flat, and so I think there is optimism around how -- what we might expect for the back-half and more specifically Q4 but Q3 we're likely still seeing similar levels to what we saw in Q2."
},
{
"speaker": "Scot Ciccarelli",
"content": "Got it. Thanks, guys."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Greg Melich from Evercore ISI. Your line is open."
},
{
"speaker": "Greg Melich",
"content": "Thanks. I wanted to start on the top-line, that sort of improvement in trends and I love an update on what credit as the penetration and also you mentioned that that was a tailwind, becoming a headwind. Could you frame that a little bit more as to what percentage of gross profit it is or something like that?"
},
{
"speaker": "Matt Bilunas",
"content": "Yes. I think for the -- on the credit side specifically, first, we've talked about the credit card portfolio is 1.4 of our domestic sales. 1.4%, so it's pretty similar to what we had said last time. I think overall what we've been seeing for the last number of years is a tailwind for the credit card portfolio of profit share. It certainly -- it came in a little better than we expected in Q2. We are seeing net credit losses normalize to where they were pre-pandemic. I think the thing we're watching for which is based on the state of consumer do this net credit-losses actually turned to higher than they used to be, which would create pressure on the profit share. And in the back half of this year, we are expecting it to be a slight pressure compared to the first part of the year being a benefit for us, but neutral for the year. So it's really that net credit losses is one aspect we're watching, especially as we get into next year. And we think about what the state of the consumer does look like as we get into next year and increasing levels of debt. So still an amazing book and partnership for us in terms of what it does for our consumers and offering a great way to pay for product. It actually also has a very loyal consumer. So we're really happy with the party, just the reality of what we've been trying to normalize a bit, if you will, from the last few years. I think to the improving trends, I think Q3 we're expecting to be a pretty similar, maybe slightly better comp than we saw in Q2. Like I said earlier, back to school is a little better than we expected, but it's running a little longer and little later into the season. And then as you look to Q4, while we are expecting the year-over-year comps improved to at the bottom of the range of minus 3 or the top slightly positive and it still does represent the fact that against FY '20, anywhere from down 7% to down 3% on the high end. So, yes, we believe the year-over-year trend should improve based on a number of the things that Corie mentioned, it still does represent a more stabilization of our consumers. As you look into the back half, the way to think about a more normalized volume that we had pre-pandemic."
},
{
"speaker": "Greg Melich",
"content": "Got it. And then my follow-up is on SG&A specifically. I know you expect it delever for the year. You mentioned the incentive comp up $185 million, was that for the full year or in the back half?"
},
{
"speaker": "Matt Bilunas",
"content": "That would be for the full year. Yes, that's for the full year."
},
{
"speaker": "Greg Melich",
"content": "And that's more back-half weighted, presumably?"
},
{
"speaker": "Matt Bilunas",
"content": "It's pretty even throughout the year."
},
{
"speaker": "Greg Melich",
"content": "Okay. And then in terms of leveraging payroll that 100 bps was in the second quarter, was there something about the second quarter that gave you an unusual amounts of hourly payroll leverage, or should we expect that going forward?"
},
{
"speaker": "Matt Bilunas",
"content": "No, I think for the year, we expect store payroll to be relatively flat on a percentage of sales basis for the whole year. It has been pretty consistent across, but has been pretty consistent across the quarters, and we would expect it to be pretty consistent in the back half of the year as well."
},
{
"speaker": "Corie Barry",
"content": "And, Greg, just to make sure we're clear that 100 basis points as versus FY '20. So that's more than like structural change that we've seen over the last four-ish years."
},
{
"speaker": "Matt Bilunas",
"content": "Thank you. Appreciate that. Well, good luck, everyone."
},
{
"speaker": "Matt Bilunas",
"content": "Thank you."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Seth Sigman from Barclays. Your line is open."
},
{
"speaker": "Seth Sigman",
"content": "Hi, good morning, everyone. I just wanted to follow up on that credit point. So neutral for the year, negative in the second half of the year slightly. Can you just size up for us what normal means if that continues into next year? I think your disclosure is that, it's up 50 basis points or so since fiscal 2020, so does normal mean that fully reversed is how do we think about that?"
},
{
"speaker": "Matt Bilunas",
"content": "Yes. I think my reference to normal. Thanks for the question is more related to net credit losses as a percentage to the book. So we haven't given that number. I won't give it today, but what we're seeing now is a more normal rate compared to FY '20. What we're watching for is it does that rate increase compared to where it used to be and certainly it's already higher than it has been the last few years when the net credit losses were very low rate. And that is just more to do with just the state of the consumer. So right now we still see a relatively good consumer to the extent that they are still continuing to make tradeoff decisions weighing a little bit more pressure on their personal finances that could less to go up into next year. That's the consideration. We will certainly, as we think about next year, we're not guiding next year, but we're thinking about next year, that could be one of the pressures we face as we think about ROI rate just in terms of where does the net credit losses go."
},
{
"speaker": "Seth Sigman",
"content": "Okay, thank you for that. Just any other perspective on credit availability today if that's impacting demand in any way? And maybe just put that in context of some of the trends that you may be seeing across consumer cohorts or markets, obviously, you talked about some of the bright spots you've seen in recent months here and what you're expecting for the rest of the year. I'm just trying to think about some of the incremental consumer headwinds ahead whether that is student loans or credit availability? Just any other context around some of the consumer behavior you may be seeing where that's coming from?"
},
{
"speaker": "Corie Barry",
"content": "Yes, right now as it relates specifically to the card, we aren't seeing massive change in credit availability. We're continuing to see and we've said before, about 25% of our business is done on the card. We're continuing to see those trends. And what are the nice things about our card is as I mentioned it in the prepared remarks, but I want to emphasize that you can either choose points or you can choose 0% financing and so it's actually it's an offering that is widely accepted and appreciated, especially against the backdrop so the consumer can decide what's more relevant for them. So like Matt said, we're seeing more of a normalization in some of those key metrics. But in general, it remains an incredibly efficient asset for us in partnership, obviously in the profit share structure that we have."
},
{
"speaker": "Seth Sigman",
"content": "Great. Thanks, guys."
},
{
"speaker": "Corie Barry",
"content": "Yes."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Liz Suzuki from Bank of America. Your line is open."
},
{
"speaker": "Liz Suzuki",
"content": "Great, thank you. Just a question on appliances, which looked like they were particularly weak this quarter and some other big-box retailers that sell appliances have talked about an increase in vendor-funded incentives and promotions. Have you seen the same behavior from your vendor partners as they try to respond to slower demand and did vendor funding funded promotions have an impact on margins this quarter?"
},
{
"speaker": "Matt Bilunas",
"content": "Yes, broadly speaking, we are seeing an increase in vendor-funded promotions across all of our categories and I think appliances would be part of that. I think as we noted in our gross profit rate improvement in Q2, a lot of that was coming from our product margin rates being better year-over-year. Part of that, we're seeing an uptick in the vendor-supported promotions that we are running. So yes, it is a more promotional environment year-over-year and in some cases, certainly more than it was in FY '20, but it hasn't manifested in lower product margins for us. We are seeing both not just us, our vendors wanting to engage in promotional activity to drive and stimulate demand."
},
{
"speaker": "Liz Suzuki",
"content": "Great, thank you. And just on the flip side of some of the categories that were particularly strong. Can you just go into a little more detail on what was successful and like the entertainment and services categories and where you see that going in the next couple of quarters?"
},
{
"speaker": "Corie Barry",
"content": "Well, on the entertainment side of things, that really is reflective of gaming and particularly gaming hardware, which had a much more stable supply this year than what we saw last year, so, we feel like that's a nice indicator as we're heading into the back half of the year. We mentioned that. And on the services side, that really is mainly reflective of our membership offering and now starting to kind of annualize that higher, larger cohorts of members."
},
{
"speaker": "Liz Suzuki",
"content": "Great, thank you."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Matt Bilunas",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Michael Lasser from UBS. Your line is open."
},
{
"speaker": "Michael Lasser",
"content": "Good morning, thanks a lot for taking my question. Matt, you alluded to operating margin pressure in the next fiscal year. So on a similar level of revenue for Best Buy, call it 2024 versus where it was in 2019, what would be the company's operating margin rate in light of the pressure that it's experienced from investments in health care and some of the impact of the rise in e-commerce penetration for the business and all the actions that the company has taken to try and preserve the profitability in light of those pressures? And what levers can be pulled from here in order to improve the operating margin rate over time, especially as things like credit income continue to decline?"
},
{
"speaker": "Matt Bilunas",
"content": "Yes, thanks for the question, Michael. What I just to clarify when I was referring to specifically was potential pressure on the credit card profit share as we look into next year, but I wasn't trying to characterize was like overall allied pressure for next year. But to get to your broad question there, I think, as you can appreciate, we're not going to guide next year. But that being said, if for example, our sales were flat next year as some of the indicators would suggest it would be our expectation or our goal to at least hold LOI rate flat if not drive a little bit of expansion. Like I said, there were few factors here. The first being that credit card. It's been a tailwind for us. And like I said, it could turn to some pressure. The second more tactical one is as we enter into next year, we always reset incentive compensation this year. We have a certain amount of that next year, but we reset the one that does sometimes create a little bit of rate pressure, but broadly speaking, if you think about next year and the years outward, a lot of the other drivers are going to be things like the industry -- level of industry growth. So the extent that the industry can grow and does grow, we expect to grow with it. And that does create SG&A leverage as our cost structure today is probably more indicative of a sales number that's higher than what we set. But we've talked about this year being a benefit for us, both the membership and the health initiatives the rate has been improving, so similar to our Investor Day, a while back we would expect those initiatives to continue to improve in terms of rate, as we look forward from here on out. So into next year and in the years after both membership and health will continue to help drive a year-over-year improvement. We also obviously always trying to have a cost takeout initiatives to help mitigate pressures that we face and just help us invest in the right places. But again, like I said, the profit share could become a pressure from an NCL. The other thing to note in terms of the profit share is this potential regulatory changes around late fees. Now, it's too early to know whether those do or don't count, but that's another item to note. And lastly, I don't think I had mentioned this. We're still in a consumer environment where it's a little uneven and steady and so I think as we think about going forward, a lot of it will depend -- the industry growth will depend upon that consumer and where they choose to spend their money, but I think like I said, our goal would be to at least maintain a flat rate, if not grow a little bit, if we have flat sales, for example."
},
{
"speaker": "Michael Lasser",
"content": "Thank you very much. My follow-up question is, there is an interesting dynamic that you're referring to on your call, which is the promotional environment in some cases is higher or more intense than it was in 2019, but you're getting more vendor funding than you were getting at least relative to last year. So A, how much is your vendor funding up or down relative to 2019, and B, what does this overall promotional environment suggest about the profit pool for selling consumer electronics in the United States in Best Buy's share of that overall profit pool? Thank you very much."
},
{
"speaker": "Corie Barry",
"content": "So, question one, overall vendor trading up for now. We're not going to say total amounts of vendor funding, but you can imagine, at any given point in time our vendors like us are trying to think in a very omnichannel way how best can we both stimulate demand and complete excellent customer experiences. When we kind of like look all in at everything our vendors do with us, we feel confident that we have at least as much if not more like total funding in partnership with our vendors, but of course they're going to use different pockets depending on the environment that we fit in. I think on your profit pool question, Michael, what's interesting is our vendors and we've said this for a long time. Our vendors are as interested as we are in stimulating consumer demand. Sometimes that means they lean highly into innovation and trying to drive replacement cycles and trying to drive that incremental demand through innovation. Sometimes that means we partner closely together in how we show up in stores, whether that's physically or in labor, and then sometimes that means, we will partner together in highly promotional or value-oriented periods to make sure, collectively, we are putting our best foot forward and it goes back to some of what I ended my comments with. There is a larger installed base of consumer electronics out there. And this is not static equipment we all have. This is equipment that whether or not you want to upgrade it, sometimes just wears out and breaks. And this is our unique place in this consumer electronics industry. In partnership with our vendors, we are arguably the best to commercializing that new technology or bringing kind of this total story agnostic just carrying about the customer to life and I think what you're seeing is this in this period right now, our ability to help drive value in partnership with our customers is really highlighted."
},
{
"speaker": "Michael Lasser",
"content": "Thank you very much, and good luck."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Matt Bilunas",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Kate McShane from Goldman Sachs. Your line is open."
},
{
"speaker": "Kate McShane",
"content": "Hi, good morning. Thanks for taking our questions. We wanted to ask a little bit more about the membership strategy, which is now in three tiers. Can you talk about how the profitability differs when compared to your previous program of Total Tech Support and does this profitability improve as the program scales and ramps?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. Yes, I think the changes we've made to the membership program have had a positive impact on our OI rate this year. I think we've talked about it being at least 25 basis points for the year. It's coming from a few different areas. The first area, I would say is the changes we've made to the My Best Buy program, the free membership where we move points away from that program, which is solely on the credit card that helps drive some improvement in rate. The cumulative growth in the members is also a place where that actually helps improve our margin rates as well. So the growth in the annual membership fees does drive some of the improvement as well. Lastly, the changes we've made to the Total Tech program and turned into my Best Buy Total, it does lower the cost to fulfill and helps to drive an improved gross margin rate as well. So those are the collection that drive the at least 25 basis points. And then Corie can speak to any sort of strategic things around the membership team."
},
{
"speaker": "Corie Barry",
"content": "I think what's most important is that at any given point in time, what the team I would argue has done a magnificent job doing is balancing acquisition, retention, and engagement. And while to Matt's point, cost to serve as part of our considerations. What we want are not just to acquire a bunch of members but to make sure they are incredibly engaged and to make sure we retain them over time. And so while the profitability impact is part of what we're looking at, the bigger question we are actually looking at is, what is that combination of acquisition, retention, and engagement that drives what we talked about, which is more sticky customers that bring a larger share of wallet and help keep Best Buy relevant over time."
},
{
"speaker": "Kate McShane",
"content": "Thank you. And then a follow-up question was just around market share. We wondered if you've been seeing any kind of meaningful change here, whether it would be sequentially or just in any specific categories?"
},
{
"speaker": "Corie Barry",
"content": "So the good news is, overall, we feel very strongly about our position in the industry and we talked about it already a bit. We are confident in our relationship with our vendors and grateful for their partnership and I think we continue to be excited to keep investing in our strategy from a position of strength. We've said before, there is not a great single source for market share, both because we have a large portfolio of services. Also because we are always evolving new categories, but from what we can see in some of the more established categories, we have at least held our share in Q2 and we believe that's been true really the first half of the year. So no major trajectory change. We feel like we're positioned well and obviously, the team will continue to work with our vendor partners and ensure that we have that great valuable assortment for our customers."
},
{
"speaker": "Kate McShane",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Brad Thomas from KeyBanc Capital Markets. Your line is open."
},
{
"speaker": "Brad Thomas",
"content": "Hi, good morning. Thanks for taking my question. I was hoping we could talk a little bit more about kind of inflation, deflation. And what you've been seeing of late, and how you're thinking about that in the back half of the year, particularly given the inflationary world that we've all been living in, but this backdrop of consumer electronics that has historically have been deflationary? Thanks."
},
{
"speaker": "Matt Bilunas",
"content": "Sure. I think broadly speaking, let's start with the categories. I think what we said from a product perspective, we certainly have seen a little bit inflation over the years. But what we're now seeing actually is more promotionality on a year-over-year basis in some cases compared to FY '20, so from category product perspective, I think we're kind of beyond past the inflation aspects that there isn't some cost of good increase, but generally speaking, the prices have gone up. So I think that hasn't changed too much outside like sometimes more promotionality is dropping that price on a year-over-year basis. I think for inflation in other areas in terms of cost, there are things that are historically have always had a little inflation there, probably it will continue to go up. Wages is an area where we always expect to have a little inflation, marketing also is a place where you see some pretty consistent inflation over the years. Supply chain is the more notable one that I think we're seeing a lot of inflation over the years and now it's starting to subside a little bit. Supply-chain has a number of different areas, one of them being the ocean side of supply-chain. That's the smallest cost that we have and that's an area where inflation actually has come down. Ground transportation or domestic transportation actually is an area where we are still seeing a higher level of inflation based on the wages that have the wage pressures and just the volume that's increased. The warehousing side of supply-chain is also an area where we've seen inflation and would probably expect to continue to see some. We also have wage inflation on the warehousing side, but also just we've expanded our footprint because our large products have grown in terms of the mix of our categories that we did it to add space. So broadly speaking, there are some areas where we probably continue to see inflation and some areas that will abate a little bit as you get into next year and years out."
},
{
"speaker": "Corie Barry",
"content": "Brad, explicitly I want to highlight. We started talking about this category becoming promotional again in the fall of 2021. And so this is a category very different than some of what you're hearing and I'll just use an example like a number, where you're starting to see that pullback. That is not the case here, but structurally, we have seen ASPs increase. So to your point about this is generally seen as a deflationary category. We spent some time talking on the last call about the fact that actually over time, it is not necessarily deflationary because every single new Rev of products carries with it a new and different price tag. So actually, over the longer period, when we look back to FY '20, we have seen structural increases in ASP, but that is due more to our premium mix and it's do more to having got more high ASP products like appliances and home theater. And so, I just want to make sure I'm explicit in saying this is a bit of a different category on the pricing side of things. Matt did an exceptional job on some of the costing side of things, but we're in a different place than many other industries and categories."
},
{
"speaker": "Brad Thomas",
"content": "That's really helpful. Thanks. Thank you both. And if I could squeeze in one follow-up here around the topic of shrink. Corie, you mentioned some of the new displays you have that have been helpful. But can you just help to put into context the success that you're seeing in this tough environment given that there are so many retailers calling out challenges on shrink right now?"
},
{
"speaker": "Corie Barry",
"content": "Yes. I will start with our number one priority is and always has been the safety of our customers and our employees. And I need to be clear that in certain parts of the country in certain stores do that attempt that whether it's breaking in or whether it's larger-scale just grabbing and running out that those are real and we are definitely seeing an increase. However, we did not call-out material impacts to the business as a result of shrink pressure. And as we think about the way we think about shrink is overarching everything we call shrink as a percent of revenue, right, because you're kind of trying to gauge it versus the volume and in total, our shrink as a percent of our revenue is within 10 basis-points of pre pandemic fiscal '20 now, I give our teams all the credit in the world around us, and one of the things that's a little bit different here at Best Buy is given the high-ticket nature of what we sell, we've been addressing shrink aggressively for honestly many-many years. It's really embedded in the culture and think about some of the things that are different for us, we have front door asset protection in our stores and likely often more floor coverage as well because we just have more employees in our stores and they just do an exceptional job of washing out over our stores, we usually just have one entrants in our stores, we tend to have less self-checkout. We have a very-high digital penetration at 33%, so that's a little bit different. We also have to spend a lot of time on online side, which is a different kind of definition upstream. And so we just have structurally. I think a little bit different and honestly have been investing really heavily in this space over-time. I'm trying to really hard in our buildings, protect our employees and assets. And then as I mentioned, now going into the next realm of technology solutions that are trying to protect the customer experience and make it still seamless for the customer to get everything they want, and at the same time, create the safest possible environment."
},
{
"speaker": "Brad Thomas",
"content": "Very helpful. Thank you, Corie."
},
{
"speaker": "Operator",
"content": "And your final question comes from the line of Brian Nagel from Oppenheimer. Your line is open."
},
{
"speaker": "Brian Nagel",
"content": "Hi, good morning. Thank you for taking my questions."
},
{
"speaker": "Corie Barry",
"content": "Good morning."
},
{
"speaker": "Brian Nagel",
"content": "My first question. I think it's a bit of a follow-up to Keith's question just with respect to memberships. So Corie, you spent a lot of time on the call today. Just talking about the ongoing enhancements of membership and you've given some of the nearer-term financial targets, but I guess the question I want to ask is, as we step-back and clearly the big focus for Best Buy. In your minds, what do we play what I don't want to say necessarily say dream the dream, but intermediate longer-term opportunity with membership either providing a financial standpoint more quantifiable or just from an overall consumer engagement standpoint."
},
{
"speaker": "Corie Barry",
"content": "Yes. I'm going to talk from a consumer engagement lens. The thesis of membership has been consistent since the beginning is to drive customer engagement and increase share of wallet in consumer electronics, that is the end game that we're trying to accomplish, all the more important in an environment where we have plenty of data that says consumers are a little less brand loyal than they've ever been, and so it becomes even more important for us to both create and then maintain this deep relationship with our customers. What we've learned across and I said it before, but ahead again across acquisition, retention, and engagement, what we've learned is different customers value and different cohorts of customers value different qualities in our membership program. And so that's why the tiers of Free, Plus and Total they will appeal to either in the free case, someone who just really wants the convenience of free shipping on everything. On the Total - or on the Plus aspect, excuse me, that's someone who loves convenience and a great value, right, they're going to get the promotions. They're going to get early access and we get 60-day return windows. And then on the total. I want all of that plus. I really value the support aspect of what we deal and the most important output of all of those at the end-of-the-day is that we can see customers who both stay engaged with us and we can see that repeat business, and we can see that increase in share of wallet meeting every time they think about making a purchase in consumer electronics, they just come to us because it's so easy why do you go anywhere else. So that structurally, is what you're trying to build to. Over time, you both want the program itself to be efficient, you wanted to be a reasonable cost of acquisition, but over time, you also want a customer who is shopping with more frequency and ultimately spending more with Best Buy."
},
{
"speaker": "Brian Nagel",
"content": "No, that's very helpful. I appreciate that. And then my follow-up question different topic. We talked about the sale, the expected sales trajectory through the balance of the fiscal year with the expectation that sales will continue to solidify improved maybe work towards that flatline. But you also did call out. I think it was in the prepared comments. The risk of it - if you will is the challenge of this resumption of student loan payments. So, it's obvious topic is starting to get air time. The question. I have is I mean, to what extent you look closely at this. How are you sizing and if you are sizing that potential risk to your sales trajectory here in the near-term."
},
{
"speaker": "Matt Bilunas",
"content": "Yes, thank you. I think it's clearly something we're trying to assess and what we effectively believe we've tried to size that in our guide for the back-half of the year. So it's clearly there are a number of different factors influencing the consumer right now shift to spend the services, their increasing use of credit card, but they're still spending money. So I think it's certainly an impact for us. I think if you look at our demographics, we potentially could be more slightly exposed, but at the same time, we have a demographic that actually has a higher income, who can more afford, increase in the number of student debt payments. So it's something we certainly tried to factor into the back-half for sure, but it's not the only factor that's happening."
},
{
"speaker": "Corie Barry",
"content": "You bet. Thank you, Brian. We appreciate the questions and overarchingly thank you to everyone who took the time to be with us today. And before we close the call. I want to make sure we acknowledge the wildfires in Maui, but also the wildfires, we've seen in Canada. And those bracing for a hurricane in Florida. Our hearts genuinely go out to those impacted and we are doing all we can to support our employees in all of those impacted areas. Thank you so much for joining us today."
},
{
"speaker": "Operator",
"content": "That concludes today's Best Buy's second quarter fiscal 2024 earnings conference call. Thank you all for joining, and I hope everyone has a great day."
}
] |
bby | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for standing by. Welcome to Best Buy's First 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 call is being recorded for playback and will be available by approximately 1:00 p.m. Eastern Time today. [Operator Instructions]. I will now turn the conference call over to Mollie O'Brien, Vice President of Investor Relations."
},
{
"speaker": "Mollie O'Brien",
"content": "Thank you, and good morning, everyone. Joining me on the call today are Corie Barry, our CEO; and Matt Bilunas, our CFO. During the call today, we will be discussing both GAAP and non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, and an explanation of why these non-GAAP financial measures are useful, can be found in this morning's earnings release, which is available on our website, investors.bestbuy.com. Some of the statements we will make today are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may address the financial condition, business initiatives, growth plans, investments and expected performance of the company, and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current earnings release and our most recent 10-K and subsequent 10-Qs for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the call over to Corie."
},
{
"speaker": "Corie Barry",
"content": "Good morning, everyone, and thank you for joining us. Today, we are reporting Q1 sales results that are right in line with the expectations we shared in March and profitability that was better than expected, demonstrating our strong operational execution. We are appropriately balancing the need to adjust in response to the current industry sales trends with the need to invest, so we can capitalize on opportunities as our industry moves through this downturn and returns to growth. In this environment, customers are clearly feeling cautious and making trade-off decisions as they continue to deal with high inflation and low consumer confidence due to a number of factors. At the same time, in Q1, we saw our purchasing customer behavior remain relatively consistent in terms of demographics, and the percent of purchases categorized as premium. In addition, our focus on being there for our customers with expertise and support was highlighted by material improvements and satisfaction scores for our in-home services and delivery and record scores in remote support, in-home repairs, store care, and Best Buy Totaltech call center experiences, all key differentiators for us. We remain as confident as ever about our strong position in the industry despite reporting lower sales than last year. In Q1, our comparable sales were down 10.1% on a year-over-year basis. From a merchandising perspective, similar to the past few quarters, the largest impacts to our Domestic comparable sales decline came from computing, home theater, and appliances. The promotional environment played out largely as expected. It was slightly more promotional than last year, and we believe we are now fully normalized to pre-pandemic levels from both the percent of products being promoted and the depths of promotions. In some products and categories, the environment was more promotional than we had expected, and we saw promotional levels above fiscal '20. We effectively managed through those situations in partnership with our vendors. On a blended basis, our overall average selling price, or ASP, was slightly down to last year due to the return of promotionality. While we're on the topic, I would like to take a step back and address what we believe is a common misperception about our industry, that all products we sell are perpetually deflationary. In fact, most of our categories have had price stability over time or even seen increases. The price of a product may come down in the year after it launches only to be replaced by the next generation of the product launched at the same or slightly higher price. Innovation drives price stability and often drives consumers to adopt even higher ASP products based on new technology or additional features. For example, the five-year compounded annual growth rate for average laptop prices is approximately 2%. For Best Buy specifically, we over index in the newest innovation and next generation of products, so we tend to carry a higher ASP than the overall industry. Additionally, as a reminder, structurally, our overall ASPs have also increased over the last several years due to category mix with the growth of higher ASP appliances and large TVs, as well as more mix into premium products at higher price points. Now back to our Q1 results. Our inventory at the end of the quarter was down 17% compared to last year as we lapped last year's elevated levels. The team continues to manage inventory tightly, targeting approximately 60 forward days of supply. We expect that our inventory levels will continue to normalize and year-over-year variances will more closely match our sales performance as we move through the year. In the first quarter, digital sales comprised 31% of our Domestic revenue, very similar to the last two years, and twice as high as pre-pandemic. Our \" Buy Online, Pickup In Store\" percent of sales was also very consistent, at just over 40%. Considering the speed of our delivery, with almost 60% of packages delivered within two days, we believe the consistency of our high in-store pickup by our customers really underscores the importance and convenience of our stores. I continue to be proud of our team's execution and ability to navigate through this challenging environment, always keeping our customers and their experience as our top priority. As we look to the rest of the year, we expect the macro environment to continue to pressure demand in our industry this year. However, our guide for the year implies that we expect year-over-year comp performance to improve as we move through the year and we lap the comparable sales declines we experienced last year. Based on what we can see right now, we continue to believe that calendar 2023 will be the bottom for the decline in tech demand. Matt will provide more color on our expectations later in the call. This year, we are focused on delivering great customer experiences while running the business efficiently and strategically setting ourselves up to flourish when the industry returns to growth. This includes our efforts to expand our gross profit rate, and to continue to prudently manage our SG&A expense. Now, I'd like to update you on our membership program. The goal of membership is to drive increased customer engagement and increased share of wallet over time. As it relates to our paid membership program, our investment thesis remains very much intact. Our members are engaging more frequently with us, shifting their tech spending to Best Buy, and buying more across categories than non-members. Additionally, members rate our experiences higher. Our net promoter scores from Totaltech members remain considerably higher than from non-members. No membership program is static, and we have always stated that it was our intent to iterate over time as we learned more. We've learned a tremendous amount from our members over the last couple of years, particularly that different customers value very different benefits when it comes to their technology. Earlier this month, we announced changes to our membership program that align all our memberships, and will give customers more freedom to choose a membership that fits their technology needs, budget, and lifestyle. In addition, these changes will provide more flexibility and result in a lower cost to serve than our existing Totaltech program. Starting June 27, our membership program will offer three tiers: My Best Buy, My Best Buy Plus, and My Best Buy Total. I'll spend a few minutes going a little deeper on each of the tiers. My Best Buy will remain our free tier plan built for customers who want convenience. It includes free shipping with no minimum purchase and other benefits associated with a member account, like online access to purchase history, order tracking, and fast checkout. As you may recall, My Best Buy had historically been a points-based loyalty program. This past February, we added the free shipping benefit. At the same time, we transitioned the ability to earn points solely to purchases made on our co-branded credit card. The customer and financial impacts we have seen thus far validate our decision. For example, the online conversion rate for products under $35 has increased, and our customer enrollments have remained steady. In addition, the early financial impact has been better than we modeled. My Best Buy Plus is a new membership plan built for customers who want value and access. For $49.99 per year, customers get everything included with the My Best Buy offering as well as exclusive prices and access to highly-anticipated product releases. They also get free two-day shipping and an extended 60 day return and exchange window on most products. My Best Buy Total is a membership plan built for customers who want protection and support. This tier is an evolution of our current Totaltech offer and is $20 cheaper at $179.99 per year. It includes all the benefits from the Plus tier, as well as Geek Squad 24/7 tech support via in-store, remote, phone, or chat on all your electronics no matter where you purchased them. It also continues to include up to two years of product protection, including AppleCare+ on most new Best Buy purchases. Instead of free in-home installation and haul-away services, members will receive promotional offers from time to time. As we reflected on the goals of our membership programs, we made this change because we could see that many customers who became members primarily for free installation services did not stay with the program as long as other members, and had significantly higher churn. From a financial perspective, we continue to expect our membership program to contribute approximately 25 basis points of Enterprise year-over-year operating income rate expansion in fiscal '24. We have already begun to deliver on this expectation as the changes we made to the free My Best Buy tier benefited our gross margin rate this quarter. Now, I will shift topics to talk about our omnichannel operations. We are continuing to adapt our omnichannel capabilities to ensure we maintain a leading position in an increasingly digital age and evolving retail landscape. For example, our portfolio of stores needs to provide customers with differentiated experiences and multi-channel fulfillment. At the same time, we need them to become more cost and capital efficient to operate while remaining a great place to work. We are on track to deliver the fiscal '24 store plans we announced this past March. These include closing 20 to 30 large format stores, implementing eight Experience Store remodels, and opening around 10 additional outlet stores. Consistent with the plans we shared entering the year and incorporated in our fiscal '24 guidance, during Q1, we advanced our operating model to align with the ongoing evolution of our business model and current trends. As I mentioned on our last call, over the past three years, our overall headcount has declined by approximately 25,000 people or 20%, as we adapted to the shift in customer shopping behavior and in the effort to drive more flexibility. As a reminder, the vast majority of this headcount change came through the pandemic from attrition and our decisions not to backfill. Throughout these significant changes, we have been working hard to balance the amount of labor hours necessary to deliver the best experience possible for our employees, customers, and shareholders. At the same time, we have been investing in tools and employee development programs that increase their flexibility within and across stores. We also know that not all roles and the associated hourly pay are the same, and strategic trade-off decisions are necessary to give us the ability to flex our labor spend appropriately, particularly customer-facing labor. Based on all these factors, we have been, as we'd previously said, making multiple changes to our labor models. One such example is the recent change to our consultation program. By lowering the overall number of in-store consultants and designers, we were able to add approximately 2 million more hours for customer-facing sales associates into our staffing plan for the year. Customers are already giving us higher marks for improved associate availability in recent customer surveys. It's also important to note that we are moving away from a one-size-fits-all approach to our stores and staffing to a market-based approach. And depending on the needs of each market, we're adding, removing, shifting, or arranging the number of associates and roles needed to better and more efficiently serve those customers and to allow for more localized flexibility. Looking forward, we will continue to iterate our model to align with business trends, including initiatives such as membership and ensuring the span of control of our leaders is appropriate. As you would expect, we are also focused on leveraging existing and emerging technology to drive better customer and employee experiences across channels that also deliver efficiencies and better margins. I'd like to share a few examples around our customer care phone experience and our in-home sales team. Our customer care agents receive millions of customer phone calls every year. We recently launched a capability that uses generative AI to summarize the main points and follow ups from each call. In the past, customer care agents manually took note to capture interactions real time with customers. This new capability allows our agents to both fully focus on the customer during the call and reduces time between calls, lowering overall cost and improving agent satisfaction. In addition, this is providing us with valuable information about friction in our experiences, allowing us to continuously drive upstream improvements. In another example, we're piloting a virtual reality training and simulation experience for our in-home consultants and designers. We expect this will decrease the cost to develop and certify in-home sales teams, and elevate the specialized in-home selling skills of consultants and designers, especially those who are newer and less experienced. Additionally, these tools are always available for reference whether a team member is in a customer's home or training in a store. Now, I will take a few moments to share our thoughts on our broader industry backdrop. As I mentioned, we expect that next year, the consumer electronics industry will see stabilization and possibly growth, following two down years. I believe it's worth repeating why we are confident our industry will return to growth. First, we believe that much of the growth during the pandemic was incremental, creating a larger install base of technology products in consumers' homes. On average, U.S. households now have twice as many connected devices as they did in just 2019. Second, we expect to begin to see the benefit of the natural upgrade and replacement cycles for the technology bought early in the pandemic possibly later this year, depending on the macro environment, even more likely in calendar 2024 and 2025. Historically, customers upgrade or replace their tech every three to seven years, depending on the category, with mobile phones on the lower end, computing in the middle, and home theater and large appliances toward the higher end of that range. We continue to see our lapsed customers returning at higher rates year-over-year, especially as customers we acquired early in the pandemic return for additional technology purchases. Third, this is not a static industry. Billions of dollars of R&D spent by some of the world's largest companies, and likely some we haven't even heard of yet, means innovation is constant over the long term, driving interest, upgrades, and experimentation. We can see the customer demand for newness exemplified in the last few weeks by the record-breaking launch of the new Zelda software for Nintendo Switch and the stronger-than-expected pre-orders for the new ASUS' handheld gaming device. We continue to believe the industry will get back to a more normalized pace of meaningful innovation toward the end of calendar 2023 and into 2024. Additionally, there are several macro trends that we believe should drive opportunities in our business over time, including cloud, augmented reality, generative AI, and expansion of broadband access. While our existing product categories have slightly different timing nuances, in general, we believe they are poised for growth in the coming years. We are also furthering our expansion into newer categories, like wellness technology, personal electric transportation, outdoor living, and electric car charging. We carry multiple EV charging brands, and we were the first retailer to carry Tesla chargers. We also launched Starlink's satellite Internet kits on our digital channels and we'll have it available in stores later this summer. In addition, we are partnering with our vendors in new ways that leverage our capabilities to create new opportunities. For example, we are partnering with Roku to make TV advertising more relevant and performance driven. The first-ever TVs to be designed and made by Roku are available exclusively at our stores and on bestbuy.com. And brands will be able to work with us to target, optimize, and measure their ads on Roku using Best Buy audience data. We also continue to build our Partner+ program that leverages our supply chain and fulfillment capabilities. We have several vendor partners, including Samsung, who are offering their online customers the option to conveniently pick up their products at their local Best Buy store. The recent launch of Oura smart rings is an example of how we partner with some of our smaller emerging vendors in a very comprehensive and unique way to drive customer engagement. Oura is a smart ring that uses sensors to track a variety of metrics to provide continuous health monitoring to improve the user's health habits. We launched the products exclusively on bestbuy.com and in 850 stores. We have an interactive demo experience with the ability to try on the rings and order any configuration of style, color, and size. We also incorporated the Best Buy store finder on Oura's website, so customers can visit their closest store and see the products in person. I want to extend my heartfelt appreciation for all our associates across the company, who continue to uniquely position us for the future through immense change. We continue to focus on providing competitive pay and benefits and leveraging flexible work models. And I am pleased to report that we maintain industry low turnover rates, particularly in key leadership roles, the vast majority of which we hire internally. It's amazing to see so many of our key leaders choosing to build the future of retail with us. And I am proud of the many ways we were recognized during the quarter for our commitment to our people and the environment. We were included on DiversityInc's 2023 list of Top 50 Companies for Diversity and ranked 17th on DiversityInc's Top Companies for Board of Directors list, reflecting our ongoing work to ensure our leaders and our company reflect the communities we serve. Just last week, we were listed on Parity.Org's list of Best Companies for Women to Advance, as well as their inaugural Best Companies for People of Color to Advance. We were one of fewer than 20 companies named to both lists this year. We were also recently named one of Barron's 100 Most Sustainable U.S. Companies for the sixth year in a row. In fact, this year, we were the top-ranked retailer. My summary is consistent with my comments last quarter. We believe the macro and industry backdrop will continue to be volatile this year. We have a proven track record of navigating well through dynamic and challenging environments, and we will continue to adjust as the macro evolves. At the same time, we remain incredibly excited about our future. We believe our differentiated abilities and ongoing investments in our business will drive compelling financial returns over time, and we are carefully balancing our reaction to the current environment with a focus on our strategic initiatives and future. I will now turn the call over to Matt for more details on our first quarter financial and fiscal '24 outlook."
},
{
"speaker": "Matt Bilunas",
"content": "Good morning, everyone. Let me start by sharing details on our first quarter results. Enterprise revenue of $9.5 billion declined 10.1% on a comparable basis. Our non-GAAP operating income rate of 3.4% declined 120 basis points compared to last year. Non-GAAP SG&A was $40 million lower than last year and increased approximately 180 basis points as a percentage of revenue. Partially offsetting the higher SG&A rate was a 60 basis point improvement in our gross profit rate. Compared to last year, our non-GAAP diluted earnings per share of $1.15 decreased 27%. While our revenue was down to last year, overall our results once again aligned closely with our expectations entering the quarter. Our non-GAAP operating income exceeded our expectations due to both higher gross profit rate and lower SG&A. The better-than-expected gross profit rate included favorable supply chain costs and benefits associated with changes made last year to our free My Best Buy membership offering. The favorable SG&A was driven by a combination of several smaller items with store payroll expense being the largest driver. Next, I will walk through the details on our first quarter results compared to last year. In our Domestic segment, revenue decreased 11% to $8.8 billion, driven by comparable sales decline of 10.4%. From a phasing perspective, February was our best-performing month on a year-over-year basis with trends softening through the remainder of the quarter. From a category standpoint, the largest contributors to comparable sales decline in the quarter were computing, appliances, home theater and mobile phones, which were partially offset by growth in our gaming and service categories. In our International segment, revenue decreased 11.6% to $666 million. This decrease was driven by the negative impact of foreign exchange rates and a comparable sales decline of 5.5% in Canada. Our Domestic gross profit rate increased 70 basis points to 22.6%. The higher gross profit rate included the following: First, improvement from our membership offerings. This included a higher gross profit rate in our services category, which was primarily driven by the cumulative growth in Totaltech members. In addition, our rate benefited from the program changes we made last year to our free My Best Buy offering. Second, product margin rates improved versus last year despite increased promotional activity. And third, the profit sharing revenue from our private label credit card arrangement was a benefit to our Domestic gross profit rate. Overall, the results this quarter aligned with our commitment to improve our gross profit rate this year. Our International non-GAAP gross profit rate of 23.7% decreased 60 basis points compared to last year, which added approximately 10 basis points of pressure to our Enterprise results on a weighted basis. The lower International gross profit rate was primarily driven by a lower mix of revenue from the higher margin rate services category. Before moving on, I would like to give some additional context on the profit sharing revenue from our credit card arrangement, which we have now called out as a benefit to our gross profit rate for the last eight quarters. In fiscal '23, the profit share was approximately 1.4% of Domestic revenue, an increase of 50 basis points compared to fiscal '20. The growth was driven by the increased usage of our card, both at and outside of Best Buy and the favorable credit environment. Our outlook for fiscal '24 assumes the profit share will have a slightly negative year-over-year impact on our gross profit rate for the remainder of the year. Domestic non-GAAP SG&A declined $29 million with the primary drivers being lower store payroll cost and reduced advertising, which were partially offset by higher incentive compensation and depreciation. Moving to the balance sheet. We ended the quarter with a little more than $1 billion in cash. Our year-end inventory balance was approximately 17% lower than last year's comparable period, and we continue to feel good about our overall inventory position as well as the health of our inventory. During the quarter, we returned a total of $281 million to shareholders through dividends of $202 million and share repurchases of $79 million. Our quarterly dividend of $0.92 was an increase of 5% and marked the 10th straight year of dividend increases. We expect to continue share repurchases throughout fiscal '24; however, we are not providing a target. We will continue to assess our overall working capital needs and provide updates as we progress through the year. Moving next to capital expenditures, where we still expect to spend approximately $850 million this year. This reflects a reduction of approximately $80 million compared to last year with lower store related investments being the primary driver of the reduced spend. Now, we'd like to discuss our fiscal '24 outlook. As a reminder, our original guide for this year assumes the consumer electronics industry would continue to feel the pressure of the broader macro environment and the high degree of uncertainty as it relates to the consumer. Our financial performance in the first quarter closely aligned with our expectations and we are maintaining the full year guidance we provided this past March. Given the current environment, we are, of course, preparing for a number of scenarios within our guidance range. At this point, we believe our sales align closer to the midpoint of the annual comparable sales guidance. It is still early in the year, so we will continue to watch the trends closely and adjust as necessary. Let me provide more details on our guidance and working assumptions. Starting with revenue. We expect Enterprise revenue in the range of $43.8 billion to $45.2 billion and Enterprise comparable sales decline of 3% to 6%. As a reminder, the fourth quarter of fiscal '24 contains an extra week. We expect the 53rd week to add approximately $700 million of revenue and it is excluded from our comparable sales. Our guide implies comparable sales trends versus last year improve as we progress through the year. Let me share context on that. Starting in Q1 of last year, our industry experienced the beginnings of macro pressure and the broader implications of normalizing consumer demand trends after two years of higher growth. This resulted in a 10% comparable sales decline for the full year. For the remainder of this year, we will continue to lap the industry pressure that only worsened from the first quarter of last year. Furthermore, when using fiscal '20 as a comparison, you will see that our guidance implies revenue trends will further soften in the second quarter. After removing the estimated revenue from the 53rd week, the midpoint of our revenue guidance reflects a scenario where our growth compared to fiscal '20 is slightly negative in the second quarter and regresses slightly more in the second half of this year. This is clearly a continued slowdown in revenue growth compared to fiscal '20. For reference, our revenue growth compared to pre-pandemic fiscal '20 peaked at 27% in Q1 of fiscal '22 and generally has been slowing ever since the last quarter at 4%. Moving on to full year profitability guidance, which is, Enterprise non-GAAP operating income rate in the range of 3.7% to 4.1%, and non-GAAP diluted earnings per share of $5.70 to $6.50. Our outlook remains unchanged for a non-GAAP effective income tax rate of approximately 24.5% and for interest income to exceed interest expense this year. As it relates to the extra week, we expect it to benefit our full year non-GAAP operating income rate by approximately 10 basis points. I will review the full year gross profit rate and SG&A working assumptions that we shared this past March. We expect to drive gross profit rate expansion of 40 basis points to 70 basis points compared to fiscal '23 due to the following actions and initiatives: we expect to see benefits from optimization efforts across multiple areas, including reverse supply chain, large product fulfillment, and our omnichannel operations; we also expect our membership program and our health initiative to improve our gross profit rate; lastly, we expect the impacts from promotions, supply chain costs, and the profit sharing from our private label credit card to have a relatively neutral impact to our annual gross profit rate compared to this past year. Now, moving to SG&A expectations. We expect SG&A as a percentage of sales to increase by approximately 100 basis points compared to last year. We expect higher incentive compensation as we reset our performance targets for the new year. The high end of our guidance assumes incentive compensation increases by approximately $225 million compared to fiscal '23. Depreciation expense is expected to increase by approximately $50 million and store payroll expense is expected to be approximately flat to fiscal '23 as a percentage of sales. As it relates specifically to the second quarter, we expect that comparable sales will decline in the range of 6% to 8%, which reflects a sequential year-over-year improvement compared to the first quarter. Our revenue growth trends during the first three weeks of the quarter improved from April and were within our Q2 guidance range. On the profitability side, we anticipate our second quarter non-GAAP operating income rate to be approximately 3% or slightly higher. Lastly, we expect SG&A dollars to be approximately flat to last year at the midpoint of our revenue range. I will now turn the call over to the operator for question."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And your first question comes from the line of Simeon Gutman from Morgan Stanley. Your line is open."
},
{
"speaker": "Simeon Gutman",
"content": "Hey, good morning, and nice job navigating in this backdrop. My question -- my one question is on industry growth, this idea that maybe we bottomed this year. If you look at the category, it's more than reverted to your point, Matt, around sales trends. It looks like it's overshot in a way. And you could have made the case that this year '23 could have -- should have been sort of the bottom and even the turn. So, what gives you confidence in '24? Because once you overshoot, it's hard to determine where that bottom is. Curious if you can provide some more color."
},
{
"speaker": "Corie Barry",
"content": "Yes. Thank you, Simeon. Let me start with a little bit of the backdrop here. And I think we've been pretty consistent in saying -- we started really in Q2 of last year in saying the consumer is clearly making trade-off decisions in a very unique environment. So, to your kind of original question on the reversion, I think what we would say is we've been seeing a consumer who is, whether or not you call it a recession, exhibiting some recessionary behaviors depending on the different category that you're talking about. So, it's absolutely unusual. I think as we look ahead, we start to feel like you see the turn in the business as you head out the back half of this year and into next year. And there are a few industry sources that we're using to help substantiate that. If you look at NPD, CTA, Forrester, a lot of those have the same kind of points of view. So first of all, we're just looking externally to say, what do we see in the landscape. But I think we tried to lay out, even within the prepared remarks, there are some key tenets here that we believe underscore our thoughts for next year. One is, this idea of truly a larger install base. Yes, absolutely, there was some pull-forward in the pandemic, but some of that had to be incremental given you now have two times as many connected devices in people's homes as you had versus just 2019. So, you absolutely have this larger install base of product. And these are not static products. These are products that we can already see our vendors working to upgrade and innovate and drive. The second point that we made, which is replacement cycles. Natural replacement cycle is three to seven years. Like we said, quicker on the mobile side, computing in the middle, appliances and TVs more on the high end. But these are pretty consistent replacement cycles that we see over time. If anything, we saw them maybe accelerate a bit during the pandemic, normalize a bit more now. But on the whole, you've got products that because of their nature, you're going to want to upgrade. And then, the third is the pace of vendor innovation. And you can -- that's why we gave some specific examples in the prepared remarks. You can already start to see some of that innovation coming. I think the window that we have into our vendors would say it's more towards the back half of this year and into next year. I think we were clear in the prepared remarks to say, this is all based on what we can see now, and we're going to continue to evaluate. But as of right now, it feels like that consumers kind of made their choices about the industry that we're in, and we still feel really well set up as we start to head into the next calendar year."
},
{
"speaker": "Simeon Gutman",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Joe Feldman from Telsey Advisory Group. Your line is open."
},
{
"speaker": "Joe Feldman",
"content": "Great. Thanks guys for taking the questions. I have a couple of quick follow-ups for you. With regard to the incentive comp for this year, can you help us out why it would go up as much as it is given it's such a challenging year? Not that you guys shouldn't get paid, but I just wanted to better understand it."
},
{
"speaker": "Matt Bilunas",
"content": "Yes, sure. First, I'll take you back to last year. Last year, we had about $455 million of favorability in incentive compensation. As you think about last year, by the end of last year, we had essentially not paid out any of our incentive comp based on our annual performance last year, a lot of which is driven by revenue and operating income expectations as you enter the year. And so, essentially we've reversed out all of that expense last year. And so, as you set new targets for this year FY '24, you reset your tables and expectations for sales and operating performance. And so, essentially just getting back from essentially almost a zero payout to a 1.0 payout, we've added over -- about $225 million of expense at the top end of our guidance, just simply reflect like a normal payout for this year because it's really more of a year-over-year impact of not paying out anything and then maybe starting the year with the expectation that we would pay out at a more normal midpoint."
},
{
"speaker": "Joe Feldman",
"content": "Got it. That's helpful. Thank you for explaining. And then, a quick follow-up on the promotional side of things. I think, Corie, you had mentioned that there were some categories that were a little more promotional than expected. I was kind of curious as to what those were. And the sort of second part of promotions, are people responding when promotions do kick in?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. I think, I'll start and Corie can jump in. There are a few categories that we saw a heightened level of promotionality, appliances is one of them, computing was one of them, headphones was another. There's a number that more promotional year-over-year and in some cases, even more promotional than they were pre-pandemic. And like any year, that's not just us who are incented to drive sales. Our vendors are incented to drive sales as well. And the outcome of that actually didn't lead to strengthen our product margins in totality. So the more heightened promotionality didn't necessarily manifest in profitability pressure on a year-over-year basis, but there were a number of categories that people are trying to stimulate and drive sales because of the environment we're in."
},
{
"speaker": "Corie Barry",
"content": "From an elasticity perspective, Joe, I hate always feeling like I answer this way, it depends on the category a little bit. I think, to Matt's point about appliances, that definitely right now is a category that is a little bit more reflecting a duress customer or someone who needs to replace an appliance versus the more aspirational customer. In that world, you have a little bit less elasticity, you can imagine, because you're not going to really respond to promotions as much. Some of the other parts of the business that Matt mentioned around particularly things like home theater, we're seeing response when there's more promotionality and more value. And I think, overarchingly, what I -- from a consumer perspective, this is absolutely a consumer who's looking for value and will respond to some extent, but it can depend a bit on the category that we're talking about and what their state of mind is in terms of how aspirational they want to be within that category."
},
{
"speaker": "Joe Feldman",
"content": "That's really helpful. Thanks, guys. Good luck with this quarter."
},
{
"speaker": "Corie Barry",
"content": "Thanks, Joe."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Anthony Chukumba from Loop Capital. Your line is open."
},
{
"speaker": "Anthony Chukumba",
"content": "Good morning. Thanks for taking my question. I was just wondering if you could just give a little bit more color on the services business. You had a pretty strong comp increase in the Domestic business, but then in the International business, it was down. And I know part of that had to do with compares, but I was just wondering if you can just give us a little more color in terms of the divergence there. Thanks."
},
{
"speaker": "Matt Bilunas",
"content": "Yes, sure, Anthony. The -- on the Domestic side, the services revenue growth is attributable to the growth in Totaltech members from this point to last year. And so, as we continue to sign up members, we continue to have more revenue come through that. And that's essentially the growth in the services category on the Domestic side. On the International side, we did say that there is some gross profit rate pressure on services. They're doing similar membership changes in Canada, and that's simply a reflection of timing of those membership changes they made last year. This year, they start to cycle those changes they made earlier in their year after this Q1. So that is a reflection of some of the membership changes that they're also making, not the same, but similar to what the Domestic side is doing."
},
{
"speaker": "Anthony Chukumba",
"content": "That's helpful. Thank you."
},
{
"speaker": "Corie Barry",
"content": "Thanks, Anthony."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Mike Baker from D.A. Davidson. Your line is open."
},
{
"speaker": "Mike Baker",
"content": "Hi. I just wanted to follow up on the membership question. And so, you're making some changes, which presumably is based on driving better profitability, yet the guidance for the profitability impact this year is unchanged, maybe that's just timing because it takes time to implement these changes. But what does this do to the long-term outlook in terms of the profitability on the membership business? Thanks."
},
{
"speaker": "Corie Barry",
"content": "Maybe I'll start and then Matt can add. We went into the year, Mike, knowing we were going to make changes to our membership program. We have the most clarity around My Best Buy, the free program, and those changes we actually put in place at the beginning of the fiscal year. But we also had an aspiration to make changes to the other side of the program. And this just gave us a little bit of time to -- before we announce the formal changes, but we had baked the assumption that we were [going to get] (ph) these changes into the guide for the year."
},
{
"speaker": "Matt Bilunas",
"content": "Yes. So, very specifically, we -- last quarter and this quarter, we've said that the gross profit rate, about 40 basis points to 70 basis points of increase this year, one of those reasons is the changes to the membership program, part of which is the My Best Buy changes, as Corie mentioned, and then just expected changes on the other parts of the membership program. And to your last part of your question, we would expect to continue to iterate and update the membership financials and expect to see probably continued profit rate expansion as you look into next year. Obviously, as you -- we still have Totaltech members that still have two years of benefits, and we'll have to honor those for that two years. And then as you get into the back half of this year, we will start to see the benefit of the changes more. And then, get into next year, we would continue to iterate and have to see it more upside."
},
{
"speaker": "Mike Baker",
"content": "Got it. Well, as someone who took advantage of the free installation, I'll miss that, but I'll take my $20 savings on the annual fee."
},
{
"speaker": "Corie Barry",
"content": "Well, we promised that there will still be great deals on installation. And we made clear that we're still going to pull some of those great deals. So, you will still see those coming. Also, please don't get too upset yet. And the other thing I just want to add, Mike, before you go is absolutely part of the changes result in impact to profitability. The intent of the changes was to understand customer behavior and then adjust the membership program based on the customer behavior we were seeing. So, in a world where you used to historically value points, but now things like free, reliable, fast shipping matter a lot more, you make that adjustment, not just because it has profitability impacts, but because you're actually learning about what your customers value and what accomplishes what you set out to do, which is to have more sticky customer relationships, increase that frequency and increase that share of wallet. So, we're really trying to balance both sides of the equation as we're making these decisions."
},
{
"speaker": "Mike Baker",
"content": "Got it. Fair enough. I appreciate the color."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Chris Horvers from J.P. Morgan. Your line is open. Chris Horvers, your line is open."
},
{
"speaker": "Chris Horvers",
"content": "Thanks. Good morning. Two related questions. So, you talked about the midpoint for the year on the sales side, but you didn't comment on the operating margin range. And you did just materially beat your sort of gross -- what you talked about for the gross margin in the first quarter here. So, are you expecting some give back? Any comments on that range? And then, Corie, you mentioned preparing for a number of different scenarios. I guess, what does that mean? You have cut a lot of expense out of the business on the labor side. That's your biggest cost. It's still inflationary. Where you see the opportunity to sort of protect the bottom line if comps do come in worse than expected?"
},
{
"speaker": "Matt Bilunas",
"content": "Yes, I'll start, and Corie can jump in. Thanks, Chris. The -- in terms of the EBIT midpoint, we did not comment on that. I think there's more moving pieces within the EBIT level between gross margins and SG&A levers that we can pull depending on where the sales trends go. The largest factor in that equation is going to be gross profit rate. And we're, obviously, reflecting a range of 40 basis points to 70 basis points. And so, in terms of where we land, we have a little bit more drivers or levers we can pull to kind of maneuver through that range. I think, in terms of the flow-through, we didn't flow through the Q1 OI beat. It's more a function of us giving us just a little bit of room to navigate the remainder of the year. We, obviously, have a wide range of outcomes for the year, and we want to just make sure we're being prudent with how we're making decisions as we get towards the more meaningful back half of the year."
},
{
"speaker": "Chris Horvers",
"content": "Thanks very much."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Peter Keith from Piper Sandler. Your line is open."
},
{
"speaker": "Peter Keith",
"content": "Hi, thanks. Good morning, everyone. I wanted to just talk about the sales trend from the last couple of months in the context of the overall retail landscape. So, you did talk about a bit of a softening through the quarter, although I think February, of the last conference call, you were roughly down 10%. So, it didn't seem like there was too much softening. At the same time, retail has seen a significant weakness in big-ticket discretionary. You would think consumer electronics would be impacted by that. So, your sales can be down, but not falling off a cliff. Maybe comment on what you're seeing within your business versus what you think is happening more broadly at retail?"
},
{
"speaker": "Matt Bilunas",
"content": "Sure. I can start talking about the cadence of the quarter and then Corie can jump in about broader retail. Similar to the retail industry, we did see our sales sequentially get worse as the quarter progressed. February was the best-performing month that we come in a little bit better than our -- the guidance we gave as we started the quarter, but there are a few reasons for that. I mean we gave growth number, not a comp number, so there's a bit of difference between the growth number and the comp number. We always have a few closing the book entry. So, comps in the quarter did sequentially get worse. We have, as we indicated, starting the quarter in line with the range that we gave for the first -- for the full quarter Q2, so therefore, improving from April into May in terms of comp. And so, we feel good about that range we gave for Q2 at the moment."
},
{
"speaker": "Corie Barry",
"content": "As it relates to the consumer, Peter, I think we've been pretty consistent since really starting in Q1 of last year, saying, we felt like, to your point exactly, in big ticket discretion and specifically in CE, given especially how much demand we saw through the pandemic, the consumer was going to make trade-off decisions. And it's a consumer that clearly, when they're faced with record high inflation versus 2020 in food, housing and fuel, that's going to drive those trade-off decisions. And I think what we've been anchored on is making sure we provide the best possible value and even altering and changing the membership program to make sure we're meeting that consumer where they are. And what we can see, I mean, we've always said, it's really hard to measure share in our business, right, because especially when it comes to services and new categories, it's very difficult. But what we believe is we're at least maintaining share in the industry. And so, to your point, it's an industry where the consumer is making decisions, but it's also an industry where everyone needs the stuff that we've got. It's not like these are just want-to-have products they're need-to-have products. And we -- especially as we look at those innovation cycles coming up, we can start to see this will stimulate a replacement and innovation cycle. So for right now, I feel really good about what we're trying to do to stay with the customer where they are given the trade-off decisions that they're making. And this industry is quite different than some of the others. And I think we've been pretty consistently trying to articulate what we're seeing in our consumers, and therefore, addressing their needs appropriately."
},
{
"speaker": "Peter Keith",
"content": "Okay. Well, thank you very much, and good luck."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Matt Bilunas",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Jonathan Matuszewski from Jefferies. Your line is open."
},
{
"speaker": "Jonathan Matuszewski",
"content": "Good morning, and thanks for taking my question. Mine is on your B2B channel or Best Buy Business. Our checks would suggest you've had some pretty big wins on this side of the enterprise as of late. Curious if you could just update us on that channel, Corie. Where is it tracking in terms of sales penetration? Is recent progress reflective of maybe any investments you've been making on that side of the business? And how are you thinking about this business performing in 2023 and beyond? Thanks so much."
},
{
"speaker": "Corie Barry",
"content": "I am incredibly proud of what our direct team has been able to accomplish, frankly, throughout the pandemic. And we haven't specifically released this as like a separate segment of the business or sized it, but its material and its growth, in general, has been outpacing what we've been seeing in the core. And I think it's a really creative approach to everything from education, which relies highly on technology, to hospitality, which relies heavily on technology, to even agreements with sports teams and facilities where any of us know, as you walk around, there are a ton of technology experiences that are available. We continue to believe this is an interesting growth channel for us. And we even talked last time on the call a little bit about our appliance business and starting to work with homebuilders directly in a small pilot that we're doing. So there's lots of different ways we're starting to -- and continuing. This has been a business for us for a long time. I think from an investment standpoint, I'm again very proud of the team has pivoted to even more of a digital experience. So if you go online and you're trying to buy at large quantity, we will basically move you into digitally the right channels to get you to the right people who can help you make more of those scaled purchases that you're looking for. So we're finding lots of digital ways to understand our customers, and therefore, target them more as potentially small business owners versus the kind of targeting we would do for a normal customer. And so, I like -- the team is doing a very nice job creating all the capabilities a little bit behind the scenes, frankly, in serving these business customers, and I'm proud of the growth that we've seen in that part of the business."
},
{
"speaker": "Jonathan Matuszewski",
"content": "It's helpful. Thanks."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Brian Nagel from Oppenheimer. Your line is open."
},
{
"speaker": "Brian Nagel",
"content": "Hi. Good morning. Thanks for taking my questions."
},
{
"speaker": "Corie Barry",
"content": "Good morning."
},
{
"speaker": "Brian Nagel",
"content": "So my first question, I guess, is a bit of a follow-up to some of the questions. But clearly, you managed very, very well a difficult environment here in Q1, a challenged sales quarter. In response to other questions, you said that, I think, if I heard it correctly, because it's actually deteriorated somewhat as the quarter progressed. So as you look at the business now and the performance or the activity of your consumers, what gives you the greatest confidence that this is the bottom and as we look towards '24, '25, that we'll begin -- we'll see this rebound to more normalized growth at Best Buy or within the sector?"
},
{
"speaker": "Corie Barry",
"content": "I think when we talk about the confidence we have, I think it is both relative to the backdrop of the performance we've seen, which was a pullback in demand last year and again projecting an ongoing pullback in demand this year. So, a little bit different than some of the other industries. We started to see the change in consumer behavior much earlier than others. And as soon as, as early as last year in Q1, we talked about it, we started to see that pullback in demand. So, we're going to have now two consecutive years, as we talked about, of a consumer who's making some choices away from consumer electronics. The nature of the industry is really what gives us the most confidence, and then obviously, our very stable position within it. The nature of the industry, this is an industry where technology is necessary, necessary to live our lives every -- think about the quantity of pieces of technology you touch in any given day, and that technology is not static. If you think about how quickly both the hardware and then if you think about what I will call \"the software\" things like generative AI or like VR and AR, how much that is changing, that will all drive form, feature changes in the product, which is part of what underlies our confidence. At some point people want to -- and we know this based on lots of history through recessions, through lots of different types of industry performance, people will upgrade and want to replace their equipment and their consumer electronics. And so, I think what gives us confidence is understanding that there is a very large vendor community out there that is very interested in continuing to stimulate demand, continuing to create really cool solutions for our customers. And that, over time, I don't see a world where we rely less on technology. And so that -- it is all those underpinnings that are giving us confidence as we head out of this year and into next year. Now we said that -- and I'll repeat it, that is based on what we can see today, it's based on the environment as we understand it today. So, of course, we're going to continue to monitor and see how consumers navigate what is, obviously, a very volatile environment, but that underpinning of how different this industry is versus any others in terms of both need and constant innovation, that is the biggest part that underscores, and then obviously, our position within it and how confident we feel in our partnership with our vendors, that is what gives us the confidence as we head into next year."
},
{
"speaker": "Brian Nagel",
"content": "That's very helpful, Corie. Thank you. And then if I could just ask a quick follow-up unrelated. So, a lot of talk about membership and some of the shifts you're making there with the program. So, I guess as we step back, I mean, clearly, Best Buy, there's a revenue piece of the membership program, how do customers that are members of Best Buy, how do they perform versus non-member customers from just from an overall sales perspective?"
},
{
"speaker": "Corie Barry",
"content": "Yes. We hit out a little bit in the prepared remarks, but they remain more engaged customers. They tend to spend more, they tend to shop across categories, they tend -- on the whole, so I'm just going to talk about this big kind of lump of members, they tend to be our most engaged customers. Now, what a couple of years of paid membership has given us though is a lot of data around what is it customers distinctly value. Because there's really three things you're trying to do with any membership program: you're trying to acquire customers, you're trying to retain customers, and you're constantly trying to engage customers. Acquisition, retention and engagement are the cornerstones of any membership program. And so, Brian, what we've been spending time on is not just who are we acquiring, but do they stay engaged with the program? Are we retaining them? And so, it's not just about kind of the full, here's what we see in our customers. They're, for sure, more engaged and they're having better experiences. But now we can start to kind of bifurcate that large customer base into different need states. And we definitely see a customer who's really oriented around value and convenience, and we definitely see a customer who's really oriented around more fulsome service and support. And this gives us the opportunity, given all the now very rich customer data we have, to start to target each of those kind of populations of customers based on a more tailored offering that we believe will resonate with them."
},
{
"speaker": "Brian Nagel",
"content": "Got it. I appreciate all the color. Thank you."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Seth Basham from Wedbush Securities. Your line is open."
},
{
"speaker": "Seth Basham",
"content": "Thanks a lot, and good morning. My question is around store labor. You guys have made a lot of changes to the labor model over the last year or two, and you're continuing to iterate. I'd like to get a sense from you as to what you think the status is of morale within the labor force? And then secondly, whether or not the lack of the specialized roles could impact customer service levels in a negative way?"
},
{
"speaker": "Corie Barry",
"content": "Yes, I'm going to start with the second part of the question, I'll work my way backwards. There is still very specialized labor in our stores. And we are very proud of that, and we are working very hard to make sure that we retain and continue to develop that very specialized experience over time. I think what we're trying to do is make sure that we are most effectively matching our labor, some of which is specialized, like any retailer, some of which is more kind of part-time and generalized in nature, that we are matching that specifically with how many and what type of people are coming into our stores and what it is that they need. And so, we have continued to obviously invest in wages. We were one of the first to go to a minimum $15. Our hourly wages are up more than 25% versus pre-pandemic. We're overarchingly investing hundreds of millions of dollars in benefits, and also, importantly, investing in career development and culture. And then really doing a lot of work to make sure we are bringing our employees along as we make these changes, involving them in the decisions and really trying to make sure that they feel like they also have a voice. And I think, how do we measure that? Well, one way is, obviously, we're looking at turnover, and we're pretty constantly looking at turnover. And we believe our general approach is working. Our turnover remains very low versus retail averages. It's consistent year-over-year. It is incredibly low in some of the most key areas like our general managers, where our turnover is in the mid-single digits, even given everything that RGMs have gone through in the last four years in particular. And I think that is one of the indicators. A second indicator, we continue to see a very high level of applications. Our applications have grown substantially year-over-year. So, you're seeing people want to come into the business, which is a good sign, because that means that GMs are pulling them into the business. And then third, you can imagine, we measure employee engagement. And we measure it very consistently. And not just at the high level, like here's the number. We're looking literally regionally, store-by-store, distribution center by distribution center, how engaged are our employees? And what can we do? How do we read those verbatims? How do we pull the themes? So, we are doing everything we can to create the most engaged workforce. So, it is constant work. It is not easy for our employees to go through this level of constant change, and I am incredibly proud that so many are choosing to stay with us and continue to build this culture for the future."
},
{
"speaker": "Seth Basham",
"content": "Great. Thank you."
},
{
"speaker": "Corie Barry",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And your final question comes from the line of Steven Forbes from Guggenheim Securities. Your line is open."
},
{
"speaker": "Steven Forbes",
"content": "Good morning, Corie and Matt. Maybe just a high-level question on ROIC. Curious if you could update us on your various initiatives, inclusive of space allocation utilization. And then, where do you see ROIC stabilizing sort of as we work our way through this normalization period? I don't know if you could sort of reference a pre-COVID level, mid 20%s. Any thoughts on where we sort of stabilize ROIC?"
},
{
"speaker": "Matt Bilunas",
"content": "Yes, sure. I think, at the highest level, our ROIC is impacted by the level of profitability that's flowing through that calculation. And I think where we're pointed is at continuing to make improvements in our operating model and our efficiency. As we've talked about, as we look into the next few years, we've said that we expect and want to continue to grow our operating income rate, at the same time, the industry will begin, we believe, turnaround, and we'll continue to grow in sales and our OI rate will continue to improve as we look forward or expected to. With that happening, we'll be able to drive a better profitability and that ROIC will start to climb probably back up closer to where we were, but again, that's through a combination of the industry improving, our initiatives continuing to improve and creating efficiencies and optimization through our business."
},
{
"speaker": "Corie Barry",
"content": "I think we have a great history, I would argue, in optimizing ROIC and making those educated bets. I would use even our store footprint as an example, things like our Experience stores, our outlets. There's a reason that we are pursuing those with vigor. And you can imagine what we're seeing in terms of return on those investments is giving us a lot of confidence into the future. There're other places where we're still testing and trying to make sure we feel like that ROIC is in line. So I think we're point to that continuing to drive that return for our investors. And with that, I think that was our last question. So thank you for joining us today. I hope that many of the investors for listening today will be able to join us for our Annual Shareholder Meeting, which will be held virtually on June 14. So, thank you, and have a great day."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for your participation. You may now disconnect."
}
] |
bdx | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Hello and welcome to BD's Fourth Quarter and Full Year Fiscal 2024 Earnings Call. At the request of BD, today's call is being recorded and will be available for replay on BD's Investor Relations website, investors.bd.com, or by phone at 800-839-1337 for domestic calls and area code +1-402-220-0489 for international calls. For today's call, all parties have been placed in a listen-only mode until the question-and-answer session. I will now turn the call over to Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations. Please go ahead."
},
{
"speaker": "Greg Rodetis",
"content": "Good morning and welcome to BD's earnings call. I'm Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations. Thank you for joining us. This call is being made available via audio webcast at bd.com. Earlier this morning, BD released results for the fourth quarter and full year of fiscal 2024. The press release and presentation can be accessed on the IR website at investors.bd.com. Leading today's call are Tom Polen, BD's Chairman, Chief Executive Officer and President; and Chris DelOrefice, Executive Vice President and Chief Financial Officer. Following this morning's prepared remarks, Tom and Chris will be joined for Q&A by our segment presidents, Mike Garrison, President of the Medical segment; Mike Feld, President of the Life Sciences segment; and Rick Byrd, President of the Interventional segment. Before we get started, I want to remind you that we will be making forward-looking statements. You can read the disclaimer in our earnings release and the disclosures in our SEC filings available on the Investor Relations website. Unless otherwise specified, all comparisons will be made on a year-over-year basis versus the relevant fiscal period. Revenue percentage changes are on an FX-neutral basis, unless otherwise noted. Reconciliations between GAAP and non-GAAP measures are included in the appendices of the earnings release and presentation. With that, I am very to turn it over to Tom."
},
{
"speaker": "Tom Polen",
"content": "Thanks, Greg and good morning, everyone. First, I'd like to take a moment to welcome Mike Feld, President of our Life Science segment, who joined BD in August from Veralto. Mike is known for building innovative, high-performing teams and his leadership principles are well aligned with BD's culture. Mike also brings deep experience in Shingijutsu Kaizen which is the heartbeat behind BD Excellence. There is no individual more suited to lead the Life Sciences team as they continue to expand the value BD brings to our customers and I look forward to Mike's partnership as we deliver on our strategy. Earlier today, we reported strong Q4 results with 7.4% revenue growth or 6.2% organic, 120 basis points of margin expansion and adjusted diluted EPS up 11.4%. For the full year, we delivered solid organic revenue growth of 5%. Despite fiscal '24 revenue growth that was below our initial expectations, we are pleased with how we navigated complex market dynamics in China and Bioscience-Pharma. Breaking things down, our MedTech and Diagnostics businesses grew a strong 5.9% this year, inclusive of absorbing a decrease in China, while our Bioscience-Pharma businesses grew about 1%, roughly in line with the end markets. Over the long term, we see Bioscience-Pharma as a durable, higher growth contributors to our portfolio and we remain confident in gradual market recovery, our competitive position and the team's execution. We consistently executed on margin expansion in FY '24, increasing adjusted EPS guidance each quarter and delivering full-year EPS of $13.14, adjusted operating margin of 24.2% and free cash flow of $3.1 billion, all ahead of our original plan and positioning us well moving into FY '25. I'd like to thank our global team of associates whose passionate commitment and focused execution of our strategy is making meaningful impact for the customers and patients we serve. Reflecting more broadly on our strategic direction and progress this past year, we made important advancements on each of our top 3 priorities. which are: one, drive sustained topline growth through high-impact innovation and commercial excellence; two, execute on BD Excellence to drive operational performance; and three, effectively deploy capital. First, on growth. We advanced multiple new growth platforms that put BD in the middle of the most significant trends reshaping health care, including the use of AI and automation in connected care to transform efficiency and outcomes, the shift to new care settings and the application of medical technology to improve treatment of chronic disease. Starting with our BD Medical segment. New biologic drugs promise to have the most significant impact on chronic disease in the history of modern medicine. In FY '24, we passed $1 billion of annual revenue in biologic drug delivery sales, driven by our leading prefillable devices and increased manufacturing capacity to serve growing GLP-1 demand. As the leader in biologics drug delivery and with a growing pipeline of targeted innovations such as our Libertas and Evolve wearable devices, we believe no company is better positioned than BD to capitalize on a significant growth opportunity. We continue to advance our platform for pharmacy robotics which now ranks as one of the largest robotics businesses in med tech and is enabling the transformation of retail, online and hospital pharmacies with significant opportunity for future growth. We're also extremely pleased with the first year of the Alaris return to market and its role in our connected medication management strategy. We exited the year at our historical revenue run rate and continue to see strong customer preference for the Alaris Power of One. Our acquisition of advanced patient monitoring in FY '24 expands our connected care solutions in a high-growth market and enables future innovation opportunities in breakthrough closed-loop monitoring and treatment which BD is uniquely positioned to deliver across our platforms. Integration is going as expected and the commercial teams are fully engaged in maximizing the benefits of APM for our customers. In BD Interventional, we had a fantastic year advancing our PureWick urinary incontinence platform, launching our next-gen PureWick Flex and expanding PureWick Male into the home. In our advanced tissue regeneration portfolio, Phasix and GalaFLEX are additional examples of how our tuck-in M&A strategy is now driving strong organic growth. We continue to transform hernia surgery and are expanding this platform into new applications for plastic and reconstructive procedures, driven by trends in aging and GLP-1 weight loss which increasingly call for soft tissue support to restore function and improve appearance. Across BD Life Sciences, we continue to reinvent the field of flow cytometry with the launch of the 3 in 4 laser FACSDiscover S8 Sorter and multiple new reagents using unique AI algorithms to optimize dye designs that are enabling new scientific insights. In Diagnostics, our new high-throughput molecular platform, BD COR and Onclarity HPV assay, continued to gain traction with self-collection and new care settings for cervical cancer screening now available in many countries around the world, representing a meaningful new growth opportunity for BD. While these and other new BD innovations are playing a key role in transforming care, most every significant healthcare procedure uses a BD COR device whether robotic surgeries, valve transplant, new cancer treatment or advanced vascular procedures, BD syringes, catheters, pumps, surgical prep, blood collection and other products are there. In FY '24, we saw strong growth across our core devices, driven by share gains and procedural volumes. Turning to operational performance; we launched BD Excellence about 18 months ago. And it's been incredible to see the momentum behind simplifying our company, improving quality and accelerating margin progression. Through BD Excellence, our team has made strong progress on network optimization, increasing plant productivity and delivering double-digit improvements in waste and operating equipment efficiency or OEE. All of this drove margins, EPS and cash flow above plan. We have much more headroom going forward through BD Excellence and it positions us well to deliver on our goals for FY '25 and beyond. On our third priority of strong stewardship of value-creating capital deployment, our focus on cash generation enabled strong growth in free cash flow, increased free cash flow conversion and allowed us to return capital to shareholders through dividends and share buybacks. Earlier this morning, we announced our 53rd consecutive year of dividend increases, extending our long-standing recognition as a member of the S&P 500 Dividend Aristocrats Index, a distinction that reflects the consistency and reliability of our dividend policy. Meaningful return of capital to shareholders will remain a key priority in our capital allocation strategy going forward. Beyond those priorities, in FY '24, we expanded our position as a leader in corporate responsibility, with significant progress toward our 2030 corporate sustainability goals. We became one of a handful of med tech companies to have near- and long-term greenhouse gas emissions reduction targets and net zero targets approved by the science-based target initiative. We surpassed both our Scope 1 and Scope 2 greenhouse gas emissions targets. And as part of our ongoing health equity strategy, we advanced partnerships around the world in areas such as improving access to cervical and breast cancer screening. We are pleased to be recognized for our efforts, most recently being named a 3BL's list of the 100 Best Corporate Citizens and ranking in the top 2 in health care. Looking ahead to FY '25, we will continue to execute in alignment with each of those 3 priorities. We have more than 25 planned new product launches this year and calling out just a few. In BD Medical, we're launching our next-generation Pyxis platform which includes the cadence of hardware and software upgrades and releases which will begin to roll out by the end of calendar year '25 and continue for the next several years. This will be the first system to use BD's new advanced AI platform that will integrate data across BD smart devices. We have a number of new launches planned in our advanced patient monitoring business to revolutionize hemodynamic monitoring. The next-gen HemoSphere Alta Monitor will feature a full range of sensors enabled with predictive IQ algorithms that provide comprehensive pressure, flow and tissue oxygenation insights for varying acuities. New Swan IQ and ForeSight IQ smart sensors will provide new patient insights, including new-to-world right heart pressures and cerebral oxygenation. In BD Life Sciences, we plan to launch the first BD FACSDiscover Analyzer, the A8, to provide customers with high-throughput sample analysis with the same innovative technologies as our breakthrough Cell Sorter. And lastly, in BD Interventional, in our PureWick platform, we're advancing the pivotal study for at-home reimbursement and expect to continue the cadence of innovation with the launch of PureWick Portable, a solution that restores mobility to people's lives. We look forward to sharing a full portfolio update at our Investor Day on February 26 at the New York Stock Exchange. We believe we are well positioned heading into FY '25, with the strength of our portfolio enabling us to effectively navigate market dynamics and the momentum of BD Excellence driving margin expansion to deliver a strong earnings and cash profile. I'll now turn it to Chris to provide further color on our financials and outlook."
},
{
"speaker": "Chris DelOrefice",
"content": "Thanks, Tom and good morning, everyone. As Tom noted, we delivered competitive organic revenue growth for the fourth quarter and full year even while navigating market dynamics in China and Bioscience-Pharma. And importantly, with strong execution of our BD Excellence programs, we exceeded our full-year margin, earnings and cash flow goals. I'll now provide some further insight into our Q4 revenue performance. BD Medical organic growth was led by MMS with another quarter of exceptional performance in infusion systems, driven by the BD Alaris return to market. Higher pull-through and utilization of infusion sets also contributed to MMS growth. The unit's performance was partially offset by a tough prior year comparison in dispensing. Our MDS consumable portfolio also contributed to the segment's Q4 growth. We continue to advance our position in the U.S. with broad volume growth and share gains, particularly in our hypodermic and vascular access management portfolios, where our quality and agility to meet increased demand has positively benefited healthcare delivery across our markets. Pharm systems performance reflects another quarter of double-digit growth in prefilled devices for biologic drugs, primarily GLP-1s which was partially offset by market dynamics across the industry, including expected customer inventory destocking. Rounding out the BD Medical segment, in early September, we closed the acquisition of Edwards Critical Care, now Advanced Patient Monitoring or APM which contributed $74 million to BD Medical revenue. BD Life Sciences performance was led by IDS. Strong mid-single-digit growth in specimen management was driven by volume growth as investment in our U.S. direct sales team drove increased demand and customer upgrades to higher-value products to provide an enhanced patient experience. Within our Diagnostics business, our results reflect some tough prior-year comparisons in lab automation and ID/AST. Offsetting these impacts was good traction leveraging our molecular platform installed base with double-digit growth in both BD MAX and BD COR. BD Life Sciences growth was partially offset by transitory market dynamics in Biosciences that resulted in lower market demand for research instruments and reagents. Clinical Solutions grew double digits, led by our FACSLyric cell analyzer and cancer reagents. We continue to outperform our life science peers given our portfolio mix of leading instruments, including the BD FACSDiscover, antibodies, dyes and software. We remain excited about the growth opportunities in BDB as a number of new innovations are driving share gains. Strong organic growth in BD Interventional was led by double-digit growth in UCC with continued momentum in our PureWick franchise. PureWick Female grew double digits and PureWick Male delivered its strongest quarter since its launch in acute care. We are also very pleased with the male direct-to-consumer launch, where the first few months of revenues exceeded our expectations. Surgery delivered another quarter of above-market growth. Within advanced repair and reconstruction, continued strong market adoption of Phasix hernia resorbable scaffold drove double-digit growth. It was partially offset by a tough comparison to the prior year in synthetic mesh. Performance in Surgery was also driven by double-digit growth in infection prevention due to increased demand for ChloraPrep related to strong procedural volumes. BDI performance was also supported by peripheral intervention with double-digit growth in peripheral vascular disease and high single-digit growth in end-stage kidney disease. PI growth was partially offset by a decrease in oncology due to prior year distributor inventory stocking in the U.S. Now, moving to our P&L. Q4 adjusted diluted EPS of $3.81 reflects double-digit growth of 11.4%. Consistent with our commitments, we delivered strong margin progression in Q4 with adjusted gross margin up 30 basis points sequentially and 200 basis points year-over-year to 54.6% and adjusted operating margin up 140 basis points sequentially and 120 basis points year-over-year to 26.6%. Margin expansion was driven by strong leverage on our revenue performance and simplification and efficiencies from BD Excellence. For the full year, we delivered adjusted diluted EPS of $13.14 which represents growth of 7.6%. Adjusted gross margin of 53.3% was in line with our expectations. As planned, strong execution of BD Excellence enabled us to absorb outsized inflation, transactional FX and about 50 basis points from inventory optimization carryover that supported strong fiscal year '24 cash flow. Adjusted operating margin expanded 70 basis points to 24.2%, exceeding our margin goal for the year, driven by shipping and SG&A leverage. While delivering strong margin performance, we also invested $1.1 billion in R&D to advance our pipeline of innovative programs that will support future growth. Regarding our cash and capital allocation, our strategic choices of strong execution on cash flow optimization drove a $1 billion or 47% increase in free cash flow to $3.1 billion and a larger-than-expected improvement in free cash flow conversion by 22 percentage points to 82%. Broad-based improvements in working capital, including our strategic choice to optimize inventory levels, continued expense management and our ability to leverage capital expenditures from BD Excellence productivity gains were all key factors driving strong execution this year. We also benefited from the timing of certain discrete cash items. Our strong cash position supported our acquisition of APM while also returning $1.6 billion of capital to shareholders through dividends and share repurchases. Cash and short-term investments on September 30 totaled $2.2 billion, inclusive of about $900 million in proceeds from February's debt refinancing. After closing the Advanced Patient Monitoring acquisition, we ended the year with net leverage of 3x which was in line with our expectations. We believe we are well positioned to deleverage to our 2.5x target over the next 12 to 18 months. We remain focused on underlying cash flow improvements. Despite the timing impact of some discrete cash items, we expect next year's organic free cash flow conversion to be consistent with this year due to strong execution in working capital. As expected, due to integration-related investments for APM, we anticipate a moderate step back in free cash flow conversion to around 75%. However, we expect this will still result in another strong year of free cash flow dollars which will support investments in growth, debt repayment and returning capital to shareholders. Given the outperformance this year and our confidence in next year's plans, we believe we are in a strong position to execute our net leverage commitments and plan to deploy about $1 billion towards share repurchases over the next 12 to 18 months, while still delivering on our deleveraging target of about 2.5x within this time frame. We see this as a value-creating opportunity based on our view of BD's intrinsic value. Moving to our guidance for fiscal year '25. Our initial fiscal year '25 guidance is anchored on high single-digit revenue growth driven by the contribution from APM and a broad-based competitive organic revenue growth profile that captures a prudent view of market dynamics in China and Bioscience-Pharma. We expect increasing momentum from BD Excellence to drive significant margin expansion which will enable delivery of strong adjusted EPS growth of about 10% at the midpoint. This growth includes increased acquisition-related interest expense and a higher tax rate inclusive of Pillar 2. We expect to deliver total revenues in the range of $21.9 billion to $22.1 billion in fiscal year '25 which reflects a modest foreign currency translation impact of 25 basis points and currency-neutral adjusted revenue growth of 8.8% to 9.3%. This includes strong performance from our newly acquired APM business, consistent with what we previously shared, plus organic revenue growth of 4% to 4.5%. This includes absorbing about 125 basis points impact from China and Bioscience-Pharma with China expected to decrease by mid-single digits. Across the balance of our portfolio which represents about 75% of our total organic revenue, we expect to deliver mid-single-digit growth around our 5.5% plus growth profile. Moving to margins and earnings. We are confident in delivering another year of strong operational performance, particularly our ability to expand adjusted operating margin by about 100 basis points and exceed our 25% margin goal we set over 2 years ago. The primary driver of margin expansion in fiscal year '25 is expected to come from gross margin with an increasing benefit from accelerating BD Excellence momentum. Below gross margin, we expect some leverage primarily in shipping and G&A, offset by increasing investments in selling and R&D to further support our growth profile. We expect interest and other to be up year-over-year, primarily due to the debt issued in connection with the Advanced Patient Monitoring acquisition. For tax, we expect our adjusted effective tax rate to be between 14% and 15.5% which includes the impact of Pillar 2. As a reminder, it would not be unusual for our tax rate to fluctuate on a quarterly basis given the timing of discrete items. Given these considerations, we expect to deliver adjusted diluted EPS of $14.25 to $14.60, inclusive of a modest foreign currency translation headwind. As you think about fiscal 2025 phasing, we expect first half revenue growth to be modestly below the low end of our total revenue guidance and the second half to be modestly above the high end. This includes our expectation of a heavier impact to first half revenue growth from the expected decrease in China revenues, a larger impact from Bioscience-Pharma dynamics in Q1 and the comparison to prior year licensing revenue in Q2. As revenue dollars increase sequentially throughout the year, we expect the benefit from BD excellence and strong OpEx leverage to result in increasing adjusted gross and operating margins throughout the year. This results in strong year-over-year growth in OIBT each quarter. Based on a ratable tax rate, we expect first half and second half adjusted EPS growth rate to be ratable which implies about 10% growth at the midpoint of our full year guidance range and is a nicely balanced phasing profile. In closing, our strategy is demonstrating positive momentum. We expect to deliver competitive growth that appropriately plans for market dynamics in China and bioscience pharma. Accelerating momentum in BD Excellence is supporting strong margin expansion, enabling investment in R&D to support further growth. This coupled with strong cash generation and a disciplined approach to capital allocation is expected to drive continued value creation for all of our stakeholders. With that, let's start the Q&A session. Operator, can you please assemble our queue?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question is from Vijay Kumar with Evercore ISI."
},
{
"speaker": "Vijay Kumar",
"content": "Maybe on this guidance question here. Thanks for all the details. The 125 basis points of headwinds on pharma, biosciences in China, it looks like you're assuming essentially those 3 segments are flattish for the year. I know China is down. But when you look at all 3, is that flattish? And the reason I ask is, it looks like those 3 segments together maybe grew slightly here in Q4. And when I look at this comparison versus some of your life science tools peers, they're all declining mid- to high singles given some of these dynamics. So I just want to understand that your trends in those 3 segments are coming in about peers but the guidance does feel like conservative. And related to that on phasing here, is Q1 going to be still in that 4% to 4.5% -- any impact on hurricane, IV fluids?"
},
{
"speaker": "Tom Polen",
"content": "Okay. Vijay, I appreciate the comments there. So I'll start off with just some comments on some of our assumptions for the year and then I'll turn it over to Chris to speak to the phasing. So stepping back more broadly as we think about the life science and bioscience space, as you said, we recognize for the full year, we obviously had to make an adjustment midyear that was below our initial guide to reflect the dynamics that are going on in that market. And while we had a very strong Q4, we also recognized that while it was within our range, it was the organic number was modestly below the Street expectation given those dynamics. What I think as we step back, we're really pleased with how our teams have navigated those spaces. If you just break out FY '24, we grew 5% overall as a company. That's 5.9% in our med tech diagnostics business and about 1% in that biopharma or biosciences-pharma space for the full year. If you look at Q4, we were 7.5% growth in the med tech diagnostics space, 1.3% in the bioscience-pharma space. So as you mentioned, Q4 was a little bit of an uptick in the bioscience-pharma versus the full year period. But both of those, obviously, very strong on the med tech diagnostic core businesses. And even at 1% for the full year or the 1.3% for the quarter, it was very competitive versus what you're seeing more broadly in the market in those spaces. And so we're pleased with our portfolio. We're pleased with how our teams are executing. And as we look forward, I think we've been -- let me start with maybe just a comment on China since you commented on that, too and how we've built that into our assumptions for FY '25. I think I've been consistent in taking a cautious view on China in the near term but also being very positive on the long term, given the large structural unmet healthcare needs and the opportunity for our local capabilities and portfolio to help serve those. And so in China, you're seeing value-based procurement dynamics pretty broad across the industry. We continue to see all throughout FY '24, we expect it to continue very strong volume growth in China but offset by the impact of VBP on price. Long term, we -- because we're holding a very strong position in the market, we think that's the right thing to do long term and we feel good about our long-term strategic position. But for FY '25, we built in mid-single-digit decline in China into our guide assumptions. That assumes continued very strong volume growth, continued holding our position very nicely there. But overall, that combination still resulting in a mid-single-digit decline that we've built into our guide. We think that's prudent. On the bioscience-pharma space, it's -- we've seen some uptick, as you mentioned, in Q4. I think it's still too early to forecast with high certainty what a recovery curve and timing looks like there. And so we're taking a prudent position on our guide and have that continuing at a rate similar to '24. Again, we really like our position in both the pharma space and in biosciences. We've got a lot of great innovation. We're extremely well positioned in the biologics. It's interesting, those 2 spaces that are going through transitory market dynamics. Of course, those 2 have been 2 of the fastest-growing businesses for BD over the last several years. And we expect they'll return to being 2 of the fastest-growing businesses in BD over the more mid- and long term. But we do think, given those dynamics that you mentioned, it's prudent for us to take a position that we've built into our guide. Just on the hurricane and then I'll turn it over to Chris on phasing. On the hurricane, we're not seeing any impact of that today. I'd say we're monitoring closely the -- any impacts that it could have on procedure volumes. I'm not seeing that broadly at this point. That's just something we're watching and we'll monitor as we see the recovery of that. There's some modest and small. We're focused on servicing our customers. People are using maybe larger volume syringes a bit more as replacement. There are some other products that could help substitute for those where there's gaps in IVs. But overall, we're focusing on servicing our customers during this period of time but we don't see a significant impact to the business. It's something we're monitoring."
},
{
"speaker": "Chris DelOrefice",
"content": "Vijay, it's Chris. On the phasing, just so a couple of things. One, relative to where we were last year, like to Tom's point, we've taken a very prudent posture as it relates to the market dynamics that are real. We're not alone there, to your point. We have businesses competing there. As you think of our total phasing and balance across the year, it's actually pretty balanced certainly on earnings, first of all, I shared in the script, first half, second half, very balanced relative to the midpoint of the growth rate of our guide at about 10%. So you don't see a lot of fluctuation there. You're going to see a strong starting gross margin as you think of Q1 and a steady kind of normalized increase as we move through the year sequentially there. So I think as it relates to kind of P&L dynamics, very strong. On revenue, we did share that you're going to have a first half, second half dynamic where the growth rate will be below the low end of the total guide range for the first half. It will be above for the second half. One way to think of it, though, is maybe more look at the dollar phasing as a percent of dollars by quarter as we move through the year. We tend to have a lower first half versus second half. We're about 48%, 52% when you think of dollars as a percent of total, with Q1 being lower than the average of the 48%. You're going to see some nuances with the growth rate in Q1 that will be low. Remember, the market dynamics will be most prominent in Q1. And actually last year, both BDB and pharm systems, where we had these businesses, we're still at about mid-single digits if you go back and look at their performance. So you actually also have a comp in the quarter that's impacting us."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Larry Biegelsen with Wells Fargo."
},
{
"speaker": "Larry Biegelsen",
"content": "Congrats on a nice quarter here. I wanted to just ask one question on Alaris, Tom. Did Alaris meet your goal of $350 million for fiscal '24? It sounds like Q4 was about $100 million or slightly below, I think, your expectation for $150 million in Q4. And how are you thinking about Alaris sales in fiscal '25 relative to fiscal '24?"
},
{
"speaker": "Tom Polen",
"content": "Yes. Thanks for the question, Larry. I'll start off and maybe turn it to Mike here in a moment. But we're really pleased with the first full year of Alaris launches. As we had shared midyear as we updated our outlook for Alaris. We expected Alaris to be back at the historical run rate within the first year of launch. And in fact, we saw that come through as expected. And so we feel good as we go into FY '25, also with having built a backlog of committed contracts which is something that we're also focused on rebuilding as we relaunched here this year. Maybe, Mike, any additional comments to that?"
},
{
"speaker": "Mike Garrison",
"content": "No, just we're really -- as you mentioned, we're really proud of the performance. I think from the standpoint, yes, we did exceed the $350 million. Larry, just to answer that question directly. In the medical number which was really positive for the quarter and MMS in particular, was really positive. There is a very difficult compared to last year with dispensing. We had a very, very strong year last year with dispensing, gained position, did a great job implementing and that continued through the year but just from a quarter-to-quarter comparison year-on-year, there's a little bit of an offset there. So Alaris actually did quite well in the quarter and we feel good. We feel good kind of feeling like next year, it's sort of business as usual. We're back to normal in terms of operating the business and continuing to serve customers. We feel good about the committed contract backlog that's been built throughout the year and the progression of how customers have moved through our sales funnel and our ability to ramp up service, ramp up manufacturing, things like that."
},
{
"speaker": "Tom Polen",
"content": "Maybe just one last thing to add is we really did -- the team did a great job on the remediation efforts as well. We're very much on track. And then we do expect continued strong growth in Alaris as we go into FY '25. So thank you for the question, Larry."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Travis Steed with Bank of America."
},
{
"speaker": "Travis Steed",
"content": "I just wanted to push a little bit on the phasing for '25 and like especially Q1 kind of being kind of sub the guide for the full year, sub to 4% with Alaris so strong, you think you'd have a pretty easy Alaris comp. I don't know maybe there's some conservatism built in there. And then understanding like the comps get tougher throughout the year but it's another year of accelerating revenue guide. So just anything you can provide on confidence that you can still accelerate revenue growth over the course of the year against tougher comps?"
},
{
"speaker": "Chris DelOrefice",
"content": "Yes. Thanks, Travis. It's Chris. I'll try and give a little extra color. I think consistent with what I've said, again, the BD profile in terms of how revenue ramps on an absolute dollar basis, it's actually pretty consistent with what you typically see. This is really all about, again, Q1, these market dynamics, you have 2 businesses that were growing mid-single digits last year. So you actually have a headwind in our comp. I know our growth rate looked low last year. But if you recall, we were cycling through moving respiratory into our base business and there was a big respiratory comp in Q1 which has no effect on this year as you think of growth rate. So really, you have a headwind when you think of year-over-year growth rates. And we feel good. So we're not reflecting substantial improvement in market dynamics as we move through the year. Q1 is the biggest. And then I would say we continue to see what I would call certainly well below our kind of normal growth rate on top line for those businesses that are market impacted. Like I said, more importantly, on earnings, we have a super balanced earnings per share growth profile with about right around the midpoint of our guide for first half, second half and you're going to see strong margins out of the gate with Q1 year-over-year margin improvement and then what I would call just a nice glide path of sequential margin improvement throughout the year."
},
{
"speaker": "Operator",
"content": "And our next question is coming from Robbie Marcus with JPMorgan."
},
{
"speaker": "Robbie Marcus",
"content": "I wanted to ask -- I realize you just gave a fiscal '25 guidance here. But as we kind of strip out the macro dynamics that you called out in the guide and I think a lot of us will just put Alaris as sort of onetime growth until you get back to the steady run rate probably sometime next year, how are you looking at the underlying growth of the business through '25 and into '26 and the sustainability there?"
},
{
"speaker": "Tom Polen",
"content": "Yes. Thanks for the question, Robbie. We feel really good about the -- how we've been moving BD into higher growth spaces. And you've seen that over the last several years, right? If you look at our underlying topline growth, we always look at it without COVID testing in there, it's been quite strong, right, north of 6% underlying growth for the company in our core business. And then obviously, we've got some transitory dynamics here that are affecting 2 of our strongest growing businesses over that period of time which are extremely well positioned in fast-growing spaces, right, biologic drug delivery and life science research on single cell or on cell analysis. So as we think about going forward, we continue to view the overall WAMGR of our spaces at about 5%. We don't change that for the short-term transitory dynamics that one sees happening in destocking in pharma or on the life science research side. And so we feel good about that. A number of the -- if you step back and I look at BD 2025 and how we've progressed there, we've got multiple growth platforms and levers now that -- many of which didn't exist at the start of BD 2025, whether or not that's our growth in biologics and GLP-1s which just crossed the $1 billion size this past year now, $1 billion of biologic drug delivery, the largest of any in the space and we're really well positioned there. The pharmacy automation to advanced patient monitoring now, a strong growth business. Our tissue reconstruction and infection prevention that you're seeing do really well in surgery, a PureWick platform which, as we've shared, we view as a $1 billion business opportunity by 2030, high throughput molecular on the diagnostics side. So we really like our position and the portfolio and the spaces that we're in. We're going to continue to reshape -- to continue to advance the portfolio in those spaces and capitalize on the opportunities that we've built. So thanks for the question, Robbie."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Patrick Wood with Morgan Stanley."
},
{
"speaker": "Patrick Wood",
"content": "Just given it's kind of topical at the moment, question around potential tariffs, supply chain impacts. Do you benefit from onshoring relative to any potential paths to go in? And how are you thinking about pricing as it interrelates within all of that?"
},
{
"speaker": "Tom Polen",
"content": "Yes. Thanks for the question, Patrick. From a tariff perspective, when we saw this dynamic that happened in the past, we were -- we didn't see significant impacts from that. Just as a reminder, from a China perspective, our strategy has always been strong local manufacturing in China for China. There's actually only really one product that we export from China today. And it's quite small in the grand scheme of BD. So as we go forward, that's something we'll certainly watch but our strategy is -- has been across the board and particularly given the volumes that we talk about when we're moving billions of units, right, our network is set up to serve local markets with heavy local manufacturing in many cases. We're a very strong domestic manufacturer in the U.S. Obviously, many things in Europe are served out of Europe, etcetera. But that's a space that we'll continue to obviously monitor that. But we do well navigating it the last time. Thanks for the question, Patrick."
},
{
"speaker": "Operator",
"content": "And we will take our next question from David Roman with Goldman Sachs."
},
{
"speaker": "David Roman",
"content": "I wanted to just to dig in a little bit more here on the P&L. And as we look at FY '25, there are some sort of discrete items here. You have a year-over-year kind of gross margin normalization as well as accretion from M&A, offset by tax headwinds and higher interest expense. And at the same time, as we look at Q4, we did see a churn in operating expense growth after kind of many quarters of year-over-year declines. So can you maybe just help us think about the construct of the P&L here both in FY '25 and how we should think about it beyond that point in terms of normalized growth drivers across the various line items?"
},
{
"speaker": "Chris DelOrefice",
"content": "Yes. Thanks for the question. I appreciate it. So we couldn't be more excited about kind of how we're shaping the P&L. The focus on BD excellence. You saw it in the back half of FY '24, all the progress we're making on gross margin. So we talked about year-over-year delivering about 100 basis points of operating margin improvement. However, this will be the first year that is predominantly coming from gross margin allows us to kind of reshape the P&L. We have differentiated levels that will enable growth as you think of selling specifically and R&D, so both shorter term and long term. And so we view this as a very healthy P&L. Obviously, if you go back to BD 2025 when we first rolled that out, at the time the market complexity and significant outsized inflation was not there. So we've been doing great things in gross margin but a lot of it has been covering those headwinds. Now you're seeing that play out. '25 is the first year that shows up, as we talk more in our upcoming Investor Day. That strategy will certainly continue and we see that as a key value driver on a go-forward basis. Thanks for the question, David."
},
{
"speaker": "Operator",
"content": "And we'll move next to Matt Miksic with Barclays."
},
{
"speaker": "Matt Miksic",
"content": "Tom, I just wanted to circle back. You mentioned -- and congrats on the quarter and the kind of really well thought and thoughtful and put together guide. I thought on taking into account the market dynamics is super helpful. But for my question, I just wanted to drill down a little bit more into what you're doing in AI. You mentioned the first of a series of products or technologies or enabling systems that you're rolling out. And just anything you can flesh out on your strategy there and maybe how you're putting some of the data that you're generating at BD to work to kind of fuel those strategies."
},
{
"speaker": "Tom Polen",
"content": "Yes. Thank you for the question, Matt. You're kind of teeing us up for our Investor Day on February 26, where we'll actually get to highlight and demo some of what we're doing there which we're really excited about. So if you just step back, BD has been focused in this space for quite a number of years. We have several products on the market today that utilize AI, whether or not that started with algorithms that we use for basically automating -- creating autonomous microbiology where there's software reading the petri dishes and determining is there growth or not and in some cases, what the bacteria is. And that's been built into [indiscernible] platform. We then partnered with Microsoft and utilize that technology to be looking at all the data across our platforms to determine where narcotic diversion could be happening in the healthcare system and identifying specific clinicians that are at risk describing why we believe that they are at risk and then helping hospital systems get them help and stop that from occurring. Of course, our new to BD business that we're really excited about, advanced patient monitoring has been doing a great job using AI building into their algorithms to help predict where there could be hemodynamic changes in the future. And we're really excited about how that can integrate in now with our infusion pump technology to help create closed loops in the future using AI combined with the devices that actually can impact patient care and be able to predict something is going to occur adjust therapy and help prevent it from ever occurring is really exciting concepts that we're working on. We did mention, as you said also on the call, the application of AI in a new platform that will be cutting across all BD devices. We'll be sharing more of that at our Investor Day on February 26 but its first launch will be taking place with our new Pyxis platform. And so think about new series of BD devices as we're launching them with Pyxis being the first of AI-enabled devices that will be able to connect into an AI cloud-based platform that will be able to take data from devices across our businesses and be able to use that to create better outcomes, create better efficiencies for clinicians and for staff that are analyzing that data. Again, we'll go much deeper on that hands-on at our Investor Day coming up in February but a little bit of a sneak preview. I'd say just one other maybe comment, Matt, is we are -- we certainly see significant opportunity on the innovation side, particularly given we have millions of smart devices out there, right? We have about 3 million smart devices out there generating data. And so right, the opportunity to use that data to do new things and create outcomes. So we think we're really uniquely positioned there. And we've been spending a lot of time thinking about that. Some of the increased R&D investment that Chris mentioned earlier is actually in this space as well. We're creating a new incubator focused on AI and our products. But more broadly, we're also applying it in operations. Of course, our large operational footprint, there's a real opportunity to use it from a forecasting perspective, optimizing line OEE and performance. And we have initiatives applying it there on the efficiency side as well. So, thanks again for the question."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Matt Taylor with Jefferies."
},
{
"speaker": "Matt Taylor",
"content": "I was wondering now that you've closed APM, if you could give us some additional thoughts on how you think that segment could grow over time and just how it's going to contribute to the margins going forward? And you were just talking about your connected strategy. So I was wondering if you had additional thoughts on how you could develop that and perhaps integrate it with some of the other segments there that are smart and connected and generating the data?"
},
{
"speaker": "Tom Polen",
"content": "Yes. Thanks for the question, Matt. We couldn't be more excited about APMs coming into BD. We're really happy having Katie lead that team. I'd say the integration could be going better, really an immediate cultural fit and they're staying heads down executing. That's our focus is making sure that as we integrate, they can stay focused on servicing customers, driving the great innovation momentum that they've got and capitalizing on the opportunities ahead. As we think about -- we did highlight for the first time in our deck and in the discussion, just some of the products that they're launching this year that we're excited about. We had shared long term, we view them as at least a 6% to 7% growth business. We certainly see that well intact. And again, the business isn't missing a beat coming into the BD. They didn't do it, miss it at all in the month that they've been part of us and that's continuing as we go into this fiscal year. I think on the integration side, we had shared this when we announced the deal. One of the key rationales for us coming together was the fact that one of the things when we talk to our customers on medication management is that their most critically ill patients, there's a really important connection between understanding their hemodynamics, right which is really their blood pressure real time and the medications because that's what's managing that hemodynamic -- it's being managed by medications and fluid intake and outtake. And so if you can combine the 2, what's happening in the patient's body with what's going into the patient's body which we know what's going into the patient's body through Alaris and they know what the impact of that is in the patient's body, you can really start letting algorithms and informatics start optimizing that to keep the patient stable and get better outcomes. And that's one of the top 3 things that our customers were asking for in that space. And so we've actually -- as Chris mentioned, we -- part of our P&L this year includes some additional investments in selling, reinvestments from the gross margin expansion also in R&D. That's a project that we funded for '25 that will be led by our APM business. And so it's early but we're already getting after it right from the start. And our teams are really excited about the opportunities to innovate in that space. So, thank you for the question."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Rick Wise with Stifel."
},
{
"speaker": "Rick Wise",
"content": "Maybe we can turn to capital allocation. Your $1 billion share repurchase announcement over the next 12 to 18 months certainly seems like a positive to me and highlights your views about the value inherent in the stock. A couple of things. Should we be interpreting this as Becton taking maybe a momentary step back from your tuck-in acquisition strategy near term as you integrate APM? Is it their value -- lack of value, lack of compelling candidates and again, more broadly on capital allocation related to dividends or -- and anything else that you want to talk about?"
},
{
"speaker": "Chris DelOrefice",
"content": "Yes, Rick. Thanks, it's Chris. Appreciate the question. I guess first, before we get into capital allocation, it starts obviously with strong margins and healthy cash flow. We've been extremely focused on cash flow progression. We had a really strong year in FY '24. We grew our free cash flow by $1 billion and exceeded our goal of free cash flow conversion, ending at about 82%. This gives us more financial flexibility is the way I would think of it. Our capital allocation priorities are largely unchanged. You did see us announce a dividend increase at 9.5%. That's something that's reliable that you can continue to rely on. We've always said that we're going to prioritize remaining free cash flow for tuck-in M&A. But we're in a position where we just digested over $4 billion acquisition. We're focused on capitalizing the value out of APM. It's an extremely exciting opportunity, a durable high single-digit grower. And so we're very excited about that. So we want to remain disciplined about our net leverage glide path down to 2.5x which we'll do in 12 to 18 months. With that said, with the stronger cash flow position we have and continued momentum in driving a strong cash flow position in '25, we just felt like given what we see a strong intrinsic value of BD, we could kind of step up the level of share repurchases to about $1 billion over that same time frame while still consistently executing against the 2.5x net leverage. So, I think it's another important part. I appreciate you asking the question. We've been very focused on cash flow and we'll continue to do so."
},
{
"speaker": "Tom Polen",
"content": "Thanks for the question, Rich."
},
{
"speaker": "Operator",
"content": "And that will conclude today's question and answer session. At this time, I'd like to turn the floor back over to Tom Polen for any additional or closing comments."
},
{
"speaker": "Tom Polen",
"content": "Well, thank you for joining us on our call today. I'd like to take a moment and again, thank our global team of associates who are advancing our strategy, supporting our customers and improving the lives of the patients we serve. We believe we are well positioned heading into FY '25 with multiple growth drivers across our portfolio enabling us to effectively navigate market dynamics and momentum in BD Excellence driving margin expansion to deliver a strong earnings and cash profile. We look forward to connecting with everyone on our Q1 call in February, and again at our Investor Day. Thank you for your continued support of BD."
},
{
"speaker": "Operator",
"content": "This does conclude this audio webcast. On behalf of BD, thank you for joining today. Please disconnect your lines at this time and have a wonderful day."
}
] |
bdx | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Hello and welcome to BD's Third Quarter Fiscal 2024 Earnings Conference Call. At the request of BD, today's call is being recorded and will be available for replay on BD's Investor Relations website at investors.bd.com or by phone at 800-839-2385 for domestic calls and area code +1 402-220-7203 for international calls. For today's call, all parties have been placed in a listen-only mode until the question-and-answer session. I will now turn the call over to Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations. Please go ahead."
},
{
"speaker": "Greg Rodetis",
"content": "Good morning and welcome to BD's earnings call. I'm Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations. Thank you for joining us. This call is being made available via audio webcast at bd.com. Earlier this morning, BD releases results for the third quarter of fiscal 2024. The press release and presentation can be accessed on the IR website at investors.bd.com. Leading today's call are Tom Polen, BD's Chairman, Chief Executive Officer and President; and Chris DelOrefice, Executive Vice President and Chief Financial Officer. Following this morning's prepared remarks, Tom and Chris will be joined for Q&A by our segment presidents: Mike Garrison, President of the Medical segment; and Rick Byrd, President of the Interventional segment. Before we get started, I want to remind you that we will be making forward-looking statements. You can read the disclaimer in our earnings release and the disclosures in our SEC filings available on the Investor Relations website. Unless otherwise specified, all comparisons will be on a year-over-year basis versus the relevant fiscal period. Revenue percentage changes are on an FX-neutral basis unless otherwise noted. Reconciliations between GAAP and non-GAAP measures are included in the appendices of the earnings release and presentation. Specifically, during the quarter, we recorded accruals resulting from recent developments relating primarily to the Italian government medical device payback legislation which essentially relates to years prior to the current fiscal year. We are presenting adjusted revenues, excluding the impact of these accruals. With that, I am very pleased to turn it over to Tom."
},
{
"speaker": "Tom Polen",
"content": "Thanks, Greg and good morning, everyone. We continue to make excellent progress advancing our BD 2025 strategy. This quarter demonstrates the durability of our portfolio and strength of new innovations, delivering mid-single-digit organic revenue growth of 5.2%. Growth was broad-based and reflects strong volume and share gains across the portfolio. Our team executed very well through transitory market dynamics in BDB and PS [ph] and macro factors in China. We continue to grow above the market and believe we are extremely well positioned as these markets recover. We have growing momentum from our BD Excellence operating system that enabled us to deliver significant sequential and year-over-year adjusted gross margin increases. This drove strong operating margin expansion contributed to over 18% adjusted earnings per share growth and is allowing us to raise our earnings guidance once again. Our team's excellent execution also drove over 100% year-to-date growth in free cash flow, reaching over 80% free cash flow conversion year-to-date, with margins, earnings and cash flow all ahead of plan. As a reminder, our strategy consists of 3 pillars: driving growth through innovation and tuck-in M&A, simplifying through BD Excellence and empowering our organization with the capabilities and systems to deliver on our strategy. I'd like to provide updates on each of these this morning. Starting with our growth pillar and the Critical Care acquisition. Things continue to progress well towards a successful close and as we've gotten to know more members of their team, we only become more excited to welcome them to the BD family. Critical Care significantly advances our connected care strategy to use AI and digital tools to help clinicians deliver more efficient and higher quality care. Additionally, it adds a high-growth business that is immediately accretive to margins and earnings. Turning to several of our most significant long-term growth drivers. To begin with, our connected medication management strategy has strong momentum, with Q3 setting another new all-time record for the number of Alaris pumps shipped in a quarter. The scale of upgrading our fleet is unprecedented and I'm very proud of the work our teams are doing to support our loyal customer base and deliver ahead of our commitments. Customer feedback has been very positive and we gained a market position in the quarter. We are now back at our historical quarterly run rate of about $100 million and have built a healthy committed contract backlog which puts us in a position to be above our historical run rate for FY '25. Our connected medication management portfolio which includes Alaris, is just one example of how BD is at the forefront of combining AI, automation and robotics to improve the core processes that run health care. Through our strategy, BD is advancing our leadership in automating the pharmacy, the medication management process and the microbiology lab. Today, BD has a $4 billion-plus business in health care automation and informatics AI and we'll increase this to over $5 billion as we complete the acquisition of Critical Care. This expands BD in the smart critical care space and creates new opportunities to combine AI-driven monitoring with systems such as infusion technologies to simplify nursing workflow and improve patient care. Looking ahead to 2030, we view health care process automation and informatics AI as having the potential to become a business exceeding $7 billion as we continue to build more connected, automated and intelligent solutions to transform the core processes underlying care delivery. Turning to other key platforms. Q3 was the 28th consecutive quarter of double-digit growth in our PureWick platform. In our recently launched next-generation female external catheter, PureWick Flex, is expected to support this continued momentum. PureWick Flex delivers improved performance for a wider range of body types, both in acute and home care settings. Given the incredible response from the first PureWick Flex users, we couldn't be more excited about the impact this will have on patients and their providers. As I think about PureWick overall, we see this as having the potential to become a $1 billion franchise by 2030, continuing its double-digit growth momentum. We're also advancing our impact in immune health in oncology, continuing the super cycle of innovation within BD Biosciences which positions it well as a long-term growth driver. Coming off the landmark BD FACSDiscover S8 Cell Sorter launch in FY '23, we recently released additional 3 and 4 laser configurations which contain the same new-to-world BD SpectralFX and BD CellView technologies, enabling new discoveries in a broader range of fields. We expect to continue our innovation cadence with our FY '25 launch of the BD FACSDiscover A8 Analyzer which will provide customers high-throughput sample analysis with the same innovative technologies. The combination of BD FACSDiscover and our BD RealBlue and RealYellow reagents were used in the world's first 50 color flow cytometry experiment which was published this year in the Journal of Cytometry. This serves as a testament to these ground-breaking new technologies. The immune health and oncology space remains a primary focus for research and as the market returns to growth, we believe a leading technology and portfolio position us well to capitalize on future opportunities in this space. Finally, within our Pharmaceutical Systems business, in Q3, biologics drug delivery continued to grow double digits. Biologics now represent over 40% of our total Pharmaceutical Systems revenue and we see it as a significant growth opportunity, including GLP-1s. Since the start of BD 2025, we've been implementing a strategy to enhance our innovation leadership, expand our manufacturing scale and prioritize quality excellence to be the preferred partner for biologic drug delivery. And we believe that no other company in med tech is better positioned than BD to capitalize on this trend. First, the majority of biologics that use a prefilled syringe have and continue to be launched in the BD device. Since 2023, BD has been the chosen partner for 19 out of the 23 new biologic drug approvals that use a prefilled syringe. Second, as we consider the significant clinical potentials of GLP-1s, the strength of BD's innovation in this category and our previously announced capacity expansion, we view GLP-1 drug delivery as a potential $1 billion product category by 2030. Today, we serve multiple market leaders, have device contracts with multiple novel GLP-1 therapies advancing through clinical trials and beyond novel molecules, we now have over 40 signed GLP-1 biosimilar agreements across our pen [ph], auto-injector and syringe platforms. We are actively supporting biosimilars for early generation GLP-1s that are entering the market over the next 12 months. Outside of GLP-1s, our customers are working to develop next-generation biologics that have the potential to revolutionize care and conditions like Alzheimer's, certain immunological disorders and types of cancer. Many of these are extremely complex molecules and proteins that will involve significantly greater volumes for injection and higher viscosity compared to therapies presently available in the market. At the same time, we see the trends to enable patient self-treatment that point to the need for wearable on-body injectors. We've developed the BD Libertas and BD Evolve wearable injectors to support the unique delivery needs of these therapies. We're actively supporting multiple customers testing their pipeline molecules with our wearable solutions and have provided product to support their clinical trials. While this is a longer-term opportunity that we expect to develop in line with drug development time lines, we believe we are well positioned for this future trend and are getting very positive feedback on our platforms. Moving to our simplification strategy and BD Excellence. First, let me express my gratitude to everyone in our organization who is accelerating BD Excellence through our global supply chain, through the completion of over 500 Kaizen events this year. I especially like to thank those working in our manufacturing plants and warehouses to improve product quality and reliability for our customers this year while delivering double-digit improvements in both waste reduction and production yield. We are seeing the outcomes of BD Excellence in accelerating margin progression and delivering strong cash flow. Our plans to reduce our manufacturing network by over 20% remain on track. And as we are consolidating our plant architecture, we're investing in smart factories. Our top 30 sites are already accelerating performance, leveraging smart automation and digital capabilities such as predictive analytics. We're excited about the opportunity to further accelerate manufacturing productivity through the combination of BD Excellence and our smart factory strategy. The momentum in our simplification programs, including BD Excellence, positions us for success as we finish FY '24 and as we look ahead to FY '25 and beyond. Lastly, we continue to empower our organization through strong corporate responsibility and recently issued our FY '23 Corporate Sustainability Report. Notably, in FY '23, we reduced Scope 1 and 2 greenhouse gas emissions, 18% versus our FY '19 baseline, surpassing our goal of 13%. We doubled the number of sites using green electric power and solar power and we reduced our water usage by 21% and waste by 18% over the same time frame. In summary, we delivered above-market mid-single-digit organic revenue growth and significant margin expansion and cash flow generation. On the strength in the quarter, we are once again raising our adjusted diluted EPS guidance for fiscal 2024 and believe we are well positioned for continued strong financial performance next year. We have leadership positions in many of the most significant trends reshaping health care, positioning us well in FY '25 and beyond. I'll now turn it over to Chris to review our financials and outlook."
},
{
"speaker": "Chris DelOrefice",
"content": "Thanks, Tom and good morning, everyone. As Tom noted, the quarter's results reflect strong performance across multiple parts of our portfolio, even amid the previously noted transitory market dynamics and macro factors. Importantly, with strong execution of our BD Excellence programs, we exceeded our margin, earnings and cash flow goals. I'll now provide some further insight into our adjusted revenue performance. Q3 revenue grew 5.2% organic, driven by volume growth and share gains. Regionally, over 90% of our revenue which includes our 3 largest geographies, grew 6% plus organic. This strong performance was partially offset by a decrease in China from continued market dynamics. BD Medical growth was led by MMS with exceptional performance in infusion systems, driven by the BD Alaris return to market and higher utilization of infusion sets, partially offset by a tough prior year comparison in dispensing. Broad volume growth and share gains across our MDS consumable portfolio in developed markets also contributed to the segment's growth. Pharm Systems had another quarter of increasing demand with double-digit growth in prefilled devices for biologic drugs, primarily GLP-1s. This growth was offset by transitory market dynamics across the industry, including expected customer inventory destocking. BD Life Sciences performance was led by IDS with high single-digit growth in specimen management which reflects both increased utilization and customer upgrades to higher-value products to provide an enhanced patient experience. The segment's growth was partially offset by transitory market dynamics in biosciences that resulted in lower market demand for instruments. Given our leading portfolio in instruments and reagents, we significantly outperformed the category in the quarter. Strong organic growth in BD Interventional was led by high single-digit growth in UCC with continued momentum in our PureWick franchise, delivering another quarter of double-digit growth. Surgery delivered another strong quarter across all 3 major platforms with double-digit organic growth across advanced repair and reconstruction, infection prevention and biosurgery. We continue to make excellent progress with conversion to our bioresorbable Phasix technology which we see as a durable contributor to future growth. BDI performance was also supported by peripheral intervention with double-digit growth in peripheral vascular disease that was partially offset by a decrease in oncology, driven primarily by market dynamics in China. Now moving to our P&L. We realized strong sequential and year-over-year margin improvement with adjusted gross margin of 54.3% and adjusted operating margin of 25.2%, both above our expectations. The gross margin year-over-year increase of 170 basis points was primarily driven by increased productivity and cost improvement from our BD Excellence initiatives and moderating inflation. Our operating margin increased by 220 basis points year-over-year, driven by the increase in gross margin and healthy operating expense leverage with expenses increasing slightly on a dollar basis year-over-year. As a result of these items, we exceeded our Q3 operating income and adjusted diluted EPS expectations, resulting in adjusted diluted EPS of $3.50 which grew double digits or 18.2% on a reported basis. Regarding our cash and capital allocation, I'm really pleased with our strategic choices and the execution on cash flow. As a result, year-to-date free cash flow increased $1.2 billion year-over-year to $2.2 billion reflecting continued improvement in working capital, including continued inventory optimization, planned phasing certain cash flow items and the ability to leverage our capital expenditures as we benefit from BD Excellence productivity gains. We remain focused on free cash flow conversion and are on track to deliver another double-digit step improvement in fiscal year '24, with our year-to-date free cash flow conversion above 80% and we remain well positioned to achieve our long-term cash goals. Net leverage improved to 2.4x and cash and short-term investments totaled $5.3 billion, inclusive of about $3.4 billion in proceeds from the February debt refinancing and the Critical Care acquisition financing in June. Moving to our updated guidance for fiscal year '24. The detailed assumptions underlying our guidance can be found in our presentation. As we look ahead, we are confident in a strong close to fiscal year '24. We remain focused on driving multiple areas of momentum and share gains across our portfolio, including Alaris. For the full year, even with this broad-based momentum, it is prudent for us to reflect the latest market dynamics which others are also experiencing. As a result, we now expect organic revenue growth to be 5% to 5.25% for the full year. Based on the strength of our margin performance, we were able to absorb the revised organic revenue growth guidance and are raising our adjusted diluted EPS guidance range to $13.05 to $13.15 on a reported basis. This reflects an increase of $0.05 at the midpoint and $0.10 at the bottom of the range. We believe we are well positioned to achieve our updated adjusted operating margin guidance of over 50 basis points improvement which implies full year adjusted operating margins of over 24%. We continue to expect margin acceleration in Q4, driven by our BD Excellence and continuous improvement efforts and continued expense leverage on our expected strong revenue performance, including Alaris. Looking ahead to fiscal year '25. While it's too early to provide guidance as we are in our planning process, I can offer the following thoughts. We are continuing to monitor dynamics in select markets. Even in an environment where these dynamics continue to exist, we are confident in delivering strong performance, particularly our ability to exceed our 25% adjusted operating margin goal and deliver double-digit EPS growth, given the increasing benefit to gross margin from accelerating BD Excellence momentum. We think 10% EPS growth would be a good starting point for fiscal year '25, including Critical Care and the expected impact of Pillar 2. So in summary, based on the durability of our portfolio and momentum in Alaris, we are confident in delivering another year of strong growth. Our team's execution supported overdelivering on our margin expectations. And as a result, as we enter Q4, we are on track to exceed our full year margin improvement goals, deliver another year of double-digit free cash flow growth and once again increase our fiscal year '24 earnings outlook. Our strategy is demonstrating positive momentum and we remain well positioned to continue to deliver on our BD 2025 value creation objectives. With that, let's start the Q&A session. Operator, can you please assemble our queue?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question will come from Robbie Marcus with JPMorgan."
},
{
"speaker": "Robbie Marcus",
"content": "Great, two for me. First, I wanted to ask on guidance, particularly fourth quarter. What's implied there in revenue guidance and the margins, it looks like, by my math, about 6.5% organic growth and still healthy operating margin performance. Maybe just walk us through some of the things that happened in third quarter that led to the touch lower organic growth and the confidence in fiscal fourth quarter, both from a revenue and a margin perspective where you did well in the quarter."
},
{
"speaker": "Tom Polen",
"content": "Robbie, thanks for the question. This is Tom. I'll start off and then turn it over to Chris. I think as we look at Q3, first off, we're really pleased with strong performance across many areas of almost every area of the company, particularly as we look at compared to market, where we saw strong share gains in a number of areas. We saw a strong volume performance. And even in markets that are undergoing transitory market dynamics, specifically the BDB research market environment and the destocking in Pharm systems. As we look at our performance, I really like our competitive position in those spaces. You're seeing us outperform what's been announced by others to date. And so as those markets ultimately rebound and you heard us talk about some of the new innovations in BDB. Obviously, our position in biologics and the differentiated growth that we're getting there. And the differentiated share gains that we're getting there in terms of our share of new molecules and even biosimilar spaces. We really like our position there long term. So I think that's really -- as we think about Q3, those dynamics in those spaces as well as just the continued play out in China is what we saw. I'll turn it to Chris, just to talk a little bit more about how we think about guidance in Q4. Pretty straightforward."
},
{
"speaker": "Chris DelOrefice",
"content": "Yes. Thanks, Tom. Thanks, Robbie, for the question. Yes, Q4 is actually pretty straightforward. So to your point on the top line revenue organic it implies upper 6% range, consistent with what you shared, maybe a little north of that. It's really attributed to one key dynamic. It's the continued momentum of Alaris. By the way, we obviously have a much stronger line of sight based on our committed contract position. This is the strongest quarter that we have this year as it relates to line of sight of that because now we're 3 quarters in that. In addition to that, if you recall, last year in Q4, we have a favorable comp in Alaris as well because we had stopped shipping under medical necessity, as we got the approval and we're preparing for launch. So you actually have a favorable comp and you have continued momentum with Alaris which as you saw was very positive in the quarter. The rest of the portfolio, we actually assume similar performance. So we're not making assumptions of significant market recovery or things of that. We're going to continue to outperform in those spaces from a relative standpoint. So I feel good about revenue. Margin, hopefully, everyone had an opportunity to see, Q3 was really strong. We outperformed margin. It led to the outperformance on EPS. The story there is straightforward. Gross margin, it basically just have to repeat Q3 which is already flowing through our cost base, right? We're in our cap and roll period there. So there's not a substantive change in terms of gross margin. On operating margin, the gross margin will flow through. We're actually increasing expenses slightly from an OpEx standpoint where you end up with that, call it, high 6% growth. You get a little bit of a natural leverage there that will flow through and we feel really good about that. I think importantly and we can talk more about this, pretends well for '25 as we think of margins."
},
{
"speaker": "Robbie Marcus",
"content": "Well, that's a perfect segue to my follow-up question on fiscal '25. You gave color about 10% EPS growth, I want to make sure that's reported, I think I heard. And there's a lot of moving parts, timing of when Critical Care closes, the accretion that could add, China versus Alaris. When you came up with that -- the 10% which I think is about where the Street is, when we factor in the Critical Care accretion. Maybe just some of the components, I heard 25% operating margin you feel good about. Just anything else you could give us up and down the P&L."
},
{
"speaker": "Chris DelOrefice",
"content": "Yes. Thanks, Robbie. Yes. Look, we're excited about '25. It's setting up nicely to deliver strong performance. First, top line, I'll just reiterate, we're extremely pleased. Our strategy is paying off in terms of strength of portfolio. Continue to focus on driving volume and share gains. And what you're really seeing in this quarter is the ability to deliver strong performance despite these market dynamics, most notably BDB, Pharm Systems and as Tom noted, China. So we're not dependent on one thing. The durability of our portfolio sets us up nicely. And then from a margin standpoint, I shared that on the momentum we have this year, we expect to now exceed 25%. I think importantly, what you'll see different in '25 going forward is the significant majority of that will come from gross margin. And actually, if you look at where we are in the back half of the year, you can kind of think of Q3 as sort of a nice number directionally to think of '25 and carrying that through. So I feel very good about line of sight to margin. As you noted, we're excited about Critical Care. It just gives us another positive catalyst to continue to deliver double-digit earnings growth. We are contemplating headwinds from Pillar 2. So still more to come on that. It's premature to share specifics but we do anticipate that's a headwind that we will absorb as part of that. And so all that collectively sets us up nicely, to your point, I think what I see externally where the Street is, we would see that more in the low end of the range and it would be 10% and that is on a reported basis. So FX at this point, there's a modest headwind into the year but we've contemplated that. The other thing, just we did actually activate formally. We had talked about doing this but partially derisk transactional FX. But we are active with now cash flow hedges that gives us another lever just to help solidify that performance."
},
{
"speaker": "Operator",
"content": "Our next question will come from Travis Steed with Bank of America."
},
{
"speaker": "Travis Steed",
"content": "I guess first two questions here. I wanted to focus on the guide change. And so I think China biosciences and pharma were the big reasons why you lowered the revenue guide this quarter. But it sounded like things were all on kind of track over the course of the quarter. So just curious like what changed, what kind of surprised you, when it happened. And I thought you didn't assume those markets to get better. So I was just kind of curious if there's -- are you changing your assumptions on when those things get better kind of going forward?"
},
{
"speaker": "Tom Polen",
"content": "Travis, this is Tom. Thanks for the question. Yes, so as we mentioned before, we feel really good about the performance across the different businesses. Of course, mid-single-digit growth is a strong position, particularly given those dynamics that we see in those spaces. And even at flat essentially in BDB, that's differentiated versus what you're seeing competitively. I think what we're doing is just recognizing that we're not calling that those markets are going to turn in Q4, that we're going to continue to see some transitory dynamics in those spaces. We assume we're going to continue to compete and perform above market in those spaces which we've been doing all year. And so that's what we've built in here. The same dynamic a bit in China. I'd say China has played out as we look at Q3 and into Q4. So MDS, BDB playing out as we projected at the beginning of the year. no real change in that. I'd say in China, the two things are the bioscience dynamic is certainly noted in China. You're seeing that reported across essentially every peer where research spending is down in China, just given the economic macro environment. And so we're projecting that, that would continue. And then also as we see anticorruption in certain markets, one of the things that we see happen and we saw that in Q3 is that distributors, when there's uncertainty, they'll pull back on their inventory until they better understand it, right? So they won't let their inventory levels come down. We saw that play out a bit in Q3. We don't expect Q3 China performance to repeat in Q4. We do think there are some onetime dynamics there. But nevertheless, particularly on the bioscience side, we expect that dynamic to continue through the year. That's really it, Travis."
},
{
"speaker": "Travis Steed",
"content": "Okay. And then I guess the follow-up question is more into next year, kind of what kind of revenue growth do you need to kind of get to that double-digit reported EPS growth. Before you were kind of talking about BD at 5.5% plus, is that still possible if some of these headwinds that you're seeing this year, linger into next year? Just kind of doing the math this year, kind of ex-Alaris, looks like the growth is close to looking at 3.5% to 4%. I just wanted to see how to think about the next year revenue growth."
},
{
"speaker": "Tom Polen",
"content": "We're not going to give revenue guidance on this call, Travis. But what I can do is maybe just share some color. Obviously, you're seeing us even in this environment which we do expect, particularly the Pharm Systems is probably easier to predict on recovery timing. Just given it's -- you can't destock forever, right? So that's pretty clear. Some of the life science research spending dynamics. If you think about a lot of pure players in those spaces are projecting recoveries later into -- early into '25. I think we'll hold to see that come up as we will give the next quarter to be able to observe that a little bit more before we give guidance on that space. But across all those spaces, we feel good. And while we're facing those exact transitory market dynamics, of course, you see us continue to deliver mid-single-digit growth this year, this quarter despite that environment. And I think we would expect, particularly those to only improve as we go into FY '25."
},
{
"speaker": "Chris DelOrefice",
"content": "Travis, just maybe one other -- just 2 things. One, in my prepared remarks, I did say even in an environment where these dynamics continue, we're confident in delivering strong performance. we did that this quarter. This is still quality growth. I think just to put in context your Alaris comment, these transitory market dynamics, just those 2 areas alone are worth more than Alaris benefit, right? You've got high single-digit growth businesses that are nearly $4 billion, Pharm Systems used to be consistent double-digit grower. We're still seeing that strong biologics performance. That's a significant headwind we're absorbing. And to Tom's point, we're well outperforming those markets and so we continue to perform well there. And as those recover, those market trends are definitely long-term durable trends and we feel good about that. So I'd just add to consensus, what that means is -- the rest of our portfolio, look at -- BDI across the board was really strong, MDS performing well, specimen management performing, there is strong growth throughout our portfolio."
},
{
"speaker": "Tom Polen",
"content": "Yes. Maybe just a couple of other bits of color is, as we look at kind of our core business, the durable portfolio is high-volume products. We're seeing really strong volume growth and share gain in areas like MDS, PAS, kind of the consumable side of MMS and we don't see a slowdown to that momentum; so we feel good on that. Certainly, as we think about our strategy in health care automation and AI informatics, now with Alaris back in our connected medication management portfolio, we're making really good progress. You heard us say we're already back -- Q3, we're back at the $100 million plus per quarter run rate that we had prior to Alaris going on ship hold. That's 3 to 6 months faster than we had expected going into the year. So we feel really good about that. And that momentum, we expect to continue basically from here on out. We're at that $100 million-plus run rate going forward and we've built a nice backlog of orders for Alaris. Remember, we started with zero backlog as we went into the year. We expect to exit this year at, again, a normalized backlog that we had pre-ship hold at least at that level. Other areas of that connected medication -- or the connected care health care automation portfolio we're really excited about for next year as well. Of course, that's our pharmacy automation strategy and our laboratory automation strategy there as well which continues to really resonate very well with customers. Products like PureWick that are targeting new care settings, we've got not only the new PureWick female launch happening but we also have the mobile PureWick launch happening next year which we're really excited about. And then in that chronic disease management space, you heard us talk about -- in Pharm Systems, double-digit biologics growth. We expect that to continue very strongly into '25. And then as destocking on the vaccine and the anti-coag side starts to alleviate, right, that will lift that whole boat. But we certainly don't expect any change in our underlying Biologics momentum there. Biosciences, maybe I can just give a little bit more color on that one, too, is I would say that we're at the point now where we're -- we've seen us be flat. The market has certainly been down. If you look at peers, I think almost every single peer is down in that space. We've been -- a bit of an outlier is being flat. We are seeing -- if we look at quarter-on-quarter instrument purchases, we're seeing them up a bit sequentially quarter-on-quarter. As we think about China in the future, there is discussion around China stimulus that's been widely discussed across the industry. I think the timing of that still needs a bit more clarity, certainly, sometime in '25, it's expected. But again, as we get into guidance and more specifics there on the November call. I would expect there'll probably be a bit more clarity on the timing of stimulus in China, too. But from a bioscience perspective, I think our assumptions now and what we're seeing, it's certainly not getting worse and we're seeing some green shoots of some positivity in some areas. Other signs that we see are people that even in the U.S. from an NIH perspective, folks that maybe were turned down initially for grants we're seeing on the second submissions, those grants starting to get approved and more POs then coming in for those instruments."
},
{
"speaker": "Operator",
"content": "Our next question will come from David Roman with Goldman Sachs."
},
{
"speaker": "David Roman",
"content": "I wanted to ask one question on revenue then one on capital allocation. But maybe starting on the revenue side, appreciate some of the perspective around Alaris and the contribution that you expect that to drive this year than the sort of high-level perspective into next year. But how should we think about the growth drivers in that business beyond the bolus of performance you have from Alaris. I think you have a next-generation Pyxis platform launching. You have some of the pharmacy automation products starting to pick up steam. Maybe sort of contextualize the growth in that business beyond just the Alaris boost that we should see for the next 5 quarters?"
},
{
"speaker": "Tom Polen",
"content": "Yes. I'll start off, David, thanks for the question. This is Tom and then I'll turn it to Mike Garrison who we have here with us in the room. Really in MMS, I'd break it into kind of -- we've got 3 or 4 categories. One is the consumables space, let's just start off with that. We see really strong growth in overall procedure volumes driving strong growth in the consumables of IV sets, etcetera, that fit along with Alaris. So as you mentioned, Alaris is not only back to its historical run rate but we believe we took share in the quarter as we look at independent market data and as well as our own. So we feel really good about the position there. And then, of course, that starts pulling through other elements of our connected care portfolio, inclusive of interoperability, health site and other solutions. We do have the next-gen Pyxis launching in the back half of next year which we're excited about long term and Mike can comment on that. And then, of course, we have pharmacy automation, both in the U.S. and Europe and the overall trends there around pharmacy shortages, labor costs and big demands for productivity improvements which we are ideally suited to address and are by far the market leader in each of those spaces when it comes to those customer needs. So maybe, Mike, some more details on what we're seeing there."
},
{
"speaker": "Mike Garrison",
"content": "Sure. So in addition to the next-gen Pyxis launch for next year, we've got about 10 additional releases across the connected med management portfolio that will come out. What we've implemented is a cadence of innovation. So whether it's in the core pharmacy, the acquisition of MedKeeper which is growing very nicely, some additions to that portfolio. Our MedBank acquisition which is going into long-term care settings and non-acute settings. These are some ways that, that entire market, we're starting to expand and go along with the shift of care into less acute environments or less hospital-based environments. But still, the hospital needing to stay connected from a data perspective, from an understanding of their total inventory perspective. So I think we're really well positioned from an innovation there. Growth in that market is cyclical. So it goes sort of with the book of business as capital would happen. But we do have a very strong service model there. And also, we offer a very flexible set of financing terms around capital and operating leases. So we're -- we have a little bit less cyclical nature than maybe some of the competitors that show a little bit more volatility in that area. Pharmacy automation between Parata and ROA and our RapidRx acquisition, we sort of built a fairly significant -- I think the largest pharmacy automation robotics company in the world. And the customer interest in that is very, very strong. It's been -- there's very high double-digit growth last year. A bit of change in tax incentives in Europe that we've commented on before that we've been watching, caused a little bit of a slowdown in Europe here this year but we've also started to see the order book pick up sequentially quarter-to-quarter, both in the U.S. and in Europe. So we feel good about that. The fundamentals there are very, very strong around labor efficiency, around safety, around the use of both artificial intelligence and robotics to provide additional efficiencies in health care, in the retail sector, in the long-term care sector and as hospitals start to reinvent their pharmacy. So I think in both areas, there are areas that augment and underscore -- while Alaris is obviously coming back very strong, it's just the 1-year anniversary on this call last year is where we announced that we had got clearance and that couldn't be going any better than the expectations than what it's going right now. But the fundamentals across that connected net management strategy are very strong and continue to resonate with the customers."
},
{
"speaker": "Tom Polen",
"content": "Thanks for the question, David."
},
{
"speaker": "David Roman",
"content": "Sorry, I assume -- can I ask a follow-up here?"
},
{
"speaker": "Tom Polen",
"content": "Go ahead, David."
},
{
"speaker": "David Roman",
"content": "Sorry about that. Can you maybe just on the P&L comments for next year, one of the things that would be helpful to put together here is -- as you think about your growth rate, a lot of what you're describing here are macro factors and sort of end market dynamics which logically flow through to you given your high market share. But what can you do to differentially position BD from a performance perspective, especially given what looks to be like flattish operating expenses. So what are the sort of underlying assumptions around discretionary expense spending that are in that kind of 10% type earnings sort of floor that you've put out there for next year? And how should we think about the rest of the P&L below gross margin?"
},
{
"speaker": "Chris DelOrefice",
"content": "Yes. Thanks, David. It's Chris. Yes, I think the exciting pivot is -- and think of Q3 as kind of an indicator of what' '25 would be, full year '25, based on the comments I shared. So we talked about exceeding now 25% operating margin in FY '25. So it implies north of 100 basis points of improvement. The significant majority of that is coming from gross margin. So you're seeing all the benefit of BD Excellence flow through which, to your point, creates an opportunity for us to kind of reshape below gross margin. The intent is to, as part of that 10% starting point, is to drive more investment in R&D and more investment in business building growth, digital capabilities, commercial go-to-market, etcetera. Our principle will always be to sort of get natural leverage from kind of our G&A space and we've also talked about that we're advancing a global business services model there as well. So that will be a minor catalyst in '25. The leverage will be there but it is also a go-forward catalyst. So that's how we think of the formula, more value out of gross margin. To your point, that lends itself nicely to the natural flow-through on sales and then reinvestment to support growth and leverage kind of your core infrastructure base."
},
{
"speaker": "Tom Polen",
"content": "Yes. David, maybe just one other thing to add to Chris' good points there. And you heard us talk about this in the prepared remarks. BD Excellence which we really launched last year, we couldn't be more pleased with the momentum that we're getting there. So as you heard, we're up to over 500 Kaizen events this year. Of course, BD Excellence is based on Shingijutsu Kaizen which is the idea of the pursuit of excellence through continuous improvement and providing our organization with the tools, the systems, the capabilities to do that as part of their everyday work and then a series of major events like the 500-plus Kaizen that we mentioned where we immersed in that as an organization in specific areas. And we're really seeing that come through in reduced waste and improved line productivity. You're seeing that flow through also in our cash flow performance with exceptionally strong year-to-date as we're able to actually operate the company on a continued basis with less CapEx, just given the productivity improvements that we're seeing from that. At the same time, of course, Project RECODE which we folded up under our excellence initiative now which is the consolidation of over 20% of our manufacturing plants, right? That starts kicking in '25 as well which at a scale level. We got a bit of it in '24 but we really see that ramping up in '25 which further flywheels that margin. And then you also heard me mention that -- of course, as we now are consolidating plants, one of the things that happens as you end up with fewer larger plants. And as you're having fewer even larger plants, we're taking advantage of investing behind our smart factory strategy and those as well. We think -- as we think about technology, around AI, predictive analytics, companion robotics, etcetera, there's no company in med tech that's better positioned to be able to capitalize and get value out of that than BDS given the scale of production that we have. And so we've been digitizing. We have now quite a few areas that are fully paperless. So we're digitizing all the data coming off of our lines which has been allowing us to now start putting predictive analytics against those. As I mentioned, we've done that and with a focus on our top 30 plants where we're seeing accelerated performance from that. And so we're really combining that excellence Kaizen strategy with that smart factory strategy as well which is going to be continuing to drive at GP [ph] strategy of ours, not just in '25 but that's going to be a key theme as we look forward to Investor Day in Q2 of '25. Expect to hear more about that and our [indiscernible] margin focus over the next phase post-BD 2025."
},
{
"speaker": "Operator",
"content": "Our next question will come from Patrick Wood with Morgan Stanley."
},
{
"speaker": "Patrick Wood",
"content": "I'll keep it to one, just given the timing. And I appreciate you guys have covered this but I definitely want to dig into China a little bit more because you've had quite a few companies come out across a range of different industries and have a reasonable tough time in the market. So I guess, obviously, the VBP [ph] dynamics, we know there's biosciences on that side, as you said, lots of companies flagging on that. I guess my question is like what are you hearing from some of the customers? Have you seen any MDS vol changes outside of stocking? I'm just trying to dig into underlying in the market. Is there anything that you feel has structurally changed? Or are these genuinely transitory dynamics?"
},
{
"speaker": "Tom Polen",
"content": "Yes. Thanks, Patrick, for the question. So we've got a great team in China. We still view it as a large market with significant unmet needs and we continue to serve that market opportunity across the breadth of our portfolio. We continue to invest in advancing health care practices and access in China. As you mentioned, we see -- VBP [ph] has been playing out in MDS as expected. Just as a note there, our volumes in MDS China are actually up very nicely. So if you look at the -- even the categories where we're seeing VBP [ph], we see price pressure but we're seeing strong volume growth in those categories in MDS that are complementing that. So our plants are very busy in China because of higher volumes in those spaces. The lower research funding, as you mentioned, that's been broadly commented on across the board. And we do think there will be an end in sight to that as the market ultimately recovers and research investment. We don't see that as a long term, that China will be de-investing in research over the long term. We expect that will recover and that's more of a transitory dynamic. And then some of these other factors, they are related. There are economic challenges at a macro level happening in China, where I think that combines with the anticorruption and some of the actions that distributors take when there's uncertainty and they'll pause to pull inventories down a bit, those dynamics, I think, will evolve as just clarity in the economy and those processes end up coming into light. So -- which, again, we would expect to be more transitory in nature. So we continue to invest in the market. We still see it as a long-term attractive space, an important market for us. And we do have areas of the business that are continuing to do really well in China beyond some of those transitory spaces that we see. So maybe that's a high-level overview of what we see and as we look forward."
},
{
"speaker": "Operator",
"content": "Our next question will come from Larry Biegelsen with Wells Fargo."
},
{
"speaker": "Larry Biegelsen",
"content": "Two quick ones for me and I'll ask them both upfront. On Alaris, the $350 million in fiscal '24 sales implies about a $600 million annual run rate using the implied Q4 sales of about $150 million, if I'm doing the math right, is that the right way to think about fiscal '25 Alaris [ph] sales, about $600 million? And just lastly, Chris, the last two years, growth in margins have been very back-end weighted. And obviously, it's caused a lot of investor anxiety, is there any way or do you expect fiscal '25 to look different from a cadence standpoint?"
},
{
"speaker": "Chris DelOrefice",
"content": "Larry, thanks for the question. Yes, on the second question but we're still in our planning stance and we need to continue to monitor market dynamics, all these factors. I think the one thing is for sure that the margin rhythm is going to be much more balanced throughout. I mean last year, we had one a strategic choice on inventory takedown that was all front-end loaded, right? That was a predominant driver. The execution this year played out exactly as we talked about. As a matter of fact, the past few years, I mean we've executed against everything we said from a margin standpoint the past two years. So that's a big change. FX also was another big front-end item that we don't see that same degree. So I think naturally, we're going to end up with a much more balanced phasing and we'll share more when we provide our official guide in November. But I don't think that's an item that should be tough."
},
{
"speaker": "Tom Polen",
"content": "But the other big thing that we had this year was, of course, Alaris was a ramp in the second half given that we just launched at the very end of Q4. So you're going to have much more ratable performance in Alaris Q1 through Q4 of next year as well. So we would expect much more smooth which we're very much looking forward to being back at that as we look forward. Just on Alaris, we're not certainly going to give guidance by any product line for '24; we're not at that point. I think that's -- I wouldn't take the run rate necessarily from that and take it through '25. But back to my commentary, we're back at, at least the $100 million historical run rate. Cannot [ph] be an opportunity to do better than that as we go into '25 for sure. And we'll give more color on that on the November call."
},
{
"speaker": "Operator",
"content": "Our next question will come from Rick Wise with Stifel."
},
{
"speaker": "Rick Wise",
"content": "Maybe back to the fiscal '25 guide. I just want to make sure I'm thinking about it correctly. It's been talked about several times but I just want to hear your language one more time. The 25% EPS growth commentary and the operating margin for over 25% clearly includes Critical Care, if I understand correctly. But to make sure it -- doesn't that sort of imply that everything else on a total basis is not going to grow as fast in fiscal '25 as it has in '24? And if I'm thinking about it remotely correctly, maybe I'm too deep into earnings season, I'm not thinking about it clearly. Are you -- does that imply you're being conservative or careful in this initial commentary? Just to make sure we're thinking about it correctly."
},
{
"speaker": "Chris DelOrefice",
"content": "Yes. Thanks for the question, Rick. Yes. I mean, look, '25 is -- we think there's a lot to be excited about. Critical Care is part of it, to your point, that's not a substantive contributor just to be clear, the margin we're generating is fully on the BD base business. So we're well positioned there to now exceed the 25% operating margin goal. Again, importantly, the mix shifts significantly in terms of where margin improvement is coming from, it's coming from gross margin. Look, I think external estimates now are sitting actually just under 9%, right? We see that to the low end of our range, 10% reported is a great starting point, above where we are externally. And like we do every year is, our goal is to continue to create opportunity to exceed that as we move throughout the year; so it's early. We just knew it was important to kind of share context and we've been able to do this, by the way, this year, like on the top line, the questions, deliver strong performance despite these market dynamics. So we'll continue to monitor those but feel really good about how we're positioned moving into 2025."
},
{
"speaker": "Operator",
"content": "Our last question will come from Vijay Kumar with Evercore ISI."
},
{
"speaker": "Vijay Kumar",
"content": "Just one for me. Some of these issues you have mentioned, right, I think on the pharma side, some of your close peers are talking about a bottoming on destocking. So just maybe from your perspective, like how are you seeing this destocking impact playing out. And when I look at those moving transitory sort of issues, like China, bioscience and pharma destocking, it looks like biosciences should -- certainly headwind should continue. I think most of tools companies have been cautious about first half of '25. How should we think about China? Is that should that get back to growth? Or is this VBP [ph] headwinds, could that last for a while?"
},
{
"speaker": "Tom Polen",
"content": "Yes, it's a great question, Vijay. So let me start with maybe the bioscience and then touch base on Pharm Systems and then touch base on China. So on Pharm Systems -- or on biosciences, I think, as you mentioned, it's been widely commented on across the tools companies. Again, we see ourselves outperforming the market this year. That's pretty straightforward. There's very few that are flat like we are in that space. And you heard us make -- share in our prepared remarks some of the really exciting innovations that we see driving that. And not only are they driving that in this environment, as the market ultimately recovers, those same technologies around FACSDiscover and the continued cadence of new innovations not only with sorters but next year, launching our first analyzer in that segment, continued innovation with dies and other technologies that are allowing more and more multiplexing in that category are all just going to benefit us as that market picks up and people can begin to buy systems in larger volumes. So we feel good about that. And it really comes down to the timing of the recovery which, as you mentioned, we're assuming it's going to continue to be tight through the balance of this year which is how we've updated our guidance. And then we would expect at some point in '25, again, let's watch Q4, we'll update '25 guidance in November on that. I think we'll benefit from that timing to get clarity as with the whole market. On Pharm Systems, look, we continue to see that strong demand on biologics underlying which is also differentiated versus peers, double-digit growth again in biologics within that space. We see no slowdown there. Obviously, GLP-1s are a big component of that and our position that we have on some of the large current market molecules is benefiting us. We also shared we've got a position with a number of new GLP-1s that are moving through the pipeline towards launch are already having our device spec-ed in. And then we also see -- we have over 40 signed agreements for biosimilar GLP-1s, the early molecules of GLP-1s that we start seeing launch as early as the next 12 months there and that will play out over the longer term as those play out. But we really like our position there. Of course, the destocking that's happening that, as you mentioned, everyone is seeing across that the sector, has really been focused on the anticoagulant and vaccine segment for us. And I think broadly for others and that can't continue forever. So we would expect that as we move into FY '25 and again, we'll give more specifics on timing as we go into guidance. But certainly, as we go to the back half of that, we would expect that to be -- start coming, returning to more normalized growth. On China, look, we have China -- we don't have -- as we think about the numbers that we've shared around double-digit EPS growth for next year, we don't have a major assumption of China returning back to high growth next year in that. We've taken a conservative position in our internal monitoring -- modeling on that. And we'll continue to watch that market play out as we go forward but we've taken a conservative stance on our own internal modeling there as we look at and build our plan for the 10% EPS growth number. So we still see -- and again, that will be related to the biopharma research spending that's happening in China will be something we'll continue to watch closely and how that overall macro recovery -- market recovers, we'll continue to watch the China macroeconomic environment overall. We do see MDS. We don't see a change in terms of the timing of VBP [ph] starting to decline. We've seen that play out this year as we expected. We don't expect that to be as significant next year for MDS, just given the scale that happened this year. I think we've said that in the past, we don't expect that to change, i.e., we see less pressure in MDS next year in China from VBP [ph] but more to come on China as we give guidance. But hopefully, that just gives some color on China and what we've built into some of our preliminary thinking as we shared the number on EPS for next year."
},
{
"speaker": "Operator",
"content": "Thank you. That concludes today's question-and-answer session. At this time, I'd like to turn the floor back over to Tom Polen for any additional or closing remarks."
},
{
"speaker": "Tom Polen",
"content": "Okay. Thank you, operator and thank you to all of our investors for joining us on our call today. We are pleased to deliver strong, above-market, broad-based growth and are well positioned to achieve our increased FY '24 earnings guidance. As we look ahead to FY '25, we are excited by multiple growth opportunities across our portfolio, momentum in BD Excellence, driving continued strength in gross margins and cash flow and welcoming the Critical Care team to BD. We look forward to connecting with everyone again in November and thank you for your continued support of BD. Thank you, operator."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude this audio webcast. On behalf of BD, thank you for joining today. Please disconnect your lines at this time and have a wonderful day."
}
] |
bdx | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to BD's Second Fiscal Quarter 2024 Earnings Call. At the request of BD, today's call is being recorded and will be available for replay on BD's Investor Relations website, investors.bd.com or by phone at +1 (800) 723-5792 for domestic calls and area code +1 (402) 220-2664 for international calls."
},
{
"speaker": "",
"content": "[Operator Instructions] I will now turn the call over to Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations."
},
{
"speaker": "Greg Rodetis",
"content": "Good morning, and welcome to BD's earnings call. I'm Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations. Thank you for joining us. This call is being made available via audio webcast at bd.com. Earlier this morning, BD released its results for the second quarter of fiscal 2024. The press release and presentation can be accessed on the IR website at investors.bd.com."
},
{
"speaker": "",
"content": "Leading today's call are Tom Polen, BD's Chairman, Chief Executive Officer and President; and Chris DelOrefice, Executive Vice President and Chief Financial Officer. Following this morning's prepared remarks, Tom and Chris will be joined for Q&A by our segment presidents, Mike Garrison, President of the Medical segment; Dave Hickey, President of the Life Sciences segment; and Rick Byrd, President of the Interventional segment."
},
{
"speaker": "",
"content": "Before we get started, I want to remind you that we'll be making forward-looking statements. You can read the disclaimer in our earnings release and the disclosures in our SEC filings available on the Investor Relations website. Unless otherwise specified, all comparisons will be made on a year-over-year basis versus a relevant fiscal period. Revenue percentage changes are on an FX-neutral basis unless otherwise noted."
},
{
"speaker": "",
"content": "Reconciliations between GAAP and non-GAAP measures are included in the appendices of the earnings release and presentation. With that, I am very pleased to turn it over to Tom."
},
{
"speaker": "Thomas Polen",
"content": "Thanks, Greg. Good morning, everyone, and thank you for joining us. Second quarter revenue growth accelerated significantly as expected, driven by the strength of our portfolio, increasing volumes across our consumables and Alaris. Margin performance drove adjusted EPS ahead of our expectations and consistent with our plan, we delivered very strong cash flow and are on track to deliver another year of double-digit free cash flow growth. These results give us the confidence to once again increase our FY '24 adjusted EPS guidance."
},
{
"speaker": "",
"content": "Turning to our BD 2025 strategy. We continue to execute well on the actions we outlined at our Investor Day to drive profitable growth and value creation. This includes advancing our innovation pipeline, which supports our durable 5.5% plus targeted growth profile. One such area is the strong cadence of new innovation across our connected medication management suite, which delivers many unique benefits to our customers."
},
{
"speaker": "",
"content": "Q2 was the second full quarter since clearance of our new Alaris system and first half Alaris sales have already eclipsed our total FY '23 performance. Our return to market is ramping faster than initially planned, which wouldn't be possible without our manufacturing team who have executed extremely well in scaling Alaris production. Q2 set an all-time record in both the number of BD Alaris pumps manufactured and the number of pumps shipped in a quarter to upgrade our customers to the cleared version of the pump. We have also seen acceleration of committed contracts, inclusive of competitive conversions as health systems value the capability of Alaris and look to standardize their fleet. This offers confidence in the planned second half contribution to growth and will support momentum heading into FY '25."
},
{
"speaker": "",
"content": "The Alaris 510(k) clearance is just the beginning. As we have shared, we are excited about our innovation roadmap, and we are planning upcoming Alaris 510(k) submissions to further strengthen our capabilities, like best-in-class interoperability with over 800 live sites, introduce a steady flow of new customer innovations and ensure continuous compliance. Examples such as over-the-air technology for efficient software updates and continued advanced cybersecurity are planned in the next submission later this calendar year."
},
{
"speaker": "",
"content": "Beyond Alaris, we have a market-leading connected medication management portfolio across inventory management, compounding, pharmacy automation, medication dispensing and infusion and are excited about future innovations and development. This includes new medication dispensing and informatics innovation, including the next generation of our Pyxis dispensing platform, which innovates on our hardware design and will advance our cloud connectivity."
},
{
"speaker": "",
"content": "We continue to scale our BD Health sites informatics platform, now live in over 1,000 sites, and have upcoming launches to integrate hospital medication data from Pyxis with non-acute medication data from our MedBank and MedKeeper platforms, to bring visibility to medication flows across the customers care network."
},
{
"speaker": "",
"content": "In Q2, we made meaningful progress achieving other key R&D milestones, including several in our peripheral vascular disease platform, which is one of our key growth areas. Longer term, these technologies are each expected to deliver over $50 million in incremental fifth year revenue and will broaden our leadership in the $5 billion PVD category that is growing high single digits."
},
{
"speaker": "",
"content": "In our venous portfolio, we have now enrolled over 60 patients in our ARCH pivotal IDE for our BD Liverty TIPS Stent Graft. This novel self-expanding covered stent improves the standard of care for portal hypertension. Building on our success in launching venous products that help deliver better clinical outcomes for patients and strengthening our presence in the venous market."
},
{
"speaker": "",
"content": "In our arterial portfolio, we enrolled the first patient in our AGILITY pivotal IDE study for our low-profile arterial stent graft, a differentiated technology that minimizes access site complications with precise stent placement that could provide an important new treatment option for over 18 million patients with peripheral arterial disease in the U.S. alone."
},
{
"speaker": "",
"content": "We also filed our SCION SFA pivotal IDE submission with the FDA for our new sirolimus DCB for the treatment of PAD. We see this new alternative drug platform as a key growth catalyst for both SFA and below-the-knee applications."
},
{
"speaker": "",
"content": "We are also executing well on our simplification strategy to drive margin expansion. We are seeing growing momentum as we scale our BD Excellence operating system and build world-class lean management systems and culture throughout BD. This drove strong Q2 performance in areas such as waste reduction and production efficiency, contributing to our margin goals."
},
{
"speaker": "",
"content": "Our focus on cash flow also continues to deliver positive results, generating about $1.1 billion in free cash flow in the first half. This strong start to FY '24 positions us to deliver double-digit growth in free cash flow for the full year. It also enables continued execution of our disciplined capital allocation strategy including accretive M&A opportunities in higher-growth categories and opportunistically returning cash to shareholders."
},
{
"speaker": "",
"content": "Lastly, our teams around the world continue to make advancements on our corporate sustainability strategy. We were recently named among Fortune Magazine's Most Innovative Companies list, a testament to our 70,000 associates who work every day to deliver innovation that meaningfully advances the standard of care around the world. We continue to forge partnerships that expand access to these critical innovations. And most recently, we announced the first-ever option in Singapore for women to self-collect a sample for cervical cancer screening in the privacy of their own home."
},
{
"speaker": "",
"content": "In summary, we are delivering accelerated revenue growth, are executing ahead of our plan on Alaris and driving strong margin performance with a growing contribution from BD Excellence. We once again raised our adjusted diluted EPS guidance for fiscal 2024 and believe we are well positioned to achieve our BD 2025 goals. I'll now turn it over to Chris to review our financials and outlook."
},
{
"speaker": "Christopher DelOrefice",
"content": "Thanks, Tom, and good morning, everyone. As Tom noted, we executed well on our performance goals in Q2. As expected, we delivered strong acceleration in our revenue growth, we exceeded both our margin and earnings goals and delivered very strong free cash flow growth."
},
{
"speaker": "",
"content": "I'll now provide some insights into our revenue performance in the quarter. Q2 revenue was $5 billion, with organic growth of 5.7%, driven by strong volume. Growth was led by double-digit growth in BD Interventional with low single-digit growth in BD Medical and BD Life Sciences. Total Q2 revenue growth of 4.7% reflects the divestiture of our surgical instruments platform."
},
{
"speaker": "",
"content": "Regionally, organic growth was driven by the U.S., partially offset by expected market dynamics in China. In BD Medical, growth was led by Medication Management with strong performance in infusion systems driven by the BD Alaris return to market and mid-single-digit growth across our Medication Delivery Solutions portfolio in the U.S. and EMEA. Strong demand in our Pharmaceutical Systems, pre-fill devices for biologic drugs offset transitory market dynamics across the industry, including customer inventory destocking."
},
{
"speaker": "",
"content": "BD Life Sciences performance was led by Integrated Diagnostic Solutions with high single-digit growth in our microbiology platforms and mid-single-digit growth in specimen management, which offset a comparison to the prior year and transitory market dynamics in select segments in Biosciences."
},
{
"speaker": "",
"content": "BD Interventional Organic growth was led by continued strong growth in UCC with continued momentum in our PureWick franchise, delivering another quarter of double-digit growth, along with related licensing revenue. Surgery delivered another strong quarter with double-digit organic growth, supported by global adoption of our Phasix resorbable scaffold."
},
{
"speaker": "",
"content": "Lastly, growth was supported by Peripheral Intervention with double-digit growth in our peripheral vascular disease platform, where we continue to drive market penetration with our Rotarex atherectomy system and our venous portfolio. The quarter's performance reflects the breadth of the BD portfolio that delivers a durable growth profile."
},
{
"speaker": "",
"content": "Now moving to our P&L. We realized strong sequential margin improvement with adjusted gross margin of 53% and adjusted operating margin of 24.3%, both above our expectations. For adjusted gross margin, our simplification and BD Excellence initiatives are continuing to drive net cost improvement and sequentially, as planned, we saw a reduced impact from prior year inventory reductions that increased cash flow, driven by strong SSG&A, expense reductions and leverage, our adjusted operating margin increased sequentially by 410 basis points and year-over-year by 160 basis points with Q2 being above our fiscal year '23 full year margin."
},
{
"speaker": "",
"content": "As a result of these items, we exceeded our Q2 operating income and adjusted diluted EPS expectations resulting in adjusted diluted EPS of $3.17, which grew double digits or 10.8% on a reported basis. Regarding our cash and capital allocation. Year-to-date free cash flow increased more than $900 million year-over-year to over $1.1 billion. This reflects continued improvements around working capital, including our actions to optimize inventory levels, continued discipline around capital investments and leveraging our fixed asset base as a result of the benefits from our BD Excellence operating system."
},
{
"speaker": "",
"content": "We remain focused on free cash flow conversion and are on track to deliver another double-digit step improvement in FY '24 and remain well positioned to achieve our long-term cash goals. With our strong cash flow, year-to-date, we returned over $1 billion in capital to shareholders, including dividends and $500 million in share repurchases."
},
{
"speaker": "",
"content": "We improved our net debt position ending Q2 with a net leverage ratio of 2.6x. Our cash and short-term investments balance was almost $3.2 billion, inclusive of about $2 billion in proceeds from debt refinancing during the quarter that will be utilized to repay maturing debt over the balance of the calendar year. Collectively, this positions us well to capitalize on accretive value-creating tuck-in M&A."
},
{
"speaker": "",
"content": "Moving to our updated guidance for fiscal year '24. The detailed assumptions underlying our guidance can be found in our presentation. As we look ahead for the balance of the year, we remain focused on driving areas of momentum, including Alaris and continue to monitor transitory market dynamics. For the full year, we are maintaining our organic revenue growth guidance range of 5.5% to 6.25%."
},
{
"speaker": "",
"content": "Based on our Q2 margin performance, we are raising our adjusted diluted EPS guidance range to $12.95 to $13.15 on a reported basis, which is an increase of $0.11 at the midpoint. Strong delivery in Q2 positions us well to achieve our second half earnings growth targets."
},
{
"speaker": "",
"content": "Regarding foreign currency, based on current spot rates, the impact of currency has moved modestly since our last update. And for illustrative purposes, we see an additional headwind of approximately 40 basis points to full year revenue from translational currency impacts."
},
{
"speaker": "As you think of the second half of fiscal '24, the following are some considerations",
"content": "First, regarding revenue, the midpoint of our guidance reflects about 7.5% second half organic sales growth with nearly 250 basis points contribution from Alaris and just over 5% growth in the remainder of the BD portfolio. We expect Q3 organic growth of at least 6% with Q4 further accelerating, driven in part by Alaris momentum and improving grow-over dynamics in China."
},
{
"speaker": "",
"content": "For the full year, our assumptions imply just over 100 basis points revenue contribution from Alaris or at least $300 million in FY '24 revenues. Second, we are well positioned to achieve our updated adjusted operating margin guidance of at least 50 basis points improvement, which implies full year operating margins of at least 24%. We expect Q3 adjusted operating margin will be modestly higher than Q2, given the strong performance in this quarter."
},
{
"speaker": "",
"content": "We continue to expect margin acceleration in Q4, driven by our BD Excellence and continuous improvement efforts and continued expense leverage on expected strong revenue performance, including Alaris. Lastly, we expect our tax rate to be ratable across Q3 and Q4 at about 15% when considering the midpoint of our updated full year guidance range."
},
{
"speaker": "",
"content": "In summary, based on the strength of our portfolio and momentum in Alaris, we have clear line of sight to deliver our fiscal year '24 revenue guide and another year of strong growth. Our team's execution supported over-delivering on our margin expectations. And as a result, as we enter the second half, we are on track to achieve our full year margin improvement goals and once again increased our fiscal year '24 earnings outlook. Additionally, we remain well positioned to deliver another year of double-digit free cash flow growth, which increases our capacity to support additional value-creating opportunities, including M&A."
},
{
"speaker": "",
"content": "Our strategy is demonstrating positive momentum, and we remain well positioned to continue to deliver on our BD 2025 growth objectives. With that, let's start the Q&A session. Operator, can you please assemble our queue?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question will come from Travis Steed with Bank of America."
},
{
"speaker": "Travis Steed",
"content": "Congrats on a good quarter. I wanted to ask about the second half ramp, both from a revenue and margin perspective. So on revenue growth, you need to step up closer to kind of above the full year range in the second half, curious what the underlying drivers there are and how much of that is dependent upon the increased demand you're seeing in Alaris?"
},
{
"speaker": "",
"content": "And then on the margin side, curious how much of the outperformance in Q2 was onetime versus underlying? And how you're thinking about the second half and how much of that's kind of derisked versus 3 months ago?"
},
{
"speaker": "Christopher DelOrefice",
"content": "Yes. Thanks for the question, Travis. Yes. So first of all, we were pleased with the quarter. To your point on revenue, one, we did see strong acceleration quarter-over-quarter as expected on revenue. We tried to outline the ramp. Clearly, the back half guidance at our midpoint implies about 7.5% growth. But when you unpack that with the momentum that we have in Alaris, we now expect nearly 250 basis points contribution to our second half growth. That would put us at least $300 million for the full year. So if you strip that out, the rest of the BD portfolio has to perform at just over 5%. We feel confident in that. We have strong areas of momentum."
},
{
"speaker": "",
"content": "I think one thing that you saw in our core performance this quarter was -- our core consumables that are anchored against the core of health care, performing really well as you see strong utilization in the health care system. We continue to see great momentum in areas like PureWick, driving strong outsized double-digit growth in that platform, momentum in PVD. And so there's a lot of pockets of strength that we'll continue to build on there."
},
{
"speaker": "",
"content": "From a margin standpoint, so first, the drivers of the margin that we articulated at the start of the year have played out as expected. To your point, we had really strong execution in the quarter. This is driven by our cost improvement initiatives, the momentum on BD Excellence. So we over-delivered 2 quarters in a row, and we're well on track to deliver the full year, which is at least 50 basis points increase year-over-year. We're just over 24%."
},
{
"speaker": "",
"content": "As you think of the performance in the quarter, it really wasn't one thing. I would just say strong execution throughout and we remain focused on executing in the back half of the year. I think the important thing is in the back half of the year, there were questions about the ramp. Q2 is a strong signal that we're well on track. As a matter of fact, one simple way to think of this is our first half gross margin was about 52%. And we know we had those kind of transient onetime items, the outsized FX and then the decision we made last year to reduce inventory levels, which improved strong cash flow. Those are worth over 200 basis points. Those are completely behind us as we move to the second half. You add that to the 52% and you're basically where we need to be in the back half already."
},
{
"speaker": "",
"content": "So we just have to continue the strong cost improvement. In addition to that, we lapped the outsized inflation. In the front half of the year, that was almost 150 basis points. We cycled through that and that moderates down very low. So lot of momentum in terms of how we're advancing margin."
},
{
"speaker": "",
"content": "And then lastly, what I would point to is, obviously, with that Alaris momentum and ramp through Q3 and Q4, you get a bit of what I would call outsized leverage on the revenue that's also worth about 150 basis points in the back half. As a matter of fact, our OpEx expenditures are not reducing. They're about flat or even up slightly. So it's not about cost reductions in OpEx. It's all about the top line leverage, which we feel good about."
},
{
"speaker": "Operator",
"content": "We'll go next to Robbie Marcus with JPMorgan."
},
{
"speaker": "Robert Marcus",
"content": "Nice quarter. I'll try and ask one that answers a couple of things. As you look at the balance of the year, you said you just need 5% in the base business. So if we look at second quarter, excluding the Urology payment and Alaris, what did the base business do so we could get that kind of comparison?"
},
{
"speaker": "",
"content": "And then maybe while you're at it, speak to some of the underlying trends in Pharm Systems and MMS where results came in a little lower, but it sounds like you're very confident for the rest of the year."
},
{
"speaker": "Thomas Polen",
"content": "Thanks, Rob. So I think as we look at the quarter and as we look forward to the year, we feel really good about the momentum and the diversity of BD's portfolio. And I'd say, as you look at the areas across the company, we see particular strengths in Medical, in Intervention, in the Life Science businesses that are focused in the health care provider space, right, that are benefiting from strong utilization across the board."
},
{
"speaker": "",
"content": "You can see our volumes, if you compare volumes this year versus last year, you're seeing strong growth from a volume perspective. And that's, of course, being supplemented by our very strong innovation pipeline as well. That's allowing us -- that strength of our diverse portfolio is allowing us to overcome what we see as transitory market dynamics that you're seeing across companies in the life science research area as well as in the B2B pharm systems marketplace where you're seeing destocking in certain areas."
},
{
"speaker": "",
"content": "With that said, we're seeing really strong growth continue, right, around double-digit growth in biologics. The biologics are now over 40% of our Pharm Systems business. So we feel really good about that. And that percentage in weighting is only increasing, right, towards $1 billion of biologic sales in that area. And so as we think about -- that's one of the strengths of BD's portfolio is those puts and takes across and being able to deliver in multiple different environments, really strong revenue performance. So Chris, anything to add?"
},
{
"speaker": "Christopher DelOrefice",
"content": "I would just add, I think Q2 is certainly representative of the growth rate that we need. We feel good about that. There's all kinds of puts and takes in the P&L. I mean just -- Alaris was a modest contribution. It wasn't significant. It's really most predominant in the second half, and that will be a strong driver for us. I articulated the second half drivers. Keep in mind, in Q2, you had some of these other negative comps, right?"
},
{
"speaker": "",
"content": "You mentioned licensing. There was also a licensing headwind that was in our Life Sciences business, and we were cycling through some very large capital installs. That's a space that -- we still feel good about customer interest, have strong momentum, and there were some timing dynamics there with the launch of our technology in BDB and a really strong install result in the quarter. So net-net, there's always lots of puts and takes. The 5% is something that we're confident in as we think of the second half."
},
{
"speaker": "Operator",
"content": "We'll go next to Vijay Kumar with Evercore."
},
{
"speaker": "Vijay Kumar",
"content": "I guess my one question here is on Alaris, the $300 million, Tom, can you give us a sense on what the implied exit rate number is in Q4 for Alaris? Because I understand from a growth perspective, it might be a little tricky. I know you have some upgrades going on. What is the dollar revenue number implied for Q4? And I know Alaris was raised from $200 million to $300 million, but the organic for fiscal was maintained. Is that just conservatism?"
},
{
"speaker": "Thomas Polen",
"content": "Yes. Thanks for the question. So first off, we are really happy that we delivered on our #1 priority last year, which is the clearance of the BD Alaris system. And we said our #1 priority for this year became the relaunch of Alaris and remediation and return to it being a contributing growth driver. And we're certainly delivering exactly on that goal like we did last year. Really proud of our manufacturing team. Hopefully, you heard it in our prepared remarks, right? We went from clearance at the end of Q4 to this past quarter, Q2, setting an all-time record in both the production and shipment numbers of Alaris. That's a combination for sale and remediation, but it really reflects that core manufacturing excellence capability that BD has, which we think is best-in-class in the industry, and this is a great example of it."
},
{
"speaker": "",
"content": "We continue to get really positive customer feedback. We've got positive contract momentum. And as you heard, we've got plans progressing for our next 510(k) submission later this calendar year, which will begin to continue to build new innovations on the back of the 510(k) that we got cleared in Q4."
},
{
"speaker": "",
"content": "So as we think about next year, to your question, we don't put out quarterly guidance by product line by any means. But what I would say is, as Chris said, our current guide implies, as you said, over $300 million, actually closer to $350 million for the year. And we've said before that we expect certainly FY '25 to be at least at our historical run rate, right, which you kind of think of as $400 million. Anything beyond that, we'll get into as we get into FY '25 guidance. But clearly, our performance this year is positioning us really well towards that previously stated goal."
},
{
"speaker": "Christopher DelOrefice",
"content": "The only thing -- just small thing I would add, we did say that for Q3, you should expect total growth inclusive of Alaris of at least 6%. And then you would expect a sequential step up in Q4. So you think of that step up, a portion of that is going to be Alaris. There's also the China grow-over favorable comp that we'll have, but Alaris is a portion of that."
},
{
"speaker": "Operator",
"content": "We'll go now to Larry Biegelsen with Wells Fargo."
},
{
"speaker": "Larry Biegelsen",
"content": "Congrats on a nice quarter here. Chris, I know it's really early, but love to hear your confidence in the 25% operating margin goal in fiscal 2025. And are there items right now we should be aware of, such as TSAs rolling off or an increase in the tax rate that would make double-digit EPS growth challenging next year?"
},
{
"speaker": "Christopher DelOrefice",
"content": "Yes. Thanks, Larry. Good question. Yes, first of all, to your point, it's a little early to get into 2025. TSA is not material. That's a normal dynamic that happens. As a matter of fact, year-over-year, we're down. So we're actually absorbing that already. And by the time you get through this year, it's not substantive."
},
{
"speaker": "",
"content": "The tax dynamics and things like that are evolving. We'll share more at a future date. I think the key thing is we remain committed to our BD 2025 goals. That remains unchanged. Specifically operating margin, I'm glad you mentioned that. I just think what we've delivered through the first half of this year, the momentum we have with BD Excellence through the back half of this year sets us up nicely with the strong exit rate that gives us confidence in delivering 25% by 2025. I think the big thing that you'll see is the progression from that improvement coming from largely gross margin. So we have really great momentum inside on our improving waste, improving yield in our manufacturing lines that will drive continued momentum there. And that will be a catalyst beyond 2025 as we get to the point that we talk about that, too, that will be very positive, help facilitate reinvestment and continue to drive the top line growth as well. Thanks for the question."
},
{
"speaker": "Operator",
"content": "We'll go now to Matthew Taylor with Jefferies."
},
{
"speaker": "Matthew Taylor",
"content": "So just because there's a lot of focus on the phasing and the ramp through the second half of the year. I guess, you gave us some math and some confidence in that. I was wondering if you could take the other side of the coin and maybe talk about any risks that you see to that ramp? I mean what would have to go wrong for you not to hit this express progression in revenue acceleration and margin expansion?"
},
{
"speaker": "Christopher DelOrefice",
"content": "Yes. Thanks for the question. I guess -- so 2 things. One on margin. If you think of margin, a lot of the momentum comes from 2 things like I shared, right? One, we just exit those one-timers in the first half. So high confidence that's done. It's behind us. The second thing is, our cost improvement initiatives with -- when you think of a cap and roll period and inventory, we have a strong line of sight to that, and we already know the embedded inflation dynamics that are all locked up. So we have a high degree of confidence in what's flowing through gross margin."
},
{
"speaker": "",
"content": "And then that operating margin, again, is you get natural leverage on top of that from the growth expansion in Q2, which we also feel good about. The momentum of Alaris is part of that kind of outsized back half growth. And we have a strong line of sight to that progression. So really with where we sit in the year, we're feeling good about that. Obviously, we continue to monitor the market dynamics that we touched on within the quarter. That's something that's -- we always have -- look for other levers and opportunities to deliver the full year, but that's probably the thing that we'll continue to watch."
},
{
"speaker": "Matthew Taylor",
"content": "Can I just ask..."
},
{
"speaker": "Thomas Polen",
"content": "Sure, go ahead."
},
{
"speaker": "Matthew Taylor",
"content": "I just want to ask a follow-up. You mentioned in the presentation some enhancements to Alaris and Pyxis. So I was hoping you could just talk about the importance of those submissions."
},
{
"speaker": "Thomas Polen",
"content": "Yes, sure. Happy to, Matt. So on Alaris, and we'll only share a certain level of information on those at this time. We want to keep some of that surprise for customers in the market as we actually launch them. But on Alaris, we're really happy to be back at the innovation cadence. I think when we got the clearance, not only are we happy to be back servicing our customers and driving growth and getting after remediation, but we're happy to immediately jump back into innovation cadence. And you can see our team didn't hesitate in doing that."
},
{
"speaker": "",
"content": "So the next 510(k) submission on Alaris later this calendar year will include customer benefits, such as over-the-air is planned for that, for software upgrades; advanced cybersecurity features; as well as a number of other components as well as making sure we continue to keep that file updated as part of our compliance strategy. So that's -- really excited about those."
},
{
"speaker": "",
"content": "And on Pyxis, there hasn't been a new Pyxis instrument. There's been software upgrades, but hasn't been a new Pyxis instrument, certainly since we've owned CareFusion, and I think it's been more than 15 years. And so the new Pyxis looks different. It's got -- so it's a new hardware platform that we'll be building off of. It significantly advances our cloud strategy and connectivity as well as continuing with advanced analytics as well as hardware features built into that. So it's a significant new platform that we'll be launching and investing in to continue to serially innovate upon over the next many, many years. But we're excited about the first launches of that plan for next year."
},
{
"speaker": "",
"content": "I'd say -- just say the other thing is that we do continue to invest across our connected medication management portfolio, which is obviously highly unique in the industry. And it's one of those -- we get asked the question about connected care and how we think about it because it can often be used as a buzzword. Our approach to connected care has been we look at major health care processes, and we look at how we use data and connected solutions to then transform them and what we've done in Med Management, right, from software in the pharmacy for compounding and inventory management to Pyxis on the floor to Alaris and our health site platform, which brings that site line or visibility to all the data coming from all of our systems to improve processes. It's a great example of how we're doing that."
},
{
"speaker": "",
"content": "Obviously, we talked about continuing to innovate Alaris, continuing to innovate on Pyxis, but we're also continuing to innovate on other elements of that. And we shared another good example of that earlier today. One of the upcoming launches, how we're taking now not only our Pyxis platform, but 2 of the acquisitions we made over the last couple of years, our MedBank platform, which is basically Pyxis for the non-acute, a benchtop unit and GSL. And we're putting that data now in through health sites so that people will be able to see end-to-end visibility of medications from Pyxis to MedBank to GSL, all integrated. So if you're an IDN, you're trying to manage across the care continuum as you've been acquiring assets there, right? BD is going to be a company that enables you to do that very uniquely as part of our strategy. So yes, thanks for the question, Matt."
},
{
"speaker": "Operator",
"content": "We'll go next to Matt Miksic with Barclays."
},
{
"speaker": "Matthew Miksic",
"content": "Yes, I was on mute. Sorry for that. So just one question, and it's kind of a high-level question, Chris and Tom. You talked about the sequential acceleration in growth, which is evident and the improvement in margins, which you had kind of laid out early in the year. I think when folks look at the results, we're seeing really strong margin growth and strength in the quarter. And what I just mentioned and what you described, sequential acceleration but sort of in an environment where volumes have been stronger across a bunch of med tech businesses. Maybe a touch closer to in line even after adjusting for FX."
},
{
"speaker": "",
"content": "And so I guess the good news and encouraging news around Alaris is great, some of the other business lines that you've talked about is great. Was there anything that's had a surprise on the downside, something that was -- remained challenging longer or anything you'd call out? And maybe how you see that playing out the rest of the year?"
},
{
"speaker": "Thomas Polen",
"content": "Yes, I'll take that, Matt. So no, we feel good. It fits right in line with what we -- what I described before, which was you're seeing the diversity of our portfolio, which is a real strength for the company. Where again, those -- the Medical products, Intervention, Life Science businesses that are exposed to health care utilization, health care provider space, right, the vacutainers, the diagnostic systems products, et cetera, along with Intervention and all the Medical products used in that. They're benefiting from that strong utilization and our innovation pipeline that are enabling us to offset what our transitory broad dynamics in the -- that people are seeing in the life science research space and the B2B pharma systems with some destocking, particularly in vaccines and anti-coag."
},
{
"speaker": "",
"content": "So we feel really good about those businesses as well. As I said, we're seeing strong double-digit growth right around double-digit growth in biologics and Pharm Systems. We've got a great pipeline there with key launches later this year, turning over to customers, Libertas and Evolve, for them to start doing trials on. We see in our B2B space, we're still in a market that's going through a cycle that we certainly see some positive signs on with NIH funding, having higher visibility. Overall, we're seeing the FACSDiscover now -- platform. We just launched the 3 and 4 lasers."
},
{
"speaker": "",
"content": "So that's adding access to a more cost-effective option for customers to get into that transformational technology. So we're excited by that. And we're still over delivering, I think, versus what you're seeing comps from others in some of those spaces. And so as those markets end up rebounding, again, which we see that forthcoming over time. We think we're really well positioned there as well, which is just going to help our overall growth. And again, in the meanwhile, that diversified portfolio strength is allowing us to do very well, both on revenue and clearly on a margin perspective."
},
{
"speaker": "Operator",
"content": "And that will conclude today's question-and-answer session. At this time, I'd like to turn the floor back over to Tom Polen for any additional or closing comments."
},
{
"speaker": "Thomas Polen",
"content": "Okay. Thank you, operator, and thank you, everyone, and thank you for your questions and interest in BD. We look forward to sharing our progress towards delivering our BD 2025 goals and increased outlook for FY '24 on our next call. Have a great rest of the day."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude this audio webcast. On behalf of BD, thank you for joining today. Please disconnect your lines at this time and have a wonderful day."
}
] |
bdx | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to BD's First Fiscal Quarter 2024 Earnings Call. At the request of BD, today's call is being recorded and will be available for replay on BD's Investor Relations website investors.bd.com or by phone at 800-688-7339 for domestic calls and area code +1 402-220-1347 for international calls. For today's call, all parties have been placed on a listen-only mode until the question-and-answer session. I will now turn the call over to Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations."
},
{
"speaker": "Greg Rodetis",
"content": "Good morning, and welcome to BD's earnings call. I'm Greg Rodetis, Senior Vice President, Treasurer and Head of Investor Relations. On behalf of the BD team, thank you for joining us. This call is being made available via audio webcast at bd.com. Earlier this morning, BD released its results for the first quarter of fiscal 2024. We also posted an earnings presentation that provides additional details on our business, strategy and performance. The press release and presentation can be accessed on the IR website at investors.bd.com. Leading today's calls are Tom Polen, BD's Chairman, Chief Executive Officer and President; and Chris DelOrefice, Executive Vice President and Chief Financial Officer. Tom will provide highlights of our performance and the continued execution of our BD 2025 strategy. Chris will then provide additional details on our Q1 financial performance and our updated guidance for fiscal 2024. Following the prepared remarks, Tom and Chris will be joined for Q&A by our segment presidents, Mike Garrison, President of the Medical segment; Dave Hickey, President of the Life Sciences segment; and Rick Byrd, President of the Interventional segment. Before we get started, I want to remind you that we will be making forward-looking statements. I encourage you to read the disclaimer in our earnings release and the disclosures in our SEC filings, which are both available on the Investor Relations website. Unless otherwise specified, all comparisons will be on a year-over-year basis versus the relevant period. Revenue percentage changes are on an FX-neutral basis unless otherwise noted. When we refer to any given period, we are referring to the fiscal period unless we specifically noted as a calendar period. I would also call your attention to the non-GAAP reconciliations included in the appendices of the press release and earnings presentation. With that, I’m very pleased to turn it over to Tom."
},
{
"speaker": "Tom Polen",
"content": "Thanks, Greg. Good morning, everyone, and thank you for joining us. Earlier today, we reported our results for the first quarter. Overall, we executed Q1 as expected. Total revenue growth was largely in line with our expectations. And on the bottom line, adjusted EPS was ahead of our expectations due to good execution on our margin goals through our BD Excellence operating system and the timing of discrete tax item. Also consistent with our plan, we delivered very strong growth in cash flow that positions us well to deliver another year of growing free cash flow double-digits. I want to thank our team of over 70,000 associates for the strong execution, agility and unrelenting determination to deliver for our customers, patients and shareholders. These results give us the confidence to increase our FY '24 guidance. Turning to our BD 2025 strategy. During Q1, we continued to execute well against the five actions we outlined at our Investor Day to drive profitable growth and value creation. This includes continuing to advance our innovation pipeline which supports our durable 5.5% plus targeted revenue growth profile. We remain focused on advancing innovation in high growth areas, anchored against three irreversible forces we see reshaping healthcare today and over the next decade, connected care, new care settings and chronic disease. Specifically in Q1, we made meaningful progress achieving several key R&D milestones for technologies that position BD as key enablers of care shift in new settings. In our PureWick portfolio, which is now the market's leading platform for non-invasive urine management in a billion dollar market growing double-digits. We started our randomized clinical trial pilots for PureWick Female to generate evidence to support future at-home reimbursement. Our PureWick program is progressing well and we remain on track to launch our next-generation Female External Catheter later this fiscal year, which will provide a better patient experience in a more dignified way for women to manage their urinary incontinence. In Q1, we received 510(k) clearance for our new BD MiniDraw Capillary Blood Collection System. Based on a recent study, two-thirds of patients prefer MiniDraw's finger-stick collection in a retail setting over a previous experience with the traditional Venous blood draw. Since it does not require a phlebotomist, MiniDraw can expand access to sample collection for several routine blood tests to new settings such as retail clinics and pharmacies. And lastly, in molecular diagnostics, we initiated clinical trial enrollment for the BD Elience Point-of-Care Molecular platform. In our first assay, a rapid CT/GC test for in-office testing and treatment. BD Elience enables BD to enter into the high growth molecular point-of-care market. We continue to see molecular diagnostics as a strong growth catalyst as evidenced by double-digit growth this quarter in our BD COR and BD MAX platforms where we continue to leverage our growing installed base through menu expansion with more than 20 assays currently available on BD MAX. Both NextGen PureWick and BD MiniDraw are on track to launch later this fiscal year and we anticipate our first 510(k) submission for the BD Elience system and our first assay this fiscal year as well. Regarding Alaris, servicing our customers and bringing all Alaris pumps in the field up to the cleared standard remains our priority. Customer response has been very positive with strong momentum, engaging with customers. And while it is still early in the process, I'm pleased with our progress and as we recently shared, we now believe $200 million as the floor on revenue in fiscal '24. We are also executing well on our broad simplification strategy to drive margin expansion and a double-digit base EPS CAGR through FY '25. This includes accelerating adoption of our BD Excellence Operating System, which focuses on the application of lean principles to drive excellence everywhere, every day across our plants and business and is driving productivity gains across our operations. In FY '23, we held 18 week-long Kaizen events. And in Q1 FY '24 alone, we executed as many, a trajectory, which will continue through the rest of FY '24. We've deployed this mindset outside of our factories, driving greater efficiency through the organization at all levels. Our BD Excellence Operating System is an important new capability we're building to drive a world-class culture of continuous improvement and lean management throughout BD. We also progressed our Project Recode initiatives including our network optimization effort to drive plant efficiencies. We have multiple site consolidations either completed or underway to reduce our footprint by approximately 20%. The combination of BD Excellence with our recode network architecture program is supporting our FY '24 goals, contributing to our plan for 25% operating margins in FY '25. And also, now providing visibility for continued margin expansion beyond FY '25. We're also seeing our systematic focus on cash flow continuing to yield results. Through working capital efficiencies and our BD Excellence Operating System, driving more efficient CapEx spend, we delivered over $850 million in operating cash flows in Q1. This strong execution to start the year positions us well to deliver double-digit growth in free cash flows in FY '24 and positions us to capitalize on M&A opportunities in higher growth categories and opportunistically return cash to shareholders. Lastly, our teams around the world continue to make meaningful advancements on our ESG strategy. Just last week, we announced a collaboration with the Kenyan government to advance access to critical cancer diagnostics for women in Kenya through self-sampling, furthering our commitment to expanding health equity and access around the world. We see the power of the cell sampling model is applicable across other underserved markets, as well as in the U.S. In summary, I'm pleased with the progress we made in Q1 and the solid margin execution, which enables us to raise guidance for fiscal 2024. With strong progress of our innovation pipeline and growing momentum from BD Excellence and our simplification programs, we believe we are well positioned to achieve our BD 2025 goals. With that, let me turn it over to Chris to review our financials, guidance and outlook."
},
{
"speaker": "Christopher DelOrefice",
"content": "Thanks, Tom, and good morning, everyone. As Tom noted, we executed well against our performance goals in Q1. Q1 revenue growth was largely as we expected and I'm pleased to share we exceeded both our margin and earnings goals and delivered strong cash flow that positions us well to support our double-digit free cash flow growth goal. I'll now provide some insight into our revenue performance in the quarter. Additional detail can be found in today’s earnings' announcement and presentation. Q1 revenue was $4.7 billion with organic growth of 2.4% that was driven by high-single digit organic growth in BD Interventional and solid growth in BD Medical with China market dynamics playing out as expected, partially offset by a decline in BD Life Sciences, which was impacted by the comparison to the prior year respiratory season. As expected, China and respiratory were the primary drivers of Q1 revenue growth under indexing our full year goal. The respiratory season alone impacted total company growth by about 150 basis points. Regionally, organic growth was driven by the U.S., EMEA and Latin America, partially offset by the expected decline in China. Total Q1 revenue growth of 1.6% reflects the divestiture of our surgical instruments platform. Turning to the segment performance. BD Medical revenue totaled $2.2 billion in the quarter, growing 2.4%, driven by growth and medication management solutions and pharmaceutical systems, min-single digit growth in MMS was led by strong performance in dispensing, driven by innovations in our BD Pyxis portfolio that are improving nursing workflows and efficiencies. In our infusion business, we are pleased with our strong progress, bringing the BD Alaris Infusion System back to the market and continue to expect Alaris to ramp over the course of the year. Infusion also reflects strong demand for IV sets. Performance in Pharmacy Automation reflects the comparison to an outsized quarter in the prior year and the timing of planned capital installations. Growth of 3.4% in Pharmaceutical Systems was in line with our expectations and was led by strong double-digit growth in pre-filled devices for biologics and as expected, was partially offset by customer inventory dynamics, including a slowdown in demand for anticoagulants. Growth in Medication Delivery Solutions was about flat and slightly ahead of our expectations. Our Vascular Access Management strategy continues to drive strong performance particularly in Catheter Solutions. As expected, MDS growth was impacted by market dynamics in China including volume based procurement, which continues to play out within our expectations. BD Life Sciences revenue of $1.3 billion declined 2.5% which reflects a decline in IDS as a result of a tough comparison in the respiratory season worth nearly 500 basis points. It was partially offset by strong growth in biosciences. Performance in IDS reflects the tough comparison in respiratory testing that was partially offset by high-single digit growth in our Microbiology platforms and double-digit growth in Molecular IVD assays on both our BD MAX and BD COR platforms. Biosciences grew 5.7% as expected despite a strong comparison in the prior year. BDB performance was driven by strong mid-single digit growth in our research and clinical platforms that reflects double-digit growth in research instruments, driven by strong demand for our recently launched BD FACSDiscover S8 Cell Sorter and double-digit growth in Clinical Reagents as we continue to leverage our growing installed base of FACSLyric and FACSDuet solutions. BD Interventional revenues totaled $1.2 billion in the quarter, growing 4.7% and 8.4% organic, which excludes the impact of the surgical instruments divestiture. BDI organic growth was led by surgery and UCC. In surgery, double-digit organic growth was led by continued market adoption of our leading Phasix resorbable hernia products in our advanced repair and reconstruction portfolio and strong demand for our ChloraPrep infection prevention solution. High-single digit growth in urology was led by strong double-digit growth in our PureWick chronic incontinence solutions with continued strong demand in both the acute care and home care settings. Mid-single digit growth in PI was in line with our expectations and reflects growth across the portfolio. It was partially offset by the expected timing of distributor orders. In our peripheral vascular disease platform, we continue to drive market penetration with our Rotarex Atherectomy System and our Venous portfolio. Performance in our oncology business was driven by growth in biopsy, including strong market acceptance of our recently launched BD Trek powered bone biopsy system. Now moving to our P&L. Adjusted gross margin of 51.1% and adjusted operating margin of 20.2% were ahead of our expectations due to good execution on our margin improvement goals across our portfolio of simplification initiatives and strong SSG&A expense leverage. R&D spend was in line with our expectations. In addition, as we previously shared a discrete tax item that was contemplated in our full-year tax rate was realized in Q1. As a result of these items, we exceeded our Q1 operating income and our adjusted diluted EPS expectations, resulting in an EPS of $2.68. Regarding our cash and capital allocation, Q1 cash flows from operations totaled over $850 million. This reflects continued improvements around working capital, including good management of inventory levels, continued discipline around CapEx investments and leveraging our fixed asset base as a result of the benefit from our simplification programs and BD Excellence Operating System. We remain focused on free cash flow conversion and expect another step improvement in FY '24. As we execute against our BD 2025 strategy, we also remain well positioned to achieve our long-term cash conversion target of around 90%. Beyond our investments in growth, we returned $775 million in capital to shareholders, including dividends and $500 million in share repurchases. We ended Q1 with a cash balance of $1.2 billion and a net leverage ratio of 2.7 times. Moving to our updated guidance for fiscal '24. For your convenience, the detailed assumptions underlying our guidance can also be found in our presentation. Based on our Q1 performance, including the strong momentum in many parts of our business and progression of our margin improvement initiatives, we raised the midpoint of our FY '24 organic revenue growth guidance, and raised our adjusted EPS guidance, increasing the midpoint by $0.09. The increase to adjusted EPS reflects Q1 operational outperformance and a small improvement in FX. As a result, we now expect to deliver organic revenue growth of 5.5% to 6.25%, which increases our midpoint to slightly above 5.8%. We now expect adjusted diluted EPS, including the impact of currency to be in a range of $12.82 to $13.06, which reflects about $12.94 at the midpoint. Regarding foreign currency based on current spot rates, for illustrative purposes, currency has improved modestly and for the full year is now estimated to be a headwind of approximately 25 basis points to total company revenues and approximately 360 basis points to adjusted EPS growth on a full year basis. As you think of phasing over the balance of fiscal '24, the following are some considerations. First, we continue to expect organic sales growth to be higher than our full year range in the second half, partially driven by the expected ramp in Alaris along with the easing of prior year comparisons, such as China. Second, our updated guidance reflects an improved margin cadence over the balance of the year. Specific to Q2, adjusted gross margin is in line with our prior expectation and continues to reflect significant sequential improvement given the lessening impacts from inflation, prior year inventory reductions and FX. We now expect Q2 adjusted operating margin to expand by 25 basis points to 50 basis points year-over-year, driven by our continued margin improvement efforts and continued leverage in SSG&A. Third, the discrete tax item realized in Q1 was largely a shift from Q2 and results and revised phasing of our full year effective tax rate. Based on this timing dynamic, we currently expect our Q2 tax rate to be nearly 17%. We expect strong operating performance to offset the tax phasing impact, and as a result, there are no changes to our expectations for Q2 adjusted earnings per share. Lastly, we remain confident in delivering about 50 basis points of adjusted operating margin improvement for the year. As a reminder, the first half inventory impact is transitory and behind us as we exit Q2. And as FX and inflation moderate at a meaningful rate to the back half, coupled with a continuation of the first half margin improvement, we expect to deliver from our strong simplification portfolio, we can naturally achieve our second half margin goals. In summary, based on the strength of our portfolio and new innovation, we have clear line of sight to deliver our FY '24 revenue guide which at the midpoint is above our 5.5% plus target and results in a three year CAGR of nearly 7% growth. I'm pleased with the continued strong execution by our talented organization to start the year, which supported over delivering on our margin and operating income goals and increasing our earnings outlook. With a strong quarter of cash flow, we remain well positioned to deliver another year of double-digit free cash flow growth, which increases our capacity to support additional value creating opportunities including M&A. We remain well positioned to continue to deliver against our BD 2025 strategy and financial targets. With that, let's start the Q&A session. Operator, can you assemble our queue?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Thank you. And our first question will come from Rick Wise with Stifel. Please go ahead. Your line is open."
},
{
"speaker": "Christopher DelOrefice",
"content": "Good morning, Rick."
},
{
"speaker": "Rick Wise",
"content": "Tom, hi, Chris. You used the word confidence repeatedly, and just picking up on that, heading into the quarter, we know you were very clear about things like currency and the peso divestitures, the flu benefit, if you will, time shift, but the setup and your new guidance clearly says that the rest of the year, we're going to see accelerating organic growth second half, I think your language in the slide, above full year guide. Help us, maybe you could talk in little more detail about the drivers of sales acceleration than the things that are most critical to creating that outlook that you're feeling confident about."
},
{
"speaker": "Tom Polen",
"content": "Yeah. Thanks for the question, Rick, and good to connect. So, as you said, Q1 played out as expected, total revenue growth was largely in line with our expectations, as you said, there were really two factors that we recognize we're going to be playing out in Q1. One was the flu compare given the large kind of early timing last year that was about 150 basis points that we knew was going to happen and then value-based procurement in China. And those two factors played out actually exactly as we expected in China, in fact that we were watching that and we saw VOBP stay focused within MDS which was just our assumption. We had really strong growth in BDI within the quarter, double-digit, mid-teen growth, high-single digit growth in life sciences and so we saw that play out. China actually did a little bit better than budgeted in Q1 and so we feel good that that's going to continue to play out for the year. I think, as we also think about the back part of the year to your question, something else we are looking at as we started and gave guidance to begin, '24 was, of course, Alaris. We were really pleased to have Alaris back with new improvements. Our new 510(k), it's a big deal to be back servicing our customers fully. It's a great product and highly unique and so, of course, Q1 was really the first quarter with Alaris relaunched and our team backed it proactively upgrading and remediating our base and we wanted to get feedback and engagement. And it's been quite positive, and I think that part also, as we look ahead, that confidence in those early engagements and the progress we're making is what's led us to also comment that we're seeing now $200 million as the floor for the year. In the other aspects, as you think about the growth drivers that we've been talking about and we often call out six specific platforms, we saw a really great growth in PureWick this quarter. Pharm systems, we have signaled very clearly the anticoagulant topic that was going to create a slower compare or slower growth in Q1. We're seeing the underlying business there do really well. Biologics grew double-digits in the quarter. Flow playing out, strong demand for FACSDiscover, Molecular double-digit growth as you heard in the prepared remarks, Peripheral Vascular and Pharmacy Automation, those trends in the marketplace continue with strong outlooks for those businesses. So again, we saw very clearly the two factors that we knew were going to impact us in Q1 and they played out as expected. Chris, any other comments to add."
},
{
"speaker": "Christopher DelOrefice",
"content": "I mean, just, sometimes, it's easier just play bigger picture right. I'm sure you're looking at our balance to go plans which we are very confident into Tom's point. We've expressed confidence in Alaris and establishing a floor now. I think the Alaris dynamics important. If you look at the balance to go, it's about 7% revenue growth. Last two years, we delivered right around 7%. This year, actually, if you think about it, Alaris is going to cycle over medical necessity. It's not a significant contributor to growth in the first half despite seeing very strong progress, but what that does is it adds about a point to growth more in the second half, right? So, we see really good momentum there. So when you think of sort of Alaris adjusted, you're at six and we cycle over the China compare in Q4, which have declined as well. So, I think plans are intact, the strong underlying fundamentals in kind of these six key areas we keep pointing to, like, Tom mentioned in biologics are well positioned and feel good about the rest of the year."
},
{
"speaker": "Tom Polen",
"content": "Thanks for the question, Rick."
},
{
"speaker": "Rick Wise",
"content": "Yeah. And just as a follow-up, I'd ask about the EPS guide, the $0.07, Chris, I think, I'm calculating correctly, you beat operationally EPS. You've raised $0.09 at the midpoint for the full year. Talk about your confidence in that driving that midpoint EPS raise. Again, how margins are -- in more detail, are going to, or mix or volume are going to help you get to those EPS targets? Thank you."
},
{
"speaker": "Christopher DelOrefice",
"content": "Yeah. Thanks, Rick. Yeah. We were definitely pleased with the margin progression and operating income delivery Q1 and it was strong and exceeded expectations. We basically passed that through to your point. The other thing we did is we actually accelerated margin improvement in Q2 by about 25 basis points to 50 basis points, so de-risks the back half of the year. We did that on a couple of things. Whenever you start the year, you want to ask -- you want to see a couple of things. One, to recall some of these transitory headwinds like China. We knew we had a transitory item in inventory that hit us in the first quarter that was 200 basis points. We have outsized FX in the quarter. All those played out as expected and we have stronger delivery on calling inflation dynamics and more importantly, our margin improvement program. So, we continue to accelerate those. We've had two years now of consistent track record of delivering against our margin expectations, back to pre-pandemic levels 400 basis points over two years. If you look at our margin progression throughout the year, basically, with these transitory items behind you, the level of cost improvement we delivered in Q1 alone with moderating outsized inflation through the back half of the year. It goes from nearly -- in Q1, we said it was almost 2x what we're calling for the full year and outsized inflation 100 basis points. It cuts in half in Q2 and then moderates in the back half. So, we just have to keep executing against our margin improvement portfolio, which is really strong. And that's what gave us confidence with the Q1 performance and our ongoing programs to raise for the year and we're focused on executing against that."
},
{
"speaker": "Rick Wise",
"content": "Thanks, Chris."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Travis Steed with Bank of America. Please go ahead. Your line is open."
},
{
"speaker": "Travis Steed",
"content": "Hi. Thanks for taking my question. I'll take the first question on revenue. Just curious if there's anything to call out in some of non-flu areas, pharm systems MMS. If you think kind of growth outlook, they are still on track with your expectations, and the decision to raise the revenue guidance. Just curious, what's giving you the confidence at this stage to go ahead and raise that revenue guidance at this point."
},
{
"speaker": "Tom Polen",
"content": "Yeah, Travis. This is Tom. Thanks for the question. Good morning. So, on pharm systems specifically, again, as I mentioned, we saw that play out as expected with the impact of the one customer that we mentioned in anticoagulants and strong underlying growth beyond that, again, double-digit growth in biologics. Our capacity continues to -- those investments that we made continue to play out as expected. We have capacity to meet customer needs, and we're engaged very actively in that space. And as we think about the slight raise on revenue, again, we feel really Alaris the floor of 200, as we see now for the year based on, again, early engagement with customers. We thought that was prudent to do given our outlook in that space. I don't know, Mike, if you have any other comments to add."
},
{
"speaker": "Michael Garrison",
"content": "Just also commented in addition to the double-digit demand in biologics, we've been pretty successful in terms of entering, the development agreements for future pipeline of molecules in this space, our innovation portfolio around Hypak and Neopak, and also the wearables portfolio with Libertas and above that continues to progress really well and additional developments -- development agreement in this area are occurring. We've described the pharm systems business is a high-single digit grower, going back to Investor Day and we continue to see that in '24. It's our expectation, despite any early part of the year headwinds."
},
{
"speaker": "Travis Steed",
"content": "Great. And last question, Chris, just on margin in Q1 was a nice kind of core outperformance on margins in Q1, especially without the revenue upside. Just curious kind of go through what got better in Q1 on the margin side and confidence, and what gets better if you think about that 300 basis point step-up in margins from Q1 to Q2, just to give some confidence that that 300 basis point step-up sequentially is achievable?"
},
{
"speaker": "Christopher DelOrefice",
"content": "Yeah. Thanks, Travis. So, first of all, in the quarter, it wasn't one thing. I'd just say execution is kind of the theme here, organization is hyper focused consistent with what we've done is predominantly our cost improvement programs. We had some mix benefit as well which has been part of our strategy on portfolio as well. So, all of that, I would say, the headwinds kind of played out as expected and we over delivered through good focus, execution on our margin improvement initiatives. To your point, the Q1 step-up, the step-up from Q1 to Q2 about 300 basis points that we've signaled. If you think of it this way, again, we had two, what I would call, pretty transitory items in Q1. We have the outsized FX, coupled with the inventory reduction in absorption dynamic. Those two items alone as you head into Q2 are about 30%, so as we're 400 basis points. They're only about 30% of that value in Q2. So, you pick up momentum there, coupled with the fact that the outsized inflation, which was almost 2x, what we call, for the year in Q1. It starts moderating significantly almost in half in Q2 and then it further moderates by the back half of the year. So really, it's just cycling over those kind of one-time items, outsized inflation moderating back and us continuing to deliver what we already delivered in Q1. So, we're confident that that progression continues. With that, you naturally get the sequential step-up that we're driving towards. And again, feel good about our operating margin, which is why we improved our phasing increased Q2 and feel good about the line of sight we have to the back half of the year."
},
{
"speaker": "Travis Steed",
"content": "Super helpful. Thanks, Chris"
},
{
"speaker": "Operator",
"content": "We'll take our next question from Vijay Kumar with Evercore ISI. Please go ahead. Your line is open."
},
{
"speaker": "Vijay Kumar",
"content": "Good morning, Tom, and thanks for taking my question. My first one, Tom, if I just look at Q1 organic 2.4 right? A lot of questions on, look utilization is strong. Why is this optically 2.4 well below medtech sort of trends we've seen so-far. Can you help us bridge? I think you mentioned 150 basis points of respiratory, does that include COVID? I think you mentioned China. What was the China impact in Q1? I think you mentioned some timing elements, customer orders. What was that impact? And Alaris, it looks like it was not a contributor to growth, so maybe just help us draw bridge between the 2.4 and what it should have been without some of these underlying one-time items?"
},
{
"speaker": "Tom Polen",
"content": "Yeah. Great question, Vijay. Maybe just those two items that we've referenced, from the start of our guide, flu and China. Those two combined, if you take those out, it's about 5% underlying growth, just excluding those two items. So, those are quite significant. If you look at procedure volumes, etc., you're seeing that flow through in the base business where those two items aren't, so as an example, if you look in Interventional, you'll see that very strong growth in surgery, right, double-digit growth, which is getting the benefit of procedure volume. We're seeing in UCC, 9% growth there as an example, solid in PI, a little bit of inventory timing there, but we're seeing those factors play out. Again I’d concentrate on those two topics, which again played out as we expected. The large flu compare just given the early timing last year in China, underlying was about five. Chris, do you have any comment?"
},
{
"speaker": "Christopher DelOrefice",
"content": "No. Just I mean on Alaris, Alaris played out as expected actually. Again, what we've highlighted is, it was going to be a journey as you think of the natural progression of engaging with customers and the natural kind of life cycle of then placement, revenue recognition, etc. We're actually very pleased with our progress there. And as a matter of fact, right, we declared the $200 million more of a floor that was part of what gave us confidence to increase the low end of the revenue guide. And so we're continuing to focus on executing there and that was as expected on the flip side, what it does is, in the back half of the year, gives you almost basically a full point of growth tailwind that will help, which so, when you look at the back half, think of that or kind of moderate the expectation that you're seeing around feeling like that growth is outsized versus the front half of the year. It's as expected with the ramp we were expecting on Alaris."
},
{
"speaker": "Tom Polen",
"content": "Yeah. I will turn it to Mike here. I think it's -- obviously, this is the first quarter that we've relaunched Alaris. And so the focus is first on engaging customers, getting agreements in place for remediation and upgrades. And that those are the key metrics that we look at in the first quarter of launch because that's what's indicating how the revenue is going to evolve in the back half of the year and that's what we, right, are feeling good about."
},
{
"speaker": "Michael Garrison",
"content": "That's right. And just to remind that last year, we had the Certificate of Medical Necessity, how we were shipping, we're not doing that now. So, it becomes more like a step over to get to there, and then growth on top of that, so that's what we're seeing in first quarter. So, it's actually, starting from ground zero in terms of selling process and ramping it up. I actually feel really good about that. I feel really pleased with the way our manufacturing ramp-up has gone and that scale-up is going quite well. So, we're able to supply product to our customers. I think the customer response, yeah, they're recognizing that, Alaris is almost like a different system. It's a different category in a way it's, the power of one with all the infusion modalities as a single system, the most advanced interoperability in the category, 750 live sites, order of magnitude more than anyone else. Yeah, so, it's almost being recognized a little differently that way, so that's good. And we have sort of exceeded, we set certain expectations, we've exceeded those relative to return to market in terms of upgrading the fleet in the field. So, it's early, but I think the way things have progressed, that's what -- those are the sort of the elements that led us to build confidence to say that we think 200 is the floor."
},
{
"speaker": "Vijay Kumar",
"content": "That's helpful. And Chris, maybe one quick one for you. The margins still imply a 300 basis point step-up in back half versus your 2Q levels. Can you just talk -- I think inflation was part of it, but just maybe a similar bridge on margins from the '23 to '26 and back half?"
},
{
"speaker": "Christopher DelOrefice",
"content": "Yeah. Again, it's basically a continuation of Q2 when you move out of Q2, both FX, the inventory dynamic goes completely away, which is almost 75 basis points still in Q2, so right off the bat, you pick that up as you move through Q2. That's probably the biggest item FX continues to moderate. We have reasonable signals on FX, obviously can continue to move, but that moderates down. The other thing is outsized inflation moves from about 100 basis points, which is our full year average in Q2 that further moderates down significantly. And then again, if you just continue the cost improvement and margin improvement initiatives, we already executed in Q1 throughout the year, it gets you to where we need to be from a margin standpoint."
},
{
"speaker": "Vijay Kumar",
"content": "Fantastic. Thanks, guys."
},
{
"speaker": "Christopher DelOrefice",
"content": "Thanks, Vijay for the question."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Larry Biegelsen with Wells Fargo. Please go ahead. Your line is open."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Good morning. Thanks, for taking the question. Mike, why would medical growth in fiscal '24 be in line with the corporate average given the tailwinds in MMS and pharm systems, you just said you expect pharm systems to grow high-single digits in 2024, so what are the expectations for MMS and MDS this year. Last year, Medical was 90%, was above the corporate average."
},
{
"speaker": "Michael Garrison",
"content": "Yeah. So for -- I'll talk first about, MDS. The business is actually showing really good momentum underlying which is masked a little bit by the impact of VOBP in China. So, that VOBP is a headwind for the year. Yeah. It's playing out as we expected, and built into our plan, but we're seeing strong momentum in the U.S., strong momentum, in catheters, and somewhat, driven by some of the new recent product launches that we've had. Site-Rite 9, Nexiva, NearPort, PIVO Pro, yeah these advancements are working out in the field and being very attractive to customers as we advance the One-Stick Hospital Stay vision. We're also watching injection systems and hypodermic. We're aware of some of the recent recalls, agency action in this area and we've ramped our capacity prepared to serve if market needs arise in the U.S. So, that's sort of, MDS. From MMS perspective, the way that I'm sort of seeing it and thinking about it as infusion sort of returning to be a contributor to growth versus maybe flat to a drag with return of Alaris. And then also, we're really excited for, very soon, our upcoming market release of the ex-U.S. infusion system BD neXus. Our dispensing business continues to perform very well. It's got solid growth both in the quarter, in hospital and alternate site. Our MedBank acquisition grew double-digits in the quarter, and continues to expand our presence in non-acute settings. So, I feel good about that. Pharmacy automation that proposition continues to resonate really well for both ROWA and Parata. As we noted previously and in the presentation, this quarter, last year was actually Parata's strong Q4 finish for their fiscal year. So, created a bit of a tough compare. This was expected and our timing ramp of installs is weighted more towards the back half. So, those are sort of the things that, give me confidence around, MDS and MMS."
},
{
"speaker": "Lawrence Biegelsen",
"content": "That’s helpful. And Tom, China was down 5% in this quarter in Q1. Talk about what you're seeing there and you're confidence. I think in the past, you said you expect China to be flat to up low-single digits this year. Thanks for taking the question."
},
{
"speaker": "Tom Polen",
"content": "Yeah. Thanks, Larry. That expectation remains unchanged. China played out essentially exactly as we expected in the quarter was a little bit favorable to budget. What we saw and what we expected was VOBP, as Mike described, specifically within MDS which is where it's remained, we didn't see it expand to other areas at all. We're not seeing that it's -- our view is as we had projected. And we also expected to see strong growth in BDI which we've had over the last several years. We saw that play out in the quarter, mid-teens growth in BDI in Q1 and we saw solid growth, high -- very high single-digits on the cusp of double-digit growth in Life Sciences in China. And so that base business in China is continuing to do well. We'll -- we saw VOBP start in the back half of last year. And so again, that's going to become a tailwind for us as we think about compare in China as we go over that, so. Thanks for the question."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Thank you."
},
{
"speaker": "Christopher DelOrefice",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Robbie Marcus with J.P. Morgan. Please go ahead. Your line is open."
},
{
"speaker": "Robbie Marcus",
"content": "Great. Thanks for taking the question. I wanted to ask, I know we're in fiscal '24 here, but wanted to look out to '25, and based on operating margin guidance, it implies about 100 basis points expansion next year to get to your long range plan target. So, I'm sure the answer is pretty similar to the '24, but how do we think about the implied about 100 basis points next year and your confidence in that?"
},
{
"speaker": "Christopher DelOrefice",
"content": "Yeah, Robbie. Thanks for the question. Actually, at J.P. Morgan, as you know, we outlined a strong plan outlining all of our margin improvement initiatives. I think gross margin is the next stage of accelerated focus for us and we already have a great pipeline of margin improvement initiatives there through Project Recode, right? We actually already completed our 20% goal SKU rationalization. We're actually going to go further there. The network architecture, Tom, highlighted in our prepared remarks the strong progress there with initiatives underway that reduced our network by 20%. As a matter of fact next year, the network architecture value we get out of that actually doubles going into '25, you're going to really start seeing the benefits of that. BD excellence is another one. We're getting great traction this year. It's part of the momentum we have in this year on margin that will continue into next year. You also have the Alaris dynamic. As that fully ramps up and scales, we'll get margin leverage there. So, all those things coupled with the continued strong growth profile of being able to consistently do 55 plus which we've been well above gives us strong confidence in 2025 and the 100 basis points, as a matter of fact, as we exit this year. Doing everything we did, we really should be well positioned to carry that kind of momentum into next year. It's premature to kind of make a formal commitment and manage all the puts and takes but certainly high confidence in the '25 and great momentum there."
},
{
"speaker": "Tom Polen",
"content": "And maybe, Robbie and good morning. Just to add to Chris's good comments, I think another way just to think about it is, as we've launched BD 2025 in '22, it was a four-year road-map ahead, right? And so, the end of '24 will be 75% of the way through BD 2025. As you think about the margin number that we've set out as our guide for FY '24, that's 80% of the way through our margin goal, right? So from a timing perspective, 75% of the way through BD 2025, 80% of our margin goal, we are clearly on track, slightly ahead. And we're seeing really good momentum in our programs as evidenced this quarter. I think you've heard us talk about BD excellence. Obviously, as we started BD 2025, our focus was let's get Alaris back. Number one, take those learnings, apply them across the company to make sure we're building capabilities. Second was optimize our portfolio for growth spinning back up. Obviously, we sold the V. Mueller. We drove tuck-in M&A that's driving accretive growth, we rebalanced our R&D into high-growth spaces. And we've built our portfolio simplification programs starting with Recode which are on track and you're seeing those play out. Along the way and starting last year, we began to develop capabilities for BD Excellence, right? And it's our operating model -- operating system to drive a whole new scale of lean capabilities across the company. And last year, we had thousands of associates across the company engaged in BD Excellence. This year, we're really pressing the pedal on that program now as we've made progress on those first three areas that I mentioned. And so, as we said in the prepared remarks, if you think about the Kaizens that we did all of last year through BD Excellence, we did just as many in Q1 of this year just completed and that's going to continue to scale as we go through the year. And so, we see really good momentum there. It's giving us visibility not only on our '25 margin goal, those we also indicated, it's giving us visibility beyond '25 to continue, margin progression as we look ahead. So, thanks for the question, Robbie."
},
{
"speaker": "Robbie Marcus",
"content": "Great. Really helpful. Just a quick follow-up. China VBP is a headwind you've talked about. How do we think about where that's hitting each of the business units and the size, just so we can, kind of try and back out that headwind in our models? Thanks."
},
{
"speaker": "Tom Polen",
"content": "Hey, Robbie. It's almost all within MDS specifically. Essentially, it is all within MDS. That's where we see it, so."
},
{
"speaker": "Robbie Marcus",
"content": "Great. Thank you."
},
{
"speaker": "Tom Polen",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Patrick Wood with Morgan Stanley. Please go ahead. Your line is open."
},
{
"speaker": "Patrick Wood",
"content": "Amazing. Thank you. Two quick ones. I guess the first is Pharmacy Automation completely get the timing of year end and that side of things, but just curious, how you think things on orders, whether it's like order mix and kind of the outlook for the rest of the year based on, what you're hearing from the customers right now from the order book?"
},
{
"speaker": "Michael Garrison",
"content": "Yeah. I'll take that. So for pharmacy automation, yeah, we feel really good on that, like I mentioned, the tough compare because, they were incentivized Parata and the team there was incentivized to finish their Q4 strong. So, they had already lined up installations last year for their finishing. They had a record for them quarter last year. So, it's a little bit of a tough compare. Order book looks good, especially in the sort of Retail Long-Term Care channels. Yeah. And we continue to leverage our BD Salesforce to talk to our acute-care customers about starting to transform the pharmacy in the acute care with our IDN customers. So, we see that continuing to grow throughout the year. Overall, it's been -- yeah, we've described it as sort of a low double-digit grower, and that's sort of what we have projected and expected for the rest of the year."
},
{
"speaker": "Patrick Wood",
"content": "Brilliant. And then maybe quickly one either you, Tom or Dave. Elience, Molecular Point-of-Care is obviously a very fast growing but very competitive market. Just curious, how you're seeing that product fit in, the interplay between like high and low plex? Just curious, how you're going to fit into that market? Thanks."
},
{
"speaker": "Tom Polen",
"content": "I turn that to Dave. Thanks for the question, Patrick."
},
{
"speaker": "Dave Hickey",
"content": "Thanks, Patrick and for picking up on Elience. Just take a step back. If you look at the molecular dynamics overall, we have said that this is one of the sort of six growth drivers for BD, right? So, we continue and if you look at the divergence of the market, there is real thesis playing out in terms of the way customer evolution will happen, right? So you think about the centralization of high-volume molecular cervical cancer testing, we satisfy that with BD COR. You think about BD MAX in the acute setting, and we're seeing good, as you heard Tom say in the prepared remarks, good double-digit growth there. But clearly, there is decentralization of relevant testing to the point-of-care and these new care settings. And obviously, Elience will be our entry there in this sort of high, you know, single-digit market. If I think about it specifically on Elience, the way to think about it is, what is different about it? Our goal here will be that we would anticipate it to be CLIA-waived giving critical results, within less than 15 minutes but can be used in a wide variety of settings. What is the unmet need that it will actually address and deliberately, we've actually selected CT/GC as our first assay because when you look at all the CDC and NIH reports, there is an increasing burden of STI. So, it will increase access to testing. And I think about it now, if you're one of those unfortunate patients and you're in the clinic, you could get that result diagnosed and a potential treatment administered while you're in a clinic in a decentralized setting. So, deliberately, we think CT/GC is really the right assay to lead with. And then, of course, because of the capabilities and these less than 15 minute results, we see a strong roadmap behind it, you know, focused on respiratory assays, other STI assays, vaginitis, etc."
},
{
"speaker": "Tom Polen",
"content": "Yeah. That testing treat concept with 15 minutes or less time to [Multiple Speakers] core component."
},
{
"speaker": "Patrick Wood",
"content": "Love it. Thank you."
},
{
"speaker": "Tom Polen",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Patrick Miksic (ph) with Barclays. Please go ahead. Your line is open."
},
{
"speaker": "Tom Polen",
"content": "Good morning, Patrick. Sorry, Matthew."
},
{
"speaker": "Matthew Miksic",
"content": "This is Matt. It's okay. Just a couple of follow-ups on some of the factors that, play through Q1, you talked about last quarter and I have one follow-up. One was, obviously, a lot of detail and questions that came after around the peso and around wages. If you could just sort of -- you know, It sounds like you're most of the way through that and during Q2 and just maybe a quick update on that. And then the anti-coagulation business in China. I think there was something that you were hoping was going to find -- that capacity would find a new home, perhaps in this quarter or next quarter and an update on that. And then just one follow-up if I could."
},
{
"speaker": "Christopher DelOrefice",
"content": "Yeah. It's Chris. Thanks, Matt, for the question. Appreciate it. Yeah, when we started the year, we talked about kind of the inflationary dynamics and supply-chain. One of the biggest ones that we were still seeing play out through the year was wage dynamics in our supply-chain organization, that continues but it's playing out as expected. So, nothing new there. Regarding FX, good news is moderately favorable. We passed through both the revenue and earnings on that. So, stable at this point and moving in the right direction. We'll continue to watch it, and I think we're happy with the operational performance in passing through both the $0.07 operational beat and the $0.02 of FX."
},
{
"speaker": "Matthew Miksic",
"content": "And maybe Mike for pharm systems."
},
{
"speaker": "Michael Garrison",
"content": "Yeah. For pharm systems, that the capacity that's freed up for anti-coagulants, there is, some of it where the teams are, hunting for home for that. And there's been some success there, but I think we also just took a strategic decision to look at the anticoagulant market overall and it returning to more of a post-COVID normalization there and our converting lines over to biologics to help accelerate our ability to have capacity to serve in that area and that's playing out pretty well. So, we've been able to -- there has been some increased demand that's come in for biologics that, we'll be able to recognize later in the year and then, we'll be able to serve that, in part because of these line conversions. So, it's been a little bit of both relative to that anticoagulant dynamic."
},
{
"speaker": "Tom Polen",
"content": "Thanks for the question, Matt."
},
{
"speaker": "Matthew Miksic",
"content": "That's super helpful. You bet. And just one follow-up if I could on cash flows and sort of M&A and I remember last quarter, Chris, you emphasized a bunch of times, and part of that impact was, bringing up excess inventory having an impact on margins, you threw that you made nice progress on leverage. Could you talk a little bit about, what that looks like for the rest of the year, drove M&A outlook and the kinds of things, maybe the size of things that you might be -- we might expect in the next, six, 12, 18 months. Thanks."
},
{
"speaker": "Christopher DelOrefice",
"content": "Yeah. Thanks for the question, Matt. I appreciate you recognize. We've definitely been extremely focused on cash flow performance. I was really pleased with the quarter. There was really strong cash flow, strong double-digits, gives us confidence for the year. It played out in all the areas we've been trying to leverage. One, we're getting more efficient with our CapEx expenditures. Part of this is from a simplification efforts on BD Excellence that we're driving through our plans. In addition, you saw improvement in inventory and you saw improvement in our collection cycle as well. So, all really positive things. We sit basically at our net leverage target and so we're well positioned and consistently will remain disciplined as you think of M&A, but as you can imagine, we always have an active portfolio of things that we look at. We're going to remain disciplined. It's been a nice contributor organically to growth last year, delivered nearly 40 basis points. So, certainly something that we're going to continue to focus on as part of our growth strategy and more to come on that. Tom, I don't know if you want to add?"
},
{
"speaker": "Tom Polen",
"content": "Extremely well said. Remains an active part of our growth strategy and I think as we've shared in the past, we've been focused on accretive growth, accretive margin acquisitions, which has been our track record and we've executed well against those over the last several years. I think we've clearly built a good track record of that. And so, we've got a strong healthy M&A, you know, active pipeline focused again in strategic areas where the market has significant structural or macro tailwinds to drive sustainable growth and where we can bring meaningful additional value either through our channel or global footprint, our manufacturing prowess. And again, we remain very disciplined on strong returns accretive growth. We haven't been doing dilutive deals that remains, right? Our emphasis is we're focused on delivering on our 25% operating margin goals. And but we're going to continue to focus on that and we have a strong pipeline. Thanks for the question."
},
{
"speaker": "Operator",
"content": "And this time, I'll return the call to Tom for any closing comments."
},
{
"speaker": "Tom Polen",
"content": "Thank you all for joining our call. As you heard, we had good momentum to start the year and we look forward to sharing our progress towards delivering our BD 2025 goals and increased outlook for FY '24 on our next call in May. Thank you very much and have a great rest of the day."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today's program. On behalf of BD, thank you for joining today. Please disconnect your line at this time and have a wonderful day."
}
] |
ben | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Welcome to Franklin Resources Earnings Conference Call for the Quarter and Fiscal Ended September 30, 2024. Hello, my name is Shamali, and I will be your call operator today. As a reminder, this conference is being recorded and at this time, all participants are in a listen-only mode. And, I would like to turn the conference over to your host, Selene Oh, Chief Communications Officer and Head of Investor Relations for Franklin Resources. You may begin."
},
{
"speaker": "Selene Oh",
"content": "Good morning and thank you for joining us today to discuss our quarterly and fiscal year results. Please note that the financial results to be presented in this commentary are preliminary. Statements made on this conference call regarding Franklin Resources, Inc. which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties, and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the risk factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. With that, I'll turn the call over to Jenny Johnson, our President and Chief Executive Officer."
},
{
"speaker": "Jenny Johnson",
"content": "Thank you, Selene. Hello everyone and thank you for joining us today to discuss Franklin Templeton's fourth quarter and fiscal year 2024 results. On today's call, I'm joined by Matt Nicholls, our CFO and COO; and Adam Spector, our Head of Global Distribution. As presented in our fiscal year executive commentary, I will comment on the evolution of our business over the past several years as well as highlights from our fourth quarter and fiscal 2024. After that, Matt will review our financial results, and then we'd be happy to answer your questions. The investor presentation has a new format, includes information that will only be presented annually. In recent years, we have expanded our business in an intentional way, adding a wide range of capabilities to help clients achieve their investment goals through a variety of market conditions and cycles. As I've traveled the world meeting with clients and investors, I've seen firsthand that they recognize and appreciate the many steps we have taken to further diversify our business and position Franklin Templeton to succeed over the long-term. Our clients view us as a trusted partner with the ability to fulfill their comprehensive investment needs across public and private markets in investment vehicles of their choice. They appreciate our ability to customize their capabilities and meet their needs through innovative delivery and solutions. Franklin Templeton leverages the talent of our multiple specialist investment managers to deliver expertise to our clients across a wide range of investment styles and asset classes. Our investment teams benefit from Franklin Templeton's deep resources and scale with centralized investments in distribution, marketing, data, and innovative technologies like blockchain and artificial intelligence. Furthermore, our model benefits our corporate shareholders with no single specialist investment manager at our firm contributing more than 10% of adjusted operating revenue. And most of our specialist investment managers are diversified within themselves as well. Most recently, we have been investing in AI, blockchain and other important areas relevant to the future of the industry that will benefit our teams and clients. Now, turning to the investor presentation. Beginning on slide 7 and 8, it's notable how much Franklin Templeton has evolved its business over the past five the past five years and where we are focused going forward. Over years, we have increased and accelerated the diversification of our AUM via organic growth and targeted acquisitions into higher growth areas of client demand. Since the beginning of 2019, we have completed significant acquisitions in areas of growth and to position the firm offer more choice to more clients in more places. And those acquired specialist investment managers now represent 64% of AUM, and 55% of adjusted operating revenue. In that period, our institutional AUM increased from 25% to 45% and we are now well balanced between institutional and wealth management. We have made great strides across a number of key focus areas for the company. Turning to slide 9 and starting with investment management. We have now a full spectrum of investment capabilities to help clients meet their varied financial goals. This year, the acquisition of Putnam Investments added strong capabilities such as target date and stable value, which are important in the retirement and insurance channels. And we demonstrated the power of Franklin Templeton's distribution, which led to $11 billion in net flows into Putnam products. This is an example of combining outperforming investment performance with powerful distribution resources. Our focus is on continuing to improve investment performance as well as optimizing the range of our investment product offerings. We are also in the position to leverage breadth of our investment capabilities across both public and private markets. And we see opportunity as these markets begin to converge. For example, Franklin has been putting late-stage venture into mutual funds for over a decade, and Franklin's global allocation fund includes private credit strategies. As a leading manager of alternative assets with approximately $250 billion in AUM, we offer key capabilities including alternative credit, secondary private equity, real estate, hedge funds and venture. Since fiscal year 2019, alternative asset AUM has increased by over five times, through three sizable acquisitions and organic growth. I'm proud to note that, since becoming part of Franklin Templeton, each alternative specialist investment manager has expanded and diversified across strategies, vehicles and clients. Specifically, on the role of alternatives in wealth management, the wealth management channel has approximately only 5% of AUM allocated towards alternatives. But depending on the clients' liquidity needs, it can be much higher. Institutions, for example, have been allocating up to 40% for years. Our global distribution footprint, investor education platform and dedicated alternative specialist team combined with our breadth of investment capabilities make us a relevant force in the wealth management channel. This year, we're pleased that we established the alternatives by Franklin Templeton brand in the wealth management channel in the US and look to broaden it in EMEA and Asia. Over the next five years, our goal is to fundraise at least $100 billion across private markets and look to add additional capabilities, for instance, in infrastructure as well as to globalize certain strategies. Next, turning to distribution. We are one of the most comprehensive global asset managers with clients in over 150 countries. Offering clients a diverse range of investment vehicles is not just beneficial but essential in today's marketplace. Over the last five years, we have seen meaningful growth in retail SMAs and both ETFs and custom indexing AUM has grown by over 3x. In particular, this fiscal year, growth accelerated in retail SMAs, ETFs and Canvas AUM, each reaching record highs. Our ETF business grew by 89% in the year with positive net flows for the 12th consecutive quarter with net flows at or exceeding $1 billion for eight consecutive quarters. And in fact, in the last two quarters, that number has been over $3 billion each. Total assets stand at $31 billion across active and index strategies from just 0 a few years ago. Canvas AUM increased by 94% from the prior year to $10 billion and has generated positive net inflows in every quarter since its acquisition in 2021. We increased the number of partner firms by almost 70% from one year ago. Over the next five years, we are looking to scale ETF AUM by 3x and Canvas assets by 5x. Today, we are a leading provider of retail SMAs with $145 billion in assets, an increase of 29% from the prior year. Going forward, we are focused on expanding our product offerings. For example, we launched a retail SMA variant of our flagship Franklin Income Fund and launched tax-managed option strategies utilizing Canvas. Investment Solutions AUM almost doubled in size to $89 billion from the prior year with the additions of K2 and Putnam's target date funds and through organic growth. Franklin Templeton Investment Solutions will remain a critical component of our growth strategy by leveraging our capabilities across public and private asset classes to deliver customized solutions to meet our clients' demands. Over the next five years, we aim to more than double our solutions platform. Additionally, our breadth and depth of investment capabilities, engagement, capital resources and value-added services positions us well as a valuable partner. This year, we've been delighted to establish new multibillion-dollar relationships with clients in each of our regions and strategic partnerships will remain an important aspect of growth in the future. Turning to Slide 10. Two other important growth areas are Private Wealth Management and Digital and technology. In the Private Wealth Management segment, Fiduciary Trust International has a clear opportunity due to the unprecedented intergenerational transfer of wealth. This will be the largest wealth transfer in history with $84 trillion set the path from older generations to their heirs through 2045. $53 trillion will transfer from households in the Baby Boomer generation. Fiduciary is a fully integrated wealth platform with investment advisory, trust and estate planning, tax planning and custody services. It has impressive client retention rate of approximately 98%. Since 2019, Fiduciary doubled its AUM, reaching an all-time high of $39 billion and had positive net flows annually for the past three years. Going forward, we look to double the size of this business through organic investments and targeted acquisitions. This represents both a standalone opportunity by owning a wealth manager and also a broader distribution opportunity. Investing in innovation and cutting-edge technologies continues to be a strategic importance for the firm. We have made important investments in value-added services, including technology and digital wealth in order to be on the forefront of innovation in areas increasingly important to our clients and operations. In addition, as early adopters of Artificial Intelligence, Franklin Templeton is working to responsibly employ AI to boost productivity, deliver greater value to clients and make our investment processes and operations more efficient. A great example is our partnership with Microsoft that was announced last quarter. We are working collaboratively to build an advanced financial AI platform that will help embed Artificial Intelligence into our sales and marketing processes, creating more personalized support for our clients. In the digital asset space, we continue to look for new ways to leverage blockchain technology. For example, we launched the first US-registered fund to use a public blockchain to process transactions and record share ownership in 2021. And this year, we launched Franklin Bitcoin ETF and Franklin Ethereum ETF, making it easier for clients to access investment opportunities with our digital asset solutions. Looking forward, there are many more exciting advancements that are underway in this space. Matt will cover capital management, operational integration and expense management shortly. Turning to the market performance during our fiscal year. Global equities rose by more than 30% while global bonds increased by nearly 12%. Throughout much of the year, large caps outperformed small caps, driven by top technology and communication services firm with growth stocks exceeding value stocks. Investor enthusiasm around Artificial Intelligence was the major theme over the past 12 months. Moderating inflation and declining bond yields helped the Magnificent Seven stocks advance 53%, while the broader technology sector notched a 52% gain. In our fourth quarter, there was also a corresponding shift in equity market leadership beyond the Magnificent Seven. In fact, only two of the seven stocks in this group have meaningfully outperformed the S&P year-to-date through October. Broader market participation is encouraging for active managers. Eight of the 11 sectors outpaced the broader S&P 500 during the quarter, with just two sectors, technology and communication services, have outperformed over the prior nine months. Both previous winners were levered in the most recent quarter. Investors' focus has shifted from inflation to concerns about the durability of the global economic expansion and by extension, the outlook for corporate profits. And while the Federal Reserve's decision to cut interest rates by 50 basis points in mid-September make a soft landing in 2025 more likely, the market's push for deeper monetary easing may elevate volatility in the coming quarters. The market expects the Fed to cut rates again this week, and this seems like a reasonable assumption. Recent Fed speak signals greater comfort with the latest progress on disinflation. There is, however, uncertainty on the outlook for labor market as it is difficult to disentangle the temporary impact of strike actions and hurricanes from the most recent week jobs data. As the Fed's rate cutting cycle proceeds, we expect traditional fixed income sectors to take their place as a primary source for yield as cash begins to look less attractive. While spreads are tight at their current levels, we are not anticipating a sharp deceleration in activity. And our fixed income managers continue to find opportunities at attractive yields. Meanwhile, in private markets, our specialist investment managers continue to see strong investment opportunities in alternative credit, secondary private equity and select real estate segments. And demand for differentiated expertise is at a premium as these markets continue to gain interest. For example, we're excited by opportunities in alternative credit, particularly in real estate debt, where BSP manages $8 billion. And given the need for liquidity in private equity, we see strong interest in secondary private equity Lexington. Turning now to fiscal 2024 results in terms of investment performance. Mutual fund investment performance improved in the one, three and 10-year periods from the prior year. Composite investment performance improved in the five and 10-year and stayed essentially flat in the three-year period from the prior year. On close, long-term net outflows were $32.6 billion for the fiscal year, and reinvestment distributions were $20.7 billion. Excluding Western Asset Management, long-term net inflows were $16 billion, compared to net outflows of $5.2 billion in the prior year. We saw a 25% increase in long-term inflows from the prior year to $319 billion. We're pleased to see that gross sales have improved across all asset classes in public markets, as well as across every region in both the retail and institutional distribution channels. From a regional perspective, our international business continues to grow. And we have seen continued momentum with positive long-term net flows for the year and AUM surpassing $500 billion. Gross sales in the US increased by 31%, EMEA by 23%, APAC by 19% and the Americas by 24%. And from a client type perspective, retail sales improved 27%, and institutional sales increased by 21%. From an asset class perspective, turning to alternatives on slide 12, in fiscal year 2024, private markets fund raised $14.8 billion, in line with our targets. Lexington closed its flagship fund with $22.7 billion in total capital commitments raised primarily in 2022 and 2023, ranking among the largest funds raised to date in global secondary private equity market and with approximately 20% raised in the wealth channel. Benefit Street Partners closed its flagship private credit fund and its special situations with $4.7 billion and $850 million in total capital commitments raised, respectively, with each fund exceeding targets. Clarion Partners AUM remained stable despite weakness in the real estate sector in the year. We believe that there is increasing sentiment that worst is behind us. For example, the ODCE benchmark turned positive. And there is the beginning of a pickup in transaction volume, strengthening confidence for potential for transactions in fiscal year 2025. Going forward, we are well positioned in the sector with minimal office exposure of 7% and well-performing products in strong sectors such as industrial, multifamily and life science. In addition, we're excited about new areas of growth that include European logistics fund and investing in new alternative strategies in the US, including self-storage, student housing, medical and senior living property types. Turning to public markets. Multi-asset net flows were $8 billion driven by positive net flows in the Franklin Income Fund, Canvas and Franklin Templeton Investment Solutions. On Slide 18, you can see equity sales improved each quarter this year and grew 53% year-over-year, excluding reinvested distributions. In addition, fixed income long-term inflows increased year-over-year by 26%. Now turning to Western Asset. As you are aware, we launched an internal investigation focusing on certain tax trade allocations of treasury derivatives by former Co-CIO, Ken Leech, in select Western Asset-managed strategies. The DOJ, SEC and CFTC are conducting parallel investigation, and those investigations are ongoing. On August 21, we announced that Ken Leech was on a leave of absence following receipt of a Wells notice from the SEC. We take this matter extremely seriously and are fully cooperating with the government. Since the announcement of the investigations, Western Asset has experienced significantly higher net outflows of $37 billion in the fourth quarter and $49 billion for the fiscal year. However, today, the Western team of more than 100 highly experienced investment professionals led by Mike Buchanan, who was promoted the sole CIO from Co-CIO, continues to manage approximately $330 billion in AUM across 88 marketed strategies. The team continues to focus on investment performance and providing leading client service. Mike has been with Western nearly 2 decades and has over 3 decades of industry experience. Since the beginning of the investigations, Western Asset's trading policies have been reviewed by third-party experts. Per this review, despite being aligned with industry standards, Western has further enhanced its trading policies and practices. In addition, Franklin Resources is working with Western's management team to explore ways to assist Western Asset, including adjustments to economic arrangements, operational and revenue synergies. This may entail changes that are similar to what we have successfully implemented with our other public market specialist investment managers, while maintaining investment process independence. And I'm sure that you understand with an ongoing investigation, we are unable to provide any further information or address questions on this matter at this time. Aside from Western Assets, we think it's important to highlight the breadth of our fixed income investment management expertise, including Franklin Templeton fixed income, Brandywine Global and Templeton Global Macro, which have non-correlated investment philosophies. As of September 30, these specialist investment teams managed in aggregate $266 billion in fixed income assets and generated positive net flows of $6.4 billion in the fiscal year. Furthermore, Franklin Templeton fixed income comprised the largest component of our won but not yet funded pipeline. Speaking of the pipeline, this quarter, our institutional pipeline of won but unfunded mandates was $15.8 billion. While new wins replenished our fundings, the $2 billion decrease from the prior quarter included a change in value in a client mandate at Western. The pipeline remains diversified by asset class and across our specialist investment managers. Finally, this year, we acquired Putnam Investments, which has exceeded our expectations. Since closing on January 1, Putnam's AUM has grown 21% to $180 billion. Putnam continues to deliver a strong track record of investment performance. The transaction also enhanced our presence in retirement and insurance markets with AUM in these channels at $645 billion. Let me wrap up by saying, we take pride in the efforts we've made over past few years to further grow and diversify our business. We have navigated challenges, created new opportunities and uphold the high standards that have defined us for over 75 years. Finally, I would like to thank our employees around the world for their unwavering dedication and commitment to always putting our clients first. It's their hard work that is the driving force behind our success. Now I'd like to turn the call over to our CFO and COO, Matt Nicholls, who will review our financial results for the fiscal quarter and year. Matt, over to you."
},
{
"speaker": "Matt Nicholls",
"content": "Thank you, Jenny. Turning to the financial results for the fourth quarter. Ending AUM reached $1.68 trillion, reflecting an increase of 2% from the prior quarter, and average AUM was $1.67 trillion, also a 2% increase from the prior quarter. Adjusted operating revenues increased by 4% to $1.7 billion from the prior quarter due to higher average AUM and higher adjusted performance fees. Adjusted performance fees were $72 million, compared to $57 million in the prior quarter. This quarter's adjusted effective fee rate, which excludes performance fees, stayed relatively flat at 37.4 basis points compared to 37.5 basis points in the prior quarter. Our adjusted operating expenses were $1.3 billion, an increase of 3% from the prior quarter due to higher incentive compensation, advertising and professional fees. This quarter, we realized $38 million of Putnam-related cost savings, representing $6 million of incremental cost savings from the prior quarter. As a result, adjusted operating income increased 6% from the prior quarter to $452 million. And adjusted operating margin increased to 26.3% from 25.7%. Fourth quarter adjusted net income and adjusted diluted earnings per share decreased by 3% and 2% from the prior quarter to $315 million and $0.59, respectively primarily due to a higher tax rate from discrete tax expenses in the current quarter and foreign exchange losses, partially offset by higher operating income. As of September 30th, we impaired the intangible asset related to certain mutual fund contracts managed by Western Asset and recognized a $389.2 million non-cash charge in our GAAP results, primarily due to the decreased AUM resulting from net client outflows and lower discounted future cash flows generated from these management contracts. Turning to fiscal year 2024. Ending AUM was $1.68 trillion, reflecting an increase of 22% from the prior year, while average AUM increased 12% to $1.57 trillion. Our fiscal year reflects nine months of Putnam financials. Adjusted operating revenues of $6.6 billion increased by 8% from the prior year, primarily due to Putnam and higher average AUM, partially offset by lower performance fees. Adjusted performance fees of $293 million decreased from $383 million in the prior year. The adjusted effective fee rate, which excludes performance fees, was 38.3 basis points compared to 39.5 basis points in the prior year. Drivers of the decrease included the impact of 0.3 basis points from the transaction-related investment management fees and 0.2 basis points catch-up fees in secondary private equity last year and 0.1 basis points from the addition of Putnam this year. Our adjusted operating expenses were $4.9 billion, an increase of 13% from the prior year, primarily due to nine months of Putnam, higher incentive compensation, double rent related to the consolidation of our New York City office space, and higher legal fees, primarily due to the Western Asset matter. In addition, as anticipated, over $150 million of annual run rate cost saves related to Putnam were achieved by year end. This led to fiscal year adjusted operating income of $1.7 billion, a decrease of 6% from the prior year. Adjusted operating margin was 26.1% compared to 29.9% in the prior year. Compared to the prior year, fiscal year adjusted net income declined by 4% to $1.3 billion and adjusted diluted earnings per share was $2.39, a decline of 8%. The decreases were primarily due to the decline in operating income and a higher tax rate, partially offset by higher investment income. From a capital management perspective, we returned $946 million to shareholders through dividends and share repurchases, funded acquisitions, and paid down a $250 million senior note in July. Stepping back, as we look over the last five years, we delivered a predictable capital management policy and prioritized returning capital to our shareholders, totaling over $4 billion, including $3 billion in dividends and $1.1 billion in share repurchases. Our dividend, which has increased every year since 1981, has grown at a compound annual growth rate of approximately 4%. Our balance sheet provides flexibility to invest in the growth of our business organically and inorganically. We have co-investments in seed capital of $2.4 billion to develop and scale new products. Additionally, the acquisitions we've made since 2019 represent 55% of our adjusted operating revenue and meaningfully contribute to our operating cash flow. Importantly, these investments provide new sources of growth and relevance to our clients. In addition, while continuing to invest in long-term growth initiatives, we also continue to strengthen the foundation of our business through disciplined expense management and operational efficiencies, especially given the ongoing transformation of our industry. Over the last five years, we've created operational efficiencies, both at the enterprise level as well as broader efforts to enhance synergies across our specialist investment managers. For example, we have outsourced our fund administration and our global transfer agency. In addition, we have achieved targeted cost savings ahead of schedule as seen in our acquisitions of Legg Mason and Putnam. Looking ahead, we plan to further simplify our firm-wide operations, including the previously announced unification of our investment management technology on a single platform across our public market specialist investment managers. Before I turn to guidance, a brief update on preliminary October flows. As we will announce next week in our monthly AUM reporting, Franklin expects to report slight long-term net outflows for October, excluding Western Asset. Western's long-term net outflows in October are expected to be $18 billion. For Western, this follows long-term net outflows of $7.7 billion in billion in August and $27.9 September. As previously announced, excluding Western, Franklin had $5.7 billion in long-term net inflows in the fourth quarter. Turning to guidance for the next fiscal quarter. Guidance assumes flat markets is based on our best estimates as of today and does not include the impact of any possible future developments from the Western investigations. We expect our EFR to be in the mid-37 basis point area, but slightly higher than this past quarter, excluding adjusted performance fees. We expect compensation and benefits to be $860 million. This assumes $50 million of performance fees. Please also note that, this includes $45 million annual accelerated deferred compensation. The prior year quarter included $41 million of such accelerated deferred compensation. For IS&T, we're guiding to $155 million to $160 million, inclusive of $4 million higher spend for Gen AI and our investment management platform. We expect occupancy to be flat between $78 million and $80 million, inclusive of double rent related to our transition to a more efficient and unified space in New York City. As previously explained, the double rent will begin to phase out in the second half of fiscal year 2025. G&A expense is expected to be in the $180 million area and includes slightly higher legal fees. In terms of our GAAP tax rate, we expect fiscal 2025 to stay in the same range of 24% to 26%. But note that, our first quarter typically has a higher tax rate due to discrete items related to deferred compensation vesting. And now we would like to open the call for questions. Operator?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our first question comes from the line of Bill Katz with TD Cowen. Please proceed with your question."
},
{
"speaker": "Bill Katz",
"content": "Okay. Thank you very much for taking the question this morning. I appreciate that you can't speak particularly to WAMCO. I certainly understand that. I guess I'm intrigued by your commentary of potentially revamping some of the economic relationships with the franchise. I was wondering if you could potentially flesh that out a little bit. And then separately, I'm wondering whether or not the WAMCO overhang is affecting gross sales in any of the segments. It's not clear from what you're sharing, but I'm sort of wondering at the margin, what you're hearing on the institutional side, in particular, given the ongoing investigation? Thank you."
},
{
"speaker": "Jenny Johnson",
"content": "Great. Thanks, Bill. So, so far, the outflows even within Western, I think it's like 72% are focused on essentially core, core plus and macro ops. So even within Western, it's pretty focused on those strategies. They're about $90 billion today. Since Ken received as well notice, Western's had outflows of $53.6 billion. So there are some instances at Western where clients who were in other strategies just didn't -- we were concerned about the headline risk and did actually redeem. But I think it's been fairly controlled there. And we have not seen it really flow over into the other Franklin strategies. It's definitely part of the conversations, but it hasn't had a tremendous impact on the other strategies. Matt, I'll have you kind of answer the question around how we're approaching and thinking about the economic relationship. And to remind you, Bill, the relationship with Western is pretty unique. I always say you can't do hostile acquisitions in the asset management business because it's all about the people and their investment process. And Western was fairly unique for us in this five year autonomous arrangement that we had. But obviously, in light of current situations that we're just having a conversation around how we should think about that. Our model in general is we always apply common sense. It's slightly different. There's no exact one size fits all. Even today, Templeton and Mutual Series, which were acquired in the '90s have slightly different models with us. For example, one insists on the trading folks, their traders to be on their desk others use our global trading platform. So we always try to have a practical approach. But Matt, do you want to take kind of the specific conversations around it?"
},
{
"speaker": "Matt Nicholls",
"content": "Yeah. Yeah. Okay. Thank you. Thanks, Jenny. Thanks, Bill. So maybe I think your question gets to a couple of things. First of all, economic arrangements but also economics related to the situation through Western. So perhaps for perspective, I'll just start by saying that the press tends to report that Western Asset is our largest specialist investment manager, but that's just by AUM. I think you know that, Bill, along with everybody else that covers us. But obviously, a much more important measure, the key measure, of course, is financial contribution of the business. And so I think it's worthwhile going through this a little bit and explain that, for example, in terms of adjusted operating revenue on a run rate basis, Western is probably something like our fifth or sixth largest specialist investment manager. And on the impact so far, if you run rate the $53 billion of outflows that Western has experienced since August, Western's annualized revenues would be expected to be declining by about 20% so far. That's just the Western revenue, which equates to about 2% decline at the Franklin Resources level. Obviously, operating income impact will initially be higher, this is to your point on margin, will initially be higher because expenses are not able to be reduced at the same rate as revenue. But importantly, at Franklin Resources, we have areas that can help achieve some of the offsets over time such as, as we talked about on this call, the addition of Putnam, growth in alternative assets, ETFs, SMAs, Canvas, our large equities business, our other fixed income SIMs, international and so on in addition to the expense discipline and other levers that we have. But look, this doesn't mean for a second that this is not important to us. It's very important to us. Western has hundreds of hardworking long-term employees with families, a strong investment team with a long-term track record. As Jenny has mentioned, together with producing good investment outcomes for clients, it's a team approach. And under CIO, Mike Buchanan, they're very focused on investment performance and client service. Our north star, if you will, has always been to achieve sustainable growth across our whole company. And Western is important to this, and this has certainly been a dent in that progress as you can see from the results we're highlighting today. But as Jenny said, this is exactly why we're working with Western management on providing assistance where possible, in particular, keeping the investment team in a good place while management works through this. So in summary, the economic arrangement that we have with Western over these five years, that's going to have to be adjusted to accommodate a decline in the revenue and the operating income, and that's what we're working through right now."
},
{
"speaker": "Adam Spector",
"content": "And Bill, I would add one thing you asked about institutional flows in general. We have really worked hard over the last two years to build better relationships with institutions around the globe. If you take a look at where we were last year, ex-Western last fiscal year, we raised $2.2 billion in the institutional channel. This year, that net number more than doubled to $5.6 billion. So we're feeling actually quite positive about the trajectory of that institutional business."
},
{
"speaker": "Bill Katz",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Benjamin Budish with Barclays. Please proceed with your question."
},
{
"speaker": "Benjamin Budish",
"content": "Hi. Good morning and thank you for taking the question. I wanted to ask about one of your five-year target, the $100 billion of fundraising across private markets. Could you unpack that a little bit? Just how much do you expect to come from, say, cross-selling across the investment managers you've acquired over the last several years? How much is predicated on future M&A? How much do you think will come from the retail versus wealth channel? Any more details around that target would be appreciated. Thank you."
},
{
"speaker": "Jenny Johnson",
"content": "Sure. So let me start. The focus on that is actually from our existing managers, and just to give you a perspective on the growth that we've had since we acquired BSP, they doubled in size. Clarion's up just under 40%. Lexington, I think we've only owned them for about two years, and they're up a little under 30%. So we've been successful in growing those, and our projections of the $100 billion comes from really looking at what those opportunities are. Just to give you a little guidance for 2025. So last year, in 2024, we gave a range of $10 billion to $15 billion in sales and achieved $14.8 billion. This year, we're saying, we think it will be between $13 billion and $20 billion in gross sales. And that comes from real estate, secondaries, private credit and ventures, so all those are bottoms up build to net. And the reason the range is fairly large is, it will really depend on whether Lexington is able to do a first close of their flagship once they decide on the timing of their Lexington flagship 11 Fund. So far, Fund 10, they've been able to deploy it faster and at higher discounts than historical levels. So we're hopeful that we'll be in the market and do a first close. But that's obviously a big portion of that number. It also depends on real estate coming back in favor. We think the signs are all showing that the winter of real estate may be over and that we should see things picking back up next calendar year. And we have some, I think, a really diverse set of offerings that are coming out in the market. So not only does Lexington have their flagship fund, but we think continuation vehicles are going to be a more and more important area. We're launching a perpetual vehicle in the wealth channel, which is something very new. We think that opens up a lot of opportunities. They've, obviously, been doing their co-investment middle market. So Lexington is going to have a lot more offerings in market. We're also launching a real estate debt fund. If you look at private credit, there's probably a lot of areas that people would say, private credit is getting pretty tight in some of the spreads. But it happens to be that BSP has a real expertise in real estate debt. They have about $10 billion or $9 billion that they manage there today. And we think with the regional banks pulling back in this area that, that's going to be a really interesting opportunity. It's unclear whether it's going to be part of the real estate portfolio allocation or the private credit allocation. But we think that has a lot of great demand there. So if you think about just in 2025 that, that ranges from $13 billion to $20 billion, we feel comfortable in the projection over the next five years to hit that $100 billion number."
},
{
"speaker": "Benjamin Budish",
"content": "All right. Thank you very much. Appreciate it."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Dan Fannon with Jefferies. Please proceed with your question."
},
{
"speaker": "Dan Fannon",
"content": "Thanks. Good morning. Matt, I wanted to follow-up just on the context of fiscal 2025 and just the outlook for expenses. I know there's a lot of moving parts with the Western dynamics. But could you talk about core expense growth and either contextualize with or without Western in terms of what legal or unknowns might come through to think about the growth in the expense base for the core business?"
},
{
"speaker": "Matt Nicholls",
"content": "Yeah. Morning, Dan. So look, obviously, it's super early for the year. I gave guidance on call -- on our, sorry, prepared remarks for the quarter. But if I think through the year, if you normalize for a full year of Putnam and exclude performance fees and with the same caveats I gave in my prepared remarks around the Western situation, we would expect expenses to be quite similar to the last fiscal year. In general, we would expect revenue loss from Western to be made up from other areas of growth that justifies that expense base. Obviously, if we experience a decline in any part of our business, well, that will be offset by very careful expense management. We have a number of initiatives going on, as we've already highlighted, across our investment management platform, operations, certain levels of integration. All that help participate in our ability to pull certain levers to manage either expected or unexpected reductions in revenue or increase in investments that we need to make across the business. So again, I'd say just very carefully and cautiously, all else remaining equal and normalizing for a full year of Putnam excluding performance fees that plus the caveats I gave on my prepared remarks that we would expect our expenses to be substantially similar to the last fiscal year that we just closed. And I think that's the best way of looking at it right now, so expense growth remaining very much in check."
},
{
"speaker": "Dan Fannon",
"content": "Great. That's helpful. But just to clarify, what would be one quarter of Putnam just to think so we can kind of normalize for the 9 to 12 months to kind of get to a dollar amount?"
},
{
"speaker": "Matt Nicholls",
"content": "One quarter of Putnam expenses will be -- wait 1 second, like $125 million."
},
{
"speaker": "Dan Fannon",
"content": "Great. Thank you."
},
{
"speaker": "Matt Nicholls",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Michael Cyprys with Morgan Stanley. Please proceed with your question."
},
{
"speaker": "Michael Cyprys",
"content": "Hey, good morning. Thanks for taking the question and thanks for the new PowerPoint deck presentation disclosure there across. Appreciate that. Just as we think about your targets and objectives over the next 5 years, just curious what that would translate into in terms of revenue, operating income and EPS in 5 years' time? And what sort of growth might that be when you sort of pull it all together? And then if maybe you could just remind us, how much Western contributes to AUM revenues and operating income today. Thank you."
},
{
"speaker": "Matt Nicholls",
"content": "Yes. I mean, Western's contribution is probably right now on a run rate basis, around 9% -- 8%, 9% of our adjusted operating revenues. In terms of operating income, it's a little bit more than that. But as I mentioned a moment ago, it's moved to being much closer to it. So we're working through those things as we speak, as I mentioned earlier and as Jenny touched on. In terms of our organic growth trajectory, what we're hoping to achieve is to get into the low single digits growth on average as a business. We're obviously not there now because of some of the issues we're working through on the Western side that we've been very transparent about. But also, look, the -- you know, Mike, better than most the industry trends. And when you look at where we were five years ago and where we are today, we're a much more balanced business. I mean five years ago, a very large portion of our business was in mutual funds retail distribution in the United States. We're extremely different business now, but we still have to work through achieving scale in the areas of investment. So we've talked about ETFs. We talked about Canvas. We talked about alternative assets. We talked about other areas of the firm that we're growing. A number of these things aren't really scaled yet to the degree that we expect them to be, given the investment we're putting in. That's why we put a five-year timeline on some of these things because it takes time to get there. Once we get there, we think it's very reasonable that notwithstanding some of the areas of shrinkage that we could be a low single digit growth business overall, the whole -- including the whole franchise. And obviously, they're taking out the Western situations getting through that and normalizing our revenue as it was before that and then looking at the areas of growth versus the areas of shrinkage and the overall business that we have under the hood here. But I don't know whether, Jenny, do you want to add anything to that?"
},
{
"speaker": "Jenny Johnson",
"content": "Well, I was just going to say -- no, I think you hit it right, but just one additional. Without Western's outflows, I think our organic growth rate runs at about 1.3%. And when you do the kind of acquisitions that we've done and you really try to put together a best athlete team, the reality is it takes time for distribution to settle in. Because even if you take, say, the best salesperson in a region, you're actually breaking relationships with some other people. So it takes time. And even with Putnam, we took on a lot of the Putnam team, and so part of this is kind of digesting that. And then as Matt said, you take our ETFs. We've talked about how over the last eight quarters, we had $1 billion. But actually, in the last two quarters, our ETFs had over $3 billion in net flows. And they're up 88%, but there's still only $31 billion. So that's a fast-growing important area. We think we have a great team, great products. We were not late to the active ETF game. So we think we have good opportunities there. And then I look at it and say, if you think about the big trends that are so important, the fact that that we have the breadth of capabilities in the private markets as well as the capabilities we have on the traditional market, I don't think there's another asset manager that has that same kind of capability. And then you combine it with the fact that we have $500 billion sourced from clients outside the United States, we sell over $80 billion outside the US, which is tremendous. It takes decades to build those kind of relationships and reputation in various markets. And then one thing that I think people don't fully understand is we're pretty unusual and unique in the local asset management capability. You go into a new market, and 80% of flows tend to go into domestic products. India, we are the first foreign manager, but we launched domestic products in India. We are viewed as a local player competing against local asset managers. And this year, we raised our largest equity fund there with -- and we haven't done it in 15 years. Mexico, Middle East, in the Middle East, we've been there for 25 years. But interestingly, we're actually one of the largest Islamic finance managers, global asset managers for Shariah and Sukuk. And so as the Middle East becomes more and more important, we can serve both global products as well as local capabilities. And then we also have local asset management in places like Canada, the U.K., Australia. So, again, if you're a global provider, you tend to go with global products. But we've always also focused on this ability to deliver local. And we think international, when you look at the demographics of the emerging economies, to be considered a local player in these markets is really powerful. So, I just wanted to add that on top of Matt's points."
},
{
"speaker": "Adam Spector",
"content": "And Jenny, the only thing I would add to that is it's starting a little earlier. We now are building scale in a lot of areas that you mentioned, especially in things like private markets in the wealth channel, we started with institutional quality managers. We built up all specialists to cover that channel. That team is now 85 people strong, not only in the U.S. but in EMEA, in APAC and in the Americas. And when we go to market in those channels, we've learned it's important to come in scale. So, now we have evergreen products in real estate, in private credit, in secondaries. And all of those products are coming with scale, which will really allow us to accelerate our efforts in that channel."
},
{
"speaker": "Jenny Johnson",
"content": "Yes. And actually, you just reminded me just one last thing is that we mentioned it in the opening comments, but like the Franklin equity team has been doing late-stage venture in their mutual funds for over a decade. It actually is really a complicated thing to do. And so our ability, as the world starts to converge with public and private products, our ability to do that with the capabilities, I think of it as the ingredients we have as a firm, I think, are really tremendous."
},
{
"speaker": "Michael Cyprys",
"content": "Great. Thanks so much for all the color."
},
{
"speaker": "Matt Nicholls",
"content": "Thanks Mike."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of John Dunn with Evercore ISI. Please proceed with your question."
},
{
"speaker": "John Dunn",
"content": "Hi thanks. Maybe just a quick one on wanting to double in the private wealth management. Has there been a kind of change? Or could you describe the appetite for firms to join your platform? And how aggressive do you think you'll be over the next several years?"
},
{
"speaker": "Matt Nicholls",
"content": "Yes, I think you think about -- sure. Where we first started was with [indiscernible], a Clarion product. And we just had a very few partners in that space for that evergreen. We're now up to over 20 partners there. So, we see that we're able to onboard to far more platforms, and that's really helping us. The other thing we've been able to do in that that channel is to co-develop products with our wealth management partners, which means we have a little more backing, and we're able to get in the calendar earlier. That was bigger a lesson for us as well as getting on the calendar early. And finally, I would say, scale. In the mutual fund world, you can start smaller, work your way up. What we found in the private asset area was that it was important to come to market with scale from the beginning to be able to offer a diversified product. And that requires really sourcing significant AUM at the very beginning of the launch and we've been able to do all of those things. So, feel good about the launch of our evergreen in the wealth management channel. And Matthew, do you want to add anything there?"
},
{
"speaker": "Matt Nicholls",
"content": "Yes, the only thing I'll add is I think part of John's question may have been about Fiduciary trust and our growth targets as it relates to our own wealth management business. And what I'd say, John, is in that front -- on that front, Fiduciary is a full-scale platform. It's a great business. It's grown quite nicely over the last several years. And as we focus so much on building out our asset management business, we haven't really turned much attention to what else we could do with that very valuable platform that we have. So our intention is, as Jenny mentioned in her prepared remarks, is to capitalize on that business that we have and spend more time attracting teams to join that platform. When we've done that, we've been quite successful doing it. And the teams have done well on the platform and grown and help the overall business growth. So what we need to do is over the next year or two really focus on how we can turn that into a natural sort of strategic operation, if you will, in terms of having people on the team, bringing new teams over and join the platform so we can grow that out."
},
{
"speaker": "John Dunn",
"content": "Got it. Thanks very much."
},
{
"speaker": "Matt Nicholls",
"content": "It's got all the resources that any wealth manager would need to offer their clients."
},
{
"speaker": "John Dunn",
"content": "Got it. Thanks."
},
{
"speaker": "Matt Nicholls",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And this concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments."
},
{
"speaker": "Jenny Johnson",
"content": "Great. Well, everybody, thanks for participating in today's call. And I just, again, want to thank all of the Franklin Templeton employees for all their hard work and dedication as well as the Western employees, who are particularly working hard and focusing on their clients and delivering continuing improving and very good performance despite all the distractions. And I just will say, we look forward to speaking to you next quarter. Thanks, everybody."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's teleconference call. You may now disconnect."
}
] |
ben | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Welcome to Franklin Resources Earnings Conference Call for the Quarter Ended June 30, 2024. Hello, my name is Sully, and I will be your call operator today. As a reminder, this conference is being recorded. And at this time, all participants are in a listen-only mode. And, I would like to turn the conference over to your host, Selene Oh, Chief Communications Officer and Head of Investor Relations for Franklin Resources. You may begin."
},
{
"speaker": "Selene Oh",
"content": "Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are just described in more detail in Franklin’s recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin’s most recent Form 10-K and 10-Q filings. Now, I’d like to turn the call over to, Jenny Johnson, our President and Chief Executive Officer."
},
{
"speaker": "Jennifer M. Johnson",
"content": "Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton’s results for the third fiscal quarter of 2024. I’m joined by Matt Nicholls, our CFO and COO; and Adam Spector, our Head of Global Distribution. We’ll answer your questions in a few minutes, but first I’d like to review some highlights from the quarter. During our third quarter, investors continued to be faced with a complex investment landscape due to dynamic financial markets amidst macroeconomic, geopolitical and election uncertainty. Starting with public equity markets. The S&P 500 reached an historic milestone earlier this month, closing above 5,500 for the first time and continuing its streak of strong performance in 2024. Likewise, the Nasdaq 100 also hit record levels surpassing the 20,000 mark. However, we’ve seen a pullback in late July as Big Tech earnings have disappointed and value has outperformed growth stocks month to-date. The two big themes of artificial intelligence and inflation drove growth stocks to outperform value stocks in the first half of the calendar year. AI is impacting companies well beyond mega-cap tech companies. Everyday companies and governments are examining how AI will improve or disrupt their respective operations and business models. Inflationary trends continue to moderate, which is supportive of markets. But, because stock market returns have been so highly concentrated, equity allocations are poised to broaden as we’ve seen in the last few weeks, which could provide a sustained boost to sectors and regions that have been overlooked. This trend will likely create investment opportunities favoring active managers. Meanwhile, on interest rates, consensus estimates currently expect two rate cuts by the Federal Reserve in the remainder of the year, which looks broadly appropriate to us. Recent Fed speak signals greater comfort with the latest progress on disinflation and acknowledges some signs of weakening growth momentum. As we get closer to the Fed’s rate cutting cycle, we expect traditional fixed income sectors to regain their place as a primary source for yield as cash begins to look less attractive. While spreads are tight at their current levels, we are not anticipating a sharp deceleration in activity, and our fixed income managers continue to find opportunities at attractive yields. Private markets continue to thrive, and our specialist investment managers are seeing very attractive yields in the private credit space and secondary private equity is seeing near unprecedented levels of pricing power. As investors weigh the impacts of these trends, we’re seeing a pickup in money in motion and investors becoming more active with alternatives, fixed income and select equity sectors as top priorities. We also continue to see the trend of clients wanting to work with fewer managers given the dynamic complex nature of current markets. In addition, we continue to have success engaging more and more in a consultative way with large clients leveraging the full strength of our firm. One of the benefits of partnering with Franklin Templeton is the breadth of capabilities we offer through a single global platform, making us a true partner for clients around the world. We offer access to specialist investment managers across public and private markets and asset classes and continue to broaden our investment capabilities to help clients achieve better outcomes. Now, turning to the highlights from the quarter. Ending AUM was $1.65 trillion flat from the prior quarter and an increase of 15% from the prior year quarter primarily due to the addition of Putnam, as well as positive markets. Average AUM increased by 3% from the prior quarter to $1.63 trillion and increased by 15% from the prior year quarter. In terms of investment performance, our investment teams have remained true to their distinct disciplines and time tested approaches. Investment performance remained consistent across the 1-year, 3-year, 5-year and 10-year periods. This quarter, 53%, 49%, 52% and 70% of our strategy composite AUM outperformed their respective benchmarks on a 1-year, 3-year, 5-year and 10-year basis. Turning to flows. Long-term net outflows were $3.2 billion. Reinvested distributions were $3.6 billion compared to $3.1 billion in the prior quarter, and $3.5 billion in the prior year quarter. $5.9 billion was funded out of the previously announced $25 billion allocation from Great-West Lifeco, bringing the total funded to $20.2 billion. We continue to make progress executing on our long-term plan of diversification across asset classes, investment vehicles and geographies. Client demand led to positive net flows in multi-asset and alternative strategies during the quarter. Multi-asset net inflows were $1.8 billion and driven by positive net flows into Canvas, Franklin Income Fund, Fiduciary Trust International and Franklin Templeton Investment Solutions. The investment solutions team takes Franklin Templeton’s best thinking and leverages our firm-wide capabilities across public and private asset classes to help provide solutions tailored to our clients’ needs, investment solutions ended the quarter with AUM of nearly $80 billion across the firm. Alternative net inflows were $1.4 billion driven by growth into private market strategies. Our three largest alternative managers, Benefit Street Partners, Clarion Partners and Lexington Partners, generated a combined total of $1.1 billion of net inflows, and Franklin Venture Partners generated net inflows of over $300 million. Benefit Street Partners continued to raise funds in alternative credit. In May, we announced the final close of its BSP Special Situations Fund II with $850 million of total capital commitments exceeding its target. Interest from clients to diversify private debt portfolios beyond direct lending into areas like real estate debt has attracted significant high-quality engagement with investors. Turning to secondary private equity, Lexington Partners announced a dedicated strategy and highly experienced team focused on leading single-asset continuation vehicle transactions in response to increased investor demand. Lexington has invested approximately $6 billion in CV transactions to-date, and the new team will be focused on increasing its participation in CV transactions with a differentiated approach. In secondary private equity, the largest, most established managers continue to see the most interest in flows reflecting a clear bias toward them in the market. Lexington has been a beneficiary of this trend. Clarion Partners has three open-end funds that perpetually fundraise in the U.S. and this year launched a fourth open-end fund in Europe focusing on the logistics sector. Clarion continues to be well-positioned with over half of AUM in the industrial and logistics sectors and less than 8% of AUM in the office sector. With regard to the wealth management channel, we continued to make strides and open new opportunities for investors given our strength in global retail distribution and dedicated specialist sales team with a focus on investor education. This quarter, we announced the expansion of our retail alternatives initiatives with a dedicated team in the EMEA region. Looking ahead, we remain focused on product development, including new products in secondary private equity and real estate private debt. Just as a reminder, at the start of our fiscal year, we anticipated raising $10 billion to $15 billion in fundraising and alternatives. And as of this quarter, we are well on our way to reaching the top-end of that range having raised over $12 billion fiscal year-to-date. It’s worth noting that since being part of Franklin Templeton’s platform, each alternative asset manager has increased AUM and continued to grow and diversify across strategies, product vehicles and client type. Fixed income net outflows were $4.8 billion excluding inflows from Great-West. Inflows improved approximately 5% from the prior quarter. As we’ve said on previous calls, we benefit from our broad range of fixed income strategies with non-correlated investment philosophies. Despite mixed performance in certain U.S. taxable strategies, we saw client interest reflected in positive net flows into highly customized multi-sector and global sovereign strategies. Additionally, we continue to benefit from vehicle diversification with cross-border funds, ETFs and SMAs and fixed income, all in positive net flows. Notably, we saw increasing interest from clients in multi-sector credit strategies, which capitalize on our team’s ability to offer multiple credit sector exposure in one strategy in a highly dynamic environment. Equity net outflows were $1.6 billion significantly improving from outflows of $5.3 billion in the last quarter, and gross sales improved by 16%. Equity net inflows were driven by large cap value and all cap core strategies and our single country ETFs. Our single country ETF now totaled $10 billion in AUM. With a broad lineup of capabilities, we are able to deliver investment expertise across vehicle types. We saw another strong quarter of positive net flows across our retail SMAs, Canvas and ETF offerings. We are a leading franchise in retail SMAs with $140 billion in assets under management. This quarter, we generated positive net flows of $500 million, the 5th consecutive quarter of net inflows. Through innovative technologies, we are continuing to enable personalized portfolio solutions and improved outcomes for investors. A good example is Canvas, our Custom Indexing solution platform. Canvas generated net inflows of $800 million in the quarter. AUM increased by 13% from the prior quarter to $8.2 billion and continues to have a robust pipeline. Meanwhile, our ETF business continues to see strong growth and generated net inflows of approximately $3.3 billion doubling the prior quarter’s net flows and was the 11th consecutive quarter of positive net flows. Our platform provides solutions for a range of market conditions and investment objectives through active, smart beta and passively managed ETFs. Just five years ago, our ETF AUM was $4 billion. AUM stood at $27 billion at quarter-end across more than a 100 strategies. As a result of our regionally focused sales model, we continue to deepen our presence across the globe. Our non-U.S. business saw its 5th consecutive quarter of positive net flows and finished the quarter with approximately $492 billion in assets under management. Our institutional pipeline of one but unfunded mandates was $17.8 billion not including the remaining allocation from Great-West. We continue to expand our Private Wealth Management business and Fiduciary Trust International AUM has more than doubled in the past five years from $17 billion to $38 billion. Athena Capital and Pennsylvania Trust acquired in 2020 have grown almost 40% since acquisition. One of our priorities is to further accelerate the growth of our Wealth Management business through organic investments and acquisitions. Our commitment to innovation, artificial intelligence, blockchain and machine learning positions us to enhance client outcomes across the rapidly changing technology enabled investment landscape. As various aspects of the asset management industry evolve, we continue to make investments in technology across distribution, investment management and operations. Earlier this quarter, we announced that we are working with Microsoft to build an advanced financial AI platform, which will help embed artificial intelligence into our sales and marketing processes to create more personalized support for clients. We also announced plans to make a strategic minority investment in Envestnet, a significant industry platform. And earlier this week, we announced the selection of a single platform to unify our investment management technologies across public market asset classes. This will support the simplification of our operation and reduce long-term capital expenditures. Formed in 2018, our Franklin Templeton Digital Assets Group has directly witnessed the revolutionary impact of blockchain technology. The digital asset space has experienced significant growth in recent years much like the proliferation of new technologies decades ago. Capitalizing on this trend, we launched our second digital asset backed ETF earlier this week, the Franklin Ethereum ETF, to give our clients additional access to this emerging asset class. Earlier today, we were pleased to announce our collaboration with SBI Holdings, a leading online financial conglomerate in Japan. The proposed joint venture will focus on ETFs and emerging asset classes, including digital assets and cryptocurrencies. The extensive reach of SBI’s brand in Japan aligns well with our commitment to help new generations of investors achieve their financial goals through innovative strategies. Turning briefly to financial results. Adjusted operating income was $424.9 million an increase of 1.3% from the prior quarter and a decrease of 10.9% from the prior year quarter. Looking ahead, we will continue to invest in the business to support our strategic priorities in Asset Management and Wealth Management. Finally, in June, Investment News recognized Franklin Templeton as Asset Manager of the Year. This is a true testament to all of our employees around the world and their commitment to being the ideal partner in helping both individuals and institutions achieve their key financial goals and objectives. I would like to thank our employees for always putting clients first. Now, let’s open it up to your questions. Operator?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And, your first question will be from Alex Blostein at Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Blostein",
"content": "Hey, good morning. Thank you for taking the question. I was hoping we could start with the Aladdin announcement. I know it’s been sort of speculated for the last couple of quarters, so nice to get it out there. But, can you talk about the operational benefits and both expense, benefits and operating margins ultimately, that you expect the platform to deliver. How long it’s going to take to get fully implemented, etcetera? And as part of that, maybe Matt, you can just hit on the expense items for the rest of the year as well? Thanks."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Thank you, Alex. Good morning. So, a couple of background points first, why have you done this, what we expect to get out of it. And then, I’ll talk a little bit about the implementation costs and timeline and so on as you’ve asked. So first of all, why we’ve done this? We’ve done this because it unifies our investment management technology across all of our public market businesses which as you know extensive amount of specialist investment managers. This importantly was a decision that was made collectively across all of our specialist investment managers and has taken us no less than 18-months to two-years to make this decision. In terms of the benefits, it brings several things including most of what you’d expect candidly, but most importantly in the form of one platform versus multiple vendors. I’ll just go through a few of the benefits. One, portfolio construction and risk management tools, a single investment book of record, integrated order management systems and connectivity, importantly consistent reporting across the firm and this is good for both clients and for internal reporting purposes. And, it assists in developing cross team, cross specialist investment manager, multi-asset solutions. And, also as you know we’ve been active strategically in the business adding companies over time and with a single platform like this it’s easier to add new business. It’s easier because it’s faster and lower cost to integrate. Thirdly, in terms of implementation costs, so implementation costs are expected to be approximately $100 million over the next three to five years. The peak of these costs will be fiscal ‘26 and ‘27 where we expect about 60% of these expenses to be assumed. Importantly though, we expect to absorb between 50% and 100% of the implementation costs, meaning on a quarterly basis over the next several years, we expect this to be close to neutral from an operating income perspective. At or around fiscal 2028, we expect to begin to realize savings of about $15 million per annum. And then in 2029, we expect that to raise to $25 million at least. Next quarter, we will add approximately $3 million of additional cost to IST associated with the start of this implementation. But again, we’ve got several things going on that should mean that we can absorb that based on other expense initiatives we have in the firm. So as mentioned, given other initiatives the impact per quarter should be quite modest if any. But, if anything is important to call out, we will obviously do that per quarter, Alex, and we’re most likely going to be able to do that in advance in our quarterly guidance. But as I said, the most important message here is even though this is an expensive implementation exercise, we’re going to absorb most of those expenses due to the other efforts that we have going on across the company. In terms of the guide for the next quarter, we expect our effective fee rate to remain stable at 37.5 basis points. We expect comp and benefits to be $825 million very stable from where we were this quarter. This assumes $50 million of performance fees. We expect IS&T to be between $150 million and $155 million. This includes the $3 million that I mentioned earlier with respect to the beginning of our implementation around the investment management platform. Occupancy, we expect to be in the high-70s around $77 million, $78 million and G&A we expect to be between $175 million and $180 million."
},
{
"speaker": "Alex Blostein",
"content": "Great. Thank you for all of that comprehensive as always."
},
{
"speaker": "Matthew Nicholls",
"content": "Thank you, Alex."
},
{
"speaker": "Operator",
"content": "Next question will be from Brennan Hawken at UBS. Please go ahead."
},
{
"speaker": "Brennan Hawken",
"content": "Good morning. Thanks for taking my question. Couple questions on Lexington. So, curious on an update about how much of Lexington 10 has been deployed. And then, when we think about the threshold for deployment where Lexington would start to look to kick-off fundraising for the next flagship, where does that typically happen?"
},
{
"speaker": "Jennifer M. Johnson",
"content": "Hey, Brandon. So, first of all, Lexington’s fundraising focuses this year, just to cover a little bit of that, has been middle market and co-investment, and that’s gone well. Meanwhile, they’ve been obviously deploying Fund 10. And, basically, the message is that they have been deploying it faster and at higher discounts than historical. So, it’s looking very good. We don’t have a specific date, but it is quite possible that they will enter the market sooner than they anticipated just because of the ability to deploy the capital faster. And, I think we all see it, right, the liquidity that’s needed in the space. They also interestingly, we mentioned it in the opening remarks about their continuation vehicle. So, they have about $6 billion that they’ve done where these GPs have a particular holding that they want to retain, but some of the LPs want liquidity, so they spit it out into a new vehicle. Lexington hired a market leader in that. They actually think that there’s opportunity to even create a fund in that instead of having it be part of, their traditional funds. So, I think that’s going to be another opportunity for Lexington."
},
{
"speaker": "Matthew Nicholls",
"content": "And Jenny, the only piece I would add to that is that, while Lexington historically has been focused on the institutional market, there are significant efforts underway, to ensure that they can better tap the Wealth Management channel by offering perpetual vehicles in Wealth Management in both the U.S. and non-U.S. markets, and that’s something we’re very actively engaged in developing."
},
{
"speaker": "Brennan Hawken",
"content": "Thanks for that. And just, Jenny, the discounts that you referred to, we had heard that those discounts have actually begun to narrow. Are they still seeing those wide discounts in the marketplace? Or they --"
},
{
"speaker": "Jennifer M. Johnson",
"content": "They are definitely starting to narrow, but they are still seeing, robust discounts versus historical discounts. They’re still better than historical discounts."
},
{
"speaker": "Brennan Hawken",
"content": "Yes. So, still at attractive levels, I guess, even though they’ve narrowed?"
},
{
"speaker": "Jennifer M. Johnson",
"content": "Yes."
},
{
"speaker": "Brennan Hawken",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Craig Siegenthaler at The Bank of America. Please go ahead."
},
{
"speaker": "Craig Siegenthaler",
"content": "Thanks. Good morning, everyone. So, my question is on the $25 billion AUM allocation from Great-West. So, you’re about $5 billion away, after this is reached probably in a few months. Can you talk about the incremental upside to this relationship over time beyond the ‘25?"
},
{
"speaker": "Jennifer M. Johnson",
"content": "Adam, do you want to take that?"
},
{
"speaker": "Adam B. Spector",
"content": "Yes, sure. So, with any client, I think you see a relationship grows over time. So, the first $25 billion was really something that was more contractually oriented throughout that process. We have been able to meet many Great-West Lifeco executives, as well as, the related power companies. We are in the midst of product development with them. So, the initial allocation has really been based on the types of products that insurance companies generally are interested in. And, I think if you look at most insurance companies, you’ll see significant allocations to some core fixed income as well as a tail that goes to alternatives. That has been the allocation we’ve received so far. But, what we’ve been able to do since acquisition is to work with Great-West, Great-West Lifeco as well as other power companies to develop newer products both for the retirement platform as well as doing things, on a JV venture on the insurance side. So, we are, not at a point yet where we can pinpoint what those will be, but there is significant product development going on, with Great-West, and we think that we will continue to see, the allocations broaden out from the core fixed income that has been the basis of things so far."
},
{
"speaker": "Matthew Nicholls",
"content": "The only thing I’d add to that, Adam and Craig is just for context, obviously we’re delighted with the $25 billion arrangement and the $20 billion we’ve got in so far. But, relative to other clients and investment management firms that the Power Group of Companies does business with, it’s still fairly modest candidly. So, we have a way to go with that relationship and we think of this as a multi-year exercise of building the relationship further versus just something has happened as far as a consequence of a transaction. But, I think it’s important to note and obviously we expect this, I mean, the Power Group of Companies have very significant relationships with other investment. That’s going to continue or we’re doing is pitching for our fair share of it."
},
{
"speaker": "Craig Siegenthaler",
"content": "Thank you, Matthew."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Dan Fannon at Jefferies. Please go ahead."
},
{
"speaker": "Dan Fannon",
"content": "Thanks. Good morning. Matthew, I was hoping you could clarify or expand upon, what you guys are doing to offset the implementation costs, with the new tech projects. So curious, what those initiatives are, if you could be more specific. And, is there some phase in of that, or are those ongoing now so we shouldn’t think about any kind of catch up period between the or mistiming of some of the implementation costs versus the ongoing savings?"
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. No, I don’t think there should be any mistiming’s, but as I said Dan, these things are quite complex. We’re not underestimating at all the implementation complexity of a project like this with Aladdin. I should say though that we’ve done this is an understatement to say we’ve done extensive planning around this both planning with our partners that’s both over at Aladdin and Deloitte, the consultant that we’ve hired to work with us on implementation. We’ve done extensive due diligence, we’ve built in contingencies and we have very significant resources, at both Aladdin and Deloitte and of course our own team. But, I don’t so I think we’ve done a ton of work to sort of determine, how the implementation expenditures will work. We’ve been extremely focused on this. If there is anything to call out, as I said, I will do that. But we and again, don’t want to jinx ourselves, but we don’t expect that to happen. In terms of how we’re able to absorb it. One of the tangential benefits I’ve referenced in previous calls of acquiring being so acquisitive over the last five years, notwithstanding all the additional work and complexity around acquisitions, it does lead to future opportunities to integrate and to be more effective and efficient across the different platforms and providers we have. A large portion of the savings is going from multiple providers down to one. Of course, we’re going to have other relationships still on the technology side that complement our relationship with Aladdin. But, we’ll have less than that. We also have a much larger scaled relationships. So of course, the pricing benefits that we have are very meaningful in that regard. The amount of resources we have externally from the Aladdin platform and our partners there and Deloitte are more than we could afford ourselves and frankly absorb some of the costs that otherwise we would have, if we were modernizing our own platform, for example. So, it’s all of those things sort of combined. We have multiple middle offices. We have multiple systems. They’re quite complex technologies all good and it works fine just to be clear. But, this is coming boiling down into one platform this way less vendors, more efficiency across our whole firm, which is needed anyway in terms of where the industry is heading is how we’re able to afford to do this in the effective way as I described."
},
{
"speaker": "Dan Fannon",
"content": "Thank you."
},
{
"speaker": "Matthew Nicholls",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Next question will be from Michael Cyprys of Morgan Stanley. Please go ahead."
},
{
"speaker": "Michael Cyprys",
"content": "Great. Thank you. Just wanted to circle back to the JV that you announced this morning in Japan with SBI. I was just hoping maybe you can remind us of your footprint in Japan today. Certainly, a lot of changes in that market. Just curious how you’re seeing that opportunity set evolving. Where do you see some of the biggest opportunities there in Japan? And how does this, JV help in terms of tapping into the opportunity set in that market? And, maybe you could touch upon what the economics will be and then how you sort of envision this JV working over-time and what success might look like?"
},
{
"speaker": "Jennifer M. Johnson",
"content": "Yes. So, I mean, we’ve been in Japan for a long time. Fortunately, Putnam actually has great relationships in Japan. And as a matter of fact, this quarter, I think we had $3.2 billion in net inflows in Japan. Big part of that was institutional business and with Putnam. Japan on the retail side has been a little bit more difficult and it is a market that is beginning to launch ETFs and starting to talk about digital assets. And, honestly the foreign investment shop, it can be difficult to penetrate that. So here with SBI, they have a tremendous reach. I mean, they’re probably the largest digital financial conglomerate. And so it’s I think it’s a 51% owned SBI, 49% Franklin Templeton. And, we’ll be launching joint ETFs. And, as the digital market opens up, we’ll be able to launch products there in the crypto space as well."
},
{
"speaker": "Matthew Nicholls",
"content": "And, our footprint now in Japan really is not that different than anywhere else in the marketplace. It’s nice to be able to have a significant local base there. Because of that, we have a strong institutional business. We’ve seen the results of that inflows this quarter. We’ve been able to really accelerate some of the great performance that Putnam has and won some assets there. In the retail space, we have a relationship with a number of different distributors. We also have a very strong insurance business in Japan. The only other thing I would note about SBI is that Japan is not a market that is, always recognized for its innovation, and SBI is an exception to that. It’s one of the first significant firms to really be breaking through on the digital side in terms of client engagement. And, we think partnering with them will allow us to be one of the first asset managers to have more of that direct consumer digital engagement model in Japan. And, the asset base in Japan now is close to $50 billion for us."
},
{
"speaker": "Michael Cyprys",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Brian Bedell at Deutsche Bank. Please go ahead."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks. Good morning, folks. If you just circle back on the ETF strategy, basically $27 billion like you said. But given the very wide range of products you have and strategies you have across the entire complex, what’s the desire to more substantially expand that ETF franchise? Is there an ability to clone more active product or is it more of a two-pronged strategy of doing that and rolling out more passive product? And then if you could just talk about connecting that with the or how easy it is to do that with the new Aladdin platform realizing it’ll take some time, of course."
},
{
"speaker": "Jennifer M. Johnson",
"content": "So, from an ETF standpoint, I mean, actually our largest category of ETFs over 40% is active. And then the next category is passive and then smart beta and then digital. So, our focus on ETFs is as a firm, we view ourselves as vehicle agnostic. So, whatever the market is interested in having us deliver our capabilities, we’ll deliver it in whatever vehicle they’d like. And there is a strong demand of advisors, particularly in the U.S. who are interested in ETFs. I think is driven a lot by the shift to fee based and so it’s been important for us to be able to launch products. I think we have over 100 ETFs today and to be able to launch products that are appropriate. There is there has been some feedback about a concern of launching close between a traditional mutual fund and an ETF, because it can bring suitability issues to the distribution platforms. And so, we like to either look at existing, say, mutual funds and potentially convert them if an ETF is a better way to deliver it or launch some sort of ETF that is a slightly different approach. Now interestingly, we’re getting a lot of demand from Latin America pensions that are interested in our single country ETFs, which are, I believe, the lowest price in the market. And so we’ve been getting good strong flows there. We’re getting flows from Europe as well as Japan. And so it’s really global. Our view is in a lot of these markets ETFs are becoming the vehicle of choice. And so we need to be able to support that. I don’t know if Adam, do you want to add anything to that?"
},
{
"speaker": "Adam B. Spector",
"content": "Yeah. I’d add a few things, Jenny. The flow there has been quite strong for us at 3.3 in net flow, this quarter and that’s 7 quarters in a row where we’ve had about a $1 billion or more, in flow. As Jenny said, that flow is coming from a geographically diverse base where we saw about $900 million coming in from EMEA, and about $0.5 billion coming in from the Americas region. I’d also just follow-up with Jenny’s point on being agnostic in terms of vehicles. Our most significant and longest tenured mutual fund, US mutual fund is the income fund. But if we look at the income fund for this quarter just as an example, we saw very slight outflows in the mutual fund, but positive flows in the related SMA, positive flows in the cross border fund, positive flows in the ETF. So, by offering four different vehicle types there, the category for the income strategies in general was net flow positive. And as investor demand becomes more global and shifts away from mutual funds, having multiple vehicles allows us to capture that flow."
},
{
"speaker": "Jennifer M. Johnson",
"content": "And actually I’m just going to say one thing on that. It’s often viewed that ETFs are potentially lower margin and I think that comes out of the history of it being sort of early on passive. Honestly it depends on kind of the strategy in the case of the income fund where we’re having so much success in those other vehicles, the pricing is actually very much in line with what the mutual fund is. And arguably over time, the cost to us will be less with the ETF and the SMA, because you don’t have the transfer agency and the fund administration costs in the same way that you do with the mutual fund. That actually was one of the drivers in our decisions to outsource those things because it allows us as the business shifts to have greater flexibility in the expense supporting the business."
},
{
"speaker": "Brian Bedell",
"content": "That’s great color. Thank you for all that detail."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Ken Worthington at JPMorgan. Please go ahead."
},
{
"speaker": "Ken Worthington",
"content": "Hi. Thanks for taking the question. As we think about possible extension of duration by investors at the FedEx later this year, which of your fixed income products do you think are best positioned to benefit with better sales? And then along the same line, some of the big flagship Western funds are still struggling with performance and outflows picked up this quarter, both gross and net. What are the issues sort of weighing on those funds?"
},
{
"speaker": "Jennifer M. Johnson",
"content": "So, first of all, as if rates go down, I think we probably are guessing two cuts this year. Obviously, cash becomes less interesting as your fixed income allocation and you’re going to probably see people move more into other fixed income. We’ve had two out of our three SIMs in positive net flows in fixed income. As a matter of fact, Franklin’s performance is excellent with 71% of AUM outperforming peers in the one, three, and five year. Brandywine has 92% of their AUM outperforming peers in the five year category. And five out of our top 10 gross selling strategies are in fixed income and that actually includes some of Western strategies. We have positive flows in a lot of different vehicles. So, our cross border with our euro short duration is in positive flows. Our ETFs and fixed income are positive flows. Our retail SMAs are in positive flows, and we have positive flows in our closed end funds. Interest and actually the largest portion of our institutional pipeline is fixed income. And again, that does not include Great-West Life. Interestingly, if you think about passive and how it potentially impacts fixed income, it’s been the areas that passive has actually cannibalized to some extent has really been in that core and core plus space. And so in multi sector, the highly customized munis, Adam help me out on the other strategies. And you’re not seeing that kind of cannibalization from the passive. And then Western as we’ve talked about their positioning has been longer duration. So as rates come down that actually is potentially a benefit as far as the positioning and, we’ve seen it in their kind of one month performance has improved a lot."
},
{
"speaker": "Adam B. Spector",
"content": "Yeah. I would add a few things. We didn’t really talk about the muni franchise in that, Jenny. The muni performance is really strong. We have about 90% of assets, outperforming on the one year period and about 75% outperforming on the three and five. We think we’ll see significant growth in munis, and the fact that we had a strong SMA franchise there as well as mutual funds, it’s really helping us. In terms of, the shift in rates with, a steeper yield curve, we think we will see money coming out of cash into longer term fixed income, which should benefit us. The other thing we’ve seen is that in a market, with fairly tight credit spreads, we see allocations going more and more to managers who have the ability, to be multi sector or multi credit exposures and, to have the ability to allocate across those different sleeves, and that bodes well for us as well as we are very strong in those areas. The final thing I would note, is that our insurance capabilities are highly specialized, and we’ve seen real growth in fixed income coming from insurance specific mandates where the regulatory, reporting compliance aspects of managing those accounts is as or more important than the alpha generation."
},
{
"speaker": "Jennifer M. Johnson",
"content": "And I just to add, one thing on the on cash management because a lot of people look at all the dollars in money market funds and think that that’s going to move out. But our money market funds, Westerns tend to have sovereign wealth and corporate treasurers who aren’t allocating as a temporary in between. As a matter of fact, Western had $2 billion in net flows, which really came from a product that was very competitively priced and attracted money from corporate treasurers. And then actually Franklin’s product, which is a Luxembourg product, had $800 million in flows. I think that was the fastest growing money market fund from some list that I saw, which was really offshore clients who wanted to take advantage of the yields in the U.S. And I think that product now it’s Luxembourg U.S. dollar short term money market fund, and it’s now $1.1 billion in AUM."
},
{
"speaker": "Ken Worthington",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Bill Katz at TD Cowen. Please go ahead."
},
{
"speaker": "Bill Katz",
"content": "Great. Thank you very much for taking the question. So, there’s a lot of ins and outs, to the franchise right now. And just maybe stepping back for a moment, I guess, where I’m struggling a little bit on the storyline is how do you drive both top line and bottom-line growth here? Because when I adjust for where your flows are coming in versus where they’re going out, it would seem to me that the fee rate may go lower. I’m so curious your thoughts on that. And then given now any incremental savings that you think you can do will sort of supplement the growth for the Aladdin platform. It would seem like you’re more of a top line story than a top line plus expense leverage, but then I worry the fee rate might go lower because of the mix. So, how do we think about how do you get revenue growth from here and then how you turn that into operating leverage? Thank you."
},
{
"speaker": "Jennifer M. Johnson",
"content": "So, let’s start and then, Matt, have you kind of jump on to some of the EFR and some of the other things. Look, I think that one of the things that the pivot into adding alternatives obviously, one of the benefits of that is that it’s just a fee even excluding performance fee as it’s based on investment management fee. And this year, we guided to $10 billion to $15 billion. We’re going to end out up close to $15 billion and yet the AUM is pretty flat and that’s really because of inflows plus market is sort of offset by some outflows and really realizations in distributions. But it was a year where we weren’t in the market with a flagship secondary PE fund from Lexington and frankly, real estate’s been really soft. So while, Clari Partners has three of their largest funds that are open ended and there’s perpetual fundraising. There just hasn’t been huge allocations to real estate. So, we hit a couple of those because I do think there’s opportunity for that pipeline to expand. Let me start with real estate. I think there’s a feeling that this market has really bottomed. And that’s driven by two things. One is more clarity on where rates are as well as probably more realistic marks that the bid and ask spreads are coming closer. And in talking to folks at Clarion, think about it. Office it used to be 35% of the index. It’s now down to 17%. So finally, maybe there’s more to go on office as far as dropping in the marks and Clarion only as 8% allocated to office. But you’ve had a huge adjustment in pricing. As a matter of fact, Clarion is seeing RFP volumes go up a little bit. You’re starting to see recessions and redemption queues. And more importantly, some of the properties that they sold in like logistics have sold for above the appraised value and, and some of the multifamily above where the marks were. So, that’s kind of a sign that the real estate market’s getting healthy again. And I think the feeling is by the end of ‘24, we’re going to start to see managers allocating back to real estate. I already mentioned about Lexington where, they’ve been deploying Fund 10 faster, and so hopefully we’ll be in the market sooner for their next fund. And again, this is just a supply and demand issue, which is so much has been deployed in the alternative space and there’s a need for liquidity for a variety of reasons. And we do see M&A starting to pick up, but their needs for that liquidity and there’s only a handful of large secondary managers that can buy big LP positions when needed. And so that’s been where we’ve been able to have true pricing power in the secondaries. And then, I mentioned on BSP, we think this real estate debt there’s some parts of private credit that have been pretty tight, but real estate debt, because of the retrenchment of regional banks, has made this just fertile ground for real opportunity, both from institutional clients interested in and really great conversations we’re having with distributors who are interested in the wealth channel and offering products there. So, we think that we’ve been -- if you just look at this year for alternatives, you’re kind of at a baseline. And I think there’s a lot more opportunity with some of this gets healthy. And that right there carries some of the fees up. I did mention the reduction in our fees, a lot of the EFR was an adjustment because we added Putnam. And so it’s not just if the asset mix in fixed income takes a much bigger percentage than equity, of course, you’re going to have it, but you’re not seeing the degradation because of vehicles as much as I think people are thinking that’s happening. We’re not seeing that at the same level. And then Matt, you want to cover anything?"
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. I mean, I think Jenny you covered most of it. I mean, there’s differences from last quarter, Bill, on the EFR, for example, the business mix is probably a little bit under 0.1 basis point, Putnam was 0.9. Now a lot of that has to do with the calculation at the EFR itself. But we thought the 0.9 would be a little bit less than that, hence the slight difference from the guide that I gave. The reason why it ended up being as much as 0.9 is because frankly, Putnam is growing faster than we anticipated, is growing faster now, projections every month it’s growing faster than we thought. For perspective, Putnam’s AUM is 23% higher than when we announced transaction or 13% higher than when we closed the transaction. And they’ve been in positive flows every month since both quarters since. So, what that’s meant is because they’re at a lower effective fee rate, the averaging and the calculation, everything, it means that the EFR has come down a bit. If you take that into account and then you take into account previous quarters where we’ve had episodic boosts to EFR such as Lexington’s catch up fees. Our EFR has actually been fairly stable. I mean, it has come down a little bit, but it’s normally by 0.1 here and there. And that as Jenny mentioned is largely due to a little bit of the mix and frankly the growth in ETF, Canvas, SMA solutions. And we expect that group of things to be growing. It’s very hard to have all of the things flowing that we’ve invested in one quarter. One day we will actually get alternatives, ETFs, Canvas, SMA and solutions all coming together at once where we get the fundraising in ops lined up with all those other more organic and more on-going growth areas of those vehicles. When we do that, we’ve got a good shot at it offsetting the areas of shrinkage that you referenced. I’ll also point out that if you take out some of the larger sort of tax or fixed income areas that you’ve pointed to and others have pointed to, we’d be in positive flows in the business right now. So anyway, just to give you a little bit more information on AFR."
},
{
"speaker": "Adam B. Spector",
"content": "And Bill, the final thing I would add is Jenny talked a lot about alternatives. Alternatives and wealth management is something obviously we’re focusing on that I think is very positive from an EFR perspective. And the final thing I would note is that our core sales that and we think about that as sales that are less than $100 million are up at about 14%. That tends to often be higher fee business, and we see very significant continued growth in core sales."
},
{
"speaker": "Bill Katz",
"content": "Thank you for the very comprehensive answer."
},
{
"speaker": "Operator",
"content": "Thank you. Next question is from Patrick Davitt at Autonomous Research. Please go ahead."
},
{
"speaker": "Patrick Davitt",
"content": "Hey. Good morning, everyone. I have a follow-up on your answer on the Aladdin expense absorption. A lot of what you described sounds like it would have to come through after implementation. So just to clarify, you’re expecting that absorption to be in lock step with the implementation expense. And if so, how do you turn off all of those extra vendor costs if Aladdin isn’t live yet to fill in that capability? Thank you."
},
{
"speaker": "Adam B. Spector",
"content": "It’s inclusive of that. So, there will be periods of time where we’re paying for both Aladdin and we’re paying for other vendors. But the quarterly kind of view or vision that I provided to you includes that assumption. So, we still think that there would be very modest adjustments to or impact to operating income per quarter based on our plan over the next five years. Remember, of course, that portion of the $100 million is capitalized. So that gets spread out over more years, probably something like 50% of it gets capitalized over more years than three to five."
},
{
"speaker": "Jennifer M. Johnson",
"content": "And I could add that we’re not on a uniform technology platform. So, as you migrate certain SIMs over, you retire their systems. And so it is a little bit lockstep as you go along."
},
{
"speaker": "Adam B. Spector",
"content": "Yes. And we have and the other thing is that we the time that we’re implementing Aladdin, we are also implementing other important opportunities across the company that again offset as I mentioned earlier, offset those the sort of the double pay you have to pay across different vendors. And that’s why when you get to the outer years like ‘28, ‘29 and so on, when that gets eliminated, you’re starting talking about $25 million plus of savings."
},
{
"speaker": "Patrick Davitt",
"content": "Thank you."
},
{
"speaker": "Adam B. Spector",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today’s Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin’s President and CEO, for final comments."
},
{
"speaker": "Jennifer M. Johnson",
"content": "Well, I just want to thank everybody for participating in today’s call. And once again, we’d like to thank our employees for their hard work and dedication, and we look forward to speaking with all of you again next quarter. Take care, everybody."
},
{
"speaker": "Operator",
"content": "Thank you. Ladies and gentlemen, this does conclude your conference call for today. You may now disconnect."
}
] |
ben | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Welcome to Franklin Resources Earnings Conference Call for the quarter ended March 31, 2024. Hello, my name is Sylvie, and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions]"
},
{
"speaker": "",
"content": "I would now like to turn the conference over to your host, Selene Oh, Chief Communications Officer and Head of Investor Relations for Franklin Resources. You may begin."
},
{
"speaker": "Selene Oh",
"content": "Good morning, and thank you for joining us today to discuss our quarterly results."
},
{
"speaker": "",
"content": "Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements."
},
{
"speaker": "",
"content": "These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings."
},
{
"speaker": "",
"content": "Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer."
},
{
"speaker": "Jennifer Johnson",
"content": "Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for the second fiscal quarter of 2024. I'm joined by Matt Nicholls, our CFO and COO; and Adam Spector, our Head of Global Distribution."
},
{
"speaker": "",
"content": "We'll answer your questions in just a few minutes. But first, I'd like to review some highlights from the quarter. In terms of public equity markets, 2023 was, to some extent, a tale of 2 markets, the Magnificent Seven and the S&P 493 with the former contributing the lion's share of returns."
},
{
"speaker": "",
"content": "So far in 2024, in the public equity markets, we've seen a significant dispersion emerge in performance among the Magnificent Seven, leading to a better environment for fundamental research to capture alpha and when augmented by robust risk management can deliver compelling portfolio results for clients."
},
{
"speaker": "",
"content": "Given the current backdrop, we believe equity allocation should, in general, tilt towards sectors and regions that are being overlooked due to the heavy concentration in the largest companies. In addition, the theme of artificial intelligence will likely continue to be a significant stock driver, both positive and negative for the haves and have-nots over time."
},
{
"speaker": "",
"content": "Meanwhile, on interest rates, consensus estimates currently indicate a notable decrease in the number of expected cuts for 2024 by the Federal Reserve from 6 to now 2. Fed speak increasingly signals openness to delaying rate cuts to later in the second half of this year on the back of improving economic growth and slower disinflation."
},
{
"speaker": "",
"content": "Against this background, while cash may continue to look attractive in the very near term, fixed income opportunities will likely provide a better total return option over high-yield and cash equivalents as the cutting cycle commences."
},
{
"speaker": "",
"content": "Looking at private markets, secular trends and macro tailwinds continue to create opportunities in alternative credit, secondary private equity and select areas of real estate. In addition, investor demand for private market exposure is increasing given its diversification benefits, potential for higher risk-adjusted returns and as a hedge against inflation."
},
{
"speaker": "",
"content": "Broadly speaking, these signals point to a complex market environment that creates opportunities for active managers. This quarter, my executive team and I had the opportunity to travel extensively outside the U.S. to meet with many of our key clients to hear firsthand what is top of mind and how Franklin Templeton can better serve them."
},
{
"speaker": "",
"content": "As a global active manager with $1.6 trillion in assets under management and operating in 35 countries around the world, we believe that Franklin Templeton is positioned to take advantage of the money in motion by assisting our clients with a broad range of investment capabilities across public and private assets in vehicles of choice."
},
{
"speaker": "",
"content": "We were also pleased to learn that our clients recognize the steps we have taken over the past few years to further diversify and strengthen our presence in important markets and distribution channels outside the U.S. We, again, saw aggregate positive net flows in non-U.S. regions, which now have approximately $490 billion in assets under management."
},
{
"speaker": "",
"content": "Furthermore, a number of our clients continue to progress toward working with fewer asset managers and in this regard, expect not only a broad range of investment capabilities, but also other services, including technology, portfolio construction, customization and thought leadership."
},
{
"speaker": "",
"content": "At Franklin Templeton, we leverage the skills of multiple specialist investment managers to deliver expertise across a wide range of investment styles and asset classes. Our investment teams benefit from Franklin Templeton's scale, with centralized investments in content, technology, data and most recently, artificial intelligence where we're excited about collaborating with leaders in technology on AI platforms."
},
{
"speaker": "",
"content": "Moreover, the diversity of our model benefits our corporate shareholders, given that no single specialist investment manager at our firm represents more than 12% of adjusted operating revenue and most of our specialist investment managers are diversified within themselves as well."
},
{
"speaker": "",
"content": "Turning to highlights from the quarter. Ending AUM increased by 13% to $1.64 trillion from the prior quarter and increased by 16% from the prior year quarter due to the addition of Putnam as well as positive markets and net inflows. Average AUM increased by 13% and 11% to $1.58 trillion from the prior quarter and the prior year quarter, respectively."
},
{
"speaker": "",
"content": "Investment performance continues to be strong and resulted in 62%, 51%, 62% and 69% of our strategy composite AUM outperforming their respective benchmarks on a 1-, 3-, 5- and 10-year basis, benefiting from the addition of Putnam."
},
{
"speaker": "",
"content": "In terms of mutual funds, investment performance resulted in 51%, 60%, 44% and 56% of mutual fund AUM outperforming their peers on a 1-, 3-, 5- and 10-year basis, and performance strengthened versus peers across the 3-, 5- and 10-year time periods quarter-over-quarter."
},
{
"speaker": "",
"content": "Our long-term net flows were $6.9 billion in the quarter, including reinvested distributions of $3.1 billion and $13.7 billion was funded out of the $25 billion allocation from Great-West. Long-term net inflows were spread across asset classes, investment vehicles and geographies. Fixed income, multi-asset and alternative assets led the way from an asset class perspective and we continue to see growth in our separately managed account, ETF and Canvas offerings. Each have achieved at least 4 consecutive quarters of net inflows and all are at record high AUM."
},
{
"speaker": "",
"content": "Long-term inflows of $85 billion increased by 23% from the prior quarter and 37% from the prior year quarter. Excluding reinvested distributions, which are seasonally elevated in the prior quarter and inflows from Great-West, long-term inflows increased by 17% from the prior quarter and 15% from the prior year quarter."
},
{
"speaker": "",
"content": "In terms of flows by asset class, fixed income net inflows were $8.3 billion, we saw client interest reflected in positive net flows into core bond highly customized corporate bond, multi-sector municipal and high-yield strategies."
},
{
"speaker": "",
"content": "Equity net outflows were $5.3 billion. We saw positive net flows into large-cap value and smart beta. Excluding reinvested distributions, which are seasonally elevated in the prior quarter, equity net outflows improved by 29% from the prior quarter. Multi-asset net inflows were $2.9 billion, driven by Franklin Templeton Investment Solutions, the Franklin Income Fund and Canvas, our custom indexing solution platform."
},
{
"speaker": "",
"content": "Alternative net inflows were $1 billion, driven by growth in the private market strategies, which were partially offset by outflows in liquid alternative strategies."
},
{
"speaker": "",
"content": "Benefit Street Partners, Clarion Partners and Lexington Partners each had net inflows in the current quarter with a combined total of $1.4 billion. As we mentioned last quarter, in January, Lexington Partners closed its latest flagship global secondary fund with $22.7 billion of total capital commitments."
},
{
"speaker": "",
"content": "Fund 10 ranks among the largest funds raised to date and significantly exceeded Lexington's private secondary fund, which closed with $14 billion in 2020, and we were delighted that approximately 20% of the capital raised in the fund came from the wealth management channel."
},
{
"speaker": "",
"content": "Also in January, Benefit Street Partners closed its 5th flagship private credit fund with $4.7 billion of total capital commitments, reflecting the strong demand for the asset class, BSP exceeded its fundraising target. We believe the current market opportunity and backdrop for U.S. direct lending and alternative credit in general is attractive, and BSP has significant underwriting experience, loan structuring expertise and focus on deep due diligence, which provides us with a competitive advantage."
},
{
"speaker": "",
"content": "In the wealth management channel, alternatives by Franklin Templeton has increased the number of product offerings and expanded platform placements, increasing market share and growing our client base. Our distribution force of more than 350 individual partners with our 50% group of alternative asset specialists to educate financial advisers and their clients on the potential benefits of private market investing."
},
{
"speaker": "",
"content": "We expect a busy next 12 months across private markets."
},
{
"speaker": "",
"content": "From an investment vehicle perspective, ETF AUM ended the quarter at $24 billion and generated net inflows of approximately $1.6 billion representing another quarter of net inflows exceeding $1 billion and the tenth consecutive quarter of positive net flows. SMA AUM ended the quarter at $138 billion and generated positive net flows of nearly $3 billion, representing the fourth consecutive quarter of net inflows."
},
{
"speaker": "",
"content": "Canvas generated net inflows of over $750 million with a robust pipeline and AUM increasing by 23% from the prior quarter to over $7 billion. Investment Solutions leverages our capabilities across public and private asset classes to pursue strategic partnerships. This quarter, Investment Solutions generated positive net flows with assets under management of over $75 billion, including the addition of Putnam."
},
{
"speaker": "",
"content": "This quarter, our institutional pipeline of one but unfunded mandates was $20 billion, a significant increase from the prior quarter and does not include the remaining allocation from Great-West Lifeco. The pipeline is one of the strongest it's been and remains diversified by asset class and across our specialist investment managers."
},
{
"speaker": "",
"content": "With the close of our acquisition of Putnam on January 1, we are a $1.64 trillion investment manager. We've been pleased with the positive reaction from our clients and in the quarter, Putnam contributed positive net flows and its AUM increased by 8% to $160 billion or 18% since our announcement in May last year."
},
{
"speaker": "",
"content": "With our expanded capabilities, our AUM in the insurance and retirement channels now exceeds $650 billion. Putnam's investment performance continued to be strong, with 89% or higher of mutual fund AUM outperforming peers in the 1-, 3-, 5- and 10-year periods and 91% of mutual fund AUM in funds that are rated 4 or 5 star by Morningstar."
},
{
"speaker": "",
"content": "We were also thrilled to see that Barron's ranked Putnam the #1 fund family for 1- and 5-year performance and #5 for the 10-year period."
},
{
"speaker": "",
"content": "Since the closing, we're also pleased to see that Putnam's average monthly gross sales has increased by approximately 30%, demonstrating the strength of Franklin Templeton's distribution."
},
{
"speaker": "",
"content": "Turning briefly to financial results. Adjusted operating income was $419.6 million, an increase of 0.6% from the prior quarter and a decrease of 4.7% from the prior year quarter."
},
{
"speaker": "",
"content": "As always, we continue to focus on disciplined expense management, while also continuing to invest in growth and innovation for the benefits of our clients and shareholders."
},
{
"speaker": "",
"content": "Before I turn the call over to you for your questions, I would like to thank our employees for their many contributions and always staying laser-focused on our clients' financial future. Now let's open it up to your questions. Operator?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions]"
},
{
"speaker": "",
"content": "One moment for your first question which will be from Craig Siegenthaler at Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "First, we have a big picture net flow question. Lots of ins and outs in the $7 billion, especially with the $14 billion and from -- Great-West. So how should we think about the core net flow run rate if we back the $14 billion out of the $7 billion of long-term net flows?"
},
{
"speaker": "Jennifer Johnson",
"content": "So Craig, thanks for the question. Let me -- let me answer that question in first, kind of how we're positioning ourselves, and I will -- I promise you, I will get to those points and Adam can add some additional cover -- color. So -- the way we're positioned the firm, I think of it as in 4 key secular trends that has driven our acquisition strategy and what we think will drive flows now and in the future. So the first obviously is our movement to alternatives. We think that it's not going away, private credit is here to stay, banks are going to lend the same way that they've done in the past, private equity is here to stay. And so if you look at our breadth of capabilities from Lexington, Clarion, BSP, Alcentra we think we have the broadest alternatives capability of any traditional asset manager."
},
{
"speaker": "",
"content": "And from a flow standpoint, obviously well known in the institutional space, what's really important is that the -- in the wealth channel, there's a desire to go from about a 5% allocation to a 15% allocation. And what's significant there, if you just take the 4 biggest wire houses a 1% increase in allocation is $130 billion. And what we're excited about is that as we mentioned in the prior comments and opening comments, Lexington's that fundraise was in the wealth channel. And believe me, that was years of learning starts and stops in blocking and tackling, learning about education, educating our own team, educating the advisers who are selling to be able to be successful in that. And we think we can take that same strategy with any of our alternatives."
},
{
"speaker": "",
"content": "The second -- I'm going to name 4 of them. The second is just customization. You're seeing from technology advances that clients want either specific vehicles or the portfolios to be customized. And so if you look at this quarter's trends, things like our SMA, which is positive, Legg Mason made us a top 3 SMA provider. You're seeing more and more flows going into SMAs, ETFs, while we were late arguably to the passive ETF space, we were actually early in the active ETF space. And today, at our $24 billion in ETFs, the largest category is actually active ETFs."
},
{
"speaker": "",
"content": "And we're seeing that in markets like Europe, where the regulatory environment has changed, there's a greater demand now for ETFs. And we're having success in our like green bond and Paris Alliance. So a lot of the ESG ETFs are doing very well in Europe."
},
{
"speaker": "",
"content": "And then finally, in kind of that customization vehicle being -- vehicle [indiscernible] is the direct indexing. And not only we're seeing positive flows consistently with Canvas. But we added 11 new partners to the 88 partners that we have with Canvas. And once you get embedded in -- from the -- in the pipes, you continue to see flow. So it's just a great opportunity."
},
{
"speaker": "",
"content": "But I think what gets us most excited about Canvas is the fact that as you're seeing this trend towards greater SMAs, Canvas was built as a technology platform. Some of the direct indexing were more about people who focused on tax optimization. This is truly a technology platform. So we can see taking traditional active portfolios of being able to tax optimize as well as tilting. And you have to have the right technology for that."
},
{
"speaker": "",
"content": "The third big trend, I think, is really global distribution. You have 1 billion people that are entering the middle class, 87% of those are in Asia. And so we've got that massive global distribution. We were in Taiwan in 1985. We were the first foreign manager in India. We have local asset management capabilities in emerging markets like in the Middle East, China, India, Brazil as well as local capabilities in a lot of developed markets. And so we think we're really uniquely positioned to take advantage of that trend. And as a matter of fact, this quarter, you saw non-U.S. flows were positive outside the U.S."
},
{
"speaker": "",
"content": "And then the fourth and, obviously, really important is the technology and technological advances. And that's where I would say, I think the players -- so far, if you play the AI move, you've been playing in the picks and shovels of artificial intelligence, it's going to be the firms that really figure out how to make this work for them to make it a competitive advantage that's important. You'll hear it about an announcement later this week where we are announcing a strategic partnership on some AI work that we're doing with one of those big players."
},
{
"speaker": "",
"content": "And then the secondary is blockchain. And we came out with a tokenized first one to have a 40 Act shareholder system on the public blockchain. We came out with the tokenized money market fund in 2021. So the first to do that, we are actually a node validator in the space with 11 different nodes. It's an area we know well, and we think it's going to be really significant. We announced a partnership with a UAE-based firm to leverage -- they're going to leverage our blockchain technology, shareholder servicing systems to launch a stable coin, and we'll be managing the portfolio there."
},
{
"speaker": "",
"content": "So as you bring those together, now to answer your question, it's going to be -- it's about execution, right? And I could tell you, I think we found it was probably -- it's a challenge when you take -- you do 10 different acquisitions and you're trying to choose best athlete for your distribution team, and we genuinely believe we put together the best team, but there are headwinds to that where you get a new wholesaler in a region and you've broken relationships maybe with the prior wholesalers clients. And so it takes time to build those relationships back. But we feel like we're really seeing that pay off this quarter."
},
{
"speaker": "",
"content": "You see it in our pipeline, I mean, to go from $13 billion to $20 billion and not have -- that's not any Great-West Life. That's just good, solid wins in the pipeline growth. Interesting statistic is our core sales, and we define core sales, sales less than $100 million. So these are the ones that just -- you get on an adviser's platform and they continue to just allocate to you. So excluding Putnam, those are up 14%. And again, those are where that wholesalers out there meeting and so a good success there."
},
{
"speaker": "",
"content": "And then if you look at inflows, excluding reinvested distributions Great-West Life, they're up 17%. So we're positive in all those vehicles, we're positive outside the U.S. where we've got good pipeline strength."
},
{
"speaker": "",
"content": "And then you take a firm like Putnam. And this is where we've talked about this, and I think you see it with Putnam, where the big distribution companies or big distributors are saying they want to consolidate the number of partners. And so you take a Putnam, we've actually grown Putnam sales by 30% since the acquisition. And that's just really, in some cases, where we're a preferred partner with a distributor, and they weren't and now they get the benefit of being part of that preferred partnership. It's where our 350-plus client-facing wholesalers can be out there telling the phenomenal story of the performance of the Putnam's funds. And so to see a 30% increase in really the first quarter of Putnam because of bringing it together that distribution is really exciting."
},
{
"speaker": "",
"content": "So long-winded answer, Craig, but I think we're -- we feel like all that we've put together is coming together in distribution now."
},
{
"speaker": "Craig Siegenthaler",
"content": "We're looking forward to seeing your AI announcement later this week. We have a follow-up on outflows. Over the last 8 quarters, we added it up, Franklin had a $13 billion of all inflows. And I know this excludes realizations too. If we add up Lexington $10 million and Benefit Street $5 million. Combined, they add a $27 billion. So all flows look to have been maybe negative $14 billion excess 2 flagship fundraises. So a similar question, but [indiscernible] on the alts business, how should we think about the [indiscernible] net flow trajectory just given that dynamic?"
},
{
"speaker": "Jennifer Johnson",
"content": "So I think it's -- there's a little bit of noise in the alts numbers. If you just look in calendar year 2022 and 2023, we talked last time about how we raised $40 billion in the private markets. But the reality in our alternatives business, we raised $55 billion, and 80% of it was private markets. But the net change in AUM, you saw $40 billion added to the private markets AUM net, net of realizations, distributions, market, everything. But $16 billion negative in the liquid alts portfolio, which represents about 6% of our alts portfolio now. So that's where you're shifting from much -- the good news is it's the higher fee private markets that have had -- that had solid inflows in that window, but it was a little bit masked by the lower fee liquid alts."
},
{
"speaker": "",
"content": "Now fast forward to this -- I'll go this fiscal year. So the first 2 quarters, first of all, we said that we would be raising between $10 billion and $15 billion. That's our goal for the year. We're on track for that. We've raised about $7.3 billion in the private markets and another just under $2 billion in the liquid alts."
},
{
"speaker": "",
"content": "But if you net out distributions, realizations, FX and market, and to be honest, market -- the only negative market was real estate with Clarion and the others were all positive. We'd say it nets to flat. So again, kind of a gross number there. But if you take away the distributions, realizations and FX, FX was actually pretty significant. Matt could probably give you more details on this, but we netted flat so far in the -- in this fiscal year."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Craig, just for perspective, I'd say, for the last quarter that we're just reporting on, realizations and distributions was $2.6 billion, for example, and we had negative FX of another $1 billion. But we do -- we get these questions, and I think we're going to try and improve our disclosure on this to try and help the question around this. Now we've got the bulk of our alternative assets together. Remembering in previous quarters, we've always said, when we were much smaller, we've always said, look, realizations and distributions just not -- they're just not significant enough to report and break down the explanation of AUM, but they're now getting to the point where we're going to start providing that level of detail. But just for information, the last quarter, again, the one we're reporting almost $2.6 billion of realizations and distributions and $1 billion negative FX."
},
{
"speaker": "Adam Spector",
"content": "And Craig, the only thing I would add is that the other thing we've been able to do really is to work more closely with our distribution partners on the wealth management side over the last few quarters and we're able to secure calendar spots further into the future than we ever thought was possible. And I think that speaks well to our future fundraising as well."
},
{
"speaker": "Operator",
"content": "Next question will be from Glenn Schorr at Evercore."
},
{
"speaker": "Glenn Schorr",
"content": "So I wanted to talk about fixed income a little bit. So I see pension-funded status is much, much better and rates are higher. I like the $8.3 billion in flows in the quarter, but I don't know how much of that came from Great-West or something else? So maybe you could talk about that. And then bigger picture, is this -- do you feel this is the beginning of a broader trend, the long-awaited fixed income flows, maybe you can give us a little bit of insight from whether it be RFPs, client combos or the consultants on -- if we're at the [indiscernible] of some larger flows into fixed income?"
},
{
"speaker": "Jennifer Johnson",
"content": "Yes. Thanks, Glenn. So interestingly, let's face it. As long as people believe rates have peaked and potentially will come down, they're going to go longer duration, right? So the only thing is you're now starting to hear the noise for the first time where actually people think rates may be longer -- higher for longer and somebody was even talking about a potential rate increases. So that could slow things. But let me give you what we're seeing."
},
{
"speaker": "",
"content": "So we obviously had positive flows, but just looking at the pipeline, and the pipeline doesn't include any Great-West Life. If you add -- well, about 70-plus percent of the growth in the pipeline, is fixed income, and that crosses Western, Franklin and Brandywine. If you actually add BSP because I always think private credit really should be thought of in the fixed income because the decisions around that are often how you're thinking about your fixed income portfolio. The growth in the pipeline, 97% of it comes from fixed income."
},
{
"speaker": "",
"content": "So 6 of our top 10 gross selling funds in the last -- this past quarter were in fixed income, corporate bond, core bond, multi-sector, munis, highly customized [indiscernible]. So definitely demand in the last quarter. But if you actually look at the pipeline going forward, the institutional pipeline, you see very strong demand for fixed income."
},
{
"speaker": "Adam Spector",
"content": "And I would say that it's also pretty broad-based. If you take a look at that funding pipeline, it's really across all 4 of the fixed income firms we have, which all have very significant pipelines right now. And if you take a look at the products we're offering, we're positive in core in high yield and munis was our best-selling segment. So really broad-based fixed income appeal, not just one product."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. And they're also -- last thing I'd say on that is they're also positioned differently in terms of their view on where rates are going. So that means where we've had some performance weaknesses. It's being offset not always fully but being partially offset by strength in other parts of the franchise."
},
{
"speaker": "Adam Spector",
"content": "And on the institutional business that you asked about is strong, we're also positive in ETF and SMAs, muni ladders, to lots of different fixed income vehicles doing well for us."
},
{
"speaker": "Glenn Schorr",
"content": "Just [indiscernible] follow up on that same topic is have allocations changed a lot? In other words, I hear you on the flows. That's a very bullish commentary for the forward look. But if you took a snapshot of a year ago and 2 year ago allocations to where we are now and maybe 2 years forward, do you think we'll see a major equity fixed income shift? Or I know it's a lot broader than that. But like will fixed income allocations be a lot higher 2 years out?"
},
{
"speaker": "Jennifer Johnson",
"content": "Again, I think it depends on your view on rates. And as I think Adam or Matt mentioned, you -- our fixed income teams are all kind of spread out as far as their view on where rates go. The frankly, guys probably think a little bit higher for longer Western is probably more aggressively positioned for rate cuts. So I think it really depends on your views. I do think if rates stay higher for longer, it has impacts on returns on equity markets as far as expectations, private markets as well. So Glenn, I think -- again, I think it's going to depend on where people -- where they think they should position our portfolio. I don't know, Adam, do you want to add anything?"
},
{
"speaker": "Adam Spector",
"content": "Yes. I think it depends on the client, right? You mentioned more fully funded pension plans, right? If we get a wave of more immunization going on, we're going to see that drive fixed income flows. At the same time, really in every channel around the world. What do we see is a move towards alternative. That money is coming out of all of the other traditional buckets. So I think both of those are kind of competing with each other and pushing fixed income allocations in the opposite direction."
},
{
"speaker": "Operator",
"content": "Next question will be from Dan Fannon at Jefferies."
},
{
"speaker": "Daniel Fannon",
"content": "I guess, Matt, maybe we could start with some expense questions. So curious about what the delta was in comp versus your guidance and then as we think about the seasonal impacts of some of this quarter, how much do you expect to roll off as we go into 2Q? And then maybe update us on kind of the full year outlook for expenses."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Thank you, Dan. Yes. So a couple of things on expenses around the second quarter, I'll get to the comp and benefits in a second. I'd just like to say that notwithstanding the higher resets around compensation calendar resets around compensation that I'll talk about in a minute and meaningfully higher markets. If you exclude Putnam, which was the main addition we had in the quarter, our expenses would have been flat. So notwithstanding higher performance fees than we expected, higher calendar resets than we expected and higher markets than we expected. Our expenses for the quarter would have been flat when you exclude Putnam. So hopefully, that demonstrates some discipline there. In terms of your specific question around comp and benefits for the second quarter."
},
{
"speaker": "",
"content": "The difference is, I said it's around almost half of it is the performance fee, a little bit less than half is performance fee increase relative to where we thought it would be. And then there's these high -- I would say, we were expecting Canada resets their composition, but they're just higher than we thought they'd be. So things like the 401(k), mutual fund units in compensation -- deferred compensation plans, vacation accruals. They were all -- when you add all those things up, plus the performance fee delta, it adds up to about $30 million. So when you add the $30 million to, I think I guided [ $815 million ] on the call, that gets you to pretty much where the [ $844 million ] is where we ended up -- where we ended up. So that explains that part of your question."
},
{
"speaker": "",
"content": "In terms of the annual guide, last quarter, we guided to $4.6 billion, and that's excluding performance fees, but including the double rent that we've talked about around our New York City consolidation exercise. And I would increase that just slightly to probably $4.6 billion -- $4 billion to $4.65 billion, a very narrow range. So less than 1% higher, and that's really driven by the higher markets that we've experienced. If markets come back down again. as we've been experiencing very recently in the first part of this quarter, it wouldn't surprise me if our annual guide remains flat. But right now, [indiscernible] remaining equal, we expect it to be just slightly higher for the annual guide."
},
{
"speaker": "Daniel Fannon",
"content": "Great. That's helpful. And then maybe just a follow-up on that with regards to the effective fee rate I think you had talked about it coming into the mid 38s as the year progressed. So I guess, given where mix is AUM levels, all the dynamics that go into that, how do you see that trending?"
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Thank you for the question. So the EFR for the quarter dropped to 38.5. And I believe that's exactly how we guided for the quarter. And we're able to do that because we had a pretty good feel for the mix that we're coming in, in terms of flows. And I think I also pointed out that we were 1 basis point higher than usual, let's call it, or the effective fee rate for the last quarter was inflated by 1 basis point based on Lexington catch-up fees."
},
{
"speaker": "",
"content": "Going forward, on an annual basis, I would say that our EFR should remain in the 38s probably in the mid-38s, it will be slightly higher than that, driven by episodic alternative asset fees, as we've experienced over the last 12 months and highlighted those clearly, I think, in our results."
},
{
"speaker": "",
"content": "And it can -- and the other thing that will help it be higher is a larger percentage of alternative assets and a higher percentage of equities. With the public markets going up as much as they did in the first quarter, obviously, as a percentage overall, our alternative assets came down a bit, so that brought the EFR pressure down slightly."
},
{
"speaker": "",
"content": "And then we had quite a few successes as Jenny mentioned in her remarks, in ETFs, Canvas, separately managed accounts. And all these things are lower fee rate businesses. It's less about fee erosion per se. I'd say, it's just more about the business mix. So for the next quarter specifically, we expect EFR to probably be even in the high 37, so let's say, high 37 to 38, but this is because of the success that we didn't anticipate as much success with Putnam because the overall Putnam business is a lower effective fee rate. They're kind of in the mid-35s."
},
{
"speaker": "",
"content": "Faster inflows from Great-West Life at the lower end as we communicated, hopefully, clearly enough that those -- the $25 billion of AUM that we expect to come in from Great-West Life, that will ultimately, when we get it all in, that will be in the mid-teens. But the initial amount that we've got are all in the lower fee categories, things like investment-grade credit, for example, for general account. But then on top of that, we expect continued growth in our ETF, Canvas and separately managed accounts, all of which are lower fee rates."
},
{
"speaker": "",
"content": "Now the reason why we keep the guide for the year in the 38s is because we have a view, again, as Jenny mentioned, of our alternative asset fundraising capabilities and expectations for the next 12 months, let's call it. So on an annual basis, we expect the mix of business around alternative assets, equities, fixed income and then these other areas of growth that I just mentioned, to offset the fee reductions that at times in various quarters could go into the high 37s, but that's just based for that 1 quarter -- on the mix that 1 quarter. But for the year, we expect to remain fairly stable in the 38 area."
},
{
"speaker": "Operator",
"content": "Next question will be from Ken Worthington at JPMorgan."
},
{
"speaker": "Kenneth Worthington",
"content": "On the institutional pipeline, when you win an institutional fixed income mandate, are you getting a bunch of cash? Or are you getting a portfolio of securities that you transition and then remanage and do you get a sense of where the assets are coming from? If it's going into fixed income, is it investors going from rates to credit? Are they going from equities to fixed income? Are they going from cash to fixed income? Or are they just switching managers because of performance? So any view on what you've seen in this pipeline that's driving the fixed income success you're having?"
},
{
"speaker": "Adam Spector",
"content": "You might not like the answer, but the answer is yes. I think we're seeing all of those things, right? So often, people will switch managers because of performance. We see people beginning to extend duration out. Those are usually funded by cash. We should see some of the plus sectors being added to those are funded in a mix of different ways. And then, of course, on the retail side, it's typically a sale of a fund, so you really don't know where that's coming from."
},
{
"speaker": "",
"content": "In terms of how folks fund things I would say that's a mix. We see 3 different ways. We see it being funded in cash. We see people using a transition manager and then sometimes we'll see folks fund to us with securities and ask us to get to the new point by a certain time. The other interesting thing we see in terms of how accounts are funded is actually outside of fixed income on the Canvas side, where we see significant use cases for Canvas as a tool to aid in the funding of accounts for taxable accounts we're able to do that in a much more tax-efficient way."
},
{
"speaker": "Kenneth Worthington",
"content": "Okay. Great. And just on ETFs, how are you thinking about ETFs outside the U.S.? You're having nice success in your franchise within the States. How are you thinking about leveraging the brand? Or are you thinking about leveraging the brand you have and the ETF franchise that you've already built?"
},
{
"speaker": "Adam Spector",
"content": "Yes. Our ETFs outside of the U.S. have grown in 2 important ways. One, I don't think this was the point of your question, but our single country ETFs, so ETFs that focus on the country, even if they're sold in the U.S. That's been a huge success for us. We were able to price those very competitively. But also in terms of ETFs that we're selling outside of the U.S. regardless of investment mandate, we've seen real growth there in Canada and in EMEA, in particular. Some of that is the single country flow. As Jenny mentioned in his remarks, we've seen some of the more sustainably oriented products go quite well. Green bonds, Paris-aligned, S&P 500 would be 2 that are examples of that."
},
{
"speaker": "",
"content": "Outside of the U.S., we continue to see a mix of active, passive and smart beta. Passive is still the most significant portion of the market, but active has by far the highest growth rate."
},
{
"speaker": "",
"content": "And just to put things into context, I believe that if you look at our flow for this quarter, about half of it or so was from outside of the U.S. in terms of our ETF business. So really trying to expand that to the best we can and seeing very good results."
},
{
"speaker": "Operator",
"content": "Next question will be from Alex Blostein at Goldman Sachs."
},
{
"speaker": "Alexander Blostein",
"content": "Jenny, I was hoping to dig into your comments from the prepared remarks when you talked about being quite busy over the next 12 months with respect to private markets. Could you, I guess, expand on that a little bit? And I'm assuming wealth is going to be part of the answer. So when you think about the opportunity set in the wealth channel and lots of other folks coming in, with offerings already and it seems like that part of the market is getting a little bit busier. What are you guys doing to make sure you don't miss the window and opportunity there?"
},
{
"speaker": "Jennifer Johnson",
"content": "Yes. So I mean we're in the market with a few different things. And as Adam mentioned, we are getting on calendars. This stuff is laid out, we've probably surprised early on to learn this. I mean sometimes up to 2 years in advance. So the areas that we're talking -- Lexington obviously, has capabilities beyond their traditional Fund 10, where they've got middle market and co-invest offerings. In the case of real estate, Clarion's top 3 biggest funds are all perpetual. So they're always fundraising, although we definitely see kind of muted demand for real estate. They've got terrific performance. They've got terrific performance. And so I think when things shift back, Clarion should do very well there because they have very little exposure to office."
},
{
"speaker": "",
"content": "In the case of the private credit real estate debt is really interesting, and we're talking to several clients about that. Obviously, CLOs, structured credit, special situations. And then actually, we've been successful. I never know how much I can talk about, but in our -- in Venture, our Franklin Venture Group is in the wealth channel right now raising money and first fund raise there, and it's going very well."
},
{
"speaker": "",
"content": "So you just had 2 between BSP and Lexington closed their flagship funds. So then you're in -- that they're digesting and investing in those cycles. They're doing more of their niche type strategies, but they're in markets with those. And they'll -- as soon as those are deployed, I think Lexington's probably deployed 60% of their LEX 10, they'll come back into the market for another flagship. But in the meantime, they've got their middle market and co-invest."
},
{
"speaker": "",
"content": "And I cannot emphasize enough the -- in the wealth channel, it's 50% the right product and 50% where you got the heft on the distribution side. And I think that is often underestimated. Our 350-plus client-facing wholesalers, internal, external specialists included can sell to an adviser's entire book. If you don't have the breadth of capability that we have, that's incredibly expensive because let's say you're just an alternatives manager, you're only selling to 5% to 10% of that adviser's book. And so it gets really expensive to build the breadth of capability that we have. And the years of investment that we've done in the Academy, again, our Academy is global, where we've now been able to bring alternatives by FT, which is a website that has tons of training on how advisers should think about alternatives in their portfolios to supplement just that wholesaler being out there in the field, I think, has been really important."
},
{
"speaker": "",
"content": "So very much focused on the wealth channel, really excited about it. I think we have a great suite of products to be able to meet the needs in that market and the distribution capability and expertise to be successful there."
},
{
"speaker": "Alexander Blostein",
"content": "I got you. Okay. All makes sense. And then clarification for you guys on the pipeline. It sounds like there's a bunch of things in the institutional pipeline, as you discussed earlier. Is it -- could you guys help us just size the fee rate of the institutional pipeline, excluding Great-West as you described it? And then I guess is it fair to assume that the remaining piece of Great-West that's going to come in will be coming in at a much high fee rate? So kind of north of that teen-ish basis points, just given that the back end or what's come through came at a pretty low fee rate?"
},
{
"speaker": "Jennifer Johnson",
"content": "And the pipeline is -- the fee rate is slightly up from last quarter. But look, any time you want it's institutional, so that's lower fee than your traditional EFRs. And then number two, it's heavily weighted in the fixed income -- well, the new stuff is heavily weighted in fixed income, but probably overall pipeline, I don't know, Adam, a 60-plus percent probably fixed income. So I never know if we give guidance on the actual numbers in the pipeline, but it's -- [indiscernible] Matt, have we given guidance there?"
},
{
"speaker": "Adam Spector",
"content": "I would say it's consistent with our institutional fee rate."
},
{
"speaker": "Alexander Blostein",
"content": "Got it. Okay."
},
{
"speaker": "Matthew Nicholls",
"content": "It's in the mid- to high 20s, Alex, and then -- but it can be -- it's gone from anything from the mid- to high 20s to our overall effective fee rate. depending on the quarter and depending on the type of the -- the nature of the pipeline in a particular time. And then the -- to answer your second question, yes, the additional flows we expect to come in will be higher on average on the rest of the Great-West Life flow. And that's expected over the next 12 months. As we've said, we'll, of course, put that detail into our monthly flow. So you can see that, and then we'll provide detail on the effective fee rate when we have these calls and provide updated information."
},
{
"speaker": "Operator",
"content": "Next question will be from Bill Katz at TD Cowen."
},
{
"speaker": "William Katz",
"content": "Okay. I apologize on London weather. So in terms of if I start with your reported net flows of 6.7 and I back out the 3.1 of dividends reinvested, which the industry doesn't include, I get down about 3.5. If I back out the initial capital from Great-West, that's minus $10 billion. If I then back out the $1.4 billion from the 3 alt managers you highlighted, I get to about $11 billion. And then if I back out the Canvas, ETF and the SMA, I think that gets about minus $18 billion for what I would consider to be a long-holding business. A, is that math correct? And B, if it is, what's the go-to plan here to sort of stabilize that part of the business?"
},
{
"speaker": "Adam Spector",
"content": "So I'm not Matt Nicholls, I can't do the math that quickly. He probably could. So I couldn't quite follow all of that. But I will tell you that the growth areas where some of the things you wanted to pull out alternatives, ETFs, Canvas. I think we said consistently that those are our growth focuses and that they're growing a little faster than the rest of the business. If you take a look at the more traditional business and you look at our outflow rate our decay rate, it's really been stable to improving. So I think over the last few years, we've been able to do a very good job at protecting ourselves on the downside. And as we said earlier, I think Jenny pointed to a notion that we talk about in terms of core sales, which is our smaller sales, which are up pretty consistently at about 14% on average. So stable outflows, increasing quarter sales we're feeling pretty good about the traditional part of the business."
},
{
"speaker": "Jennifer Johnson",
"content": "And I'll just add, look, we've been very open and honest that we've been underrepresented in the retirement channel. As I mentioned on the last quarter's call, we were ranked 14th on Empower's platform, and it's similar in some of the others. And with this acquisition of Putnam and the relationship and the absorption of their retirement team as well as their target date products, 1/3 of retirement flows go to the qual side investment plans, and they've got phenomenal performance of their target date products as well as stable value, we think we are poised to -- and again, if we just take our market share, it's a massive increase -- the retirement channel is still a very traditional asset-oriented channel, traditional mutual funds, equities and fixed income."
},
{
"speaker": "",
"content": "And we just think with our distribution capability, not just to benefit from Empower, but taking that to all the different retirement platforms and gain more market share there."
},
{
"speaker": "Matthew Nicholls",
"content": "And then the last thing I'd just add, Bill, is that this area you're trying to get to, which we actually have a little bit -- it's not really 18, but we think of it as I think it's more like 10 that we got to. But when you get to those numbers, it's very concentrated in areas where performance is even more important than usual, let's call it. And in those areas, performance has begun to improve, certainly on the equity side, in particular, quite significantly. So we've seen quite a slowdown in those outflows."
},
{
"speaker": "",
"content": "On the fixed income side in the couple areas, we've had some weaknesses there, as you know, but we've seen some improvement there, too. So it's a fairly concentrated situation you're referring to and one that as performance improves, you see a correlation of slowdown in outflows."
},
{
"speaker": "Adam Spector",
"content": "And Bill, I would add that it's sometimes difficult to separate investment product from the vehicle itself. We have a number of businesses where an investment team is positive, but they're positive because their SMA, their usage, their ETFs are all positive, and the mutual fund might be negative. So is that the core business, they're not, right? At the traditional asset class, they're gaining flow, but they're gaining it because of the vehicle choice, not necessarily because the mutual fund is positive."
},
{
"speaker": "William Katz",
"content": "That makes some sense. And just a follow-up on all of that, Matt, maybe for yourself, just your base fee rate, it just seems like it's bouncing around a little more than I would envision just given the sheer sizing of the platform today. So can you help me understand if you're going to be sort of in that 37% range plus for the next quarter. And then you sort of bounce back into the fourth? Is that input to a very high level of flow in the alts managers. And if that's the case, is that just vehicles that are just turning on from capital to raise? Or is that from new money coming in the door? And if so, where might that be?"
},
{
"speaker": "Matthew Nicholls",
"content": "Well, remember, the annual guide I gave included the first quarter or so where we had an elevated EFR for the reason that I explained around the catch-up fees and so on. I think we were pretty close to 40 basis points at one point. We've been trying to be quite clear about that. So when you normalize that out, you get into the 38."
},
{
"speaker": "",
"content": "And then the only thing that's driving it down periodically from quarter-to-quarter is the areas of growth. And when you add those areas of growth up and you just a second ago, Bill, when you went through your analysis on the traditional side of the business versus other areas of growth. When you start adding up ETFs, Canvas, SMAs and then the flows from Putnam, the overall Putnam -- remembering that it's not just the flows coming from Great-West Life from Putnam, it's the $160 billion, which is 17% higher than when we announced transaction of AUM that's at a multiple basis -- multiple point lower than the EFR of Franklin."
},
{
"speaker": "",
"content": "So the fact that we've been more successful in that has -- that's what's driven the EFR down a little bit. But what we'd expect is that going into at least fiscal 2025, what we experienced at the beginning of fiscal 2024, depending on what products we have and everything that Jenny just read through or not, there's a possibility that it could step back up again into the higher 38 based on the episodic alternative asset fees. But that's just an exclamation around why it could go up a little bit more and down a little bit more than usual. It's those offsetting factors. It's basically a form of business mix plus the episodic activity out of alternatives."
},
{
"speaker": "",
"content": "Bill, I'll also answer because I think you had the question on a little bit more of a breakdown of our third quarter. I've already gone into some detail on EFR. In terms of comp and benefits for the third quarter, we expect that to be around $820 million. That assumes performance fees of $40 million. That's lower than the previous quarters, driven by lower performance fees out of our real estate business for the reason that Jenny mentioned, it's important to note that the relative performance of Clarion is very strong, but the absolute valuation of real estate has come down, that's impacted the extent of performance fees. That's why we're guiding that down to $40 million from $50 million."
},
{
"speaker": "",
"content": "IS&T, we expect it to remain at $150 million, occupancy, $80 million. As you all know, that's going to come down later on in fiscal 2025 based on the double rent going away. But for next quarter, we expect that to remain at $80 million. And then G&A, we expect to be probably around $175 million. It could be as high as $180 million because we're planning on spending more in advertising, but it won't go -- it shouldn't go a bit beyond that. So let's say, $175 million to $180 million in G&A."
},
{
"speaker": "",
"content": "And I already provided the annual guidance earlier on based on Dan Fannon's question."
},
{
"speaker": "Operator",
"content": "This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments."
},
{
"speaker": "Jennifer Johnson",
"content": "Great. Well, everybody, thank you for participating in today's call. And once again, we would like to thank our employees for their hard work and dedication delivering this quarter. And we look forward to speaking to all of you again next quarter, and everybody stay healthy."
},
{
"speaker": "Operator",
"content": "Thank you. Ladies and gentlemen, this does indeed conclude today's conference call. You may now disconnect your lines."
}
] |
ben | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Welcome to Franklin Resources Earnings Conference Call for the quarter ended December 31, 2023. Hello. My name is Joanna, and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions] I would now like to turn the conference over to your host, Selene Oh, Chief Communications Officer and Head of Investor Relations for Franklin Resources. You may begin."
},
{
"speaker": "Selene Oh",
"content": "Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements."
},
{
"speaker": "",
"content": "These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings."
},
{
"speaker": "",
"content": "Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer."
},
{
"speaker": "Jennifer Johnson",
"content": "Thank you, Selene. Hello, everyone, and thank you for joining us today to discuss Franklin Templeton's results for the first fiscal quarter of 2024. I'm joined by Matthew Nicholls, our CFO and COO; and Adam Spector, our Head of Global Distribution. We're happy to answer any questions you have in just a few minutes. But first, I'd like to call out some notable highlights from the quarter."
},
{
"speaker": "",
"content": "Our first fiscal quarter results reflect ongoing momentum in a number of significant areas across asset classes investment vehicles and geographies. Our efforts are always focused on meeting the varied investment needs of our diverse global client base across market cycles, while staying at the forefront of the asset management industry, driven by increased expectations of interest rate cuts by the Fed and other central banks amidst disinflation, the 2023 market rally was particularly concentrated in the last quarter of the calendar year, regardless of the market environment, investors remain cautious."
},
{
"speaker": "",
"content": "According to Morningstar, global money market assets stood at $7.7 trillion as of December 31, 2023, the highest level since Morningstar started collecting the data in 2007. Broadly speaking, our specialist investment managers see recession risks moderating and expect the global economy to slow over the course of 2024. But even as the economy slows, there are many opportunities for investors to put that cash to work into risk assets."
},
{
"speaker": "",
"content": "Specific to the equity markets, last year, we saw a small group of stocks dominate market returns with the top 5 stocks representing 23% of the S&P 500 total market cap. Compare that to the height of the dot-com bubble in March 2000 when that number was 18%. While our investment professionals regard companies like the Magnificent 7 as market leaders, the level of relative outperformance for these stocks is likely unsustainable."
},
{
"speaker": "",
"content": "We believe that this backdrop has created an opportunity for active managers like Franklin Templeton that offer a full range of investment capabilities across public and private markets, spanning geographic boundaries in vehicles of our clients' choice. With greater clarity on interest rates in 2024, and as investors look to deploy cash on the sidelines, we believe Franklin Templeton is well positioned."
},
{
"speaker": "",
"content": "In short, 2024 is likely to be a year in which balance and diversification are once again rewarded. During the most recent quarter, our clients gravitated towards alternatives, multi-asset equity, ETFs and SMAs, which all saw positive long-term net flows. Continued client interest in private market strategies led to net inflows for our 3 largest alternative managers."
},
{
"speaker": "",
"content": "Additionally, we continue to see aggregate positive net flows in non-U.S. regions. We are pleased to announce that our acquisition of Putnam Investments closed on January 1, with $148 billion in assets under management. Putnam adds complementary investment capabilities and a track record of strong investment performance. In fact, 87% or higher, a Putnam's mutual fund AUM outperformed peers over the 1, 3, 5 and 10-year periods."
},
{
"speaker": "",
"content": "The transaction also enhances our presence in the attractive retirement and insurance markets. The addition of Putnam brings Franklin Templeton's AUM to approximately $1.6 trillion."
},
{
"speaker": "",
"content": "In addition, Great-West Lifeco, a member of the Power Corporation group of companies has become a long-term shareholder in Franklin Resources consistent with its ongoing commitment to asset management. We are delighted to have the talented team at Putnam join us and pleased to have Great-West as a key stakeholder."
},
{
"speaker": "",
"content": "Turning now to specific results for the quarter, starting with assets under management. Ending AUM increased by 6% to $1.46 trillion from the prior quarter and increased by 5% from the prior year quarter, primarily due to market appreciation. Average AUM declined by 2% from the prior quarter to $1.39 trillion and increased by 3% from the prior year quarter."
},
{
"speaker": "",
"content": "Our specialist investment managers continue to produce competitive investment returns across a broad array of strategies. Investment performance this quarter resulted in 61%, 46%, 60% and 61% of our strategy composite AUM outperforming their respective benchmarks on a 1, 3, 5 and 10-year period."
},
{
"speaker": "",
"content": "Notably, investment performance for the 5-year period jumped from 47% in the prior quarter to 60% in the recent quarter, primarily due to certain taxable fixed income strategies. With interest rates at current levels, fixed income opportunities are considered more attractive now and going forward may provide a better total return option over high-yielding cash equivalents."
},
{
"speaker": "",
"content": "On the mutual fund side, the majority of AUM beat their peer groups and improved percentile rankings quarter-over-quarter in the 1, 3 and 10-year periods. One of our largest funds managed for yield was the primary driver of the decline in 5-year performance. Turning to flows. Long-term net outflows inclusive of reinvested distributions were $5 billion compared to net outflows of $7 billion in the prior quarter and net outflows of nearly $11 billion in the prior year quarter."
},
{
"speaker": "",
"content": "Reinvested distributions were $11 billion compared to almost $3 billion in the prior quarter and $12 billion in the prior year quarter. Alternative net inflows were $2.7 billion, driven by growth into private market strategies, which were partially offset by outflows in liquid alternative strategies. Our 3 largest alternative managers, Benefit Street Partners, Clarion Partners and Lexington partners, each had net inflows in the current quarter with a combined total of $3.8 billion. Client interest was strong across a number of alternative strategies on wealth management platforms under the alternatives by Franklin Templeton brand in the U.S."
},
{
"speaker": "",
"content": "Earlier this month, Lexington Partners announced the closing of its latest flagship global secondary fund with $22.7 billion of total capital commitments. Fund 10 ranks among the largest funds raised to date and significantly exceeded Lexington's prior secondary fund, which closed with $14 billion in 2020. Fund 10 attracted a diverse group of over 400 investors, including public and corporate pensions, sovereign wealth funds, insurance companies and wealth channel distribution partners globally."
},
{
"speaker": "",
"content": "We are delighted that approximately 20% of the capital raised in the fund came from the wealth management channel, which demonstrates the power of our coordinated global distribution network. We successfully brought together the alternatives expertise of Lexington and our alternatives by Franklin Templeton specialist sales team and leveraged our generalist sales team who have deep relationships across the adviser market."
},
{
"speaker": "",
"content": "Also this month, Benefit Street Partners closed its fifth flagship private credit fund with $4.7 billion of total capital commitments. Reflecting the strong demand for the asset class, BSP exceeded its fundraising target. We believe the current market opportunity and backdrop for U.S. direct lending is attractive and BSP has significant underwriting experience, loan structuring expertise and focus on deep due diligence, which provides us with a significant competitive advantage. BSP also announced the completion of the merger between Franklin BSP Lending Corporation and Franklin BSP Capital Corporation, business development companies."
},
{
"speaker": "",
"content": "BSP believes this transaction will be immediately accretive to its shareholders and unlock nearly $700 million of capital that can be deployed into a very attractive origination environment. For further context, alternative assets now represent 18% of our AUM and comprise approximately 25% of our total adjusted investment management fees for the last 12 months. In terms of other areas of activity during the quarter, multi-asset net inflows were $500 million, driven by Canvas, our custom indexing solution platform and Franklin Templeton Investment Solutions."
},
{
"speaker": "",
"content": "Canvas has achieved net inflows each quarter since the platform launched in September 2019, and AUM has more than doubled to approximately $6 billion since the close of the acquisition. This quarter, Canvas generated net inflows of approximately $400 million and continues to garner client interest across retail and institutional channels."
},
{
"speaker": "",
"content": "Equity net inflows were $200 million, including reinvested distributions of $8 billion, while active equities continued to be impacted industry-wide by the risk-off environment we saw positive net flows into all-cap growth, smart beta, all cap value, equity income, large-cap value and small-cap core strategies, among others."
},
{
"speaker": "",
"content": "Although fixed income net outflows were $8.4 billion. Client interest drove positive net flows into tax-efficient global opportunistic mortgage-backed securities and multisector strategies. From a regional perspective, we continue to benefit from a regionally focused distribution model, which resulted in aggregate positive net flows in non-U.S. regions for the third consecutive quarter."
},
{
"speaker": "",
"content": "For context, we now manage approximately $450 billion in non-U.S. markets, including emerging markets that are poised to grow. Although the U.S. saw long-term net outflows, we are pleased to see our U.S. gross sales, excluding reinvested distributions, improved by approximately 15% from the prior quarter."
},
{
"speaker": "",
"content": "We continue to see the benefit of offering investors strategies in a range of investment vehicles. ETFs, for instance, generated net inflows of approximately $1 billion, representing the fifth consecutive quarter with net flows of approximately $1 billion, resulting in over a 40% increase in ETF AUM from the prior year quarter. Including Putnam, ETF AUM is approximately $20 billion. Importantly, we now offer ETFs from a dozen different specialist investment managers, truly bringing the best Franklin Templeton has to offer to the market."
},
{
"speaker": "",
"content": "Earlier this month, we launched one of the industry's first bitcoin ETF, consistent with our emphasis on innovation and staying ahead of disruptive technologies. SMAs continue to grow in popularity industry-wide as individual investors look to customize their portfolios. According to Cirelli Associates, SMAs represent about $2 trillion in assets and are expected to reach $2.9 trillion by 2026."
},
{
"speaker": "",
"content": "Our SMA AUM ended the quarter at $125 billion and generated positive net flows for a third consecutive quarter. We continue to make progress with SMA strategies across platforms with Canvas, muni ladder and Franklin Income strategies, each in a positive flow territory for the quarter. Our institutional pipeline saw increased level of funding this quarter, bringing one but unfunded mandates to over $13 billion. The pipeline remains diversified by asset class and across our specialist investment managers."
},
{
"speaker": "",
"content": "Turning briefly to financial results. Adjusted operating income declined by 18.5% to $417 million from the prior quarter, an increase by 5.5% from the prior year quarter. We continue to focus on strong expense discipline and our net cash and investments position allows us to continue to invest in growth and innovation for the benefit of clients, shareholders and employees."
},
{
"speaker": "",
"content": "Finally, in December, Franklin Templeton was recognized as one of the best places to work in money management by pension and investments. This recognition is a source of pride for us and the credit goes to all of our employees around the world who worked tirelessly on behalf of our clients. I'd like to sincerely thank them for their hard work and dedication to our organization."
},
{
"speaker": "",
"content": "Now let's open it up to your questions. Operator?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] First question comes from Alex Blostein from Goldman Sachs."
},
{
"speaker": "Alexander Blostein",
"content": "So maybe just to get some of the numbers questions out of the way, obviously, with Putnam closed, maybe, Matt, you can give us an update of couple of items, but maybe one, where do you see the management fee, excluding performance fees and kind of catch-up fees jumping off point for the first quarter, first calendar quarter of this year and just broader update, I guess, on accretion and contribution for Putnam for this year."
},
{
"speaker": "Matthew Nicholls",
"content": "Okay. Alex, I mean that should probably just give you the forward guide to put things into perspective, that will help get through the Putnam update also. So in terms of the effective fee rate, remember, last quarter, I mentioned we expect it to be around 39 basis points consistent with previous quarters."
},
{
"speaker": "",
"content": "We actually ended up at 39.7 or a little bit higher. The reason for that is about 1 basis point or 0.9 basis points was to do with the Lexington catch up fees. So if you think about that for the second quarter, fiscal second quarter guide, we're expecting that to be consistent again excluding these episodic catch-up fee or any other episodic management fee events to about the high 38, so high 38 basis points, very consistent with the previous quarter and other quarters that we presented recently."
},
{
"speaker": "",
"content": "So that's in terms of EFR. I'll give the annual EFR guide in the second, which includes Putnam. Of course, we closed Putnam on January 1. And so our first full quarter will actually be this guide I'm giving you now. I thought it would be useful to provide the guide for the fiscal second quarter, inclusive of Putnam, but I will call out the individual components. Putnam, you can see that we're being disciplined with our expenses around Franklin and being transparent about the difference between Franklin and expenses and Putnam additions."
},
{
"speaker": "",
"content": "So I mentioned the EFR already being in the high 38s excluding any sort of one-off episodic revenue. In terms of compensation and benefits, assuming a $50 million performance fee quarter, including Putnam, we'd expect total comp and benefits to be approximately $815 million. This includes $65 million of comp and benefits for Putnam. Just for further perspective, we expect to be able to bring that down to about $50 million to $55 million by the end of the fiscal year. Again, this assumes $50 million of performance fees."
},
{
"speaker": "",
"content": "Information Systems and Technology, we expect to be $155 million for the quarter, this includes $25 million for Putnam, and we expect to bring that $25 million down to between $15 million and $20 million by the time we reach the end of our fiscal year. Occupancy, we expect to be approximately $80 million. Recall in the last call, I mentioned that we're going to have a period of double rent based on our consolidation of New York City office space of $12 million."
},
{
"speaker": "",
"content": "Last quarter, I mentioned $8 million, but that was only for a short quarter in terms of how long we're -- 2 months out of the 3 for the double rent. This time, we have for 3 months, which is $12 million for the double rent and $10 million for Putnam in this context. I wouldn't guide $10 million down yet because we're still working on real estate optimization."
},
{
"speaker": "",
"content": "And for G&A, we expect the consolidated amount to be $175 million, which includes $35 million for Putnam. We expect this to come down to about $30 million by the time we reached the end of the fiscal year. In terms of what this means for annual guide, you'll recall that in the last guide we gave, I mentioned that our fiscal 2024 at the -- then levels of markets and revenue expectations was expected to be about flat to 2023."
},
{
"speaker": "",
"content": "Excluding Putnam, and excluding performance fees and excluding the double rent in New York City, I would now guide that amount, which excludes Putnam to about 1% to 2% higher, but that's because we now anticipate all else from any of -- that revenue would be 5% higher for the year, including Putnam and excluding performance fees, but including the $50 million of double rent."
},
{
"speaker": "",
"content": "We would currently expect total adjusted operating expenses for fiscal '24 to be about $4.55 billion to $4.6 billion. And for perspective, this assumes the Putnam expenses addition to this is about $375 million to $380 million."
},
{
"speaker": "",
"content": "In terms of the EFR, back to your first question, for the year, inclusive of Putnam because Putnam has a slightly lower effective fee rate, it brings the overall amount down to -- down about 0.2 basis points. So it brings the number for the guide for the year to about the mid-38, mid- to slightly better than mid-38. This excludes any catch-up fees, episodic fees on performance fees, as I mentioned at the beginning."
},
{
"speaker": "Alexander Blostein",
"content": "Great. Okay. I think I got all of that or most of it, and I'm sure folks will follow up as well. I guess my only other follow-up for you. I think we talked about Putnam being around $150 million contribution to operating income on exit run rate. Can we just get an update on where that stands now? Obviously, their asset base is a little bit higher as well, but just want to get a sense whether $150 million is still kind of the run rate number we should be thinking about by the end of your fiscal year."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. So just to break that down further, so I'll start the call with all these numbers. But just to break this down a little bit further. So in terms of revenue, obviously, we don't normally guide revenue, but we want to be useful in terms of modeling purposes for the second quarter, again, fiscal second quarter, Putnam revenues stand-alone would be about $160 million."
},
{
"speaker": "",
"content": "Of that, $135 million is management fee revenue and $25 million is in the other revenue item, that's for the TA basically. We would have said between $85 million and $100 million of expenses in the first 9 months, so through our fiscal year, $85 million to $100 million. And by the time we reach the end of 9, 30th, at the end of our fiscal, yes, our expense savings for the full 2025 would be at least $150 million. This translates to get specifically to your question around operating income addition, Alex. This translates into probably between $150 million and $170 million of operating income contribution from the transaction."
},
{
"speaker": "",
"content": "In terms of how we think this translates into. Obviously, there's a lot of moving parts below the line, but how this translates into accretion dilution, it's probably just very slightly accretive, maybe one centers about that. In the second fiscal quarter, so the first fiscal quarter that we'd have on Putnam it's accretive right away."
},
{
"speaker": "",
"content": "And by the time we reach the full year, it's probably near high single digit cents accretion and that translates into about a 3% accretive situation for full year '24. Remembering that's only 9 months of Putnam that's where we expect things to be. Assuming revenue stays where it is today, and markets stay where they are today and so on."
},
{
"speaker": "Operator",
"content": "The next question comes from Craig Siegenthaler from Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "My question is on the alternatives net flow trajectory. If we back out the 2 flagship fundraisers at Lexington and Benefit Street, there would have been a large swing in net flows over the last 12 to 18 months. So I wanted your perspective on the flow trajectory in terms of net flows from alts. And are you expecting other funds to kind of step up and fill in that gap?"
},
{
"speaker": "Jennifer Johnson",
"content": "Thanks, Craig. So in the last 2 years, we have had about $40 billion in fundraising for our private markets. That was offset a bit by $12 billion in net outflows in the liquid alternatives. That just gives you a little bit of perspective there. We anticipate this year of fundraising between $10 billion and $15 billion in the private markets. And I would expect in this environment to have that translate into alternative asset revenue growth that's at the mid-single digits."
},
{
"speaker": "",
"content": "So far, in Q1, you've probably seen that we raised $5 billion in the private markets and that between closing of Lexington's flagship fund and BSP. In the same period, we had about $1.1 billion in net outflows in the liquid alts. Just to kind of look forward for the rest of the year, we can't talk about specific funds. But the areas that we think there's strong interest is alternative credit, specifically like direct lending, we see interest both in the U.S. and Europe. There's opportunities in the alternative credit in special situations, opportunistic real estate debt as well as CLOs."
},
{
"speaker": "",
"content": "And just on that real estate debt point, as you see less and less of the regional banks having retracted in that space, we think there's both an opportunity to do very well there and strong client interest in that space. With respect to secondary, just as a reminder, Lexington does a lot more than just their flagship offering. They have offerings in middle market and co-invest offerings."
},
{
"speaker": "",
"content": "2023 was the third consecutive year where secondary industry surpassed the $100 billion in the fund raise, and we think that, that -- there just continues to be strong demand. And just again, a supply demand issue that keeps feeds very high, where you had $6 trillion deployed in private equity and only, say, $150 billion deployed in secondaries and strong demand by the LPs and GPs because of liquidations being down and distributions being down to have a portion of their secondary portfolios picked up."
},
{
"speaker": "",
"content": "With respect to real estate, our 3 largest funds at Clarion are perpetually fundraising. We see opportunities to continue to expand in Europe. And then we're incredibly excited about the success that we had in the wealth channel with Lexington, where 20% of the fund raise of Lex 10 fund came from the wealth channel. And this has been years of building up our capabilities with the FT alternatives where we built both a team of specialists, the 30-plus specialists to help assist our wholesaling team."
},
{
"speaker": "",
"content": "We've leveraged our academy to not only educate our own force, but also to help our distribution partners educate their advisers on how to think about this. And so it's a lot of years in the making, and we're really excited to see it come together with this fundraise. But that same expertise is going to be very helpful in both private credit as well as real estate."
},
{
"speaker": "Adam Spector",
"content": "And Jenny, I would add 2 things in terms of the momentum we've had in the wealth channel. One is the success we've had to date with things like Lexington, mean that we're able to now have more meaningful conversations with our distribution partners about calendar placement many quarters into the future, which really helps us plan our product launches."
},
{
"speaker": "",
"content": "At the same time, we're now in a position where our distribution partners want to work with us to co-create products. So we're working on doing that together so that the products we come to market with in the wealth management channel are meeting their needs. The final item is that a lot of our success to date has been in the U.S. market in terms of wealth management, and we're now building out our specialist capabilities, our education, our academy, et cetera, in markets outside of the U.S. where we hope to have a similar level of success in the wealth management channels there."
},
{
"speaker": "Operator",
"content": "The next question comes from Bill Katz from TD Cowen."
},
{
"speaker": "William Katz",
"content": "So first question, maybe switch up the conversation a little bit, just talk about capital. You announced a pretty sizable repurchase authorization, have some equity that you have issued in consent with the transaction of Putnam. Looking at your balance sheet, it looks like you're saying about sort of net cash of 0 if you sort of adjust for the debt. How should we be thinking about maybe the tempo or pacing of capital deployment or buyback as we think through the year?"
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Thanks, Bill. I'll take that. And then, Jenny, maybe you'd like to comment also. So as usual, Bill, we're focused on making sure that we maintain our dividend and the same trajectory that's been on since the 1980s. We are very focused on organic growth investments. There is a ton going on, as you all know, in the industry. And there's a lot of call on capital for internal growth and internal projects and investments. So they're our 2 most important things."
},
{
"speaker": "",
"content": "Then we've got debt service coming up this year are $250 million. Obviously, if the market becomes more reasonably priced in terms of debt, perhaps we access the debt markets at the end of the year or stuff like that. But we want to position ourselves to be able to pay that debt down with our cash. We're absolutely going to hedge our employee grants as we always explain."
},
{
"speaker": "",
"content": "And then what I'd say is that -- and this is sort of the interplay between M&A and share repurchases. We've been very active, obviously, as you know, in terms of M&A to make sure we've got the right strategies at both institutional and retail and so on as we've discussed extensively. And when that slows down, which it has done for us, we've got 1 or 2 more payments in the next 1 to 2 years in terms of M&A. But once that's done, we'll be in a position where the M&A we look at is even much more strategic involving shares like we've done with Putnam, Great-West Life, for example, or it's involving much smaller M&A transactions to fill in gaps, a few gaps that we've got."
},
{
"speaker": "",
"content": "And that means we can be more opportunistic with our share repurchases. And as you've seen from the last couple of quarters, we certainly picked that up a little bit. But the backdrop is complicated, market's quite volatile and a lot going on globally that influences the market. So we're constantly assessing that backdrop. But I would say that we would hope what else remaining equal to move into more of a capital return position as we've demonstrated, both with dividend and share repurchase over the last couple of quarters in the future versus just being very much focused on M&A."
},
{
"speaker": "William Katz",
"content": "Okay. That's super helpful. And just as a follow-up, Jenny, perhaps for yourself or Matt, or Adam. Any sense or can you give us an update on how the insurance mandates are -- the momentum is building there. I think there was some $20-odd billion that should flow in. So once the deal has been completed, and then how you think about the backlog behind that? And maybe the broader question underneath that is what are the early stage discussions with the enhanced distribution opportunity now that the transaction is complete?"
},
{
"speaker": "Jennifer Johnson",
"content": "Well, so I mean, obviously, we have the $25 billion that we've talked about with Great-West Life, and that will come in kind of through the year. And it's a mix of multiple our SIMs with the bulk of it actually going to Western, but goes -- it has alternatives in there. And as well as fixed income and equity. And we announced that we're going to be a sub-adviser [indiscernible] And part of that is because we -- when we acquired Western, we acquired real expertise in understanding the insurance space, and we've been able to leverage that capability more broadly. But Adam, you want to talk about some additional things that you're seeing."
},
{
"speaker": "Adam Spector",
"content": "Okay. I would say just in terms of scale, our insurance business is about $170 billion now, and that's not including the flows we've talked about from the power-related companies. So it's a very significant business. As Jenny said, to be successful in a lot of the general account area, you've not only need to have investment expertise, but really insurance, domain-specific expertise, technology compliance."
},
{
"speaker": "",
"content": "We're one of the few firms we think to combine both of those. And then the partnership with Power Corp. has also allowed us to co-create products with them that we think will be very successful in the marketplace, and you're seeing some launches there as well. The team there has been -- Putnam has been very successful in the DC channel as well as in insurance. And we think bringing those salespeople on to our team now that they have a wider array of products to sell will really hockey stick our efforts there as well."
},
{
"speaker": "Matthew Nicholls",
"content": "And just a little bit more perspective on the $25 billion, Bill, just to be clear. But right now, for all intents purposes, for modeling purposes, we don't have any of that in. I mean we have a little bit, but it's not really nothing's really hit the revenue line yet. We expect, as Jenny mentioned, about 2/3 of this to be kind of investment grade and a little bit emerging market and other corporate credit across a broad range of our specialist investment managers."
},
{
"speaker": "",
"content": "As you think about modeling, I think it's probably appropriate to think about the effective fee rate being in the mid-teens. I think Jenny mentioned that as a whole. This will likely to begin in earnest later on this quarter that we're in now. So kind of March time, maybe March, April, that sort of thing. And of course, we will update you when we have large inflows associated with this, we will provide that context and make sure we're transparent with you about when that comes in."
},
{
"speaker": "",
"content": "But just to be clear, beyond the $25 billion, we expect to grow -- there's a lot of opportunities to grow beyond the $25 billion. And even with this, we're just alongside other asset managers that also have important relationships with the Power group of companies. So we're just alongside them. We're increasing market share, frankly, where it should be aligned with what we -- the capabilities regarding the size of our franchise."
},
{
"speaker": "Operator",
"content": "The next question comes from Daniel Fannon from Jefferies."
},
{
"speaker": "Daniel Fannon",
"content": "A couple of clarifications. Matt, I just want to confirm the 1Q guide for comp that was, I believe, $815 million around that included $50 million of performance fees. Did the full year guide of the $455 million to $466 million assume a $50 million a quarter performance fee contribution?"
},
{
"speaker": "Matthew Nicholls",
"content": "Yes, plus the $93 million that we had this -- in the first quarter. So it's $93 million, $50 million, $50 million, $50 million."
},
{
"speaker": "Daniel Fannon",
"content": "Yes. Got it. Okay. That's helpful. And then just on the Lexington what's happened -- I'd like to just clarify what's in the numbers now in terms of AUM and flows that we've seen as of 12/31. And then in terms of catch-up fees, we got the disclosure for this quarter and last, but should we assume given the final close in January, another round of catch-up fees here for the March quarter?"
},
{
"speaker": "Matthew Nicholls",
"content": "So there's no more catch-up fees to book at this point. The fund had its last fundraising in the -- by 12/31 and that's when they sent the press release out that indicated that we have $22.7 billion of additional AUM. And that's all included in our reported numbers."
},
{
"speaker": "Daniel Fannon",
"content": "And the would BSP's fundraise be in there as well? 12/31?"
},
{
"speaker": "Matthew Nicholls",
"content": "No, not yet."
},
{
"speaker": "Operator",
"content": "The next question comes from Brennan Hawken from UBS."
},
{
"speaker": "Brennan Hawken",
"content": "So you spoke earlier about fixed income and the attractiveness and demand and a shift from cash and short duration investments. What are you specifically seeing as far as RFP activity? And could you talk about Western and their level of engagement with their client base?"
},
{
"speaker": "Jennifer Johnson",
"content": "Yes. So Brennan, maybe just a little bit of color kind of on the industry everybody talked about the $7.7 trillion in money market funds and what's going to be transferring from cash into other investments. And first of all, Western's money market fund is primarily institutional and institutions tend to build in the first 2 quarters and then spend in the second 2 quarters."
},
{
"speaker": "",
"content": "Having said that, and we don't have a meaningful presence in the retail money market business. However, obviously, we have relationships with those distributors, which we do that's where you're going to capture the transition. So even if you don't have the money market plus, it doesn't mean you get the transition. So we've had actually good interest and positive flows in some categories in our fixed income. Unfortunately, it's masked. It's masked a bit by some performance challenges we've had in the core strategies. Over half of our top 10 gross selling funds are in the fixed income space."
},
{
"speaker": "",
"content": "And actually, from a vehicle standpoint, were positive flows in ETFs and muni ladder SMAs. So it's really important to think about this as being vehicle-agnostic. And our fixed income gross sales are up 8%. We've had the greatest portion of our institutional pipeline is actually fixed income in multisector credit, high-yield, global income and Western, to your question about Western, they represent the largest portion of that."
},
{
"speaker": "",
"content": "So Western is having good conversations or clients -- been -- have a lot of very good performing strategies but have struggled, obviously, in their core strategy. Global [indiscernible] positive in things like tax efficient, global opportunistic, [indiscernible] back securities. But I think the most -- and by the way, Putnam brings in really top-performing fixed income performance as well plus additional products and things like stable value, ultrashort duration, intermediate core and really the performance in munis as well."
},
{
"speaker": "",
"content": "So we think cash is still attractive. And frankly, some people would argue the risk reward, you got cash yielding 5% and same high yield, yielding 7.5%, that you're not going to see the full rotation until you see some rate cuts as opposed to just peaking. And we just think we're incredibly well positioned, both in public fixed income, traditional fixed income as well as private credit to be able to capture this. And our view is what we're seeing is it demonstrates that we're well positioned there. I don't know, Adam, if you want to add anything?"
},
{
"speaker": "Adam Spector",
"content": "Yes. Jenny, I would just add that I think you're spot on that we've really seen strength in a number of areas of fixed income that was masked by some of the outflows in Core and Core Plus. But the performance in Core and Core Plus turned around. If you take a look at the end of the year, Core is up 37 basis points in the index, Core Plus 124. And traditionally, those products get very, very strong inflows after the Fed stops hiking. So we're in the position now from a performance standpoint as well as in the rate cycle, where those products are poised to do quite well."
},
{
"speaker": "Brennan Hawken",
"content": "Great. And then just, Matthew, I wanted to reconfirm because a lot of times when you speak to expenses, you speak to it ex some items, but it sounds like the $4.55 billion and the $4.6 billion for the fiscal quarter would be inclusive of the double rent would also include the expectation -- the actual performances from this past quarter plus [ 50 ] expected the next few as well as the 9 months of Putnam. Do I have that correct?"
},
{
"speaker": "Matthew Nicholls",
"content": "That's right. Yes. And just to -- the reason why I went through the detail is because I want to be very clear that if you take Putnam out of the equation, our expenses are up like 1% or something like that year-over-year. And that's only because -- and again, we don't normally talk about revenue on -- from a guide perspective, it's almost impossible to guide, as you know. But that does assume 5% higher revenue. So just if you often people ask us about margin, the relationship between revenue and expenses and leverage and operating leverage in the system -- well you can see that if we expect revenue to go up 5%, we only expect our expenses to go up between 1% and 2% on a foundational level."
},
{
"speaker": "",
"content": "And then in addition to that, we're adding Putman. But of course, we're in the process of reducing expenses around the Putnam acquisition. That's when you get to all these -- when you put all that together, you get to the $4.55 billion to $4.6 billion. Next year, we expect that to be a further reduction in expenses. I mentioned $375 million for 9 months of expenses for Putnam, we expect on a dollar-for-dollar basis for that to come down for 2025."
},
{
"speaker": "",
"content": "I said to you that for the year, we expect to actually realize $85 million to $100 million of expenses, expense savings from the Putnam transaction. For a full year, that's $150 million at least in expense savings, and that's what translates into about $150 million to $170 million of operating income addition."
},
{
"speaker": "Brennan Hawken",
"content": "Yes. That's -- that $150 million, that's the run rate when you exit your fiscal year basically right?"
},
{
"speaker": "Matthew Nicholls",
"content": "That's exactly right. Yes. So on the last day, at the very least on the -- I think we could be a little bit better than this. But on the last day, [ 9, 30 ] when you times that number of savings by the year, it's $150 million at least."
},
{
"speaker": "Operator",
"content": "The next question comes from Michael Cyprys from Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "I wanted to ask about retirement with Putnam and the Great-West strategic relationship, this accelerates your push into the retirement channel. I hope you could talk about some of the steps you're taking and may take over the next 12 months to capture the growth opportunity that you see. Maybe you could elaborate on that as well as which products you think might resonate the most."
},
{
"speaker": "Jennifer Johnson",
"content": "Adam, you want to take that?"
},
{
"speaker": "Adam Spector",
"content": "Yes. So first of all, the Putnam acquisition gave us capabilities. And I think those capabilities are really important in terms of things like stable value where there's $18 billion in assets, ultrashort and target date. If you take a look at target date, it's a third of industry DC AUM right now, had $150 billion in net flow last year. We can now play in that segment where we haven't really been able to play effectively historically."
},
{
"speaker": "",
"content": "So from a product standpoint, we're in a much stronger position. I would also say that from a sales force position, when we took folks in from Putnam, one of the areas where we added most significantly within that retirement and somewhat in the insurance channel as well. So we just have a much, much larger field force. So that lets us be better partners both of those things, both the expanded field force, the expanded products."
},
{
"speaker": "",
"content": "We're better partners with the power-related companies, but with all of our insurance partners. And I think that's what's really important to mention is this is not just about being stronger with one partner, it's about being stronger in insurance and retirement across the board."
},
{
"speaker": "",
"content": "Putnam's DC assets are about 30% of overall AUM. It's just a real strength in bringing that DNA into Franklin will be a real benefit in the relationship with Empower allows us to build some custom products together that we can go to market with that we think will really help us win because we can have multiple sales forces now selling the same products, which just gives us leverage."
},
{
"speaker": "Michael Cyprys",
"content": "Great. And just a follow-up question on the technology front. Just curious how you're thinking about front to back outsourcing opportunities and evolving the tech stack from here. Maybe you could speak to some of the opportunities that you might see from improving data integration across the multiple systems that you have, what sort of factors go into consideration? And any sort of lessons learned you might take away from others that have partnered externally on this front."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Thanks, Mike, I'll take that and then Jenny, maybe would like to comment. Because we're all very involved in these very critical decisions for the company. So as you know, we outsourced transfer agency, fund administration and parts of that technology, as we've described beforehand. We then moved on to understanding the potential opportunity for effectively partnering with one single provider for our investment technology platform."
},
{
"speaker": "",
"content": "That's a huge undertaking a process that takes a year, 18 months just to go through all the analysis. What I'd say on this is the #1 point is and most important to us, candidly, is that all of our specialist investment teams are on board with moving to a single investment technology platform. We've done a huge amount of work, and I'd say that we are close to deciding on who that partner should be."
},
{
"speaker": "",
"content": "It's going to be a long time to implement. I wish it was faster, but it's slower. It's a very long and complicated process. We're probably going to take something like 3 years to implement. So to give you guide on expense reductions and how it's going to be applied internally is really premature at this stage. But we are encouraged by what we see and what we think we can achieve from this transaction. But candidly, there's so many other demands to invest like artificial intelligence, data, additional teams and resources that they require to be leading in the industry, that while we expect long-term savings to be meaningful over time, we've got a lot of other things to circulate those savings into."
},
{
"speaker": "",
"content": "But again, we'll share that with you when we're through the process with the partner that we expect to announce here in the coming quarter or 2 or so. So that's sort of the update and whether Jen, do you want to add anything to that?"
},
{
"speaker": "Jennifer Johnson",
"content": "No, Matt, that was perfect."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick Davitt from Autonomous."
},
{
"speaker": "Patrick Davitt",
"content": "First, on Putnam, as we try to kind of level set our model expectations. Could you give an update on how the net flow picture tracked from announcement through the December quarter with and without reinvested dividends."
},
{
"speaker": "Matthew Nicholls",
"content": "Yes. Excluding reinvested dividends, it's slightly positive. No, obviously, we closed the transaction, as you know, Patrick, on January 1, I'd say, in the quarter before that and the period we're in now, it's kind of flattish, excluding reinvested dividends. So slightly positive."
},
{
"speaker": "Jennifer Johnson",
"content": "And I'm just going to throw one thing in. I mean Putnam's got 85% of their AUM beating their peers in all time periods. 87% of mutual funds are -- or 91% of mutual funds are rated 4- and 5-star ratings. So both on the equity and fixed income, they've got phenomenal performance."
},
{
"speaker": "Patrick Davitt",
"content": "Great. And then one housekeeping item. It wasn't clear to me earlier when you were talking about this, but the $5.5 billion-ish win from Great-West announced last week, is that a part of the $25 billion? Or should we consider it incremental?"
},
{
"speaker": "Unknown Executive",
"content": "Incremental."
},
{
"speaker": "Jennifer Johnson",
"content": "Yes. I think that's from the -- yes, from the retirement channel. So."
},
{
"speaker": "Patrick Davitt",
"content": "So it is incremental."
},
{
"speaker": "Unknown Executive",
"content": "Incremental."
},
{
"speaker": "Operator",
"content": "And the next question comes from Brian Bedell from Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Just one clarification also. I think I'm not sure you mentioned this, but the alternative was I think the $5 billion of private markets to play with them correctly, $5 billion of private markets, less about $1 billion of liquid also is that for the quarter just reported or for the current month quarter."
},
{
"speaker": "Jennifer Johnson",
"content": "Well, so BSP -- so they closed their fund in this quarter. And so you don't see those flows in last quarter. So we're talking about in Matt, what was the date that they closed the [ 4.7 ]."
},
{
"speaker": "Matthew Nicholls",
"content": "Like a week ago..."
},
{
"speaker": "Jennifer Johnson",
"content": "This quarter. So -- and just the different BSP charges when they call capital, so they don't have catch-up fees like Lexington does."
},
{
"speaker": "Brian Bedell",
"content": "Yes. Perfect. Okay. That's clear. And then just more broadly, I guess, just the ETF franchise are growing nicely. Maybe Jenny, if you want to -- and Adam also or Matt, just talk a bit about the -- your long-term vision for active semitransparent ETFs, you've already got 12 managers, using these products to $20 billion in the total ETF, which of course, includes a lot of smart beta. But just how you're thinking about this over, say, the next 2 or 3 years the demand from the marketplace for ETFs, but whether you think it might cannibalize mutual funds where you actually think you can develop strategies that will be incrementally growing sales on top of your mutual fund tranches?"
},
{
"speaker": "Jennifer Johnson",
"content": "Yes. So I think the key to think about with ETFs and frankly, SMAs A lot of the growth is driven from the fact that the world has moved more towards fee-based and how distribution fees are paid and things like traditional mutual funds. And then obviously, the tax efficiencies and ETFs. So we view it as our expertise is our investment -- risk-adjusted investment capabilities, risk-adjusted returns. We have a very small passive suite in the ETFs, but we really focus on active management. And we are agnostic to the vehicle in which we deliver that. So we look at the ETF as a vehicle which works really well in certain channels."
},
{
"speaker": "",
"content": "And on the wealth side, you're starting to see more growth internationally in ETFs, more discussions like in places I just came from Asia, where you haven't seen the kind of penetration there, but they're interested in them. And then things like SMAs are also very much growing in the wealth channel. And we look at Canvas as a great way to bring tax optimization to the SMA platform. So that it can be leveraged as a tool to provide tax-efficient active SMAs to the market."
},
{
"speaker": "",
"content": "We've had close to $1 billion in a quarter in flows in the ETFs. I think we're now over $21 billion when we've added Putnam into that and have had really great success diversifying our strategies into these other types of vehicles. So the Franklin Income Fund, now we have the Franklin Income-focused ETF, which has again been really well received in the market since it was launched as well as having traction outside the U.S."
},
{
"speaker": "",
"content": "So ETFs are incredibly important to us. Yes, it will probably cannibalize some of the mutual funds. But for -- in our case, where we have been underpenetrated in the areas of retirement, that's actually been an area where the tax benefit of ETFs hasn't made a difference, and you're seeing very strong support from mutual funds to the retirement channel. So as we grow there, we're able to make up for any of that cannibalization in that retirement channel while also growing our ETFs."
},
{
"speaker": "",
"content": "So Adam, do you want to add anything to that?"
},
{
"speaker": "Adam Spector",
"content": "Yes. I would just reiterate the point that, for us, ETFs is about the vehicle, not about being passive, just to put some numbers around that 24% of our assets are smart beta and 36% are active. So our passive ETF business, it's only 40% of our AUM is in passive and it was only 20% -- passive was only 20% of our ETF flow for the quarter. So as more and more people begin to consider active management within an ETF wrapper, we think that's great to us."
},
{
"speaker": "",
"content": "And to the point about cannibalization, we would also say that direct indexing is the real threat to mutual funds, and that's where we're so thrilled to have Canvas on board to see the growth there to see our ability to actually use Canvas to manage active portfolios now as well. We think that puts us in a very good position."
},
{
"speaker": "Jennifer Johnson",
"content": "And I think that Canvas is [indiscernible] is more of a threat to the passive mutual fund that has and passive ETF."
},
{
"speaker": "Matthew Nicholls",
"content": "We had another question come in to clarify a point around guidance on performance fees. So just to be clear, the [ 815 ] guide that I gave around the fiscal second quarter guidance, includes an assumption of $50 million of performance fees. The annual guide of $4.55 billion to $4.6 billion is excluding performance fees. Just as you know, we always give our annual guide excluding performance fees. I just want to be clear on that. That's fully inclusive of Putnam. It includes the double rent, but it excludes performance fees."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO for final comments."
},
{
"speaker": "Jennifer Johnson",
"content": "Great. Well, thank you, everybody, for participating in today's call. And once again, I just want to thank our employees for their hard work and dedication to be able to deliver this quarter. And we look forward to speaking to you all again next quarter. Thanks, everybody."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. You may now disconnect."
}
] |
bf.b | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to the Brown-Forman Corporation Fourth Quarter and Fiscal Year 2024 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please note that today’s conference is being recorded. I will now hand the conference over to your speaker host for today, Sue Perram, Vice President, Director of Investor Relations. Sue, please go ahead."
},
{
"speaker": "Sue Perram",
"content": "Thank you, and good morning, everyone. I would like to thank each of you for joining us today for Brown-Forman’s fourth quarter and fiscal year 2024 earnings call. Joining me today are Lawson Whiting, President and Chief Executive Officer; and Leanne Cunningham, Executive Vice President and Chief Financial Officer. This morning’s conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine future results are beyond the company’s ability to control or predict. You should not place undue reliance on any forward-looking statements, and except as required by law, the company undertakes no obligation to update any of these statements whether due to new information, future events or otherwise. This morning, we issued a press release containing our results for the fourth quarter and fiscal year 2024, in addition to posting presentation materials that Lawson and Leanne will walk through momentarily. Both the release and the presentation can be found on our website under the section titled Investors, Events and Presentations. In the press release, we have listed a number of the risk factors you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we will be discussing certain non-GAAP financial measures. These measures, a reconciliation to the most directly comparable GAAP financial measures and the reasons management believes they provide useful information to investors regarding the company’s financial condition and results of operations are contained in the press release and investor presentation. With that, I would like to turn the call over to, Lawson."
},
{
"speaker": "Lawson Whiting",
"content": "Thank you, Sue, and good morning, everyone. Thank you for joining us today as we share Brown-Forman’s fiscal 2024 results. Before diving into the details, I wanted to provide a few high-level comments on our performance and my perspectives on the year. Brown-Forman is a 154 year old company, so we have been through periods of complexity and uncertainty in the past. We understand what it means to be resilient. We know how to navigate short-term challenges while remaining focused on our long-term strategy. Fiscal 2024 has certainly been a challenging year as we’re still operating in a highly dynamic environment. While our business is not immune to the impacts of industry and macroeconomic headwinds, Brown-Forman and its people have remained agile, focused and committed to the long-term growth of our brands and of our business. There is certainly a lot of complexity to our results, which we will walk you through momentarily. However, when you consider our depletion based results, which we believe represents the true health of our business, we’re pleased with our fiscal 2024 performance as it is in-line with our long-term growth expectations. While that statement may surprise some of you, this past fiscal year was greatly impacted by changes in consumer, retail and distributor inventories. We believe our brands remain healthy, we’re in the right categories and price points, and we’re confident in the outlook for our business. So, let’s discuss all of this in greater detail. Throughout the year, we’ve been using the word normalization as we lapped the impact of the supply-chain challenges and the rebuilding of inventory in the prior year, as well as consumers getting back to historical consumption patterns. We expected our organic results to moderate in fiscal 2024 after two plus years of double-digit growth. However, as we move through the year conditions changed, consumers faced higher inflation and increased interest rates that made them as well as distributors and retailers reconsider when and how they made purchases. In this environment, our fiscal 2024 results were below our expectations with organic net sales declining 1% and organic operating income decreasing 2%. And, this is where it gets particularly complex and potentially confusing, so thank you for allowing me to get into the weeds here a bit. As seen in Schedule D, the estimated net change in distributor inventory had a very significant influence on our results this year, reducing our organic net sales by 6% and operating income by 14%. The scale of this impact is significant when compared to any other time prior to the pandemic as the estimated net change in distributor inventory has historically only impacted organic results by one or two points in any given year. The sizable difference in fiscal 2024 between shipments and depletions was driven by several factors converging at one-time. This includes the tough comparison against the rebuilding of distributor inventories in fiscal 2023 related to the glass and supply-chain challenges along with the more recent changes in distributor and retail ordering patterns. We found that the timing and size of orders has fluctuated from their historical patterns to adjust for higher interest rates and moderating consumer demand. We believe our performance is best captured by factoring in the impact from the estimated net change in distributor inventories, which is what I referred to earlier as our depletion-based results. These depletion-based results which capture the sale of our brands from distributors to retailers is the way we manage our business internally within Brown-Forman and the way we incentivize our leaders. From this perspective, our topline results more closely reflect our longer-term trends and our bottom line results were particularly strong. For these reasons, we believe the fundamental health of our brands and our business remains solid. We’ve also been using the word normalization because if we look back over the past five years, which encompasses the numerous impacts of the pandemic, our five year organic net sales compound annual growth rate is 6%. This is in-line with our long-term growth algorithm and demonstrates our strong track record of consistent and sustainable results over the long-term. I also want to highlight the 150 basis points of reported gross margin expansion that we delivered in fiscal 2024. We’ve benefited from favorable price mix as we continue to execute our long-term pricing strategy along with our enhanced revenue growth management capabilities. We also benefited from the growth of our super premium brands. Price mix along with the absence of the supply-chain disruption costs in the prior year period more than offset higher input costs and unfavorable foreign exchange. We’re very pleased with our strong reported gross margin expansion and believe we will continue on this path in the coming fiscal year. Now, as we dig into the full results of the fiscal year, I’ll start with our topline performance and share some highlights from our portfolio of brands. Leanne, will then provide additional details for fiscal 2024 before providing our outlook for fiscal 2025. The main growth drivers of organic net sales were Jack Daniel’s Tennessee Apple, the Jack Daniel’s Super-Premium expressions, New Mix and Glenglassaugh. We haven’t talked much about these brands in the past but there are examples of how the consumer trends of premiumization, convenience and flavor continue to drive our business. They also illustrate the value and importance of our portfolio evolution and innovation strategy as well as our continued geographic expansion and route-to-market strategy. The work we have done to build a diversified global portfolio focused on premium and super-premium brands provides us with many opportunities for growth even in dynamic and challenging times. Jack Daniel’s Tennessee Apple was a top performer as the brand delivered very strong double-digit organic net sales growth and is now almost 900,000 nine-liter cases. The brand was launched in 2019, just prior to the beginning of the pandemic when the closure of the on-premise and supply-chain disruption significantly impacted our ability to build brand awareness. However, the supply and logistic challenges eased, we were better able to meet consumer demand for the product. Today, we’re seeing strong growth in markets such as Brazil and Chile. And, we’ve also continued to introduce the brand into new markets and had a strong launch in South Korea in fiscal ‘24. Collectively, the Jack Daniel’s super-premium expressions also delivered strong double-digit organic net sales growth in fiscal ‘24. This growth was led by Jack Daniel’s Sinatra, Jack Daniel’s Single Barrel Rye, Barrel Proof and the newest member of the bonded series, Jack Daniel’s Bonded Rye. Our exclusive global travel retail offering, Jack Daniel’s American Single Malt also contributed to the strong results. Over the last several years to meet consumer preferences, we have purposefully premiumized the Jack Daniel’s family of brands and elevated our whiskey credentials through innovation and specialty launches. This allowed us to offer both long-term friends of Jack Daniel’s and new friends the opportunity to explore and discover within the Jack Daniel’s family. Of course, another trend in beverage alcohol is the continued growth of ready-to-drink beverages, specifically spirit-based RTDs. This trend is evident in our fiscal ‘24 results with new mix serving as the second largest positive contributor to organic net sales, growing to more than 10 million nine-liter cases in fiscal ‘24. The brand continued to deliver double-digit organic net sales growth benefiting from higher pricing and value share gains in the RTD category despite a challenging environment in Mexico. The third largest positive contributor to overall organic net sales was Glenglassaugh as the brand’s awareness and prestige among whiskey connoisseurs continued to grow. Most notably, Glenglassaugh Sandend being named “the 2023 Whiskey of the Year” by Whiskey Advocate Magazine. And, as we’ve shared over the last couple of quarters, the brand continued to benefit from cask sales, particularly in Asia through its old and rare program. The growth from these brands was almost entirely offset by declines in organic net sales from Jack Daniel’s Tennessee Whiskey. Jack Daniel’s Tennessee Whiskey declined 5%, led by lower volumes in Japan as we transitioned to own distribution, the United States due to slowing consumer demand and the United Arab Emirates and Sub-Saharan Africa, both of which had strong comparisons given the significant rebuilding of inventory last year. As we shared during our Investor Day in March, despite recent short-term headwinds in our industry, we believe Jack Daniels has a significant runway for growth and are confident in achieving our long-term ambitions. Jack Daniel’s remains one of the most iconic brands in the world with solid brand health and a long-term performance track record with Jack Daniel’s family of brands growing volume at a 5% compound annual growth rate over the past five, ten and 30 year periods. The fact that the brand’s five year growth rate is the same as its 30 year growth rate means that it is not slowing down. That is impressive for a brand of its size. The Jack Daniel’s family of brands is a robust portfolio that expands across multiple occasions, price points and geographies. And, we believe we have strategies and plans in place to engage a new generation of legal drinking age consumers while retaining our core consumers. In addition, we are positioned to capture the global growth of American whiskey as we accelerate the geographic expansion of the Jack Daniel’s family of brands. We continue to support the brand’s health and growth through the Make It Count global campaign, McLaren Formula 1 sponsorship and the Jack Daniel’s and Coca Cola RTD. I do want to acknowledge that the impact of Jack & Coke RTD is difficult to see in our fiscal 2024 results, primarily due to the transition to Jack & Coke RTD from our pre-existing Jack and Cola RTD business. Even so, we continue to believe Jack & Coke is an iconic brand and a fabulous product and can build a stronger and more global foundation for the Jack Daniel’s family of brands. Consider for example, the Jack & Coke RTD grew to 4.5 million nine-liter depletions in over 25 markets around the world in fiscal ‘24, of which 2 million of the cases were incremental and leading to more than 120 million cans in consumer hands. Brand investment increased significantly in markets where we transitioned from [Anne Cola to Anne Coke] (ph) with more than half of the increase contributed by Coca-Cola and very positive consumer response with greater than 86% of consumers indicating strong intent to repurchase the Jack & Coke RTD. Jack & Coke was a significant portfolio enhancement for us as were the additions of Gin Mare and Diplomatico. In fiscal ‘24, Gin Mare and Diplomatico were integrated into the Brown-Forman portfolio brands and I’m pleased to say that both brands delivered strong double-digit organic net sales growth. These brands have given us scale in Europe and enabled route-to-consumer changes such as our recent announcement for Italy’s own distribution transition. And with these brands, Brown-Forman owns at least one of the top five brands globally in four strong growth categories, Super-Premium American whiskey, Super-Premium Tequila, Ultra-Premium Gin and Ultra-Premium Rum. We believe this portfolio evolution alongside product innovation gives us the best opportunity for long-term growth and value creation. As I close, I want to thank my Brown-Forman colleagues around the world for their commitment to our company values and their daily efforts to deliver our long-term ambitions. Throughout our 154 year history, it has been the strength of our people, the health of our portfolio and the breadth of our geographic reach that has enabled us to navigate short-term uncertainty and volatility. While we experienced a very dynamic operating environment in fiscal ‘24, we still believe the spirits category and Brown-Forman offer attractive growth. We delivered over 60% gross margin and a 30% operating margin while generating strong cash flows with high returns on capital. And, we are well-positioned to benefit over the long-term from the evolution of our brand portfolio and the investments behind our brands and people. Leanne, I’ll now turn the call over to you to provide more detail on our fiscal 2024 performance and our outlook for fiscal 2025."
},
{
"speaker": "Leanne Cunningham",
"content": "Thank you, Lawson, and good morning, everyone. As Lawson has thoroughly reviewed our topline growth and the performance of our brands for the fiscal year, I will share details on our geographic performance, other business results and our outlook for fiscal 2025. First, from a geographic perspective. Emerging international markets and the travel retail channel delivered mid-to-high single-digit organic net sales growth, respectively, which was more than offset by organic net sales declines in the United States and the developed international markets. In the United States, organic net sales declined 4% largely reflecting lower volumes due to a negative 4% impact from an estimated net change in distributor inventory. First, I’ll speak to the significant amount of noise, if you will, created by changes in distributor inventories in the U.S. market for our business this fiscal year. We have been sharing with you throughout this fiscal year. In our first half, we cycled against the significant inventory rebuild during the same period last year. As we entered our second half, takeaway trends for total distilled spirits and also for our business moved below the historical mid-single-digit range as consumer demand slowed. As consumer takeaway remains below its historical range, retailers have adjusted their inventory levels in response to the slower demand and the higher interest rate environment. Distributor inventory levels were largely at normal levels throughout fiscal 2024 with movement to the low-end or just below the normal range in our fourth quarter. While we are on this topic, I will add here that in our outlook, the expectation is that distributor inventory levels will remain consistent with their current levels. Now, to turn to what we believe are the more important indicators of the health of our business in this market. While total distilled spirits trends continue to be below their historic norms in the low-single-digit range, our portfolio of brands is holding share. Consumer demand for U.S. whiskey, particularly super-premium, is strong as U.S. whiskey remain one of the largest contributors to total distilled spirits value growth in Nielsen. In the whiskey category, consumers continue to seek premiumness, which drove the growth in our super-premium Jack Daniel’s offerings such as Jack Daniel’s Single Barrel Rye Barrel Proof, Jack Daniel’s Sinatra and Jack Daniel’s Bonded Rye, all of which delivered strong growth. This growth partially offset the decline in Jack Daniel’s Tennessee Whiskey volume. In addition, our founding brand Old Forester delivered another year of double-digit organic net sales growth driven by strong consumer demand. The Woodford Reserve was negatively impacted by an estimated net change in distributor inventory levels from a depletion-based and takeaway perspective, the brand remains healthy with strong consumer demand. In our developed international markets, collectively, organic net sales declined 5% in the fiscal year and was negatively impacted by 6% due to an estimated net change in distributor inventories. In Germany, our largest developed international markets, we have been continuously gaining value share which drove 7% organic net sales growth. Growth from Glenglassaugh’s cask sales in Singapore, the continued launch of Jack Daniel’s Tennessee Apple in South Korea and the integration of Diplomatico were more than by the decline in Jack Daniel’s Tennessee Whiskey largely related to the route-to-consumer transition in Japan. Japan is one of the world’s largest spirits markets with a significant footprint and a leading position in premium-plus whiskey, and we have now transitioned successfully to own distribution on April 1, 2024, representing the 16th market where we own and operate the distribution of our portfolio. Though there are short-term impacts to our P&L as we increased the ownership of our route-to-market, we believe these investments will lead to unlocking growth for our broader portfolio brands. The travel retail channel, which has returned to its pre-COVID level of 4% of our organic net sales, delivered 6% growth driven by strong double-digit growth from our super-premium brands, particularly our exclusive global travel retail offering, Jack Daniel’s American Single Malt along with Woodford Reserve and Glenglassaugh. This growth was partially offset by a decline in Jack Daniel’s Tennessee Honey. And, wrapping up our geographic commentary with emerging international markets that collectively increased organic net sales by 8% for the fiscal year despite a 12% headwind from an estimated net change in distributor inventories, which was largely driven by the lumpiness of how the supply-chains were refilled in these markets in the second half of the prior year. Jack Daniel’s Tennessee Apple drove the organic net sales growth most notably in Brazil and Chile due to our ability to meet the strong consumer demand with the return of consistent supply. In Mexico, as Lawson mentioned, New Mix continued to deliver strong double-digit growth as the brand continued to benefit from our pricing strategy and gain share of the RTD category. This growth was partially offset by declines in el Jimador and Herradura, particularly Herradura Ultra, largely due to the challenging macro environment. Jack Daniel’s Tennessee Whiskey growth was led by Turkiye as momentum in the premium whiskey category continued. Moving to our gross profit growth and gross margin expansion of 150 basis points. For the full fiscal year, reported gross profit increased 1% with organic growth of 2%. The successful efforts of executing our pricing strategy and reducing cost led to reported gross margin expansion of 150 basis points, which was in-line with our expectations. In total, our favorable price mix and the absence of supply-chain mitigation cost more than offset higher input cost and the negative effects of foreign exchange. Now to operating expenses. Our total reported operating expenses increased 1% with organic increasing 7%, which again was in-line with our expectations. The increase in reported operating expenses was driven by increased SG&A expense, advertising expense growth and the negative effect of foreign exchange. The increase was largely offset by the absence of a non-cash impairment charge for the Finlandia brand name in the prior year as well as the absence of post-closing costs and expenses in connection with the acquisitions of Diplomatico and Gin Mare in the prior year. Our advertising expenses, as we have shared with you throughout the year, had abnormal seasonality due to the phasing of our investments behind the launch of Jack Daniel’s and Coca Cola RTD in the first half of the fiscal year that moderated through the year with reported and organic advertising expense growth of 4% and 2% respectively for the fiscal year. Reported SG&A expenses increased 11% in fiscal 2024, led by higher compensation and benefit related expenses and our commitment to the Brown-Forman foundation to support the vision of transformative community impact. Our organic SG&A expenses grew 7% as we continued to invest behind our people and strategic route-to-consumer initiatives. Again, we anticipate that these investments, which have short-term impacts on our P&L, will unlock future growth. In total, reported operating income increased 25% and organic operating income declined 2% in fiscal 2024. These results led to a 32% diluted earnings per share increase to $2.14 per share. And lastly, to our fiscal 2025 outlook, we believe our business is continuing its path back towards our longer-term norms following the significant multi-year disruption related to our supply-chain, two years of exceptionally high-demand and the current impact of higher inflation and interest rates on the consumer and trade. We remain confident in the strength of our portfolio that is well-positioned to capitalize on the consumer trend of premiumization that excites existing consumers and convenience and flavor that provides access points to new consumers along with our pricing strategy and the further globalization of our entire portfolio across vast geographies. We expect that the operating environment ahead will remain volatile with global macroeconomic and geopolitical uncertainties. In this environment, we are not forecasting significant changes in trade inventories as the impacts from inflation and higher interest rates on the behavior of the consumer and trade are expected to continue. We do believe we have now experienced the majority of the movements in inventories across the distributor retailer and consumer supply-chain and that we will benefit from having a full-year of growth from our outstanding new brands of Gin Mare and Diplomatico. Therefore, we expect organic net sales growth in the 2% to 4% range driven by our emerging and developed international markets. Similar to fiscal 2024, we expect fiscal 2025 to be a year of two halves. In our first half, on a year-over-year basis, we will still be comparing against the strong shipments in a few emerging international markets as well as lapping stronger shipments associated with the execution of our pricing strategy. We expect the second half of the year to be stronger, which is reflected in our guidance. We believe we will benefit from price mix through the evolution of our portfolio and our revenue growth management activities. And, while costs will continue to benefit from lower agave prices, we expect the benefit will be more than offset by the impact of inflation on our input cost and lower production volumes. Our outlook for organic operating expenses reflects continued investment behind our brands and our people leading to the growth generally in-line with our topline growth. Based on the above, we anticipate organic operating income growth in the 2% to 4% range. We also expect our effective tax rate to be in the range of approximately 21% to 23%. We will continue to fully invest behind our business to meet what we believe will be the future consumer demand for our brands over the long-term. Therefore, in fiscal 2025, we estimate our capital expenditures will be in the range of $195 million to $205 million for the full-year. And lastly, as a reminder, in fiscal 2025, we will begin to reflect our equity share of the Duckhorn Portfolio’s earnings or losses as a line item below the operating income line of our P&L based on the equity method. In summary, we believe we have navigated the highly dynamic operating environment in fiscal 2024, maintaining our growing market share in some of our largest markets including the U.S. and from a depletion-based perspective, our full-year results came in, in-line with our expectations and consistent with our long-term growth algorithm. It was great to see many of you in person during our Investor Day in March. From there, you may recall that we shared that we believe our business is healthy and the issues impacting our topline growth are temporary and not structural which we hope we have clearly shared are largely related to changes in inventory levels. We are confident with the support of our 5,700 employees who are incredibly committed to Brown-Forman and the opportunities we see for our portfolio of brands and our ability to achieve our fiscal 2025 outlook as well as our long-term ambitions. This concludes our prepared remarks. Please open the line for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And, our first question coming from the line of Bryan Spillane with Bank of America. Your line is open."
},
{
"speaker": "Bryan Spillane",
"content": "Hey, thanks, operator. Good morning, guys."
},
{
"speaker": "Lawson Whiting",
"content": "Good morning."
},
{
"speaker": "Bryan Spillane",
"content": "I guess just a couple of quick questions, like probably more clarifications. But, I guess the first one, can you give me you mentioned ingredient costs as inflationary for next year. Is that like corn? I know we have obsessed so much about agave and barrels, but I just wanted to kind of clarify just what it is that’s moving against you?"
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. So, Bryan, it’s Leanne, and the things that we have going, again as a tailwind for us will be the agave, which we’ve talked about many times. It’s kind of going from that 28 to 30 Mexican pesos per kilo at the high. We’ve now seen down to as low as nine pesos per kilo in June depending on the quality of it. And also grain, we’re continuing to expect lower prices in the shorter-term, but still above the pre-pandemic averages. Where we’re seeing some increases are related to our glass, even though we have lower natural gas and diesel prices that are slowing the rate of inflation, we’re still expecting that in the U.S. where the vast majority of our glass comes from, it’ll be 2% to 3% increase. And then, again with transportation, that’s going to be in the low-single-digits. So, what we’ll also be, what we talked about in our prepared remarks, higher inflation on our costs, but then also the cost associated to lower production volumes. That’s all about us working to return to our more normal levels of working capital on our balance sheet. We’ve talked about a lot over time, the commodity costs continues to be high. We’ve talked about adjustments in our infrastructure that we believe will help to offset some of that commodity costs, but we still expect it to be high as well."
},
{
"speaker": "Bryan Spillane",
"content": "All right. Thanks, Leanne. And then Lawson, maybe can you just give us a perspective as you’re looking forward, I guess, this year? The category has been soft. Is your expectation in terms, and I’m really more focused on America whiskey. Is the expectation that the current trends kind of hold for next year? Do you expect that the category to accelerate? And, just to tie to that Lawson, can you talk a little bit about the amount of inventory, the industry inventory of sitting, I guess, aging at this point and whether we’re at risk of like an oversupply situation? We’ve had that question a couple of times, so it would be great to sort of get your perspective on it. Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Yes. All right. Thanks, Bryan. I mean, a few things. One, U.S. whiskey and tequila which are our two biggest categories continue to be the healthiest part of TDS. So, that I mean, that is a good thing but TDS has been bouncing along in that sort of 1% range now for, what nine months, something like that. So, it hasn’t really changed a whole lot. So, it’s obviously been a tough year for the consumer and a tough year for us. One thing I think that’s important to hit, Leanne said it a bit in her opening remarks. And, I think it’s the sort of question of the day. Is the changes, is the slowdown structural in some way or another where spirits demand, which COVID aside, was been in that 4% to 5% range for decades and decades. Or is it largely based on timing, really difficult comps and the inventory issues. And, I do believe, the big three that everyone talks about GLP-1s, cannabis and Gen Z, they are headwinds that are looming in the long-term. But, I don’t think that really has much, if anything to do with the current state of the consumer or the current state of the spirits business in the U.S. And, the reason I say that is, when you look at TDS and say in Nielsen, I mean it was going along actually pretty well and then late summer early fall it fell sharply and it caught everyone in our industry, including you all. I think everyone got caught up in it, and was surprised a bit by it. But, I really do believe that it’s really driven by inflation for the most part. And then, if there was a level of demand that got pulled forward during COVID and where that’s the consumer element of it that we talked about last quarter, a lot on this conference call where consumers had an bottle or two sitting in their cabinet at home and it’s taken some time to work through that. And so, I’m just not a believer that things like cannabis have a lot to do with the current state out there. If TDS went from 5 to 4.5 to 4, and you saw there’s sort of gradual weakening, I would be quite honestly more worried than I am now based on every trend that we can follow. So, and then your other question about industry whiskey supply, I’ve seen a few people write things about that in the last few months. So, it’s something we track internally and have been for a long, long time as part of our planning processes. And a lot of it has to do with what you think the demand is going to be going forward, obviously. So, for a long, long time, whiskey wasn’t growing in the United States. It has for the last about 12 or 13 years. But, we went through that 40 year when they were, didn’t grow at all and so supply and demand were kind of equal. I think it depends on what you think the forward-looking demand number is going to be, but it doesn’t seem to be that far out of line for us. We actually kind of have a different point of view on that than some of the folks that have written that. I do think it’s important to note too, the majority of the inventory that is out there is from the largest suppliers. There’s a lot that’s been written about the number of craft producers that have multiplied many times over in the last decade. I don’t really, that’s not really what I that’s not even worried about, but that’s not where I think the oversupply, if there is much is coming from. It’s the big players. I mean, it’s in whiskey, it’s you know who they are. I mean, it’s the big players, that have been continued to build for a long-term growth and they’re behaving rationally for the most part. And, I think, so I just don’t see there being that big disconnect between supply and demand."
},
{
"speaker": "Bryan Spillane",
"content": "That’s very helpful. Thanks, Lawson. Thanks, Leanne."
},
{
"speaker": "Operator",
"content": "Thank you. And, our next question coming from the line of Nadine Sarwat with Bernstein. Your line is open."
},
{
"speaker": "Nadine Sarwat",
"content": "Thank you for taking my question. One short-term and one long-term for me. On the short-term, coming back to inventories, obviously, large headwind in this quarter. Could you talk about how this compares versus your expectations on the last conference call and what would have been the cause for any difference there? And, a little bit more color on where your inventories are today? I understand there are sort of moving parts, but do you feel they’re fully at the right-level, right-size to that right-level going forward? And, then my long-term question coming back to the U.S, what’s your best assessment of where underlying spirits net sales growth for the U.S. today is for the industry? Obviously, Nielsen, NASDAQ covering some very different channels. And, what would you need to see in your opinion for the industry to get back to mid-single digits? Is it a more favorable macro environment for the consumer? Is it something else? Thank you."
},
{
"speaker": "Leanne Cunningham",
"content": "Thank you, Nadine. And, I’ll take the inventory question. Again, kind of pointing to what we have talked about that our depletion-based results came in, in-line with our expectations. First, I’ll point you to Schedule B for fiscal 2024 depletions are ahead of shipments on our full strength portfolio and even to a greater extent than when we reported in our third quarter call. In the U.S. we know retailers have adjusted their inventory levels in response to the consumer takeaway trends being below their historic mid-single-digit range and with a higher inflation rate environment. We’ve been talking about for the entire fiscal year that at the distributor level, our distributor inventories have been within that normal targeted range as we have gone through the majority of this fiscal year. However, in the fourth quarter in the U.S, the distributor levels did unexpectedly for us dropped to the low-end or just below their normal targeted range. We’re continuing to partner really closely with them as we have been all year, probably even more so now. But, I will say we do believe we’ve now experienced the majority of the movement in the inventories across the distributor retailer and consumer supply-chain and our kind of thoughts on that were in our prepared remarks, we have that built into the guidance that we’ve provided. And then, I’ll turn it over to Lawson, for the second part of your question."
},
{
"speaker": "Lawson Whiting",
"content": "So, the question just being a little bit over the longer-term when and what’s it going to take essentially to get the U.S. market back on track again. It’s very difficult to predict when what is going to happen with consumer spending. I mean, the one thing we know for sure is the comps are going to get easier. So, even not only ours, but even in the Nielsen number world that, as I mentioned earlier, that sort of August, September fall-off, we’re coming up upon that. And so, I hate talking about easier comps, but the reality is that they will ease up. I do believe given partially the way you call it underlying or depletion-based results are better than shipments. This largely is an inventory correction issue that includes the consumer. As we said just a minute ago, the consumer has got to work through it’s the bottles that are sitting at home. And, we talked about this on the last call and I know a few of you all did some analysis on this and sort of agreed I think with our statements that it was going to take about a year to work through that consumer inventory. And so, we’re coming up on that year lapping period in a few months. So, it’s difficult to predict and consumer spending is going to need to improve across all CPGs, not even just spirits. I mean the consumer has been heard everywhere. So, but if you pin me down and said, what do you really think? I think we would say that sometime in the fall or into the winter that trends will improve."
},
{
"speaker": "Leanne Cunningham",
"content": "And then, the only thing I’ll add is, and we’ve said it in our prepared remarks again, but just to emphasize it, in the U.S. and some of our other key markets, we have been able to maintain market share in this volatile environment. So, we feel good about with all the noise that’s in the system that our brands are maintaining the share in the marketplace."
},
{
"speaker": "Nadine Sarwat",
"content": "Understood. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. And, our next question coming from the line of Robert Moskow with TD Cowen. Your line is open."
},
{
"speaker": "Seamus Cassidy",
"content": "Hi, this is Seamus Cassidy on for Rob Moskow. And, thanks for taking the question. So, given the target that you reiterated at your March Investor Day to double fiscal ‘22 operating income by fiscal ‘32. With fiscal ‘25 expected to be another below algo year, I’m curious how you see this trending beyond fiscal ‘25 and maybe where you expect to get operating leverage in the out years given that you’ll need to invest more this year in terms of advertising and promotion? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Yes. Well, look, we always knew that ambition was not easy, call it lofty a little bit, particularly the last couple of years or really last year for the most part has been difficult. But look, 2032 is still a fair ways away. We still believe in the portfolio and everything that we are doing has the growth characteristics to deliver on those goals. And so, we are not changing our long-term growth algorithm at all. And, you asked about leverage. I know we are working very hard to get some gross margin leverage around here. And so, I think that’s going to take continued work, but continued, you’ve heard me say it before low and slow. I want to continue that and everyone is we’re all on-board and focused on that right now. And thankfully, even in the current environment that we’re in today, we still think that pricing is a lever in all this to continue to generate growth and it’s actually coming true in the numbers. And so, a little bit of gross margin improvement with expense controls that make sure that our operating expenses don’t grow at a rate greater than our sales. I mean, that’s the model that we believe in and we’ll continue to do. And then, I know we’re only two years into this 10-year plan and so there’s plenty of time to accelerate."
},
{
"speaker": "Seamus Cassidy",
"content": "That’s helpful. Thanks. And then, maybe just one quick follow-up. You sort of talked about your excitement about a return-to-annual pricing in the spirits industry, but you also sort of called out inflation as something that’s been a headwind for consumers. So, I’m curious how you’re thinking about that in fiscal 2025? Thanks."
},
{
"speaker": "Lawson Whiting",
"content": "Well look, I mean we kind of already hit that. I mean the consumer demand is normalizing. Now, we all, but I mean keep in mind, there is 2.5 years worth of double-digit growth, where every, it was difficult to drop all that to the bottom line because of all the things you all know about. But, it was outstanding for a period of time, and I think it’s just a return to that normalization a little bit. I think, if we’re honest with ourselves, a year ago, we thought that meant it was just the market was going to hit, go back to that 4% to 5% range and stay there. And, it’s taken a year of being below that to sort of correct this consumer inventory thing. So, the timing we’ll see, but I still feel pretty confident that the long-term outlook for spirits in this country is excellent and nothing really has structurally changed. So, did that answer your question?"
},
{
"speaker": "Seamus Cassidy",
"content": "Yes. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And, our next question coming from the line of Lauren Lieberman with Barclays. Your line is open."
},
{
"speaker": "Lauren Lieberman",
"content": "Well, it’s great, thanks so much. I guess completely hounding on what you guys have already been talking about, but the notion that the inventory cleanup, both at distributors, consumers, retailers and so on is complete, it’s just very different than what we’re hearing from others in the industry. So, not taking issue at all with your view Lawson on the long-term health of the industry that nothing structural has changed, really just getting at the question of the longevity of the correction and the visibility that there is. So, I’m just curious, what is it that you guys are seeing or your reasons to believe that inventory correction throughout the being distributor, retailer, consumer landscape is complete? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "And, this goes back Lauren, to what we’ve been saying for quite some time now with all the disruption that has been in our system that started with the pandemic and the glass supply challenges, logistics challenges. We continue to be in a significantly different position than most of our comp set because of the glass supply challenges that we have gotten into. We’ve talked about this over time, how we prioritize brands, we prioritize markets to rebuild and refill our supply-chain and even in ‘24, there was lumpiness that we had to compare against especially in the fourth quarter in the prior year, where we were reloading our emerging international markets. And, we have had to comp against that. We’ve come up to normal inventory levels where others were in a different place and maybe coming down. And so, we’ve really felt like we have been there and been closely aligned with our partners in the U.S. distribution system. For us, it really was about that unexpected drop in their inventory levels in the fourth quarter as they got kind of down to absolutely the lowest end and below, just below their targeted inventory range. So, that was kind of for us the miss and what was unexpected. As we continue to do our work, we continue to believe the vast majority of that movement is now behind us. But, we’re definitely not saying that all of it is behind us as it relates to the U.S. So again, all of that would be included in our guidance."
},
{
"speaker": "Lawson Whiting",
"content": "And, understanding the distributor side of it and the retailer is fairly clean and we have data against it. The biggest question is the health of the consumer itself and when that comes back. And look, everybody is going to have a different opinion on that and I don’t have a great crystal ball any better than you do. We’re just, I won’t walk through the consumer example again, but we do think that the pantries are not as full as they were a year ago. And, it just depends a little bit when the consumer comes back and starts spending in a big way, particularly also we haven’t talked at all about the on-premise. But, on-premise has weakened over the last year and that doesn’t help overall trends either, but we think that’ll start to come back too over the next year."
},
{
"speaker": "Leanne Cunningham",
"content": "And again, it was just one small line in our prepared remarks, but the importance of what we talked about that in our outlook, it just assumes that where our inventories are today, it’s going to continue going into the future."
},
{
"speaker": "Lauren Lieberman",
"content": "Okay. And Leanne, actually I wanted to clarify on that point. Should we think about that as the absolute level of inventories, distributor inventories are where they should be? So, from a growth standpoint, like the next quarter or two, that’s still a headwind to growth. But again, like an absolute level, we’re at the right point, if you’re following what I’m asking?"
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. So, what we’re talking about is kind of there in the U.S. they’re kind of at the low-end or just below their levels. In our guidance that assumes they’re going to stay consistent with where they are right now and that as we move forward, we’ve talked about in our outlook, we’re going to go against in our first half strong shipments. Again, part of its related to the lumpiness of the shipments in F‘24 for the emerging international markets, but then also in the U.S. again, as we executed our pricing strategy last year that would have seen stronger shipments in the first half. And again, all that’s build in, so the stronger first half as we look at F‘25 and, then we expect a stronger second half in ‘25."
},
{
"speaker": "Lauren Lieberman",
"content": "Okay. Got it. That’s right. Absolute levels, but then the growth rates are something different, but the absolute levels have kind of reached the point where they need to be. Okay."
},
{
"speaker": "Leanne Cunningham",
"content": "Generally."
},
{
"speaker": "Lauren Lieberman",
"content": "I’ll pass it along. I have more, but I’ll pass it on. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And, our next question coming from the line of Nik Modi with RBC. Your line is open."
},
{
"speaker": "Nik Modi",
"content": "Thank you. Good morning, everyone. Lawson, I had two questions. First was just on Jack Daniel’s, given all the kind of line extensions over the years and different flavor expressions, have you as an organization figured out how to spend behind the Jack Daniel’s equity and really kind of provide a halo for all the expressions because there’s a lot of innovation coming out from other players in some of these areas that seems like there’s some cannibalization of your business. So, just wanted to get your perspective on how you think about brand building long-term? And then, just kind of sticking on the Jack Daniel’s mainline brand, we’re hearing a lot of promotional activity from your competitor base, some of that’s not tracked in the Nielsen or Circana data, instant redeemable coupons etcetera. So, I just wanted to get your perspective on that and kind of how you’re thinking about that embedded in your guidance?"
},
{
"speaker": "Lawson Whiting",
"content": "All right. So first, I’ll hit the Jack one first. Well, for one, the short-term and then I’ll take it a little bit longer-term and a little bit higher up, but organic net sales for Jack Daniel’s Tennessee Whiskey, so Black Label was down 5%, but there was an 8% impact from the net change in distributor inventories. And so, let’s not think that all of a sudden the brand is in this big decline from a consumer perspective. We still feel very good about that. There’s just been there’s been, so much noise and we’re also comparing against in the prior period, some very high numbers. And so, when you step back and you look at it, say on a five year basis or even longer than that, the brand has maintained the growth rate. I think we just said, the same growth rate on a five year basis, 10 year basis, on a 30 year basis is all plus five. So, we’re not seeing a long-term slowdown even in Tennessee Whiskey as we have introduced, we’ve had the flavors. It’s been a few years since we’ve introduced a new one, but we’ve got all these higher in-line extensions that we’ve doing on the brand, that I do think act I mean, they drive profit in and of themselves, but they’re also a halo over top of the brand or the franchise altogether. But the health metrics remain stable, and we do believe that Tennessee Whiskey is going to normalize over the next year. And so, it’s and then back to the marketing and the brand expense and the levels that we have and all those kind of things. Look, we’ve changed up the marketing mix quite a bit over the last few years. We do, I’m very happy with the state of the brand and some of the communications that we’re doing now. We’re doing a whole lot with McLaren in racing and that’s been fun and it’s been interesting and a different brand building model for the brand, but a very good one, a very, very premium one. And so, and as far as absolute spend to be able to continue to deliver the kind of growth and momentum we have, we’re pretty comfortable with where we are and expect I think we’ve said many times before the brand expense is going to grow in something close to the brand’s topline sales. So, the combination of Black Label continuing and remaining in growth mode, we will continue to do some innovations, RTDs are very popular right now and Jack & Coke well, just getting started is something, we really believe in and we do have a pipeline of new thoughts on premium offerings. And so, we remain comfortable overall with that. And so, and then back now down to the second question that you asked on the U.S. pricing environment and maybe you and I maybe we’re looking at the same thing. I’m actually, I’ve been a little surprised, that some of our competitors have said that, because I’m looking at the data and I’ll just throw out some very basic ones. But TDS pricing of 52 week basis is 1.2 on a 13 week basis is 0.8. So, still positive and it’s positive across most of the major brands, particularly American Whiskey, which I don’t know if I’m surprised at this necessarily, but American Whiskey pricing is strong as any, probably the strongest pricing environment of any of the major categories in the U.S, which bodes well that rational people are maintaining a positive price outlook and we are definitely as part of that. We’re in that just even Woodford for example is plus 1.9 and Jack is plus 1.3. So, that low and slow thing comes back again, particularly in American Whiskey. Tequila is a little different, and we’ll see how this plays out over the next year or two or three years. A lot of you have written stuff about agave cost, what’s that going to do to the promotional environment. But, it’s not really happening yet. It’s not coming through in the numbers. And you mentioned it, I think it was a coupon thing or something. I actually don’t really know about that. But, I can say that the big tequila brands, particularly ours and some of the stronger tequila brands continue even over a 13 week basis take pretty hefty price increases or they are not discounting. There are a couple of brands that are having a struggle and they’re weaker and they are starting to discount a little bit more. They’re not ours and we hope that the industry will maintain sort of that rational pricing perspective. But, you just don’t see it through the numbers now. So, I’m not sure why everyone is coming up with this, the notion that the environment has gotten a lot more promotionally driven."
},
{
"speaker": "Leanne Cunningham",
"content": "And, then one thing I’ll add to that is for el Jimador specifically, when you look at Brown-Forman’s pricing in tequila versus TDS, you will see ours is definitely higher and that’s all about the repositioning of our el Jimador brand getting it firmly into that $20 to [$29, $99] (ph) price tier where we see the fastest growth right now. So, and we have a new package that will be coming out that supports that in this year. So, we’re excited about what we’ll see from el Jimador as we move forward with that price repositioning work we’re doing."
},
{
"speaker": "Nik Modi",
"content": "Thanks so much. I’ll pass it on."
},
{
"speaker": "Operator",
"content": "Thank you. And, our next question coming from the line of Filippo Falorni with Citi. Your line is open."
},
{
"speaker": "Filippo Falorni",
"content": "Hey, good morning, everyone. I had a question on the developed international and emerging market business. In the past calls, you talked about some weakness in some European markets. So, maybe can you give an update there and also in emerging on Mexico? And then, for the second half of the year, Leanne, you mentioned the improvement in the second half. What gives you the confidence in the improvement in the second half on topline? Is it mainly the kind of the comps on the inventory side or are you assuming also an acceleration in category growth in the U.S. and international markets? Thank you."
},
{
"speaker": "Leanne Cunningham",
"content": "I’ll start with your last one first, because it’s the most of thing which is about what we will be comping in the second half of this year. And then, to go to some of the international markets in the U.K., we’re continuing to hold our value share in both the on and off trade. The consumer does continue to reduce their spending and trade downs present in that market. For us, Germany continues and you can see that in the numbers continues to be really strong and the consumer climate there we see as improving. Poland, we’re still growing nicely in that market while consumers are remaining cautious with their spending. And then, France is just a market. I think it’s a consistency theme we’ve talked about for the entire year, which is they just continue to down trade and having the promotional activities. So, maybe having the Olympics this summer will change that a bit. And then, as it relates to Mexico, the similar trend is what we have been reporting, which is the consumer continues to be slowing down in spending and we’ve been talking about that in our business and you can see that through el Jimador and Herradura performance. Brazil, we continue to deliver low-single-digit growth there because our Jack Daniel’s Tennessee Apple, is just being really well received with the consumers and its driving market share gains. And, the consumer takeaways there is slowing a bit as well. And, it’s the competitive environments intensified, but we’re actually delivering double-digit our strong growth in Brazil."
},
{
"speaker": "Lawson Whiting",
"content": "Hey, let me add one point on the U.K., because if you look at Schedule C it looks kind of ugly on the U.K, down 14% sales, but very importantly that is largely driven by Jack & Coke and Jack & Cola. So, that was a very big Jack & Cola market, very healthy and a good business for us for a long time. That is the cleanest example, I guess, of a market where we used to sell directly ourselves and now it’s The Coca-Cola Company is doing it. So, we’ve had to pull Jack & Cola off the shelves, and now we’re selling like we do with all the other markets where Coca-Cola is selling. We’re effectively selling them concentrate really, which just obviously has a lot lower sales number. So, it makes the U.K. look worse than it really is."
},
{
"speaker": "Filippo Falorni",
"content": "Great. Thank you. That’s helpful. And then, maybe following up on the gross margin questions previously, is the Q4 decline and performance mainly driven by the lower inventory that you had expected? Have you already starting to see some of those costs inflation headwind that you mentioned for next year already playing out in Q4? And then, thinking about ‘25, I know you mentioned there’s puts and takes agave favorable, some other commodities inflationary. But overall, are you still expecting some margin expansion, gross margin expansion in ‘25? Thank you."
},
{
"speaker": "Leanne Cunningham",
"content": "So, to your first one, the big change in the fourth quarter is really going to be driven by inventory related cost as we would call it LIFO and it’s our LIFO calculation on the year-over-year change of what we had in the fourth quarter of ‘23 compared to the fourth quarter of ‘24. So, that’s the extreme change there. And then, related to gross margin expansion for F ‘25, just as we talk about reported gross margin, the change in our portfolio as it relates to the addition of Gin Mare and Diplomatico and the divestiture of Finlandia and Sonoma‑Cutrer that will provide us with gross margin expansion from a reported perspective. And then, for the rest of our gross margin, we will have that low-single-digit favorable price mix largely driven by price in F ‘25. But again, that’s going to be a little bit more than offset by cost and the work that we will be doing to normalize the working capital on our balance sheet."
},
{
"speaker": "Filippo Falorni",
"content": "Got it. Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And, our next question coming from the line of Peter Grom with UBS. Your line is open."
},
{
"speaker": "Peter Grom",
"content": "Thanks, operator. Good morning, everyone. So, Leanne, maybe building on that last question, you kind of touched on those a tale of two halves, first half more subdued. Can you maybe provide some parameters in terms of how you’re thinking about the first half versus second half in terms of gross rates? And then, maybe kind of following up to Filippo’s question, it seems like one of the primary reasons you’re expecting a more challenged first half was due to the tougher shipments. But can you maybe just share what’s embedded in the guidance from a category perspective? I think you mentioned that the improvement in the back half is more comp driven, but there just doesn’t seem to be a lot of visibility in terms of when this inflection to the historical growth rate occurs. So, just to be curious what’s kind of the assumption embedded into the outlook from a category standpoint? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Well, I would say from what we are looking for in our growth rates is we shared that it was really going to be driven by developed and emerging international markets that those will be driving the greatest growth rates. To your point, the tail of two halves that we will have in F ‘25 which because of disruptions we’ve the tail of two halves story now for a couple of years. Again, for us in the first half of ‘25, it’s really going to be about comping against those strong shipments that we had in the first half. Conversely, when we just talked about the lower distributor inventory levels, we’ll be comping against that in the second half of this year. When we continue to look at our business, we continue to be on a path back to kind of our long-term growth algorithm in F ‘25. It’ll be another step in that path back to normalization. But again, with what we see right now from the consumer, the trade, we’re just assuming that we’re pretty consistent with where we are until we get some indicators of change as we go through this year."
},
{
"speaker": "Peter Grom",
"content": "Got it. Thanks so much. I’ll pass it on."
},
{
"speaker": "Operator",
"content": "Thank you. And, ladies and gentlemen, that’s all the time we have for Q&A session. I’ll now turn the call back over to Sue, for any closing comments."
},
{
"speaker": "Sue Perram",
"content": "Thank you. And, thank you to Lawson and Leanne, and to everyone for joining us today for Brown-Forman’s fourth quarter and fiscal year 2024 earnings call. If you have any additional questions, please contact us. As we close, I want to acknowledge an anniversary that the company just celebrated yesterday on June 4, 1924, in the midst of prohibition, Brown-Forman relocated to its headquarters in the location that we’re sitting in today, marking a century as another milestone in our 150 year, four year history and a reminder of the agility and resilience of this company and its people as we work every day to ensure that there’s nothing better in the market. With that, this concludes today’s call."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, that does conclude conference call for today. Thank you for your participation. You may now disconnect."
}
] |
bf.b | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to the Brown-Forman Third Quarter and Year-to-Date Fiscal 2024 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Sue Perram, Vice President, Director, Investor Relations."
},
{
"speaker": "Sue Perram",
"content": "Thank you, and good morning, everyone. I would like to thank each of you for joining us today for Brown-Forman third quarter and year-to-date fiscal 2024 earnings call. Joining me today are Lawson Whiting, President and Chief Executive Officer; and Leanne Cunningham, Executive Vice President and Chief Financial Officer. This morning's conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine future results are beyond the company's ability to control or predict. You should not place undue reliance on any forward-looking statements, and except as required by law, the company undertakes no obligation to update any of these statements, whether due to new information, future events or otherwise. This morning, we issued a press release containing our results for the third quarter and nine months ended January 31, 2024, in addition to posting presentation materials that Lawson and Leanne will walk through momentarily. Both the release and the presentation can be found on our website under the section titled Investors, Events and Presentations. In the press release, we have listed a number of the risk factors you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we will be discussing certain non-GAAP financial measures. These measures, a reconciliation to the most directly comparable GAAP financial measures and the reasons management believes they provide useful information to investors regarding the company's financial condition and results of operations are contained in the press release and investor presentation. With that, I would like to turn the call over to Lawson."
},
{
"speaker": "Lawson Whiting",
"content": "Thank you, Sue. And good morning, everyone. Thank you for joining us today as we share our third quarter and year-to-date results for fiscal 2024. Before we get into the specifics of Brown-Forman's performance, I wanted to take a moment to offer a few comments about the dynamics and trends within the broader spirits industry. The last few years have been some of the most volatile and complex in my 26 years in the spirits industry with a variety of factors creating noise within the system. This can make it hard at times to distinguish between short-term headwinds and long-term trends. The last few months have been particularly noisy as demand for Spirits has been normalizing after more than two years of outstanding growth. To truly understand the current environment, however, it's important to reflect back on the beginning of the pandemic when the closure of the on-premise, limitations on travel and remote work prompted many consumers to shift their spirits consumption from bars and restaurants and invested at home bars for entertaining. Once restrictions eased and bars, pubs and restaurants reopened, consumers began spending heavily on vacations and other experiences they missed during the lockdowns. In addition, many consumers continue to entertain at home. Many in our industry call this the COVID super cycle. In calendar 2023, after two-plus years of above average spending, consumers were getting back to more normal consumption patterns, but were soon faced with high inflation and increased interest rates that made them reconsider when and how they purchase spirits. By the late summer of 2023, the spirits industry across much of the developed world, including the U.S., saw the impact of these changing consumer behaviors in the form of weakening takeaway trends. However, we continue to believe, as we mentioned last quarter, that these trends are a direct result of the volatility consumers experienced since the pandemic and do not imply a longer-term change in the way they consume and enjoy spirits. At the same time, consumers were adjusting their behavior as a result of the pandemic. Brown-Forman had its own set of pandemic-related challenges to navigate. This included disruptions to supply chain logistics and glass supply constraints that impacted our historical distributor ordering patterns and created unusual comparisons over the past few years. Today, we have a supply chain that is adjusting back to normal levels of consumer demand, and at the same time, it's also facing increased inflation, increased interest rates and increased competition. I share all of this to try and bring clarity to the difficult dynamics we've had to navigate and to explain why despite a challenging fiscal year, we continue to remain confident in the long-term health of the spirits consumer and the spirits industry. The other very important topic for Brown-Forman this fiscal year is the improvement in our gross margin. This too has been a journey we've been on now for several years. We've continued to execute our pricing strategy through our enhanced revenue growth management capabilities and increased price. We've benefited from the growth of our super premium brands in the form of more favorable price mix and these improvements, along with the absence of the supply chain disruption costs in the year ago period more than offset higher input costs, and we're pleased with our strong gross margin expansion. Now let me provide a bit of perspective on our fiscal 2024 net sales. Our reported net sales growth increased 1% in the nine months of fiscal 2024 with flat organic net sales growth. These results compare against strong results in the prior year where strong consumer demand, higher pricing and the rebuilding of distributor inventories generated high single-digit reported net sales growth and double-digit organic net sales growth. I encourage you to reference Schedule D, which illustrates 5 percentage points of impact to our organic net sales from an estimated net decrease in distributor inventories. If you factor in this impact, our top line results continue to be in the range of our longer-term trends and help support our belief that our business is solid and our brands remain healthy. In the nine months of fiscal 2024, the largest growth contributors to organic net sales growth were in Jack Daniel's Tennessee Apple, New Mix and Glenglassaugh. As you will recall, the international rollout of Jack Daniel's Tennessee Apple had been slowed by the pandemic-related impacts. However, as supply and logistics challenges were eased we were better able to meet consumer demand, which drove growth for Jack Daniel's Tennessee Apple, particularly in markets such as Brazil and Chile. We've also had a strong launch in South Korea, resulting in very strong double-digit growth for the brand. Despite a challenging environment in Mexico, New Mix continued to deliver double-digit organic net sales growth as the brand benefits from higher pricing and continues to gain value share in the RTD category. Glenglassaugh continues to be a standout brand as its awareness and prestige among whiskey connoisseurs continues to grow. As we discussed last quarter, the brand continued to benefit from cask sales through its old and rare program. In addition, Glenglassaugh Sandend was named the 2023 Whiskey of the Year by Whiskey Advocate Magazine. This is our second year in a row that a Brown-Forman brand has received powerful and impactful acclaim from whiskey critics across the globe. If you'll recall, Jack Daniel's Bonded captured this most coveted global accolade in the whiskey industry back in 2022. Since I mentioned Jack Daniel's Bonded, I'll also note that collectively, the Jack Daniel's super-premium expressions delivered strong double-digit organic net sales growth in the year-to-date period. This growth was led by Jack Daniel Sinatra, Jack Daniel's Single Barrel Rye Barrel Proof and the newest member of the bonded series Jack Daniel's Bonded Rye. This is the result of our purposeful efforts to premiumize the Jack Daniel's family of brands and elevate our whiskey credentials through innovation and special launches. In doing so, we give both long-term friends of Jack Daniel's and new friends the opportunity to explore and discover within the Jack Daniel's family. Also included in this innovation is the Jack Daniel's and Coca-Cola RTD, which just celebrated one year since the national launch in Mexico. While it's still early to the brand's global launch, the Jack & Coke RTD has earned numerous awards, including best canned cocktail and best drink concept by Beverage Digest and named the Coca-Cola Company's number one innovation in 2023. Jack & Coke is the number one RTD SKU in Great Britain and Poland and remains the number one whiskey-based RTD in the United States. And in less than 12 months, over 100 million cans have been sold in just 13 markets, increasing brand visibility not only for the RTD, but also for Jack Daniel's full-strength portfolio. The Jack Daniel's RTD portfolio had minimal impact on the overall organic net sales results in the year-to-date period, largely due to the transition of the Jack and Cola business to Jack & Coke. We believe this transition is building a stronger, more premium and more global foundation that creates value and supports our long-term growth. The benefits from the premiumization trend continue to be evident in the organic net sales growth of Woodford Reserve, which returned to growth in the year-to-date period, driven by the brand's luxury expressions, such as batch proof and the masters collection. Our founding brand, Old Forester, introduced the newest expression in its super premium Whiskey Row series Old Forester 1924, a 10-year-old whiskey with a suggested selling price of $115. The Whiskey Row series continues to grow, but also creates a halo for the parent brand, and I'm proud to say that Old Forester has recently crossed the 0.5 million nine-liter case milestone. And our newest super and ultra-premium brands, Gin Mare and Diplomatico entered our organic results in the third quarter and collectively delivered a very strong double-digit organic net sales growth. To wrap up our top line performance, I'll share a few thoughts on Jack Daniel's Tennessee Whiskey, which was the largest offset to growth of our organic net sales. First of all, it is lapping an exceptionally high comp from the prior year period. Also, volume declined in the nine months of the fiscal year, mainly related to our route-to-consumer transition in Japan, the U.S. and the comparison against the inventory rebuild in Sub-Saharan Africa in the year ago period. We believe these disruptions are circumstantial and temporary and are confident that Jack Daniel's remains in a position of strength with robust medium and long-term performance and exceptional brand health. For example, Jack Daniel's Tennessee Whiskey has again been named the most valuable spirits brand in the world by Interbrand, making this the eighth year in a row. In fact, based on our consumer insights research, Jack Daniel's Tennessee Whiskey ranks number one or number two across the measures of brand awareness, penetration and consideration across most markets. And we continue to support the brand's health and growth through the Make It Count global campaign, the Jack & Coke RTD and the McLaren Formula 1 sponsorship. We have strategies and plans in place to return Jack Daniel's Tennessee Whiskey to growth, which we will share in more detail during our Investor Day later this month. While the path to normalization in the spirits category impacted our top line results, we continue to be pleased with our gross margin. As I shared previously, we have moved from contraction to expansion. In the first nine months of fiscal 2024, our reported and organic gross profit increased 5% and 6%, respectively, both were ahead of the respective top line growth rates. The strength and health of our brands, along with our continued brand building investments enabled us to increase price across many brands in our portfolio, which helped drive the 290 basis points of price/mix contribution to gross margin. Gross margin also benefited from the absence of supply chain mitigation costs, which more than offset higher input costs. As a reminder, in the prior year-to-date period, we incurred increased transportation and logistics costs in order to satisfy the demand from our distributors and retailers for the important holiday season. In total, favorable price mix, the absence of supply chain mitigation costs and lower tariff-related costs due to the removal of the U.K. tariffs on American whiskey more than offset higher input costs and the negative effects of foreign exchange and acquisitions and divestitures. This resulted in 250 basis points of reported gross margin expansion in the year-to-date period. In summary, we continue to operate in a very dynamic operating environment that has impacted our short-term results. We believe that we will benefit from the evolution of our brand portfolio, long-term pricing and revenue growth management strategies, as well as a moderating cost environment even as consumer demand normalizes. The spirits category offers attractive growth, healthy margins and high returns on capital, and we're well positioned globally with premium and super premium brands in growing categories. We also have an organization of highly talented people who are committed to our strategic priorities and company values. I'd like to thank all of our Brown-Forman employees across the world for their focus on growing our brands and achieving our long-term ambitions. With that, I'll turn the call over to Leanne and she'll provide additional details on our geographic performance, other financial highlights, as well as our updated fiscal 2024 outlook."
},
{
"speaker": "Leanne Cunningham",
"content": "Thank you, Lawson, and good morning, everyone. From a geographic perspective, our emerging international markets collectively delivered 11% organic net sales growth and continue to lead the company's growth in the year-to-date period. Jack Daniel's Tennessee Apple, particularly in Brazil and Chile, once again led the growth due to our ability to meet strong consumer demand with the return of normal levels of supply. Jack Daniel's Tennessee Whiskey growth was led by Turkey as momentum in the premium whiskey category continued. In Mexico, New Mix continued to deliver strong double-digit growth as the brand continued to benefit from our pricing strategy and gained share of the RTD category. In the travel retail channel, organic net sales grew 1% in the nine months of the fiscal year, which is impressive as it lapped 52% growth in the year ago period when international airline travel and the cruise industry rebounded and nearly returned to pre-COVID levels. Strong double-digit growth of our super premium American whiskeys such as Woodford Reserve, Jack Daniel's American Single Malt, our exclusive global travel retail offering and Jack Daniel's Single Barrel was partially offset by declines in Jack Daniel's Tennessee Whiskey and Jack Daniel's Tennessee Honey. Turning to the United States. Organic net sales decreased 2%, driven by lower volumes, partially reflecting an estimated net decrease in distributor inventories of 2%. The impact of our year-to-date results due to the comparison against the significant inventory rebuilding during the first half of fiscal 2023 moderated as we believe distributor inventories normalized in the third quarter of fiscal 2023 and have remained at normal levels. Our pricing strategy, which led to higher prices across much of our portfolio, led by Jack Daniel's Tennessee Whiskey and el Jimador helped to limit the decline. Consumer demand for U.S. whiskey, particularly super premium remains strong as U.S. whiskey is the second largest contributor to total distilled spirits value growth in Nielsen. The demand for our super premium Jack Daniel's products, Jack Daniel Sinatra, Jack Daniel's Single Barrel Rye Barrel Proof and Jack Daniel's Bonded Rye, along with our limited releases of Jack Daniel's 10- and 12-year old delivered strong growth and partially offset the decline in Jack Daniel's Tennessee Whiskey volume. The fastest-growing category in the U.S. remains the ready-to-drink category. It has been nearly one year since the launch of the Jack Daniel's and Coca-Cola RTD in the United States, and the brand continues to grow and gain share. Jack Daniel's RTD, led by Jack & Coke remains a top 10 brand family by value in Nielsen. We continue to believe that our portfolio is well positioned to benefit from the consumer trends of premiumization and convenience. Moving on to our developed international markets. Collectively, organic net sales declined 6% for the nine months of fiscal 2024, driven by lower volumes, primarily reflecting an estimated net decrease in distributor inventories of 6%. Growth of Jack Daniel's Tennessee Apple, led by the continuing successful launch in South Korea and Glenglassaugh's old and rare cash sales in Singapore was more than offset by declines for Jack Daniel's Tennessee Whiskey in Japan related to the estimated net decrease in distributor inventory due to fulfillment of backlog orders in the second half of last year when supply was available to meet this demand coupled with the transition activities to our own distribution. We continue to progress as planned with our launch just a few weeks away on April 1. In addition, as we continue to drive and build our business in Europe, we are pleased to announce that we will establish our own distribution organization in Italy effective May 1, 2025. Italy is one of the top five spirits markets in the European Union, making it an important market for driving the growth of our Jack Daniel's family of brands globally and in particular, for our latest portfolio additions. Italy is the largest market for Gin Mare and the fifth largest market for Diplomatico Rum globally. This market holds significant potential for future growth, and we believe this change will enable us to strengthen our commercial and brand-building capabilities, while increasing consumer focus and prioritization of our portfolio. As Lawson has shared the details of our strong gross margin expansion for the nine months of fiscal 2024, I will now turn to our operating expenses and income. As we have shared with you in prior quarters, we allocated more brand-building investment in the early months of fiscal 2024 to support the launch of the Jack Daniel's and Coca-Cola RTD in the United States. We also increased investment for Jack Daniel's Tennessee Whiskey. Due to the phasing of our investments, our operating expenses continued to moderate through the nine months of fiscal 2024, which resulted in organic advertising expense growth of 7% in the year-to-date period. Similarly, organic SG&A investment also moderated through the nine months of fiscal 2024 as we continue to invest behind our people. Primarily led by higher compensation and benefit expenses, resulting in an increase of 8% for the year-to-date period. Our year-to-date reported operating expenses, which decreased 11% were impacted by three items: the absence of the prior year noncash impairment charge for the Finlandia brand name; the current year gain on the sale of Finlandia; and the absence of the prior year post closing costs and expenses related to the acquisition of Diplomatico and Gin Mare. In total, reported operating income increased 25% and organic operating income grew 2% in the nine months of fiscal 2024. These results led to a 32% diluted earnings per share increase to $1.58 per share. Before moving to our outlook, I'd like to take the opportunity to provide you with an update on our share repurchase program that we announced on October 2, 2023. As you may recall, the Brown-Forman Board of Directors authorized the repurchase of up to $400 million of our outstanding shares of Class A and Class B common stock. I am pleased to announce that as of December 31, 2023, we have completed the program. Now turning to our updated fiscal 2024 outlook. As Lawson highlighted, global trends are normalizing after two years of very strong organic net sales growth in what has been a challenging and dynamic operating environment we experienced softer-than-expected consumer trends during the important holiday selling season globally, which limited our expected top line acceleration. While we have to lap stronger shipments associated with the launch of Jack Daniel's and Coca-Cola RTD in the U.S. in the fourth quarter of fiscal 2023, the year ago period is in line with longer-term historic trends. We also expect to continue to benefit from our long-term pricing and revenue growth management strategies, as well as the contribution from our recent super premium brand acquisitions, Gin Mare and Diplomatico. We now expect our organic net sales growth to be flat for fiscal 2024. Also in this fiscal year, we continue to believe our gross margin will expand as higher input costs driven by inflation will be more than offset by price mix and the absence of supply chain disruption. Our outlook for organic operating expenses to increase remains the same and assumes incremental advertising spend will be above our top line growth rate. Our expectation is that SG&A growth will remain higher than historical averages as we continue to expect higher compensation and benefit-related expenses and costs related to our transition to own distribution in Japan. Based on these expectations, we anticipate organic operating income growth to be in the range of 0% to 2% for the full fiscal year. We have revised our expectation for the effective tax rate for fiscal 2024 to now be in the range of approximately 20% to 22%, and we now anticipate capital expenditures to be in the range of $230 million to $240 million for the full year. Before opening the call up to Q&A, I would also like to add a few comments on our recent capital allocation actions, in particular, the sale of our cooperage in Alabama, the pending divestiture of Sonoma-Cutrer and our long-standing commitment to our community and the environment. During the third quarter, we announced the sale of our cooperage in Trinity, Alabama to independent stave company. In our continuing efforts to optimize our wood supply chain, we have committed to a long-term strategic relationship with Independent Stave Company to ensure a stable supply of high-quality barrels to meet our demand at a competitive price, while creating efficiencies and optimizing capital allocation in our supply chain. The relationship also allows for the expansion and diversification of our supply chain network. Brown-Forman will continue to own and fully leverage the Brown-Forman Cooperage in Louisville, Kentucky. This allows us to produce approximately half of the barrels required to support our needs, while enabling us to continue developing and innovating for our brands and new expressions. Moving to Sonoma-Cutrer the divestiture to the Duckhorn portfolio and the assumption of an equity ownership position in the company, subject to certain customary closing adjustments and conditions is still expected to close in the fourth quarter of fiscal year 2024. We continue to believe in the strength of the Sonoma-Cutrer brand and its future growth opportunities and that this transaction reflects our portfolio evolution strategy as well as our commitment to long-term value creation. And lastly, I would like to share that we have recently announced that in fiscal 2024, we have committed to a $22.5 million investment benefiting the Brown-Forman Foundation and Dendrifund. Brown-Forman Foundation was created in fiscal 2018 with the goal of helping fund our ongoing philanthropic endeavors with a focus on our corporate hometown of Louisville, Kentucky. The Dendrifund, a nonprofit seed fund created by Brown-Forman and the Brown family in 2012 and helps to promote a more sustainable whiskey industry with a focus on the three natural resources most important for the distillation and aging of whiskeys: wood, water and grain. As you know, at Brown-Forman, we take an integrated approach to value creation, where all aspects of our company contribute to and are fundamental to our strategy, including our commitment to environmental sustainability, alcohol and marketing responsibility, diversity and inclusion and contributing to the vitality of the communities in which we live and work. These investments are just two examples of how we are living our spirit of commitment. In summary, we are adjusting to more normalized levels of consumer demand and a challenging and dynamic operating environment. As we look to the end of fiscal 2024, we believe that we have moved beyond the most difficult comparisons and disruptions of our fiscal year and will benefit from our long-term strategies, as well as our portfolio evolution. We believe our portfolio of brands is strong as they are participating in growing categories and price segments and are driven by the consumer trends of premiumization and the desire for convenience and flavor. While we have more modest near-term expectations, we believe our long-term perspective will enable us to navigate the current environment and its short-term impacts as we have many times since our founding in 1870 and to deliver consistent and reliable performance and returns over the long term. We look forward to seeing many of you in person soon and sharing more about the confidence we have in our long-term ambitions at our Investor Day on March 20. This concludes our prepared remarks. Please open the line for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our first question comes from Lauren Lieberman with Barclays. You may proceed."
},
{
"speaker": "Lauren Lieberman",
"content": "Great. Thanks so much. So I'm still honestly after all the prepared remarks, a bit confused around where the shortfall really stemmed from both in the quarter and stemming going into Q4 because you talked about sequential improvement in the second half with what was expected. Third quarter looks like it decelerated sequentially despite the easier comp. I know you mentioned softer holiday demand globally, but again that doesn't really help me with the 4Q. So just if you could maybe rank order what sort of where the areas were of short term negative surprise, I think that'd be really helpful. Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Thanks, Lauren and I'll go ahead and I'll step back a little bit broader first and then I'll narrow in specifically to your question. So first, let me say, we think about our business in decades and generations and I'd like to point you to slide five, which when we think about the 2020 decade that we're in and the kind of the first three full fiscal years, you can see that our compounded annual growth rate for that period of time on an organic net sales basis is at a 9%, which is definitely above our long-term growth algorithm. And then kind of moving closer into the periods that we're in now, we have now lapped the first half of F 2023, which was our strongest first half growth rate in the last decade, we talked about that in our last call and that was all about rebuilding our inventories. And then if you kind of look at last year, kind of nine months year-to-date and this year that CAGR is 6%, which is in line with our longer-term growth algorithm. So when we step back and look at it at the broadest perspective so far for this decade, we believe we're off to a good start and we have confidence that our business is sound with a strong gross margin expansion and strong cash flow. So just to set the stage and then I'll dial in even closer to your question is, you're right and that's what we said is during the important holiday selling season, we did not expect the softness of consumer trends that we did see during that important holiday selling season and that has now limited our top line acceleration. When we think about it from a markets perspective, for us, it was US and the key developed markets of the UK and France. And I'm sure in this call we'll talk a lot about the US. But while we're here, I'll talk about the UK, which we know the UK part of it is about our transition of the Jack Daniel's and Cola to the Jack Daniels and Coca-Cola business. But we really did see a slowing consumer and a very strong promotional environment during the holiday selling season. And then in France, we saw the slowing consumer trend, even kind of declining more than what we expected with the softness in the whiskey category and definitely some trading down in that market. And then what I would say then kind of the rest of that piece is, the slowdown across many of our emerging international markets, which was just more than what we had expected in our guidance. One thing I can say, as you can see in Schedule D, sorry, Schedule B, that when we reported last time our shipments and depletions for our full strength portfolio were in line, we now see where we are year-to-date that our depletions are head of shipments. So again, that's another signal that we believe that we are kind of moving beyond what we have had to lap. But then, as we talk about kind of to your point with the last quarter, like we shared in our last call, when we think about the second half, we know we have to lap the launch of Jack Daniel's and Coca-Cola RTD in the US. But when you look at kind of the half as a whole, we have to comp a plus 5%. And where we believe we're going to be able to do that is, again, with the contribution of our newly acquired brands of Gin Mare and Diplomatico, we're continuing to see benefits from pricing and revenue growth management, which is kind of equating to that strong gross margin expansion that you have seen in our results. And then again, our operating expenses increased, that remains the same where we had phasing, where our brand expense was greater in the first part of the year, we now -- that will moderate through the rest of this year and SG&A expenses, that's related to the higher compensation and benefits related expenses, as well as our increased expenses for the own distribution investment that we're making in Japan that's set to go live on April 1. So that is all built into our guidance."
},
{
"speaker": "Lawson Whiting",
"content": "Let me give you a shorter version of that, Lauren. Christmas stunk around the world for a month, I mean, we had a lot of markets that disappointed during Christmas this year, which we did not expect when we were thinking about our year to go period three months ago. So it was surprisingly weak."
},
{
"speaker": "Lauren Lieberman",
"content": "Okay. Now, just one quick follow-up, because that was a very fulsome answer, so thank you, both versions, both short and long. But what does that mean for inventory levels in Q4? Because I know, Leanne, you called it the ships versus depletes and that like the big picture lapse are getting to a better, we're moving along. But shipments, look shipments were also weak for Christmas, right? I'm just trying to put the two pieces together, because if you expected Christmas to be better usually the shipments have kind of happened, right and it's the depletions that are the problem. So that's also a little bit surprising to me if I'm making sense, I would expect it to be shipments might have been okay, but depletions would have been the problem and that would leave a hangover for Q4."
},
{
"speaker": "Leanne Cunningham",
"content": "Yes, I think what we saw was, we didn't see those orders come in for the important holiday selling season like we -- at the level that we traditionally do and being able to comp above where we were. So that didn't come in the way that we expected again in that late November, December time frame that we were expecting. And so when we think about again and we continue to be in a bit of a different position, which we've talked about this many times as we rebuilt our inventory. We continue to believe that our inventories, through the supplier to the distributor, to retailers, to consumer are in line and really this is about consumer takeaway at this point for us. And so, again, that fluctuation in consumer takeaway being lower than what we expected really drove that for us. We do continue to see when we'll go to the US specifically, you continue to see that net change in distributor inventory kind of come back in line. If you look from the first half to the third to the nine months ended, that is coming much more back in line, which we said we expected it to moderate."
},
{
"speaker": "Lauren Lieberman",
"content": "Okay. All right, great. Thank you. I'll pass it on."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Bonnie Herzog with Goldman Sachs. You may proceed."
},
{
"speaker": "Bonnie Herzog",
"content": "All right, thank you. Good morning. I actually just maybe have a bit of a follow-on, on the conversation you guys were just having regarding inventory levels, but more at the consumer, I guess level. Do you have a sense of where these are and really how much you think consumer pantry destocking is impacting the category? And then your thoughts on when that might reverse? And, Lawson, do you still believe the category growth will get back to the mid-single digit range and then if so, how quickly could this occur? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Yeah. Okay, Bonnie. That's a good question, because we have talked a lot about that internally over the last few weeks around, I'm talking about the consumer inventory thing. And I do think and I believe, although, it is -- that's a hard number to get to, there's really no way to study consumer inventories necessarily of what's still in the pantry. But my theory, if you look at the last three, four, five years, you can see the elevated growth rates, Leanne was just quoting a few of them. But let's just focus on the three year, because it's on that page five of our. You're looking at a 9% organic growth rate over three years, including this year. That is way several points above any sort of normal run rate for the most part in our industry. Some of that has to be sitting in a consumer's pantry at home. Now, people think of spirits as often referred to as a fast moving consumer good and it's really not. This is not like food or some other categories that move much faster. Spirits, I call it kind of in the middle. When I think about different consumer categories, I think about food being the fastest, I think about an exercise bike is the slowest, because once you pull that demand forward, you're not going to go buy another bike. Spirits is in the middle and so it is taking some time to clear those consumer cabinets. We've said before that we look at like 80% of our consumer base only buys two bottles a year. So they have a bottle sitting in their cabinet at home that's probably half full and it's just the deferred cost. The good thing is, we think that if you do the math around that, that should largely be over and that's why Leanne just said here, we expect going forward, particularly in the US I think we're talking, but our sales rates to be much closer to what consumer takeaway is right now. So, that's question. What was the other? [Multiple Speakers] Yes, TDS getting back to norm of 4% to 5% which is what it has been for like decades, short of the last couple of years on all the volatility. I know I've seen some of our competitors that have said anywhere from six to 18 months and that's a pretty big range. I think for us is what we're saying, we do believe next year will start to return to those normal levels as this inventory conversation largely, we think will largely be over."
},
{
"speaker": "Bonnie Herzog",
"content": "All right, thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Andrea Teixeira with JP Morgan. You may proceed."
},
{
"speaker": "Andrea Teixeira",
"content": "Hey, good morning. This is Drew on for Andrea. Thank you for taking our question. So just following-up on the US, you talked about some changes in consumer behavior internationally, in France, I think you're seeing some trade down. Can you talk about what you're seeing in the US, any evidence of perhaps more value seeking challenges or trade down? And then also what you're seeing from an on-premise perspective, if there's been any incremental softness there? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Yes. So look, I mean, on the trade down, converse, now this is US and I think this is good news, I think relative to probably what people are expecting. But if you look at the data, particularly, I'm looking at Nielsen data over the last three months, you're not seeing trade down and we've still got that same dynamic where -- I'll simplify a little bit here, but $30 and above is growing much and take RTDs aside, pull that out of that when I say this, but 30 and above is growing at a materially better number than 30 and below. And so that's -- we're not seeing the trade down in our old portfolio and we're not really seeing it across the industry yet. So I think that just hasn't happened. And that I think we were expecting to see maybe a little bit more of that. So I generally consider that good news. On the pricing environment, which you didn't specifically ask about that, but I think it's worth talking about that for a second because pricing really has not -- we've been worried, as you've seen, consumer weakness, that somehow that would result in more aggressive pricing, deeper pricing to Christmas, all those kind of things and it didn't really happen and we're not really seeing that coming through the data right now. You look at TDS across spirits, it's still positive, like plus one or 1.5 something right in there. And interestingly, this is where we were narrowing down even quicker as Tequila in the US and then US Whiskey across the US and both are also positive. So there's been a lot of speculation that Tequila pricing would start to fall apart as the costs have come down. It's just not showing. And if you look at the last 13 weeks and you go, which would cover the Christmas time period, both of those categories saw improved pricing, not lower. And so while I do hear a lot of these anecdotal stories of X, Y, Z brand went deep or whatever it might have been and there are examples out there like that. But for the most part, pricing is holding up so far and I consider that to be a pretty big positive too. Did I answer..."
},
{
"speaker": "Leanne Cunningham",
"content": "On-premise."
},
{
"speaker": "Lawson Whiting",
"content": "On-premise, do you have -- I don't have the on-premise numbers in front of me. Sorry, we -- I don't have the on-premise numbers right in front of me, so I haven't seen a material change in those necessarily, but I'm trying to find the data point. Let's get back to you on the on-premise."
},
{
"speaker": "Leanne Cunningham",
"content": "This is where we talked about that there's two points of acceleration compared to the October 23rd. So we continue to see acceleration there with TDS and Brown-Forman now growing low single digit."
},
{
"speaker": "Andrea Teixeira",
"content": "All right, I'll pass it on. Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Chris Pitcher with Redburn Atlantic. You may proceed."
},
{
"speaker": "Chris Pitcher",
"content": "Thank you very much. Just a question in terms of buying patterns, you've sort of alluded to it, but in the current environment, have you seen any structural changes in how retailers or wholesalers are buying and given the sort of the interest rate environment and the uncertainty, is that creating, making it harder for you guys to plan? And then if I could have a follow-up just on Japan, you flagged that as being one of the areas that got hit by hard by destocking, with sales down 100%, it's quite hard to gauge what the real underlying revenue is with your new route to market there. Could you give us an idea of what sort of scale the Japanese business is still running at, despite all these massive distortions? Thanks very much."
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. So I'll go back to your -- the first part of your question, which is, as far as buying patterns, we shared with you I think in our last call that as -- how we prioritize rebuilding the markets that we have with and replenishing their distributor and retailer inventory, that kind of has changed in the short-term our traditional consistent seasonality of the shipments that we pattern buying that we have seen, we're still lapping some of that, especially as you get into our emerging international markets and we're lapping the way that we rebuilt that and the timing and the cadence is a little bit different. It makes -- it does make it a little bit harder, but I think for us the biggest piece again was back to that important holiday selling season and consumers being stretching their discretionary spend because of how they've been impacted with interest rates and inflation. And for Japan, when we look at that business, again, this has been a year of kind of two pieces. One was how we rebuilt our inventory in the prior year. And I think we said in our prepared remarks, we had a backlog of orders waiting for supply to be able to fill those. We were able to do that in the second half of last year. So coupling that with our route to consumer change, it has just basically -- we haven't needed to make any shipments to Japan this year. To your point, what's the business look like more on a depletion base and we would say, we have been in frequent connection with the team there as they continue to progress to this own distribution model on April 1st and from a depletion base, we're still excited about the health of our brands in that market. So again, I would say from an organic perspective, we just have -- we're investing in the long-term value creation opportunity in Japan and it's set to be a growth driver as we're moving forward."
},
{
"speaker": "Chris Pitcher",
"content": "Just quick -- normally a company, a country, a market would drop out if it's not in the top ten in a period, can we assume the fact you've still put Japan in there that it would be a top ten market for you on a normalized basis?"
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. How we set our top ten and I think we have it in our queue, it's basically set on April 30 of our prior year. So it's in there for that reason."
},
{
"speaker": "Chris Pitcher",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Nadine Sarwat with Bernstein. You may proceed."
},
{
"speaker": "Nadine Sarwat",
"content": "Hi. Thank you for taking my question. Two for me. First, just a clarifying question. You had mentioned your view that perhaps the market in the US could get back to that historical 4% to 5% value growth in the next year, could I just clarify with that fiscal next year or calendar next year? And then my second question, something I think a lot of people are bringing up amongst investors the topic of moderation, perhaps younger consumers drinking less, adding some GLP-1s in there. I mean, all of this has been thrown around as potential reasons for the weakness that we're seeing in US spirits, but to be honest, in US alcohol more broadly with the implication that, that could be a permanent change. I would be curious to get your views on that, all those factors I listed and where do you think it goes from here? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Yes. Good. So, Nadine, a few things on this, because this is obviously a topic that we have spent a lot of time trying to understand a little bit better too. Over the last, I'll make it up five years, we had seen TDS go from 5% to 4% to 3% to 2% to 1%, something like that. I would be concerned that some of those things you just talked about, wellness trends, cannabis trends, GLP-1s, all those types of things, that would be an indicator that something is happening structurally in the business that's going to -- that could be permanent, but that's not what we saw. We as -- I think everyone on this call knows. I mean, that 4% to 5% range, COVID moved it around volatility wise, but it has been in that range for decades. And then all of a sudden, if you look at TDS the same, you look at July of last summer and you see a very sharp deceleration in the market, like GLP-1s or cannabis isn't not going to take a market and move at 4 or 5 points seemingly overnight. And so I just don't think that's what is -- I don't those big macro concerns that are out there are what is impacting the market today. Now over the next decade or two, do I want to look at that and understand that better? It is -- it could be a headwind, yes, but particularly on a healthier Gen Z kind of conversation. Cannabis, that's been around now for, I don't even know, ten plus years, whatever it is. We've studied that 18 ways till Sunday and have never been able to find a state where we saw reduced alcohol consumption based on it going legal and it's tough to do now because so many places are legal, but -- so, yeah. So I do think in general these are shorter-term challenges, particularly the US, but it's also true in Europe too. Europe is dealing a lot of the same macro factors the US is. And I do think it's the combination of what we've already talked about, but the very difficult comps, I think the consumer is weakened than it was, say, this time last year. But now predicting is the turnaround going to be six months or twelve months, I don't know. I don't have a crystal ball on that. But I am a believer that the macro factors impacting our business are more short-term in nature than these big macro headwinds."
},
{
"speaker": "Nadine Sarwat",
"content": "Got it. And just to confirm that getting back to 4% to 5% next year comment with that next year fiscal calendar."
},
{
"speaker": "Lawson Whiting",
"content": "I don't know, if I was kind of -- I'm not making it up, but I mean, it's more of a return to normal over the next, call it 12 to 24 months in our world, something like that."
},
{
"speaker": "Leanne Cunningham",
"content": "Yes, and then the one thing that we looked at is, history is not always a predictor of the future for many reasons. We know when we went and looked back at the last time, the consumer was really stretched with macroeconomic factors. We looked at 2000, 2001, 2008, 2009, they were followed by really strong years of growth and those trends were, when they were negatively impacted were much shorter and like Lawson just said, it's kind of that 12 to 18 month window by which we're already in it, so none of us know, but that's what history has said to us."
},
{
"speaker": "Nadine Sarwat",
"content": "Got it very clear. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Eric Serotta with Morgan Stanley. You may proceed."
},
{
"speaker": "Eric Serotta",
"content": "Good morning. Thanks for taking the question. First, Lawson, hoping you could expand upon your comments earlier on pricing and promotion. First, I guess as a housekeeping item, when did your pricing in the US, particularly on Jack Daniel's go in? And then I know you said that thus far not seeing much pricing in the data, but it does seem like it's more been kind of one off anecdotal or the anecdotal reports about discounting seem to be more than one off. I know Diageo mentioned some increased promotions in the US. Just wondering if you have any broader perspective between what seems to be a broader theme of increased promotions and what you guys are seeing in the data?"
},
{
"speaker": "Lawson Whiting",
"content": "Yeah, well, on the pricing history, I guess, when did it kick in? It was -- if we're talking about the US, it was about three years ago now. So we have chosen, I think, a slightly different path than some of our competitors. We've talked about this numerous times, but it's kind of that low and slow and it's what I want to see continuing going forward and is what we're trying to strive again even over the next twelve or 24 months. And that's a US comment for the most part, but it actually does apply to much of the rest of the world too. Europe had pretty healthy price increases the last couple of years too, which is collectively why we, one of the main reasons why we've been able to improve our gross margin. And so I have very little interest in giving that back and so we're going to continue to be pretty strong with that. As I mentioned earlier, I mean, I know anecdotally it feels that way and I've heard the same things and I saw what some of our competitors have said, but the reality is it's not coming through the data. So, I don't know -- I'm not sure how else to answer that. I mean, we talked about trade down earlier a couple of questions ago or the lack of, I should say. So it's not coming through in trade down here and we're not seeing it in terms of really individual brands that have all of a sudden gone deep and by the way, I think it's worth probably commenting too and this is at a very high level, so I personally -- we're not deep studying this quite yet. But the competitive, some of the brands that have gone lower haven't seen much in the way of a decent rebound in their volume. I'm just not sure these, not sure that's the core consumer problem right now is higher pricing. Pricing elasticity, as I said, low and slow, but if you compare pricing changes over the last two, three years to what grocery has done to what other consumer categories have done, where it was much more, you saw much higher inflation in the food channel, let's say, than you did in spirits. And so I just not -- I don't think -- I'm not that worried that our pricing actions have chased consumers away from our products. I just don't -- I think that would be sort of missing what the actual problem is."
},
{
"speaker": "Eric Serotta",
"content": "Great. And then just one other question, hoping to get your perspective on either Brown-Forman or industry, Barreled whiskey inventories obviously been a massive investment cycle over the past decade, making up for the previous three or four decades. But maybe, hopefully you could give some comments as to where you think inventories are today relative to future demand, realizing you've got a plan for multi-decade cycles here."
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. So I'll talk about our barrel whiskey inventory and I think for anybody who's followed us for a while, you've probably heard us say that we have a very robust, semi-annual process where we're always adjusting to future consumer demand outlooks. And with doing that, we capture the change in trends, if there are any. So when you look at our that our barrel whiskey, we're constantly adjusting it. When you look at our balance sheet, when you see increases for us there, it is about looking out over the long term and that represents our future growth expectations. And with work in process, also in some brands, you would find our aging inventories there and with the acquisition of Diplomatico, you would have seen that increase as well. So for many in the industry, I don't want to speak on anybody's behalf, but many in the industry use not the same proprietary way of doing the work, but I know that they often look at their long-term demand over that cycle as well. So I think people are always adjusting."
},
{
"speaker": "Eric Serotta",
"content": "Great. I'll pass it on. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Peter Grom with UBS. You may proceed."
},
{
"speaker": "Peter Grom",
"content": "Thanks, operator and good morning, everyone. Hope you're doing well? So I guess I'm a bit confused by the commentary on the top line trajectory. So on one hand, you're talking about a normalization of category growth and you'd expect that to get back to that mid-single digit growth at some point over the next 12 to 18 months and that would kind of seem to imply that 2025 could be another challenging year. But on the other hand, if you back out the distributor inventory headwind, which sounds like you expect to be largely complete after 4Q, you're kind of already at this mid single digit growth rate. So I know we'll get to fiscal 2025 in June, but how should we think about the building blocks for your organic growth outlook over the next 12 to 18 months? Should we focus more on that category growth rate or should we be kind of focusing on kind of mapping this distributor inventory headwind? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. So as excited as we are to begin to talk about our next fiscal year, we'll have that in full detail for you in our next call."
},
{
"speaker": "Lawson Whiting",
"content": "But I do think you picked up on an important point. If you look at that depletion schedule or Schedule D, if you assume that we're there from an inventory perspective, certainly depletions are better than, certainly a lot better than shipments over this year. So we're getting there. We're getting past these comps. I mean, there's like light at the end of the tunnel. We can't get there fast enough, but we're almost there."
},
{
"speaker": "Peter Grom",
"content": "Okay, that's helpful. And then maybe just a quick follow up on gross margin. I know a lot of moving pieces here and Lawson, I appreciate the commentary on the year-to-date progress, but from a quarterly perspective, you would have to really go back to kind of the tariff days to see a sequential step down of this magnitude in the third quarter relative to the second quarter. Was that simply a function of weaker volume performance or was there something else that drove that kind of sequential step down?"
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. So when we think about our gross margin and the outlook that we have driven by a couple of thing. So, one, we lapped supply chain disruption in, largely speaking, we had the majority of the cost in our second quarter of last year. So that benefit continues to moderate as we move through the rest of the year. And then just as we do kind of estimates from an inventory costing perspective, we would have had a benefit in our fourth quarter of last year that we will have to comp this year. But all of that has been built into our full year guidance for the entire year where you've been able to see kind of the difference between our top line growth estimates and our operating income and the leverage that we've expected through there. But we have been very happy to return to gross margin expansion and have the strong expansion that we've had through the nine months to date. But again, talking about in that last quarter, it will go more towards the guidance that we have provided."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Filippo Falorni with Citi. You may proceed."
},
{
"speaker": "Filippo Falorni",
"content": "Hi. Good morning, guys. I have a question on the ready-to-drink spirits part of the category, particularly in the US. If you look at total spirits categories stripping out ready-to-drink, actually the trends have been a lot more negative than it looks on the surface. So do you think this growth in the ready-to-drink spirits is more structural and have you done any work of calculating any impact on your volumes given, obviously, you sell less liquid in ready-to-drink compared to like a full bottle if that were to continue to grow at this rate. And following-up on the margin part, you talked in the past about ready-to-drink spirits being more of gross margin dilutive, although more similar at the operating margin level. So any thought on the margin implications will be helpful as well. Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Yes, so your first part of that was the TDS and yes, you're right, RTDs are boosting TDS for sure. You take those out and it's closer to flat, which, honestly, close to flat. It's been 30 plus years since TDS has gone negative in the United States, not since the early 1990s when they had the excise tax changes. So from a pure TDS takeaway US figure it's about as bad as it's been, well, it is as bad as it's been in my career. So there are certainly challenges there. Now, do I think there's this big structural move in the world of RTDs? One, I mean, they meet a lot of consumer trends and needs right now. So I do believe it's a very powerful category. But if you go back over the last 20 or 30 years and you look through our industry, there have been so many booms and busts of different brands that we always start out by talking about California cooler 30 years of brown form 30 years ago when it went from 12 million cases to zero in about two years. So, I mean, there are booms and busts in that space. Jack and Coke is a bit different in that it's such an established drink already, it's the largest bar call in the world. That is not a fact in my mind. There are other brands we'll see. We've seen what happened to the malt based RTDs over the last few years and that category got blown up largely by these spirit based RTDs. So it's a volatile space for sure."
},
{
"speaker": "Leanne Cunningham",
"content": "And then to your -- the liquid part and the margin part of your question from liquid, yes, there is less liquid in a case of RTDs, of course, than the full strength. But we will be planning to supply liquid to significantly broader geographic reach with this product. Again and we just talked about the process that we use and looking for the demand needed for our liquid, so that would be built into there. And then from a margin perspective, though, gross margins for RTDs are lower than our company average, Jack and Coke should be higher than the rest of our RTD portfolio because we will have advertising support jointly funded between Brown-Forman and the Coca-Cola company. And also we have to look at it in totality of when we are increasing our RTD business that we're also adding in the two super and ultra premium brands of Gin Mare and Diplomatico, which have higher gross margins than the company. So you'll have to take all of those factors into account."
},
{
"speaker": "Filippo Falorni",
"content": "Got it. Thank you. I'll pass it on."
},
{
"speaker": "Operator",
"content": "Thank you. I would now like to turn the call back over to Sue Perram for any closing remarks."
},
{
"speaker": "Sue Perram",
"content": "Thank you. And thank you Lawson and Leanne and thank you to everyone for joining us today for Brown-Forman's third quarter and year-to-date fiscal 2024 earnings call. If you have any additional questions, please contact us. We look forward to seeing many of you in Louisville on Wednesday, March 20th for our 2024 Investor Day. Presentations by the company's executive leaders will focus on Brown-Forman's strategic priorities and long-term ambitions. Details regarding the live webcast of the presentations, along with a question-and-answer session can be found in the March 4 press release about the event. And with that, this concludes today's call."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. You may now disconnect."
}
] |
bf.b | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Hello and welcome to Brown-Forman Corporation Second Quarter and First Half of Fiscal Year 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Sue Perram, Vice President, Director Investor Relations. You may begin."
},
{
"speaker": "Sue Perram",
"content": "Thank you, and good morning, everyone. I would like to thank each of you for joining us today for Brown-Forman’s second quarter and first half of fiscal year 2024 earnings call. Joining me today are Lawson Whiting, President and Chief Executive Officer; and Leanne Cunningham, Executive Vice President and Chief Financial Officer. This morning’s conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine future results are beyond the Company’s ability to control or predict. You should not place undue reliance on any forward-looking statements, and except as required by law, the Company undertakes no obligation to update any of these statements, whether due to new information, future events or otherwise. This morning, we issued a press release containing our results for the second quarter and first half of fiscal year 2024, in addition to posting presentation materials that Lawson and Leanne will walk through momentarily. Both the release and the presentation can be found on our website under the section titled Investors, Events and Presentations. In the press release, we have listed a number of the risk factors you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we will be discussing certain non-GAAP financial measures. These measures are reconciliation to the most directly comparable GAAP financial measures and the reasons management believes they provide useful information to investors regarding the Company’s financial condition and results of operations, are contained in the press release and investor presentation. With that, I would like to turn the call over to Lawson."
},
{
"speaker": "Lawson Whiting",
"content": "Thank you, Sue, and good morning, everyone. Thank you for joining us today as we share our second quarter and first half results for fiscal 2024. As anticipated, the key drivers behind our first quarter results continued into the second quarter. First, consumer demand for our brands continues to reflect a normalization back to our more historical trends. Second, as we’ve shared, we continue to grow on top of a very strong first half than the prior year driven by the rebuilding of distributor inventories in the prior year period. To help put this into better context, I encourage you to reference Schedule D in today’s earnings release. Third, we’re starting to see beneficial contributions from both Diplomático and Gin Mare, while also continuing our portfolio reshaping with the announced sale of Sonoma-Cutrer. Fourth, while higher input costs were persistent in the first half, these costs were more than offset by favorable price and mix and the lapping of the supply chain disruption costs in the year-ago period. And finally, while our operating expense growth rate moderated in the second quarter, the timing and phasing of these expenses had an unfavorable impact on our first half operating income. Now let’s turn our attention to how these drivers influenced our first half fiscal 2024 results. Our reported net sales growth increased 2% in the first half with organic net sales growth increasing 1% after adjusting for the recent acquisitions. Notably, this growth was delivered against an 11% reported and 17% organic net sales increase in the same period last year. If you were to simply add the organic growth rate in the first half of fiscal ‘24 to the organic growth rate in the first half of fiscal ‘23 and divide by 2, the average in the first half over these periods has been 9%. Fundamentally, our brands remain in very strong shape. However, over the last couple of months, we have seen a slowdown in consumer spending, similar to the trends we’re seeing across total distilled spirits and other consumer packaged goods. After two years of strong growth, which was above our long-term historical trends, consumer demand for our brands is normalizing on this elevated base. In addition, as we have highlighted in past earnings calls, our glass supply significantly improved in the spring summer of 2022, which allowed us to rebuild distributor inventories. Historically, the estimated net change in distributor inventories would have had a minimal impact on our organic results, typically in the range of plus or minus 1 percentage point in any given year. However, the pandemic related supply chain disruptions created changes in our historical distributor ordering patterns which has created unusual comparisons and larger impacts over the past few years. If you were to factor in the 5 percentage points of impact to our organic net sales from the estimated net change in distributor inventories, as seen in Schedule D, our top line results more closely reflect our longer term trends and help support our belief that the fundamental health of our brands and our business remains solid. Our first half results reflect our ability to consistently deliver growth, even in dynamic and challenging times. This is largely attributable to our broad geographic reach and our portfolio reshaping strategy over the past decade as we built a diversified global portfolio focused on premium and super premium brands. In the first half, organic net sales growth was driven by Jack Daniel’s Tennessee Apple, New Mix and Glenglassaugh. These gains were partially offset by volume declines associated with our significant inventory rebuild in the first half of the last fiscal year, particularly for brands such as Jack Daniel’s Tennessee Whiskey, Jack Daniel’s Tennessee Honey, Herradura and Woodford Reserve. Jack Daniel’s Tennessee Apple grew organic net sales more than 50% led by a strong launch in South Korea. We’re also better able to meet consumer demand, particularly in markets such as Brazil and Chile, as supply chain and logistic challenges eased. New Mix was the second largest contributor to the Company’s organic net sales growth, increasing 22% as the brand continues to gain value share in the RTD category in Mexico. And Glenglassaugh, a fabulous brand we haven’t had yet much opportunity to discuss, we’ve primarily talked about this brand as part of the trio of single malt scotches that we acquired back in 2016 along with Benriach and GlenDronach. Glenglassaugh was the smallest of the single malt scotch brands we purchased. And while we’ve always believed in the strong future for the brand, there just hasn’t been enough supply to be material to our results as it takes a decade or more for these products to mature. Through the brand’s old and rare program, we’ve discovered that while Glenglassaugh may be smaller relative to our other single malt brands, the value of its casks are mighty. We recently sold a single Glenglassaugh cask from 1967 that was one of the largest cask sales in terms of rarity, volume and value in the history of the scotch whiskey industry. Cask sales from Glenglassaugh in the first half of fiscal 2024 helped place the brand as the 3rd largest contributor to the Company’s organic net sales growth. In addition, the brand has recently been relaunched with its first ever 12-year old expression, new packaging and new creative assets. And having just returned from a trip to Scotland, I can personally attest to the fabulous liquid and the strong growth potential of this wonderful coastal single malt. In addition to Glenglassaugh, we continue to increase our supply for all of our single malt scotch brands and believe these brands will be critical contributors to Brown-Forman’s next generation of growth. Our single malt scotch portfolio is one example of our portfolio reshaping efforts over the last decade to increase focus on premium and super premium brands. Last year, of course, we acquired our newest brands, Gin Mare, and Diplomático. I’m very pleased with the integration of these brands as they contributed 2 percentage points of growth to our reported net sales in the first half of fiscal ‘24. Our portfolio evolution has also required us at times to say goodbye to brands. It’s always a highly deliberate and thoughtful decision when we decide to sell a brand and we do so only when we feel it aligns with our strategic ambitions and portfolio priorities. This was the case with both Finlandia Vodka and Sonoma-Cutrer, our two most recently announced divestitures. The sale of Finlandia Vodka to Coca-Cola HBC AG was completed on November 1, 2023. And the recently announced decision to sell Sonoma-Cutrer to the Duckhorn Portfolio and take an equity ownership position in the company reflects our commitment to long-term value creation. We believe our equity ownership stake in the Duckhorn Portfolio will be a value generating relationship for Brown-Forman and offers the benefit of allowing us the opportunity continue to participate in the premium and ultra-premium wine category. We continue to believe in the strength of the Sonoma-Cutrer brand and its future growth opportunities in the hands of the Duckhorn Portfolio. With their expertise combined with their strong and diverse route to market, we have great confidence that Sonoma-Cutrer will continue to grow and on an accelerated trajectory. In addition to acquisitions and divestitures, we’ve also focused significant efforts on premium innovations. We recently released the 3rd member of the Jack Daniel’s Bonded series, Jack Daniel’s Bonded Rye, building on the success of the Jack Daniel’s Bonded Tennessee Whiskey and Jack Daniel’s Triple Mash. And it was just a year ago that we launched the iconic Jack and Coke cocktail as a branded ready to drink adult beverage in Mexico. Since then, we’ve expanded Jack and Coke into 13 markets, including Germany, which just launched in September. Overall, we’re pleased with the initial launches and are excited about the brand visibility and market share gains. For example, in the U.S., the Jack Daniel’s and Coca-Cola RTD is now a top-10 spirit based ready to drink brand in the number one whiskey based RTD in Nielsen. And the spirit business, a global industry trade publication just named Jack Daniel’s and Coca-Cola as the best new product in 2023. The positive feedback from distributors, retail and most importantly consumers continues to benefit not only the Jack Daniel’s and Coca-Cola RTD, but also the perception for Jack Daniel’s Tennessee Whiskey, as noted in consumer research. We continue to expect the planned organic net sales declines in the Jack Daniel’s and Cola RTD will partially offset the growth of the Jack Daniel’s and Coca-Cola RTD as we continue its transition. We believe this premiumization provides us with the greatest opportunity for long-term growth and value creation. Before turning the call over to Leanne, I’d also like to add some additional perspective on our gross margin and operating expenses. In the first half of fiscal 2024, our reported and organic gross profit increased 7%, both ahead of the respective top line growth rates. We continue to focus on the execution of our long-term pricing strategy and believe we’re in a strong position given the strength and relevance of our brands and our continued brand building investments. We’re also benefiting from the absence of costs related to the supply chain mitigation. As you’ll recall, this time last year, we incurred increased transportation and logistics costs in order to satisfy the demand from our distributors and retailers ahead of the important holiday season. Collectively, we have tailwinds of favorable price mix, the absence of supply chain disruption related costs and lower tariff-related costs due to the removal of the UK tariffs on American Whiskey, which more than offset the headwinds of higher input costs and the negative effect of foreign exchange. This resulted in 280 basis points of gross margin expansion in the first half. As expected, operating expenses moderated in the second quarter as the phasing of our brand building investments was significantly skewed to the first few months of our fiscal year to support the launch of the Jack Daniel’s and Coca-Cola RTD as well as increased investments for Jack Daniel’s Tennessee Whiskey. This resulted in organic advertising expense growth of 12% in the first half of fiscal ‘24. While also moderating in the second quarter, organic SG&A investments increased 9% for the first half as we continue to invest behind our people, driven primarily by higher compensation and benefit expenses. Since I mentioned the removal of the tariffs on American whiskey, I will share the latest update on the EU tariffs. When the EU tariffs were removed a year ago, a final agreement still needed to be reached concerning steel and aluminum prior to November 1, 2023 or the retaliatory tariffs on American whiskey would return. In mid-October, the U.S. and EU announced they will continue negotiating for two more months. Importantly, the American whiskey tariffs are not expected to return while negotiations are ongoing. Brown-Forman continues to work with governments on both sides of the Atlantic, advocating for a solution that brings long-term stability to the U.S. and EU trade relationship. We believe that all parties are seeking a solution that neither party wishes to see the return of these tariffs. We hope that as the deadline for an agreement approaches, the U.S. and EU governments will find a solution that enables the long-term health of the global spirits industry. In summary, we believe we’re off to a good start in fiscal ‘24 continuing to grow on the exceptionally high same prior year period base, even as consumer demand normalizes. I hope these results illustrate how our business has remained resilient through very dynamic operating conditions as we continue to focus on our long-term strategic ambitions. We believe we will continue to benefit from our long-term pricing and revenue growth management strategies as well as a more normalized cost environment. Our brands and our business continue to grow because of the people of Brown-Forman. I would like to thank them for their continuous efforts and commitment to ensuring that there’s nothing better in the market than Brown-Forman. With that, I’ll turn the call over to Leanne, and she will provide more details on our first half results."
},
{
"speaker": "Leanne Cunningham",
"content": "Thank you, Lawson, and good morning, everyone. I will provide additional details on our geographic performance, other financial highlights, as well as our updated fiscal 2024 outlook. From a geographic perspective, our emerging international markets continued to lead the Company’s growth, collectively delivering very strong double-digit organic net sales growth, driven by Jack Daniel’s Tennessee Whiskey, particularly in Türkiye as momentum in the premium whiskey category continued, the United Arab Emirates due to increased distribution and strong consumer demand, and Poland, which is benefiting from our pricing strategy. New mix, which grew strong double-digits in Mexico, is benefiting from our pricing strategy and gaining share of the RTD category, and Jack Daniel’s Tennessee Apple, led by Brazil as well as Chile where the brand is returning to normal levels of supply. Also during the quarter, we launched our own distribution in Slovakia. Slovakia has a substantial premium whiskey market where American whiskey is the value leader of the category. This makes it an important market as we drive the global growth of the Jack Daniel’s family of brands and bring our broader portfolio to the market, in particular our recently acquired Diplomático Rum. As we have demonstrated with our previous route to consumer investments, we believe owned distribution provides us with increased consumer insights, focus on our broader portfolio, and a greater portion of the value chain. Organic net sales in the travel retail channel were flat in the first half as the channel lapped 67% growth in the year-ago period. Strong double-digit growth of our super premium America whiskeys such as Woodford Reserve, our exclusive global travel retail offering Jack Daniel’s American Single Malt and Jack Daniel’s Single Barrel were offset by declines in Jack Daniel’s Tennessee Whiskey and Jack Daniel’s Tennessee Honey. Organic net sales in our developed international markets collectively were down 2% for the first half as growth in Singapore, Germany and South Korea were offset by declines in Japan and the United Kingdom. Jack Daniel’s Tennessee Apple was again the largest contributor to growth driven by the continuing successful launch of the brand in South Korea. Glenglassaugh, as Lawson highlighted earlier, drove the growth in Singapore. El Jimador was the next largest contributor. This performance supports our belief that el Jimador has the ability to create and grow the premium tequila category outside of the U.S. and Mexico. This growth was more than offset by year-over-year declines for Jack Daniel’s Tennessee Whiskey, which was negatively impacted by Japan due to an estimated net decrease in distributor inventory. As an update on our transition to own distribution in Japan, we are pleased to announce that we recently opened our new office and are on track for the launch on April 1st of this fiscal year. Turning to the United States, organic net sales decreased 5% as a result of lower volumes due to an estimated net decrease in distributor inventories of 6%, partially offset by higher prices across much of our portfolio. As Lawson highlighted, in the first half we cycled against the significant inventory rebuild during the same period last year. This was particularly impactful to the U.S. market where we saw a 7% contribution to organic net sales growth in the prior year period from an estimated net increase and distributor inventories. As we lap this inventory rebuild, we believe that distributor inventories are at normal levels. From a takeaway perspective, trends for total distilled spirits as well as Brown-Forman continue to normalize with the recent value growth below the historical mid-single-digit range as consumer demand has slowed. Growth continues to be driven by RTDs, U.S. whiskey and tequila, which aligns well with our portfolio. We expect our portfolio to continue to benefit from consumer premiumization as the launch of the Jack Daniel’s and Coca-Cola RTD and demand for our super premium Jack Daniel’s products partially offset the volume declines. The Jack and Coke RTD continues to grow, gain share and bring recognition to the entire Jack Daniel’s family of brands. And the newest member of the Jack Daniel’s Bonded series, Jack Daniel’s Bonded Rye along with Jack Daniel’s Sinatra and our specialty launches such as Jack Daniel’s Single Barrel Rye, Barrel Proof are delivering strong growth. Not only do these innovations premiumize the Jack Daniel’s family of brands, they elevate our whiskey credentials, provide a halo for the rest of the family and give consumers the opportunity to explore and discover within the Jack Daniel’s family. As Lawson has shared the details of our gross margin expansion and operating expenses for the first half, I will now turn to our operating income. In total, reported and organic operating income increased by 1% in the first half of fiscal 2024, largely driven by our gross profit growth, partially offset by the phasing of our operating expenses. These results along with the benefit of a lower effective tax rate were more than offset by an increase in interest expense resulting in a 1% diluted earnings per share decrease to $0.98 per share. Before moving to our outlook, I’d like to take the opportunity to provide you with an update on our recently announced share repurchase program. As we announced on October 2, 2023, the Brown-Forman Board of Directors authorized the repurchase of up to $400 million of our outstanding shares of Class A and Class B common stock from October 2, 2023 through October 1, 2024. As of November 30, 2023, we have completed over half of the program. Our Board of Directors also recently approved a 6% increase in the quarterly cash dividend, marking the 40th consecutive year of an increase to the regular dividend. Brown-Forman continues to be a member of the prestigious S&P 500 Dividend Aristocrats Index and has paid regular quarterly cash dividends for 80 consecutive years. We remain appropriately attentive to today’s uncertain market conditions, while also confident in the long-term potential of our portfolio of brands. Our capital allocation philosophy has allowed us to maintain a healthy balance sheet and has produced superior returns over the long term. We continue to believe that our capital allocation philosophy coupled with our strategic ambitions will deliver strong results for our investors. Turning now to our revised fiscal 2024 outlook. In what has been a highly volatile and dynamic operating environment, we continue to be optimistic and believe global trends are normalizing after two years of very strong growth. We expect to continue to grow on this elevated base due to the contributions from our long-term pricing and revenue growth management strategies as well as the addition of two super premium brands, Gin Mare and Diplomático to our portfolio. As a reminder, we completed the Gin Mare and Diplomático acquisitions in the third quarter of fiscal 2023. Therefore, the contributions of these brands will be included in our organic results going forward. As we mentioned last quarter, we remain cautious due to the current macroeconomic volatility and the potential impact of inflation on consumer spending. Despite a moderating inflationary environment, complex global economic conditions remain, which is creating mixed consumer and channel dynamics and creating a more challenging operating environment. We maintain our belief that the collective strength of our U.S. and international markets, along with the travel retail channel will deliver growth in fiscal 2024, though have tempered our expectations due to slower than anticipated growth through the first half of the fiscal year, particularly in the United States and Mexico due to recent changes in trends in the whiskey and tequila categories. With this, we now expect our organic net sales growth for fiscal 2024 to be in the 3% to 5% range. Today, we have highlighted the impact on our results from the strong shipments in the year-ago period related to the rebuilding of distributor inventories as supply chain disruption eased. As we have shared in previous calls, I would like to remind you again of the stronger shipments associated with the launch of Jack Daniel’s and Coca-Cola RTD in the United States in the back half of fiscal 2023 that will be lapped in the second half of fiscal 2024. This is reflected in our guidance. We believe inflation will continue to negatively affect input cost even with the favorable agave pricing trends. As we mentioned last quarter, while we are very encouraged that agave prices are finally on the downward trajectory, the benefits to our cost of goods sold will not be immediate. Additionally, we believe higher input costs will be partially offset by lower year-over-year costs due to the absence of the supply chain disruption we incurred in fiscal 2023. Our outlook for the full year operating expenses continues to reflect a normalization of incremental advertising spend aligned with our long-term philosophy for advertising spend to be aligned with our top-line growth. Also, our expectation is that SG&A growth will remain higher than historical averages as we continue to expect higher compensation related expenses and expenses related to the transition to own distribution in Japan. Based on these expectations, we anticipate organic operating income growth in the 4% to 6% range for the fiscal year. We also continue to expect our fiscal 2024 effective tax rate to be in the range of approximately 21% to 23% and our capital expenditures to be in the range of $250 million to $270 million for the full year. Before wrapping up, I would like to add a few additional details regarding the sale of the Finlandia brand. As is customary, divestitures are subject to a closing process where the sale price is adjusted for inventory and other working capital items. Based on the adjusted sale price at closing, the value of the net assets held for sale as well as the absence of Finlandia’s operating income in the second half of fiscal 2024, we expect the transaction will be accretive to our fiscal year 2024 diluted earnings per share by an estimated $0.12 per share. In summary, we have now lapped the historically high first half reported and organic net sales growth rates, while adjusting to more normalized levels of consumer demand and we continue to deliver both organic net sales and operating income growth. As we look towards the second half of fiscal 2024, we will begin to compare against a more normalized environment. We believe we will benefit from the strength of our strong portfolio of brands, the benefit of our portfolio evolution efforts with the addition of Gin Mare and Diplomático, our pricing strategy, our gross margin recovery and the phasing of our brand investments. Over the last few years, we have faced significant disruptions and challenges. We believe we have now moved beyond the most difficult comparisons of our fiscal year and remain focused on executing our strategy and delivering sustainable and consistent long-term performance. This concludes our prepared remarks. Please open the line for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Peter Grom with UBS."
},
{
"speaker": "Peter Grom",
"content": "So, obviously, a tougher first half given the inventory dynamic, and I recognize if you back that out, organic would have been relatively solid in the first half. But to kind of hit the low end of the range, it does imply a return to kind of mid-single-digit growth in the back half of the year. So, can you maybe just walk us through the confidence in the outlook at this stage? Should we expect growth to be more at the low end rather than the high end? And just any thoughts on phasing as we look out to the back half of the year? Maybe specifically, obviously, I’m not -- it might be hard to guess, but is there any kind of shipment dynamic if that’s kind of occurring as we kind of work through this EU tariff situation? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Thanks, Peter. I’ll start with that. Our guidance does imply that we’re going to have sequential improvement in the second half. And as we shared in our Q1 call, we continue to remain cautious with changes in trends such as the impact of inflation on consumer spending and the current macroeconomic volatility. And then, you heard in our prepared remarks, we do expect kind of all of our markets and channels to continue to grow, but it’s about the tempering of our expectations. And when we were -- specific to the United States when we were on our call in our first quarter, we were looking at U.S. three-month value growth trends for TDS with acceleration and trends kind of in that mid single digits and the environment that we’re in today has -- we’ve had a change or shift in trends where we’re looking at TDS decelerating in low single digits. So, that’s been included as we look out, but the drivers that we see for our acceleration is that you can see on slide 5. We’ve now lapped and are growing on top of just a really exceptionally high first half of last year, which was a plus 17, so like we said in our prepared remarks, the average is 8. And one thing we’ve also talked about is we did launch Jack Daniel’s and Coca-Cola in the second half of last year and we will have to comp that as we go through the fourth quarter of this year. But again, generally speaking, the back half of the year, we have significantly easier comps in the back half, and we continue to believe that we’re going to be able to benefit from our long-term pricing strategy. We’re really leaning on our revenue growth management strategies. We’ll talk about that probably in a bit. What else is going to drive our acceleration is that Gin Mare and Diplomático, our recent super- and ultra-premium acquisitions are going to come into our organic results in the back half of the year, which will help us. And we continue to see that our cost trends are heading in the right direction and we’re on a path to gross margin recovery, which is going to continue to help deliver some of that acceleration in the second half as well as you heard us say in the first quarter call as well as this quarter, in the support of the launch of Jack Daniel’s and Coca-Cola in the U.S, we just had a lot of operating expenses loaded into the first quarter of this year, we saw moderation in the second quarter and we’re going to continue to see that moderation as we go through the rest of this year. So, those are kind of the components that are built into our outlook."
},
{
"speaker": "Lawson Whiting",
"content": "And you talked about tariffs, real quick at the end of that, just a brief thing on that. First, and I assume what you meant was have we been shipping incremental cases into Europe ahead of the potential for these tariffs, and we have not. We have not largely, because we don’t believe that they are going to come through in the real near future. For those that are not as close to this whole situation, we continue to work with both sides of the Atlantic. We said that on the prepared remarks a little bit. There have been some rumblings lately that these tariffs could come back around. Look, we’re smarter about this than we were 4 or 5 years ago when it first came out. We’ve got a lot of mitigation scenarios that we know what to do. But at this point, as long as both sides are at the table, which they are right now, we do not expect this to come around, and I think our pretty strong belief is that this will be kicked down, we’ll kick the can down the road for at least a couple of years until some of these tariff conversations can get resolved."
},
{
"speaker": "Peter Grom",
"content": "Got it. So basically, even if we get to this deadline, you’re kind of more of the view that this could still be kicked down the road, negotiations could continue. So, it’s not like a month from now, this automatically goes back in, it’s kind of your view?"
},
{
"speaker": "Lawson Whiting",
"content": "Correct. Correct."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Vivien Azer with TD Cowen."
},
{
"speaker": "Vivien Azer",
"content": "I was hoping to follow up on your commentary around more cautious outlook on the U.S. Lawson, maybe you can just unpack it a little bit. Are we more concerned around price elasticities? Is this more tempered outlook a function of more down-trading than you were anticipating, or is there something kind of more structural in terms of per capita consumption within spirit? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Oh no, it’s definitely not the last. Look, I think it is simply -- the consumer has weakened a bit over the last 3, 4, 5 months. That’s kind of what’s changed since where we would have been last quarter. As Leanne went through it, I mean, if you just look at TDS, which as you know, has been running at 4% to 5% for 20 years or something like that. Certainly stepped up over the COVID, which I know some of you called it a super cycle, went up quite a bit over those years, and it’s come back down. And I would have said most of 2023, calendar 2023, we were in that mid-single-digit range, and then it really fell off, over the last, as I say, 3 or 4 months. And so I think there’s just been a bit of weakness in consumer confidence that has hit the entire market and brought the number down a little bit, but it’s still growing, I should say, too. It’s still at a sort of plus 2 range. And so it just made us get a little bit more cautious on the outlook for the U.S."
},
{
"speaker": "Vivien Azer",
"content": "And just as a quick follow-up, you guys noted the inclusion of Gin Mare and Diplomático. Those are quite high end offerings. So, how are you kind of thinking about the contribution to organic growth from those two brands? Is your outlook a little bit more restrained on that too, given concerns around the consumer? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Well, where we see kind of really strong growth for Gin Mare and Diplomático, globally, yes, but these brands are really large in our European markets where we align well with investments we made in our route to consumer. So, we believe with those brands in our hands in those markets and the performance that we’re seeing in those markets, we do see consumers in Europe. I mean, they’re optimizing their spend but they’re still looking for experiences in everyday affordable luxuries. And so, we see a path to growth for those brands. And again in our reported results, they’ve contributed 2 points of growth for year-to-date and we expect that momentum to continue as we go into the back half of this year."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Filippo Falorni with Citi."
},
{
"speaker": "Filippo Falorni",
"content": "I had a question on the -- your comment on distributor inventories. I know you cycled the rebuild in the first half. And you also mentioned that they’re now at a normal level. Given the weakness that we’re seeing at the consumption level, which you alluded to, is there a risk that you’re going to see more of a normalization further below this current level? Many of your spirit peers have talked about more of a normalization of distributor inventory? So, I’ll be curious on your perspective there?"
},
{
"speaker": "Leanne Cunningham",
"content": "Okay, great. Yes, we believe that -- and kind of like we stated in our prepared remarks in general that distributor and retailer inventories have normalized. The impact of that estimated net change in distributor inventories for us is largely related to that year-over-year comparison. And if you take a look at Schedule D, which -- B, I’m sorry, which is in our earnings release and you kind of look at the shipments and depletions for our full strength portfolio, you’ll see that they are -- the shipments and depletions are largely aligned. And we’ve talked about we’ve lapped supply chain challenges, our inventories returning to normal. So really what we see going forward is going to be related to consumer demand. One small note is that our recent acquisitions of Gin Mare and Diplomático aren’t yet reflected in the schedule and we’ll be adding those in the next quarter. And maybe just to kind of dig in a little bit deeper, the U.S., we believe they’re back to normal. This time last year in Europe, we were -- and really in October was the big month where we were air freighting cases into Europe. So, we had product available. So, we were still rebuilding inventory. Again, in Q2 of this year, we have really the largest impact of the absence of those supply chain disruption costs, but we believe they’re back to normal as well. And then, in our largest markets in Latin America, Brazil, our business is strong and our inventories are at normal levels and Mexico as well -- for both Brazil and Mexico, we own our route to consumer. So, we have visibility through there. And then we purchase retail inventory data that continues to let us see further through the chain. So Brazil, we feel like our levels are normal. And Mexico, yes, with the really recent change in trend, we’re adjusting accordingly and all that’s built into our guidance."
},
{
"speaker": "Filippo Falorni",
"content": "And then a quick follow-up on your tequila business, obviously, we’re coming off a cycle of very high inflation in agave costs, which is now turning the other way. How do you assess the potential risk of more price competition in the category, particularly given we’re seeing also a slowdown in consumption levels? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "So look, tequila has been on a pretty unbelievable run actually over the last few years as particularly, I’ll say that 22, 24-year olds up into their 30s really have adopted tequila as sort of their drink of choice and it’s done really, really well, particularly at that super-premium, ultra-premium price point, which is where Herradura plays, el Jimador is going to be a little bit less than that, but still a solid well-positioned brand across both Mexico, the U.S., and in el Jimador’s case increasingly in some other markets around the world. So now to your question about what’s going to happen with pricing in the category. Look, I think and hope that the people that are playing in that ultra-premium price point for tequila are the big players, who all have suffered through a period of time when the agave costs were so high and hurt everyone’s margins that would have been playing in that that it’s time now to reap some of those benefits of the better margins. So, I don’t expect that we’re going to see significant changes in promotional pricing, and I haven’t seen it yet in any kind of material way, but we’ll have to see what happens over the next 6 to 12 months. But I know at least from Brown-Forman’s perspective, we are not planning to get more aggressive in that category. We want to be able to stay as an ultra-premium brand."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Nadine Sarwat with Bernstein."
},
{
"speaker": "Nadine Sarwat",
"content": "Earlier you called out seeing low-single-digit net sales growth for the U.S. spirits market overall. Are you anticipating getting back to that long-term mid-single-digit growth rate that we saw in the U.S.? And if so, over what time horizon? Are your expectations sort of that coming back in the next few quarters, or is this well over a year into the future? And then, just a slightly shorter term question. Any color that you could add on what you’re seeing in the last month in U.S. spirits and global spirits since the end of the quarter? Any changes to the trends that you’ve reported today, or is it largely in line? Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "Well, look, those are pretty short timeframes there. I mean, I think forecasting where the U.S. market is going to go, as I said, it’s in that sort of low single digit range right now. I just talked a minute ago about it being in the 4% to 5% for years and years and years with the exception of the COVID boom. But I don’t know how to predict when it’s going to come back. Certainly, if we looked at past cycles, the only time that TDS has really materially weakened in the last 20 years was after the financial crisis, so sort of 2009 timeframe. And it snapped back really fast. I think all of us -- well, those that have been in this business that long, remember that, because it surprised everyone and came back. And I think it’s a category -- this is an amazingly resilient category in the United States spirits and I do not believe it’s lost that factor. So, I do think it’s just sort of a weakening right now, and then we’re just going to have to see where consumer spending goes over the next six months, but hoping and believing we’ll be back in that sort of mid single digit range. And I’m guessing here, but we’re talking 6 to 12 months. What was the second half of the question? Oh, to be honest with you, I haven’t really -- I haven’t seen -- I’m looking at same data you are in terms of Nielsen and NABCA. I haven’t seen anything real recent that was any different. The step-down was more in the August, September range, not even sure the numbers have updated to October yet, so."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Bryan Spillane with Bank of America."
},
{
"speaker": "Bryan Spillane",
"content": "First question, just Leanne, I might have missed this, but Finlandia, is the divestiture now included in the guidance? I think I kind of missed that towards the end of your prepared remarks. Just trying to understand how Finlandia impacts the guidance now versus the previous guide?"
},
{
"speaker": "Leanne Cunningham",
"content": "Right. Well, we guide on an organic basis, which would exclude that benefit. But that’s why we also thought it was important to give to you all today, quantify that impact because it does kind of fall outside of our organic outlook. So, we wanted to make sure that you had that piece."
},
{
"speaker": "Bryan Spillane",
"content": "Okay. And that’s true for EBIT as well as revenue, right?"
},
{
"speaker": "Leanne Cunningham",
"content": "Yes."
},
{
"speaker": "Bryan Spillane",
"content": "Okay. And then second is just, Lawson, as you talked about the U.S. a bit, just -- travel retail in Mexico, I guess those are two other areas where we have fielded some questions, just about potential slowing. So, is there anything there we should have noted? I guess, in terms of how the, you kind of moderated the full year outlook aside from the U.S. Those two or any other geographies, I guess, that might have factored into the more moderate growth expectations?"
},
{
"speaker": "Lawson Whiting",
"content": "Yes. Let me hit global travel retail first. That one really is a factor of comps. If you can remember, this time last year, we were refilling that channel in a big, big way. And I do expect that -- I mean, just look, anyone who’s been traveling anytime recently, the planes are absolutely jammed. And so, I feel pretty good that that business will return to sort of its historical rate very, very quickly. It’s just got to get through this comping thing. Mexico is a little bit different and a little -- it’s not confusing necessarily. I mean if you look at our schedule and I think the year-to-date sales is plus 9%, something like that. So Mexico is the second largest market in the world for Brown-Forman. And so it is an important market and has been growing pretty dynamically for us for a period of years. Now that’s been led right now by New Mix, which is a great brand. It is absolutely enormous down in that country and I think everyone knows that at this time. But the rest of the business, which had been doing okay throughout this year, I think we’re getting a little more cautious that the Mexican consumer is showing some weakness, too. And so, we are expecting a little bit of a slowdown in the second half of the year in that market, but not falling off a cliff or anything like that either. It’s just both tequila and whiskey have slowed down a little bit, and so we’re expecting that to continue through the rest of the fiscal year."
},
{
"speaker": "Leanne Cunningham",
"content": "I’m sorry. I was just -- the only thing I was going to add on to that is we said on our prepared remarks, GTR is comping at plus 67%. When you look at the two first halves, the average of that we’re at 29%. And then one of the things that we would also add on Mexico is that while we’re seeing kind of weakness in the whiskey and tequila categories, we’re gaining share across that in our takeaway data. So -- but again, what it’s talking about for our outlook, kind of a revision in our expectation, and that’s just kind of for that deceleration in the back half of the year."
},
{
"speaker": "Bryan Spillane",
"content": "No, that makes sense. And Lawson, maybe if I could just sneak one last one, just the Sonoma-Cutrer deal was creative actually, a pretty good creative solution I thought in terms of finding a good home for it and making it a transaction that is kind of attractive to both sides. So, I’ll give you -- it was actually a really good, I thought, creative solution. Just thinking about portfolio more going forward, is there -- just how should we be thinking about acquisition divestiture, is this just a continuing on kind of the reshaping you’ve done, or is there a chance we see it sort of move in either direction more meaningfully?"
},
{
"speaker": "Lawson Whiting",
"content": "Sure. So, I mean look, as we would have said literally 10 years ago, that we were going to reshape our portfolio to focus on spirits, in particular on super- and ultra-premium spirits, and that is largely finished. You know all the different brands that we’ve sold over the last, 5, 6, 7 years, and we’ve brought a lot of new things in. And so, we have definitely premiumized the portfolio to a pretty big extent. The Sonoma-Cutrer one was Slightly different because that within the world of wine, that is certainly a super premium brand, but we were not -- it was the only wine brand that we owned fully on. I mean, Korbel is still here, but the brand was sort of sitting by itself, which is not the most efficient way to operate it. And the Duckhorn Group are, one, they’re fully focused on super-ultra-premium wines. They’re one of the sort of premier wine companies in America. And it’s one of those where we believe the value creation opportunity is better under their hands than ours. I hate to say that in some ways, but wine is really -- it’s their focus. It’s what they do. It is the accounts that they call on are all very similar and Sonoma-Cutrer is a huge benefit to them, too, because it is so big, particularly in the United States. And so, we just thought it made more sense that way. And then as you say, we own a piece of that company now and we’ll share in the upside that hopefully comes in the relative near future."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Lauren Lieberman with Barclays."
},
{
"speaker": "Lauren Lieberman",
"content": "I was curious if you could talk a little bit about Latin America, about Brazil in particular. You already touched on Mexico, but in Brazil, which I know is a smaller market for you, definitely heard some of your peers out there talking about a more challenged environment. So, wondering if you could talk a bit about that and then probably much more importantly the UK. The UK, just backing into it looks like it was down pretty this quarter. And I know there’s the Jack and Cola dynamics in there, but just any help and perspective on UK, I guess, I should throw in Germany too, but Western European -- sorry, I meant France. Sorry, those are the two that for me were -- a little weird. But just perspective on the consumer environment there or how much of this is more about Jack and Cola transition that’s impacting the numbers right now? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Okay, great. Thanks, Lauren. For Brazil specifically, again, you can see in our year-to-date results, we’ve got high-single-digit, organic net sales growth. A lot of that is being driven by -- and again, when you think about how we prioritize brands and geographies in supplying our products at -- post supply chain constraints. Jack Daniel’s flavor portfolio has a much improved supply or really a back to normal supply. And we are able to support the consumers’ taste profile for our products of honey and apple and really the launch of Jack Daniel’s Apple along with our geographic expansion strategy that we’ve had in that market for a while is continuing to gain market share. So the consumer takeaway is slowing a bit and we do see the competitive environment intensifying, but we continue to believe we’re going to do strong business in Brazil. So, I’ll move to UK and I think you’ve already that our business is strong there. What we’re seeing is this is really about the transition of our Jack and Cola business out of our results because this will be a market where, that is led by Coca-Cola with the Jack Daniel’s and Coke. And then specifically to France, that continues to remain a challenging environment, with declining consumer sentiment. And inflation has been high. It is starting to impact the consumers there and their discretionary income spend. We are seeing a little bit of down trading in that market and maybe a little bit, even a switch to beer, in that market while the consumer is going through this period of high inflation. But again, as we look over the longer term and how we are thinking about how Diplomático rum will have a strong impact to that market over a period of time, we believe that -- and as we continue to revise strategies there, we continue to believe France is going to be a contributor to growth over the mid to longer term."
},
{
"speaker": "Lawson Whiting",
"content": "A follow-up on the Tennessee Apple question or comment, you saw that how it is doing a brilliant job in Brazil, actually doing a really good job in Korea, some sort of unusual market that we would be talking about. But Jack Daniel’s Tennessee Apple was launched in the middle of COVID and was -- as really all new products during COVID was a really tough time to launch things and it didn’t meet anywhere near our expectations. But now that we’re through a lot of that, the expectations on Apple are going up a lot, and I think it’s a great product. I mean it’s just -- the taste alone is excellent, and appeals to a very wide palate I think on a global basis. And so, you’ll hear more from us on Apple over the next quarters or years, as we think that really has potential to be a really nice big addition to the Jack Daniel’s family."
},
{
"speaker": "Lauren Lieberman",
"content": "Okay. And sorry, just one more follow-up on the Jack and Cola piece on the UK. Should we assume that there’s a significant drag for the next like another three quarters, so that’s fully out of the base, as we model that…?"
},
{
"speaker": "Leanne Cunningham",
"content": "Yes. As we’re transitioning because that Jack and Cola business will be coming out of our results, so that we would need a full 12 months before we lap that."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Steve Powers with Deutsche Bank."
},
{
"speaker": "Steve Powers",
"content": "Just one final question on the U.S, if I could. In terms of the lowered growth expectations, are you able to talk a little bit about whether that’s whiskey, that’s tequila or other in your mind or any color by kind of price tier product? Just trying to get a little color as to where you see, within the portfolio, the most -- the biggest step-down relative to your prior views or if it’s more widespread?"
},
{
"speaker": "Leanne Cunningham",
"content": "I think it’s just about lapping and growing on top of that really high impact of rebuilding the inventories in the year-ago period and then, as we look at where we are year-to-date and understanding what acceleration can be and what it could potentially look like between here and the year to go period. So I think we would just say that. And then Gin Mare and Diplomático would be a smaller positive impact for the U.S., but again we do think it will be a positive impact for the U.S. I mean, I think that’s -- it’s just kind of generally where we are in a year to go period with what we’ve seen the current trends of TDS. And one of the things we’ve talked about is on this kind of path back to normalization and currently being kind of below that mid-single-digit, we believe there’s not going to be a linear path back to normalization or probably be a little bit up and down over a period of time, but we’ve factored in a little bit of that as well."
},
{
"speaker": "Lawson Whiting",
"content": "I do think American whiskey and tequila are still the two strongest categories in the U.S. spirits business, which is where the vast majority of our portfolio is. Now, delta from where we were, I mean, I think we spread it out a little bit. I think both are -- tequila is coming down off of sky high numbers, where American whiskey was steady high, but not as high as tequila. And so I guess, the delta would be more on the tequila side of things. I do want to point out too. I just want to reiterate one more time. Now, for Jack Daniel’s Tennessee Whiskey, so core Black Label. Now, this is not a U.S. statement, this is global, but the brand was up last year first half plus 18. For a brand the size of Jack Daniel’s Tennessee to be a plus 18 is an enormous amount of volume movement. Now to be down 2 over the first half of this year, while we don’t love that the two-year average is still 8. And so, I want to make sure people don’t take away from this that the brand is somehow not healthy or anything down that path. The brand has had a -- not only the last two halves, but even over the last five years, Tennessee Whiskey has continued to be a really strong supporter and continues to be the single biggest source of growth for Brown-Forman and will be for the foreseeable future."
},
{
"speaker": "Leanne Cunningham",
"content": "And then one last thing I’ll add on specifically about the U.S. As we talk about understanding what our opportunity -- our long-term opportunity is with Jack Daniel’s and Coca-Cola, we know it’s now a top ten spirit based ready to drink brand. It’s the number one whiskey based RTD in Nielsen. It’s got over 2% of the category share. And it’s really getting great accolades like we talked about in our prepared remarks as named one of Jack Daniel’s and Coca-Cola as the best new product in 2023 from the spirits business. So again, we think this product is still fairly new in the market, but the accolades are supporting what we believe will be that future growth."
},
{
"speaker": "Steve Powers",
"content": "So just playing it back, it sounds like the revised expectations are fairly broad based, but just given the large numbers that were embedded in tequila growth, to begin with, more of the step-down is showing up in that category. Is that fair?"
},
{
"speaker": "Lawson Whiting",
"content": "Correct, yes."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Robert Ottenstein with Evercore."
},
{
"speaker": "Robert Ottenstein",
"content": "Two questions. First, I think in prior calls, you had talked about going to kind of a 2% to 3% or 3% price increase in the U.S. and trying to do that on a steady basis. Is that under review or at risk now, given the weakness in the market? So that would be the first question. And then the second question is more on your distributors and route to market in the U.S. and whether you’re getting the kind of execution that you expect, doing a lot of channel checks, talking to a lot of people. A lot of the wine and spirits distributors have gotten very big. Some of them are taking on beer, doing other things. And I am hearing more complaints about the execution in the U.S. market and people trying to figure out what they’re going to do and deal with that. So, I was just wondering if that’s an issue that you’re looking at. Thank you."
},
{
"speaker": "Lawson Whiting",
"content": "I’m laughing people complaining about U.S. distributors. Look, the pricing question first. Look, we still believe and see solid consumer demand. And so, we are not planning on really changing that pricing strategy. We’ve been doing it now for 2, 2.5 years where we like -- in the U.S. it’s been that 2 to 3 range. It’s actually been higher in other parts of the world and it has a lot to do with why our gross margin has expanded so much over the last say six months. And so, we’re -- we love that and still see a lot of really good pricing opportunities. So it’s that low -- very casual, low and slow, where we believe in that over the long-term is the way to go. We did not do like some of our competitors, took huge increases back when supply chains were very constrained and all that and go to double digits. And that is a risky strategy I think in our industry and not one that we’re going to pursue, but we are going to continue with the sort of low-single-digit range and I see that continuing for the foreseeable future. Now back to the U.S. distributors, I mean we are -- certainly there’s been a lot of consolidation in that space over the last decade or really two decades. We’re very comfortable where we are. They’re doing a good job for us. We’re in many cases the largest supplier in many -- particularly in the RNDC market. And so, we get our fair share of attention and feel good about that. And these are great partners that we have and we need and have good relationships with. So, I don’t really see any significant changes happening there in the near future."
},
{
"speaker": "Operator",
"content": "Thank you. Ladies and gentlemen, due to the interest of time I would now like to turn the call back over to Sue for closing remarks."
},
{
"speaker": "Sue Perram",
"content": "Thank you. And thank you, Lawson and Leanne. And thank you to everyone for joining us today for Brown-Forman’s second quarter and first half of fiscal year 2024 earnings call. If you have any additional questions, please contact us. We’d like to note that yesterday December 5th was the 90th anniversary of Repeal Day, which is the end of Prohibition in the United States. And if that isn’t enough reason to cheer, 90 years ago today, Brown-Forman became a publicly traded company. So, I hope you will join us in celebrating responsibly, of course, these two milestones as well as the holiday season ahead of us. Cheers to everyone, and happy holidays."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect."
}
] |
bf.b | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to Brown-Forman First Quarter Fiscal Year 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to Sue Perram, Vice President, Investor Relations. Ma'am, you may begin."
},
{
"speaker": "Sue Perram",
"content": "Thank you, and good morning, everyone. I would like to thank each of you for joining us today for Brown-Forman's First Quarter Fiscal Year 2024 Earnings Call. Joining me today are Lawson Whiting, President and Chief Executive Officer, and Leanne Cunningham, Executive Vice President and Chief Financial Officer. This morning's conference call contains forward-looking statements based on our current expectations. Numerous risks and uncertainties may cause actual results to differ materially from those anticipated or projected in these statements. Many of the factors that will determine future results are beyond the company's ability to control or predict. You should not place undue reliance on any forward-looking statements, and except as required by law, the company undertakes no obligation to update any of these statements, whether due to new information, future events or otherwise. This morning, we issued a press release containing our results for the first quarter fiscal year 2024, in addition to posting presentation materials that Lawson and Leanne will walk through momentarily. Both the release and the presentation can be found on our website under the section titled Investors, Events and Presentations. In the press release, we have listed a number of the risk factors you should consider in conjunction with our forward-looking statements. Other significant risk factors are described in our Form 10-K and Form 10-Q reports filed with the Securities and Exchange Commission. During this call, we will be discussing certain non-GAAP financial measures. These measures are reconciliation to the most directly comparable GAAP financial measures and the reasons management believes they provide useful information to investors regarding the company's financial condition and results of operations, are contained in the press release and investor presentation. With that, I would like to turn the call over to Lawson."
},
{
"speaker": "Lawson Whiting",
"content": "Thank you, Sue, and good morning, everyone. It's a pleasure to be able to speak to you today about Brown-Forman's first quarter results for fiscal 2024. Before we get into the details of the quarter, there are a few key drivers of our first quarter results that you will hear about repeatedly throughout this call. First, the rebuilding of distributor inventories, primarily in the United States in the prior year period had a significant impact on our first quarter results. As you will recall, this rebuilding in the prior year occurred as a result of supply chain disruptions. If you reference Schedule D in today's earnings release, it will provide you with additional information to put this quarter into better context. Second, the timing and phasing of our operating expenses had an impact on our first quarter operating income as we launched and acquired new brands while also investing in our existing portfolio. As you can surmise from our full year guidance, we expect this to moderate as we continue throughout the rest of the fiscal year. And finally, and most importantly, we believe the health of our brands and our business remain strong as evidenced by consumer takeaway trends. We continue to be confident that we have the best portfolio and the best people in the market, and it's this confidence that allows us to reaffirm our full year outlook for fiscal 2024. With this backdrop, let me quickly walk you through our high-level results for the first quarter. From a top-line perspective, our reported and organic top-line results were below our longer-term historical trends. Much of this is being driven by the comparison to the strong double-digit top-line growth in the first quarter of last year. You'll recall our glass supply significantly increased in the spring and summer of 2022, which allowed us to rebuild distributor inventories, which created a strong comparison for the first quarter of this fiscal year. Our gross margin expanded with favorable price mix and the removal of the UK tariffs. These gains more than offset increased input costs, foreign exchange headwinds and the impact of our recent acquisitions. In the first quarter, we also made significant investments behind our brands and our people, which resulted in a year-over-year decrease in reported and organic operating income. Now let's go into each of the P&L items a little bit more. I'll briefly provide a few more details on the top-line from a brand perspective, and then I'll turn it over to Leanne who will share additional insights on our geographic performance as well as other financial heights before closing with some comments on our fiscal 2024 outlook. Our reported net sales growth increased 3% with organic net sales growth increasing 2% after adjusting for the recent acquisitions and the negative effect of foreign exchange. Organic net sales growth in the quarter was driven by the continued growth for Jack Daniel's Tennessee Whiskey, Jack Daniel's Tennessee Apple and el Jimador. This growth was partially offset by declines related to the estimated net decrease in distributor inventories, particularly for brands such as Woodford Reserve, Jack Daniel's Tennessee Fire and Gentleman Jack as we cycled against the significant inventory rebuild in the first quarter of last year. In total, we estimate that the net change in distributor inventories had a 6% impact on our overall top-line results. If you were to factor in the net change in distributor inventory, our net sales growth would have actually been above our long-term growth expectations. As I mentioned earlier, we believe our business is strong. Jack Daniel's Tennessee Whiskey led our growth as organic net sales increased 2% after lapping an organic net sales increase of 21% in the prior year period. We believe the consumer demand is normalizing and estimate that the growth rate on Jack Daniel's Tennessee Whiskey in the first quarter was lower by approximately 2 percentage points due to the net change in distributor inventory. Growth continues to benefit from our pricing strategy as well as our revenue growth management initiatives. Second, Jack Daniel's Tennessee Apple grew organic net sales more than 50% as we lapped the impact of the glass supply constraints in the year-ago period, and we're better able to meet consumer demand, particularly in markets such as Brazil. The brand also benefited from a strong launch in South Korea. Demand for tequila, particularly in the US, remains strong. el Jimador was the third largest contributor to overall company organic growth, increasing organic net sales 26%. We continue to see strong momentum in our ready-to-drink portfolio, which grew organic net sales 5%. This was led by the launch of Jack Daniel's and Coca-Cola and the continued growth of New Mix which performed well as the RTD category in Mexico is growing and the brand is increasing share. The growth was partially offset by planned declines in Jack & Cola as the markets prepared for the Jack Daniel's and Coca-Cola launch. I know there's been tremendous energy and curiosity around our new Jack Daniel's and Coca-Cola RTD. So I thought I'd share a bit more detail on the continued launch. Impressively, the global volume has already grown to 1.8 million cases across 11 markets, led by the US and Japan. As we've shared before, some markets are being led by Brown-Forman, whereas others are being led by The Coca-Cola Company. Therefore, this total case volume is not reflected in our 9-liter depletion results. We expect that this total volume will continue to grow as we plan to expand from 11 to 30 markets by the end of calendar 2024. In the US, the Jack Daniel's and Coca-Cola RTD launch has been the most successful launch in Brown-Forman history, having achieved the second highest level of off-premise distribution across the portfolio, only behind Jack Daniel's Tennessee Whiskey. Today, it has reached over 2% of the RTD categories value share. And overall, we're pleased with the initial launch of this iconic product and believe our success is driven in part by the strong investment behind the launch including significant investments in broad-reach media, events and trade execution. As the launch evolves, we would naturally expect this investment to normalize. We're also excited by the brand visibility, the market share gains and the positive feedback from distributors, retailers and most importantly, consumers. I must say, you know you're doing something right when consumers start wearing your spirit brands. And I just saw a picture of the first reported Jack & Coke RTD Tattoo. The loyalty of our Jack Daniel's fans is strong and impressive. The Jack Daniel's and Coca-Cola RTD has been strong addition to the portfolio, which as you now, we have been very strategically reshaping over the last couple of decades to focus on premium and super premium brands. We continue to believe this premiumization provides us with the best opportunity for long-term growth and new creation. The integration of our newest brands, Gin Mare and Diplomatico continues to go well. The brands increased reported net sales in the first quarter by 2%, and we continue to expect these brands will be meaningful contributors to our long-term growth. Also, as a part of this portfolio evolution, we announced the sale of Finlandia Vodka earlier in the quarter. Finlandia has played an important role in the global growth of Brown-Forman since it joined our portfolio fully in 2004, and we appreciate the many talented employees who worked hard over the two decades to build the brand. We know this brand will continue to evolve in the capable hands of Coca-Cola HBC when the sale closes in the second half of the 2023 calendar year. Before turning the call over to Leanne, I'd also like to add some additional perspective on our gross margins and operating expenses. In the first quarter of 2024, our reported and organic gross profit increased 5%, both ahead of the respected top-line growth rates. While we experienced some headwinds in the form of higher input costs and the negative effect of foreign exchange, they were more than offset by the tailwinds of favorable price/mix, lower supply chain disruption related costs and lower tariff-related costs due to the removal of the UK tariffs on American whiskey. This resulted in 90 basis points of gross margin expansion in the quarter. We continue to be focused on the execution of our long-term pricing strategy and believe the health and relevance of our brands, supported by our continued brand-building investments, will allow us to continue to achieve our strategic priorities. Our brand-building investments were evident in our first quarter as organic advertising expenses grew 14%. This was largely due to the timing of our increased spend to support the launch of the Jack Daniel's and Coca-Cola RTD, which, as I mentioned earlier, is significantly skewed to first few months of our fiscal year as well as increased investment for Jack Daniel's Tennessee Whiskey. We also continue to invest behind our people. Our organic SG&A investment increased 12%, driven primarily by higher compensation-related expenses related to organizational changes, including our route to consumer expansions, which we believe will support Brown-Forman's long-term success. In summary, we're off to a good start in fiscal 2024 and remain optimistic that we can achieve our full year goals. While consumer demand for our brands begins to reflect a normalization back to our more historical trends, we expect to continue to benefit from our long-term pricing and revenue growth management strategies as well as a more normalized cost environment. We're still operating in a highly dynamic world, yet we have remained agile, focused and committed to the long-term growth of our people, our brands and our business. We take pride in our ability to deliver consistent and reliable growth year after year, decade after decade, and we believe this tradition of excellence will continue in fiscal 2024. With that, I'll turn the call over to Leanne and she'll provide more details on our first quarter results."
},
{
"speaker": "Leanne Cunningham",
"content": "Thank you, Lawson, and good morning, everyone. As Lawson mentioned, I will provide additional details on our geographic performance, other financial highlights, as well as our fiscal 2024 outlook. From a geographic perspective, collectively, our emerging international markets continued to deliver very strong double-digit organic net sales growth, driven by Jack Daniel's Tennessee Whiskey, particularly in the United Arab Emirates due to increased distribution and strong consumer demand in Turkiye, where the premium whiskey category is accelerating. Jack Daniel's Tennessee Honey led by Turkiye as well as Brazil, where the brand is returning to normal levels of supply and new mix, which continues to grow strong double digits in Mexico, where the RTD category is accelerated, and we are gaining share. As the international airline travel and cruise business continued to return to more normalized growth levels, the travel retail channel grew organic net sales 9%, led by higher volumes of Woodford Reserve. Our business in this channel continues to remain above pre-pandemic levels. Organic net sales for our developed international markets collectively were flat in the first quarter as growth in the United Kingdom, South Korea and Germany was offset by declines in Australia and Japan. Jack Daniel's Tennessee Apple was the largest contributor to growth driven by the successful launch of the brand in South Korea. This growth was offset by year-over-year declines for Jack Daniel's RTDs, driven by Australia, where macroeconomic pressures negatively impacted volume growth and the United Kingdom, where we are transitioning from Jack Daniel's and Cola to Jack Daniel's and Coca-Cola, partially offset the growth in Germany and Jack Daniel's Tennessee Whiskey, which had strong growth in the United Kingdom, but was negatively impacted by Japan due to an estimated net decrease in distributor inventory where we remain on track for our transition to own distribution on April 1st of this fiscal year. And for the United States, organic net sales decreased 9% as a result of lower volumes due to an estimated net decrease in distributor inventories of 11%, partially offset by higher prices across our portfolio. As Lawson highlighted, in the first quarter, we cycled against the significant inventory rebuild during the same period last year, which was particularly impactful to the United States market as we focused on rebuilding distributor inventory for brands with substantial volume in the US, including Woodford Reserve, Gentleman Jack, Jack Daniel's Tennessee Honey and Jack Daniel's Tennessee Fire. With the rebuilding of finished goods inventory across the three-tier system we accomplished in fiscal 2023, we believe that distributor inventories have returned to more normal levels. The consumer premiumization trend continued to drive demand for our super premium Jack Daniel's products and partially offset the decline. This included growth from Jack Daniel's Sinatra, our specialty launches such as Jack Daniel's Single Barrel Rye, Barrel Proof and the newest member of our Bonded series, Jack Daniel's Bonded Rye. These products highlight our whiskey credentials and give consumers the opportunity to explore and discover within the Jack Daniel's family while premiumizing the Jack Daniel's family of brands. The tequila category also continued to experience growth in the United States with el Jimador leading the growth of our tequila portfolio, delivering double-digit organic net sales growth and the launch of Jack Daniel's and Coca-Cola RTD drove a high single-digit organic net sales increase for the Jack Daniel's ready-to-drink portfolio. From a takeaway perspective, the data reflects a normalization as total distilled spirits, as well as Brown-Forman delivered value growth in the mid-single digits, driven by growth in RTDs, tequila and US whiskey. As Lawson shared the details of our gross margin expansion and operating expenses for the quarter, I will now turn to our operating income. In total, reported and organic operating income decreased 4% and 6%, respectively, in the first quarter of fiscal 2024, largely driven by the phasing of our operating expense growth, partially offset by our gross margin expansion. These results, combined with a decrease in our effective tax rate and an increase in interest expense resulted in a 7% diluted EPS decrease to $0.48 per share. And finally, to our fiscal 2024 outlook, which we are reaffirming. In what has been a highly dynamic operating environment, we continue to be optimistic. We continue to believe global trends will normalize after two years of very strong growth. And while consumer demand for our brands is also starting to reflect more historical trends, we expect to continue to grow on this elevated base as a result of our long-term pricing and revenue growth management strategies as well as the addition of two super premium brands, Gin Mare and Diplomatico to our portfolio, partially offset by a portfolio mix shift to RTDs. I'll also note that due to the timing of the Gin Mare and Diplomatico acquisitions, which were in the third quarter of fiscal 2023, the contribution of these brands in the first half of fiscal 2024 will only appear in our reported results as the operating activity in this period will be non-comparable year-over-year. Once we lap the acquisitions, the results will then be included in our organic results. While we remain cautious due to the current macroeconomic volatility and the potential impact of inflation on consumer spending, we maintain our belief that the collective strength of our US and international markets, along with the travel retail channel should reflect our longer-term growth algorithm and therefore, reiterate our organic net sales growth expectation for fiscal 2024 in the 5% to 7% range. Today, we have intentionally highlighted the impact of our results from the strong shipments in the year-ago period related to the rebuilding of distributor inventories. As a reminder, we began rebuilding distributor inventories in the second half of fiscal 2022 through the first half of fiscal 2023. I also want to remind you of the stronger shipments associated with the launch of Jack Daniel's and Coca-Cola RTD in the United States in the back half of fiscal 2023 will have to be lapped in the second half of fiscal 2024. Both are reflected in our guidance. We believe inflation will continue to negatively impact our input cost which will partially be offset by lower year-over-year costs associated with the supply chain disruption we incurred in fiscal 2023. On the topic of input cost, I'd like to take a moment here to share some thoughts on the recent changes in the agave pricing. As we have discussed with you over the last few quarters, given the increase in tequila demand, there was a significant increase in the number of planting several years ago. We have long believed that this would lead to an eventual increase in supply and subsequent decrease in cost, assuming the tequila category remains strong. In the last three months, we have seen a significant decrease in agave cost from MXN28 to MXN30 per kilo to MXN16 to MXN18 per kilo depending on the quality of the agave. While we are very encouraged that prices are finally coming down, the benefits to our cost of goods sold will not be immediate for three reasons. First, we have finished goods inventory produced prior to the reduction in agave prices that need to be sold. Secondly, more than half of our tequila is aged liquid for expressions such as reposado and anejo, which will require some time before it is bottled and sold. For our blanco expression, we will begin to see a benefit more quickly. In addition, and as we have shared, we both grow agave internally and source it externally, and this mix can vary based off our needs and the volume growth by expression. So while the overall agave pricing trend is increasingly favorable, we still believe that inflation will be a headwind for our overall input cost in fiscal 2024. Turning our attention to the full year operating expenses. Our outlook continues to reflect a normalization of incremental advertising spend aligned with our long-term philosophy for advertising spend to be aligned with our top-line growth. And SG&A growth is still likely to remain higher than historical averages as we continue to expect higher compensation-related expenses and expenses related to the transition to own distribution in Japan. Based on these expectations, we continue to anticipate organic operating income growth in the 6% to 8% range for the full fiscal year. We also expect our fiscal 2024 effective tax rate to be in the range of approximately 21% to 23% and our capital expenditures to be in the range of $250 million to $270 million for the full year. In summary, we have had a good start to fiscal 2024. The results reflect the continued normalization of consumer demand as well as the comparison against the very strong shipments related to the rebuilding of distributor inventories in the year-ago period. They also include the benefit of our pricing strategy and the phasing of our brand investments. While our short-term organic results in the quarter were below our historical trends, we believe our brand and our business are healthy. We remain optimistic as we look ahead to the full fiscal year and are confident in our ability to deliver our near-term goals and our long-term strategy. This concludes our prepared remarks. Please open the line for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. Our first question comes from the line of Nadine Sarwat with Bernstein. Your line is open."
},
{
"speaker": "Nadine Sarwat",
"content": "Hi, thank you for taking my questions. I'd like to zoom in on the distributor inventory in two parts. So the first, could you just quantify how much of the change in distributor inventory was due to the tough comp you highlighted versus how much is due to actual distributor destocking? And if there is a fair amount of actual destocking, what is driving this? And then secondly, are you happy with current distributor stock levels? Or should we be expecting some destocking in the next quarter? Thank you."
},
{
"speaker": "Leanne Cunningham",
"content": "Good morning, Nadine. Thank you. I'll start with the first part of your question, which is we have talked about the comp that we had in the first quarter compared to the comp that we had in the last -- the first quarter of last year, which was when we had very strong shipments. And if you go back to our -- what is that point in time was the Schedule C, you would have seen the impact that we had there. So it is partially that we are comping the very strong comp. It's also, we don't see it as destocking. We have finally gotten our inventory levels back up to what we believe is normal. We've been working on that for a year and bringing you along in that story along the way. What we see now is a change in distributor buying patterns in that other part that you're asking about. And it really comes back to, we continue that we lapped everything related to the pandemic. We now have to comp the things related to supply chain disruption. And as we got into supply chain disruption before that, we had a very consistent cadence and seasonality of our shipments. But due to the various ways that we determined that we needed to rebuild our distributor inventories, first, prioritizing Jack Daniel's Tennessee Whiskey, which would have started in the second half of 2020 and then moving into the first half of 2023, where we were able to prioritize Woodford Reserve, Gentleman Jack and Jack Daniel's flavors. We also prioritize markets for the US first and then Europe and emerging international as we worked our way through the rebuilding of the inventory. So the cadence and timing of our shipments are abnormal from what we would -- our historic norms. So once we're back into a stable inventory position for long enough, we believe it will become less volatile and will be kind of back to our historic norms. But again, for us, we have been working for a year to get back up to that normal level of inventory across the world, and we now believe that we're there. So I hope that helps."
},
{
"speaker": "Lawson Whiting",
"content": "Let me try to add on to that, Nadine, a little bit, too, because I do want to make sure everybody sort of -- I get that this is really confusing. And I do make -- reiterate really what Leanne said, that this is a comparison issue though, it is not a destocking. And let me give you why it's not a destocking because I knew that would sort of feel normal at this point. So if you go -- literally, you can go back three years, the summer of 2020 into the fall, really into the spring of -- I'm talking calendar years here, not fiscals. We -- it was kind of the boom years. It was the post-COVID, Nielsen numbers were up at like 30% for everyone, and there was just an enormous uplift in the entire industry. You get to the summer of '21, and it begins to show up in terms of glass shortages really for Brown-Forman, it's seemingly worse than everyone else. But we really began to have those challenges in the summer of '21, and it was a challenge for about eight months, where we ran global inventories down so low, and that would be going so far as to say the consumer inventory, the retail inventories, layers of distributors had got very low and we had out of stocks all over the place. We were at that time, working very hard. We're diversifying our glass supply. We're moving bottling lines. We're doing all sorts of things to try to alleviate the glass shortage and it starts to come back right in the spring of '22. So -- and as Leanne said, we prioritize Jack because at that point, the on-premise is opening around the world and we did not want to miss that. But so Jack Daniel's really begins to move and had a huge year in fiscal '22 and had a big year in fiscal '23 also. So Jack gets replenished in the spring and into the early summer, but now you get into the summer of '22, which is the one we're comparing against as we said earlier Woodford, Gentleman Jack, all three flavors and basically our whole portfolio really begins to come back online. Now the reason there's not a destock here, this is where it takes -- it doesn't -- you wouldn't think this at first, but what was happening because retail inventories were so low that those cases of Woodford and the Gentleman Jack, the entire portfolio got to the distributor warehouse they were outside the back door in about 20 minutes because the retail environment was so desperate for the product. So our days never crept up. And so we haven't had to take them down. I mean, so it's not a days of inventory issue, and it's not a destocking issue. It's just these comparisons against some crazy quarters. And I finish this off, and I don't want to spend much more time on this. But Q1 of last year, JD -- Jack Daniel's Tennessee Whiskey was plus 21%, total company was plus 17%. So you're comping against numbers like that. Q2, just to sort of foreshadow everyone is a big quarter, too. So we have another one as we continued to replenish these inventories through Q2 of last year and then the comps get much, much easier. But it's been a volatile ride. It's been a volatile ride for five years. But the business is solid. I think if you look at the Nielsen numbers, in particular right now, they're kind of -- they've normalized. But as we said last quarter, normal is good. We've got this business, I think, rolling in the right direction and momentum is good and the volatility, we don't love the volatility, but it is there. We've got a little bit longer to go, but I still argue -- not argue, but I'd still venture to say that our underlying business is in pretty good shape."
},
{
"speaker": "Nadine Sarwat",
"content": "All right. That's very helpful. So just to clarify, I know in the release you called out that it was partially due to the comp issue, are you saying that there is no destocking whatsoever? There isn't a change in distributor buying patterns more caution. This is purely a comp cadence issue? And then if you could just clarify what we should expect for Q2? Thank you."
},
{
"speaker": "Leanne Cunningham",
"content": "Yeah. So just for clarification, we said partially comping the rebuilding and it's also partially a change in the distributor buying patterns because we are off our normal cadence of shipments or our historical trends because of how we chose to prioritize how we rebuilt our brands and in what markets we were rebuilding those. So over the longer period of time, that will begin to normalize."
},
{
"speaker": "Nadine Sarwat",
"content": "Thank you. Perfect. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Bryan Spillane with Bank of America. Your line is open."
},
{
"speaker": "Bryan Spillane",
"content": "Hey. Thanks, operator, and good morning, Lawson, Leanne. So thanks for all of that commentary on inventory. And I guess if I were to sum it up, if you deplete 10 cases, you'll ship 10 cases, right? That's what the plan is built on?"
},
{
"speaker": "Lawson Whiting",
"content": "Pretty much."
},
{
"speaker": "Bryan Spillane",
"content": "Okay. And then, Lawson, maybe could you just give a little perspective on depletions in the quarter. Volume depletions were up 1%. And so could you just kind of put that in context of -- is that more or less in line with what you were expecting? Maybe what that looks like relative to the industry? There's a lot of focus right now on volume and volume growth and just what's happening with consumption, not just for Brown-Forman, just more broadly across our entire coverage, consumer coverage universe. So just trying to get a sense of, if you could put that into perspective of just what you're seeing in terms of volume consumption trends and whether kind of a 1% to 2% type depletion is maybe what we should be thinking about in terms of Brown-Forman and maybe just the industry for the year?"
},
{
"speaker": "Leanne Cunningham",
"content": "I'll add some color to that. And if you look at Schedule B, you can see that really, for the most part, shipments and depletions are aligned except for where you -- we get down to the Jack Daniel's ready-to-drink and that's all about the launch of the Jack Daniel's and Coca-Cola in the US. So where we are right now is they're in line. Over a longer period of time, as shipments over the last few years have been stronger than depletions as we've been working to rebuild inventories, we do expect that depletions would need to come back in long and will exceed our shipments in this year is what is built into our guidance. So as we think about that, we will continue to update you as we go through the quarters. But right now, you still believe our depletions will be a bit ahead of our shipments as we go through this fiscal year."
},
{
"speaker": "Lawson Whiting",
"content": "I mean, I think to tear it apart a little bit by geography, I mean, the US market, if you look at GDS in Nielsen, it's sort of between five and six, I think, we're right there, too. So the US market, I mean, there's so much noise in the sales numbers, I know. But the US market is in a pretty decent shape. It's definitely being elevated by the RTD piece of things. So I do -- I think it's fair to say the full strength has the -- some of its comparisons, but the full strength market has softened a little bit. But it's being made up for us for the most part in our international markets, which continue to be really strong and particularly the emerging markets, which really is in its third year of pretty outstanding growth. That growth is coming from a very wide variety of markets, which is always nice also. It's one of the -- while we are so dependent on Jack Daniel's, when you talk about the international markets, there's so much geographic diversification that for instance, South America and Mexico, we've had an outstanding run and there are markets in Eastern Europe that are on really strong runs right now. So we've got really strong pockets of growth coming out of some of our most important markets. UK is actually in pretty good shape right now, too, and is delivering well. So no, the business is not turning into a 1% growth. No one is thinking of that."
},
{
"speaker": "Bryan Spillane",
"content": "Very helpful. Thanks, Lawson."
},
{
"speaker": "Operator",
"content": "Thank you. Please stand by for our next question. Our next question comes from the line of Eric Serotta with Morgan Stanley. Your line is open."
},
{
"speaker": "Eric Serotta",
"content": "Great. Thanks, everyone. With regards to the comment that you made in the press release and on the prepared remarks about declines in the old Jack & Cola offsetting growth in the Jack & Coke launch. If I remember correctly, the previous comments that you made were that Jack & Coke was nicely incremental. So just looking for some color as to why they largely offset in the quarter. Was there a timing issue with getting some of the old Jack & Cola of the channel or was some of this -- a lot of this growth reported Coke’s books and not yours? Any color into that dynamic would be very, really helpful."
},
{
"speaker": "Lawson Whiting",
"content": "Yeah. Sure, because this is one of the topics that also is a little bit confusing. So as I mentioned in my prepared remarks, the global volumes, it's about 1.8 million cases across the 11 markets. Now the part -- I think most people know, but a reminder, I guess, some markets are led by Brown-Forman and others are being led by the Coca-Cola Company. So that is what is throwing some of our volume numbers off in the spreadsheet. And I think it's what you're referring to. There are markets where Coca-Cola is taking the lead, and I'll use the UK as a good -- probably the clearest example. We had a big Jack & Cola business there, and now we are evolving that over to Jack & Coke. So those sales of the actual -- sales to the Tescos of the world, will not be on our books anymore, it's going to be on the Coca-Cola's books but it doesn't mean the business is going away, it's just we're taking out the cola and replenishing or replacing it with Jack & Coke. And so that's why the numbers look like they're going down, but that's not really the case in real -- system-wide, they're not. It's just the way that's being reflected on our financial statements. So -- and I think -- look, I'd also reiterate, I mean, this has been a great launch. It's an iconic product. We are really investing highly behind this launch as is the Coca-Cola Company. And so -- there's been a lot of broad reach media, there's events, there's trade executions, and it's got -- it is off to a very strong start. So the increased visibility, I think, is important, the market share gains we're getting. We've got a lot of positive factors. So -- and it's got 2% of the category in the US. It's got 2% share already, and it's only been three or four months. So it's off to a good start, and we feel pretty good about it. And I think the long-term potential is exciting and a lot of things that it does for the health of the brand, along with the actual business proposal itself. So it’s ff to a good start."
},
{
"speaker": "Eric Serotta",
"content": "Great. And then just to follow up on the inventory dynamic. Hopefully, this is one of the last questions on it. You did mention or you did flag rightfully so, I think some tough comp again in the second quarter. My recollection is the rebuild last year in the second quarter was somewhat less than it was in the first quarter. Am I remembering that correctly, and should we expect some sort of moderation in that year-on-year headwind in the second quarter before, all things being equal, should be about neutral in the second half?"
},
{
"speaker": "Leanne Cunningham",
"content": "You're remembering that correctly. And what we're talking about as far as comp is the entire company because we had the really strong shipments in the first half of last year. But you are correct that as we get into the second quarter, the shipments and depletions more normalized. But the one thing we have to remember is, and we'll share this with you every quarter as we get into the fourth quarter of fiscal 2024, then we'll have to lap the launch of Jack Daniel's and Coca-Cola in the US."
},
{
"speaker": "Lawson Whiting",
"content": "Yes. I mean, so it is less. Q2, I said a minute ago, Jack was still up 14% in Q2. So it's still -- we've still got high comps, but it is normalizing."
},
{
"speaker": "Eric Serotta",
"content": "Terrific. I’ll pass it on. Thanks for your help."
},
{
"speaker": "Operator",
"content": "Thank you. Please stand by for our next question. Our next question comes from the line of Andrea with JPMorgan. Your line is open."
},
{
"speaker": "Drew Levine",
"content": "Hey, good morning. This is Drew Levine on for Andrea. Thanks for taking our questions. So I wanted to pick up on the US. So it looked like underlying trends were up around 2% in the quarter and, Lawson, you mentioned TDS was up sort of mid-single digit. And in the track channels, it looks like given Brown-Forman was up stronger than that. So just curious if you can elaborate maybe on what the disconnect there is? And if we should see that sort of delta between the underlying growth rate and what we're seeing in track channels narrow looking ahead?"
},
{
"speaker": "Lawson Whiting",
"content": "Well, I mean, those numbers never tick and tie exactly. I think the 5% growth number, which includes Jack & Coke, it’s a pretty solid sort of result. The US for like a decade has been between 4% and 5% with the exception of these sort of post-COVID years when it really blew up. Yeah, the difference between the -- getting from minus 9% on an organic basis and adjusting for the distributor inventories is what gets you to the 2%. I don't know if I can explain the difference between the 2% and 5% necessarily. I don't think it's not a huge number."
},
{
"speaker": "Leanne Cunningham",
"content": "It's really about the launch of the Jack & Coke and how it is and the buying patterns that are in there. So that's creating a lot of noise in the difference between what you would see in our takeaway trends and what's happening in our net sales. So it's just -- again, as we were coming through and the gap is narrowing over the last few quarters, but then as we launched Jack and Coke and it's not all the way through into those takeaway numbers yet. That's creating the gap for us."
},
{
"speaker": "Drew Levine",
"content": "All right. Fair enough. And then if I could ask a follow-up on gross margins. So it looks like costs were about 100 bps headwind this quarter, moderated from the fourth quarter, which I think was around 350 bps. And you mentioned you'll be lapping a lot of those supply chain mitigation efforts from last year. So can you maybe offer some more color on gross margin expectations looking ahead? Should we think about gross margins potentially over 60% here going forward? And then on the Blanco or agave situation, is there any sort of way to think about the internal versus external mix of supply there? So, thank you for that."
},
{
"speaker": "Leanne Cunningham",
"content": "Okay. Great. Thanks. So I'll start with our gross margin for the first quarter, which was, as you noted, expanded 90 basis points, and it's where our price/mix more than offset the inflation on our input cost. And it was really driven by our price mix, which was plus 250 basis points that was driven by kind of the price increases across our portfolio that was led by Jack Daniel's Tennessee Whiskey. We also still, and I'll just point this out, as the last time I'll have the opportunity to say it is the last of the benefit from the removal of the UK tariffs on American whiskey because they rolled off June 1 of '22. And as you pointed out, the impact of inflation on our input cost has been partially offset by supply chain disruption costs. And then, so that's a good segue for me to go into the full year. And again, everything I say here is built into our operating income guidance. But we do expect price mix to continue to be a leader for us this year with our long-term pricing and new growth management strategies. We'll have the -- from a cost perspective, we'll have the absence of the supply chain disruption costs that will be significantly less to zero in F '24. And we'll still have inflation that will negatively impact our input cost in total, but though at a lower level. And to your question, I'll talk to you about a couple of our key input items starting with agave. And it really is about what we said. We've been talking about this for a very long time. We're really excited that it's finally starting to come down. We've been looking out there for such a long period of time seeing those large number of plantings and waiting for supply to catch up with the demand, and we are approaching and arriving to that now. We just wanted to be clear, though, with everybody, though, like we said in our prepared remarks, we do have finished cases in the supply chain -- in the supply chain and our inventory that need to be sold through, and it varies by SKU how much inventory we have, but generally speaking, that would be three to four months depending on SKUs. So well, we need to work through that. And then like we talked about for our portfolio of tequilas, reposado and anejo and some of our other expression are aged liquid. So we need to continue to let them go through their aging cycle before they're bottled and that inventory is sold through. But as we get to expressions like blanco or any non-aged expressions, we'll see that benefit more quickly. So it's really more about the inventory -- moving through the aged liquid and the finished goods inventory. Though there -- a bit of it will be the mix, just between what do we need to meet our needs. So we do grow our own internal agave. And but where we have needs, we source on the spot market. As you know, we've been clear with that over time. So balancing all those things, and I think I'll just say that in a number of months from now, we're going to continue -- we're going to see a meaningful benefit that will come towards the end of our fiscal '24 and well into F '25, which continues to make us excited about it to look ahead because we know agave and the cost of wood have been our two biggest challenges over the last number of years as it relates to our costs. And just to give you a quick update on wood while I'm here, the commodity cost for wood continues to remain high, but we have made a lot of strategic changes to our wood supply chain that is beginning to benefit us and yield those benefits. And we continue to believe, we are going to continue to see those benefits as we move through '24 and then well into the future as well. So we've got that positioned well. Just -- I'll real quickly hit just in case anybody's curious, grain for us, which is largely corn, it's below its peak. We're expecting it to be stable but well below kind of the prior year's prices. And with the reduction of natural gas and diesel prices, we will still see a bit of a small -- a slight increase in our glass cost but less than what we've had. So all in all, this is built into our guidance. And in total, our cost trends are moving and appear to be moving in a favorable direction for us. So I hope that helps as you think about gross margin where we were for the quarter and kind of where we're thinking for the full year."
},
{
"speaker": "Drew Levine",
"content": "Thanks for the color."
},
{
"speaker": "Operator",
"content": "Thank you. Please stand by for our next question. Our next question comes from Vivien Azer with Cowen. Your line is open."
},
{
"speaker": "Vivien Azer",
"content": "Hi, good morning. I was hoping to ask about advertising spending a little bit. Understanding that the growth this quarter is really a phasing, and we heard you loud and clearly on kind of the longer-term aspiration to grow A&P in line with sales. But, Leanne or Lawson, I was just curious how you're viewing the evolution of the competitive dynamic in TBA in the United States, for a whole host of reasons, a number of public beer companies are stepping up their A&P for the remainder of the year. I'm just wondering how you're thinking about the potential impact on distilled spirit sales as a result and the potential to -- potential need for you guys to spend more? Thanks."
},
{
"speaker": "Lawson Whiting",
"content": "Yeah. I mean I had not heard that the beer companies were really stepping up that much. But I do think, as you said, the long-term philosophy is to keep it in step with sales. We have significantly increased our [pop-up] (ph) spending in the last two years, I mean by well over $100 million. And so I think we feel pretty good that we have gotten ourselves in a comfortable place. And I think we can manage the P&L from there. I mean, look, the beer companies are struggling. And so they are quite sure they are trying to figure out ways to obviously turn their brands around, some brands are in real trouble. And they're going to find a way to try to spend their way out of that. But I don't see us doing that. And I don't really think, at least in the short term, I don't see much of a reaction out of us because of that. Their challenges are sort of unique to them, and we'll continue to hop forward the way we have."
},
{
"speaker": "Leanne Cunningham",
"content": "Yeah. And if you don't mind, Vivien, I'll kind of scope back out, and I'll kind of talk about our full year because I think we need to put what happened in Q1 into context with how we're thinking about the full year. So I'm going to go a little bit broader first, just to say, like I've shared, we've lapped the impact of the pandemic to a more normalized level, and we're on that elevated base. We're still lapping impact of just supply chain disruption. But the reasons we believe that we're going to deliver our full year guidance is we lap those strong shipments of the rebuilding of our distributor inventory. And like we talked about here today, once we adjust for the estimated net change in distributor inventories that you've seen on Schedule D, we believe our brands and our business are healthy. So I'll tie that back to how we're investing in it. The investment really kind of came with the launch of Jack Daniel's and Coca-Cola in the US. We are getting ready to launch that in September, which is just a few days away in Germany. So when Lawson said in his prepared remarks that the majority of that hit in the first few months of the year, it's to support those launches, and we're going to get back to that normal trend. But I think it's important to go ahead and say, for our full year, we've got our pricing and our revenue strategies, we've got the addition in the back of the year that's not in the first half of the year, which is the impact of Gin Mare and Diplomatico that will be moving into our organic results. So we feel good about our top-line guidance. We also feel good about the absence of supply chain disruptions and the costs associated with that. We feel good that from a full year perspective, we will invest in our brands in a way that lands with how we planned it, which is in line with top-line growth though heavily skewed to the front end. And that, we've said this already, but from an operating expense perspective, SG&A, we continue to invest in our route to consumers. We know that's Japan and also Slovakia for fiscal 2024. And we've got all this built into our guidance. So even with all the noise that we're talking through today, we believe we're going to land our operating income growth at that 6% to 8%."
},
{
"speaker": "Lawson Whiting",
"content": "One more comment on the beer versus spirits thing, more to the RTD world. I think it's just -- and their need to advertise because the malt-based RTDs obviously have gone through a huge amount of upheaval in the last few years where they exploded and then they've taken a sharp dive. Most -- a lot of it is coming at the expense of the spirit-based RTDs which I just -- I found interesting. I don't think any of us predicted that to happen. But I think at the end of the day, the consumer is willing to pay more, substantially more for a spirit-based RTD than a malt-based RTD because they taste better. And that is making the numbers get a little bit wild in the world of Nielsen and all the rest of it. But I think we have -- we -- not Brown-Forman, but I mean the industry is showing that the consumer is willing to pay a little bit more for something that tastes really good. And it's been interesting to watch those dynamics."
},
{
"speaker": "Vivien Azer",
"content": "Absolutely. Thank you for that color. If I could just squeeze in a quick follow-up on Japan specifically. We've observed Brown-Forman evolve the route-to-market process in a number of different markets historically. I've never this much dislocation. So can you just help us think through the 80% decline in Japan and how that evolves over the course of the year? Thanks."
},
{
"speaker": "Leanne Cunningham",
"content": "Yeah. So again, we've been working, again, scoping out working on our, increasing our route to consumer in to own distribution models for quite some time. We've had prior to 2020 -- fiscal 2024, we've had 14 markets move into own distribution. We've seen a lot of success. They deliver a lot of things like they fuel our growth, strengthen our position. They do unlock value for us, and we're continuing to move forward in that. So specifically, and this year as it relates to Japan, we are in the process of transition. We know that if you were to look at a year-ago period, we were with our distributor partner, we had inventory in that market to supply the sales, and we're going through just the transition. And so as we -- again, all of this is built into our full year plan. But again, fiscal 2024 for us is going to be a year of transition in Japan. And with that, we have SG&A costs associated with it, and we have a bit of volatility in our inventory levels as we make that transition."
},
{
"speaker": "Vivien Azer",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Please stand by for our next question. Our next question comes from the line of Bill Kirk with Roth MKM."
},
{
"speaker": "Bill Kirk",
"content": "Hi, good morning, everyone. I wanted to ask about your inventory levels, not necessarily the distributor levels. Naturally, they're up from the glass shortage [error] (ph). You highlighted that. However, if I go back further, I have the days up about 25% over fiscal '19. So I guess, how do you feel about the amount of inventory you hold?"
},
{
"speaker": "Leanne Cunningham",
"content": "So what I would say and you can probably see some of this on a cash flow statement is that, again, as we compare to a prior year period where we were working really, really hard to get all of the supply chain replenished with finished goods inventory, we now have what we've talked about, all of the parts of the chain replenished, including our own inventory. We go into probably the important holiday selling period ready to supply that. So we believe by the time, it's a bit high right now, again, if you look for our own inventories. But as we go through the holiday period, we will, by the end of the year, our plan is that we have that worked down and then our own inventories, too, are back in the normal. That's the last piece of the chain that we will be normalizing and we are ready to make those shipments for the holiday season."
},
{
"speaker": "Bill Kirk",
"content": "Okay. Excellent. And then there were two comments I want to try to tie together. I think Lawson, you made both of them. One was you mentioned that absent distributor inventory changes, net sales would have been above long-term growth expectations. But you also suggested that 1% depletions are below what people should expect going forward. So I guess how are the net sales ex-shipment timing above long term, but the completions below long term? I'm having a little trouble with those two comments."
},
{
"speaker": "Lawson Whiting",
"content": "Well, that's just going straight to that Schedule D. So that's where we would -- I think Leanne said, if you adjust to the distributor inventory topic, we'd be running it at 8% top-line. So that's the reference to the higher than sort of higher than historical norms in terms of sales growth. And that's the part that gets -- honestly gets us feeling confident because that number is pretty healthy. Now the 1%, I think we talked about that a few minutes ago, there's a lot of RTD movement in there, it's suppressing it. And the other part of it is volumes. We've taken a lot of pricing. I think that contributes to it too because we're getting -- more of our sales growth now is coming from pricing than it has over the historical periods. So it's a little bit of a balance."
},
{
"speaker": "Bill Kirk",
"content": "Thank you. That’s helpful."
},
{
"speaker": "Operator",
"content": "Thank you. Please stand by for our next question. Our next question comes from the line of Steve Powers with Deutsche Bank. Your line is open."
},
{
"speaker": "Steve Powers",
"content": "Yes. Hey, good morning. I had two follow-ups on two different questions. The first one, just quickly on the agave topic, Leanne. Is there a way to summarize or quantify the percentage of the company's agave needs that you currently have the capacity to self-grow versus source externally?"
},
{
"speaker": "Leanne Cunningham",
"content": "We've never shared that and it changes over time depending on the category demand, our finished goods inventory, our liquid inventory. So it does ebb and flow and we do grow our own and we supplement it with the external as we see demand above what we are able to grow ourselves and then our sourcing strategy that's implied in there. So again, we are excited that, that is finally coming down, that supply is coming on. We continue to think that, that's going to be a tailwind for us as we move through F '24 and well through '25."
},
{
"speaker": "Steve Powers",
"content": "Okay. Okay. Fair enough. Thank you. And then probably Lawson for you. On Jack & Coke, I was wondering if you could talk at all about sort of the incremental distribution gains, new launches that are planned over the balance of the fiscal year, that should I think at least partially offset the tougher comp in the fourth quarter as you lap the US launch? Any perspective there would be helpful. I’d also love, if you have it, any details on consumer repeat rates or what have you -- the trial has been great. Just curious as to how much of the demand we are seeing is incremental, like first-time trial versus repeated consumption? Thank you very much."
},
{
"speaker": "Lawson Whiting",
"content": "All right. Let me answer the second one first a little bit because it is -- we were obviously getting prepared for this, I knew that question would come. It was very difficult to get sort of turns of repeat purchase rates. It's just too early. We're getting massive distribution flow and that has been impressive and very good. And so we've essentially reached most of our goals in a pretty short period of time. But we just don't have that. We'll have that -- I assume by next quarter, we'll probably have some indications on that, that will be a little bit better, but it's just playing too early. Now as the year -- as the year goes on, the highlight or the highlights, I guess, we've launched in the UK. We've launched in Spain and Poland, and all is going pretty well, and I think we've talked about that. We're really, the big one that's coming is Germany. So that's going to happen in September. And Germany is a very large RTD market for Brown-Forman. And so, sort of getting that right is obviously going to be very important, but that will be exciting to watch, and we'll see how that goes. So -- and then Coca-Cola is taking it in a lot of other -- getting bigger in a lot of other markets, places like Japan, we talked about the Philippines, the UK, Poland, Hungary, Netherlands, Ireland. So the international rollout continues throughout this fiscal year."
},
{
"speaker": "Steve Powers",
"content": "Okay. Very good. Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. Ladies and gentlemen, due to the interest of time, I would now like to turn the call back over to Sue for closing remarks."
},
{
"speaker": "Sue Perram",
"content": "Thank you. And thank you to Lawson and Leanne, and thank you to everyone for joining us today for Brown-Forman's first quarter fiscal year 2024 earnings call. If you have any additional questions, please contact us. We do look forward to presenting at the Barclays Global Consumer Staples Conference next week, and we hope to see many of you there. For those of you that are unable to attend, the presentation will be made available as a webcast, accessible via the Brown-Forman corporate website under the section titled Investors, Events and Presentations. We also want to wish everyone an enjoyable weekend, particularly those in the United States that will be celebrating the Labor Day holiday. And on September 2, we hope you will join us in raising a glass as we say happy birthday to our founder, George Garvin Brown. Cheers, everyone. With that, this concludes our call."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect."
}
] |
bg | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Bunge Global S.A. Fourth Quarter 2024 Earnings Release and Conference Call. [Operator Instructions] Please note that today's event is being recorded. I would now like to turn the conference over to Ruth Ann Wisener. Please go ahead."
},
{
"speaker": "Ruth Wisener",
"content": "Thank you, operator, and thank you for joining us this morning for our fourth quarter earnings call. Before we get started, I want to let you know that we have slides to accompany our discussion. These can be found at the Investor Center on our website at bunge.com under Events and Presentations. Reconciliations of our non-GAAP measures to the most directly comparable GAAP financial measure are posted on our website as well. I'd like to direct you to Slide 2 and remind you that today's presentation includes forward-looking statements that reflect Bunge's current view with respect to future events, financial performance and industry conditions. These forward-looking statements are subject to various risks and uncertainties. Bunge has provided additional information in its reports on file with the SEC concerning factors that could cause actual results to differ materially from those contained in this presentation, and we encourage you to review these factors. On the call this morning are Greg Heckman, Bunge's Chief Executive Officer; and John Neppl, Chief Financial Officer. I'll now turn the call over to Greg."
},
{
"speaker": "Gregory Heckman",
"content": "Thank you, Ruth Ann Wisener, and good morning, everyone. I'll start by thanking the team for their continued hard work and commitment in 2024. We made good progress on a number of significant growth projects while also advancing our work to build an even stronger Bunge Limited. Our team is prepared for the close of our business combination with Viterra. Teams at both companies have put in countless hours of planning to ensure a smooth integration so that our customers at both ends of the value chain, farmers and consumers, see good continuity of service. And we expect to close the transaction soon. You likely heard we received regulatory approval from the Canadian government last month. We continue to engage in constructive conversations with regulatory authorities in China while we work through the final stages of the asset divestment process in Europe. Also in the late stage of the regulatory process for our acquisition of CJ Selecta, a leading manufacturer and exporter of soy protein concentrate in Brazil. We expect that transaction to close in the near future. In the coming weeks, we expect to close our announced partnership to develop new opportunities to help meet the growing demand for lower carbon intensity feedstocks for the production of renewable fuels. This alliance is the first of its kind in Europe and furthers our long-term strategy to create alternative paths towards the decarbonization of agriculture and the role we can play in the liquid fuel supply chain. In October, we announced the completion of the sale of our sugar and bioenergy joint venture in Brazil to BP. As we've discussed, this streamlines our business and allowed us to expand our stock repurchases authorization. Getting ready for these large initiatives takes teamwork and cross-functional collaboration. The team has done a great job of running our day-to-day business while also working on these strategic growth initiatives. In addition, we continue to return capital to shareholders through our share repurchases and our regular dividend. We repurchased a total of $1.1 billion of shares in 2024, and share buybacks will continue to be an important part of our capital allocation strategy. Shifting to our operating results, we didn't close the year as expected. Particular operating conditions have been challenging in South America, and they continue to be in the fourth quarter. Fortunately, we're seeing things stabilize and expect to see improvement. After the Viterra transaction closes, we expect to provide an outlook for the combined company. In the meantime, we are providing an outlook for the current Bunge Limited business. Forward visibility is limited, particularly at this point given the increased geopolitical uncertainty. Based on what we see in the markets and the forward curves today, we currently expect full-year adjusted EPS to be approximately $7.75. With that, I'll turn it over to John Neppl for a deeper look at our financials and outlook."
},
{
"speaker": "John Neppl",
"content": "Thanks, Greg, and good morning, everyone. As Greg mentioned, the fourth quarter came in below our expectations. This was particularly true in South America, where the market environment has been challenging all year, impacting industry margins throughout the oilseed and grain value chains, including those of our joint ventures. We also felt the impact of a declining margin environment in North America from biofuel rate uncertainty. Now let's turn to the earnings highlights on Slide five. Reported fourth-quarter earnings per share was $4.36 compared to $4.18 in the fourth quarter of 2023. Reported results included a favorable mark-to-market timing difference of $1.25 per share and a net positive impact of $0.98 per share. Notable items were primarily related to the gain on the sale of our Sugar and Bioenergy joint venture, partially offset by transaction and integration costs associated with Viterra. Adjusted EPS was $2.13 in the fourth quarter, compared to $3.70 in the prior year. Adjusted core segment earnings before interest and taxes, or EBIT, was $548 million in the quarter, inclusive of the Ukraine business interruption insurance recovery of $52 million, versus EBIT of $881 million last year. In processing, strong results in Europe and Asia were offset by lower results in North America and South America, as well as in European softseeds. Higher merchandising results were driven by improved performance in Finance Services, Freight, and Global Grains, offsetting lower results in Global Refined and Specialty Oils. Lower results in North America were primarily due to the combination of a more balanced supply and demand environment and uncertainty related to U.S. biofuel policy. Results in Europe, South America, and Asia were also down due to lower margins, though the variances were much narrower. In milling, higher results in North America were more than offset by lower results in South America. The corporate and other increase in corporate expenses was primarily driven by lower performance-based compensation and various project-related expenses in the prior year. Other results related to our captive insurance and securitization programs and Bunge Ventures. Core results and non-core reflect only one month of income from the Sugar joint venture due to the recent close on the sale. Net interest expense of $62 million was down in the quarter compared to last year, reflecting lower net debt levels and interest rates. The increase in income tax expense for both the quarter and full year was primarily due to lower pretax income and earnings. Adjusting for notable items and mark-to-market timing differences, the full-year adjusted effective income tax rate was approximately 23% for the current and prior year. Let's turn to Slide six, where you can see our adjusted EPS and EBIT over the past five years. Strong performance during this period reflects a combination of a favorable market environment and excellent execution by our team. The recent trend indicates a more balanced supply and demand, translating into less volatility and lower margins. Slide seven details our capital allocation. For the full year, we generated approximately $1.7 billion of adjusted funds from operations. After allocating $451 million to sustaining CapEx, which includes maintenance, environmental health, and safety, we had approximately $1.2 billion of discretionary cash flow available. Of this amount, we paid $378 million in dividends, approximately $925 million in growth and productivity-related CapEx, two-thirds of which related to our growth pipeline of large multiyear investments, and repurchased $1.1 billion of Bunge Limited shares. $500 million of those repurchases were from the $728 million of cash proceeds received to date for the sale of our Sugar JV. This resulted in the use of $444 million of previously retained cash flow. Moving to Slide eight, we finished 2024 with a total CapEx spend of approximately $1.4 billion, which was in line with our last forecast. As we head into 2025, we expect CapEx to be in the range of $1.5 billion to $1.7 billion, reflecting the continued investment in our ongoing multiyear greenfield projects. This range is down from the preliminary estimate of $1.9 billion to $2 billion we provided you previously, reflecting our decision to not pursue some projects as well as timing changes related to existing projects. We continue to expect to return to a baseline run rate on CapEx levels during the second half of 2026. Moving to Slide nine, at year-end, readily marketable inventories, or RMI, exceeded our net debt by approximately $2.3 billion. The adjusted leverage ratio, which reflects our adjusted net debt to adjusted EBITDA, was 0.6 times at the end of the year. Slide ten highlights our liquidity position. At year-end, we had committed credit facilities of $8.7 billion, all of which were unused at the end of the year, providing ample liquidity to manage our ongoing capital needs. In addition, we had a cash balance of $3.3 billion, accumulated in large part as a result of the $2 billion of cash proceeds from the U.S. debt offering that we closed in September. All proceeds will be used to fund the cash portion of the Viterra transaction. In addition, we have a $6 million term loan commitment secured last year to refinance Viterra's outstanding bank debt upon closing the transaction. Please turn to Slide eleven. Our full-year adjusted ROIC was 11.1%, while our ROIC was 9.7%. Adjusting for construction in progress on large multiyear projects not yet operating and the excess cash on our balance sheet for the Viterra closing, adjusted ROIC would increase by approximately two percentage points and ROIC by approximately one percentage point. Our returns have declined from recent highs but remained well above our adjusted weighted average cost of capital of 7.7%. Moving to Slide twelve, for the year, we produced discretionary cash flow of approximately $1.2 billion and a cash flow yield of 11.1%, compared to our cost of equity of 8.2%. Please turn to Slide thirteen for our 2025 outlook. As Greg mentioned in his remarks, taking into account the current macro environment and market conditions, we expect full-year 2025 adjusted EPS to be approximately $7.75. This forecast excludes the impact of announced acquisitions expected to be closed during the year. In agribusiness, full-year results are forecasted to be down from last year, with lower results in processing where current performance in South America is expected to be more than offset by North American and European softseeds. Results in merchandising are forecasted to be down slightly from last year. Finally, in Specialty Oils, full-year results are expected to be down from last year, mainly driven by a more balanced supply and demand environment in North America. In corporate and other, full-year results are expected to be up from last year. Additionally, the company expects the following for 2025: an adjusted annual effective tax rate of 21% to 25%, interest expense in the range of $250 million to $280 million, capital expenditures in the range of $1.5 billion to $1.7 billion, and depreciation and amortization of approximately $490 million. With that, I'll turn things back over to Greg for some closing comments."
},
{
"speaker": "Greg Heckman",
"content": "Thanks, John. So before we go to Q&A, I just wanted to offer a few closing thoughts. In today's complicated global environment, we're confident that the work we've done and continue to do to improve our business and operations positions us well to deliver on our critical mission of connecting farmers to consumers to deliver essential food, feed, and fuel to the world. We continue to see the benefits of our global operating model, portfolio optimization work, and financial discipline as we navigate the cycles inherent in our industry. With our culture of continuous improvement, our team continues to strengthen the business, both with the M&A work we talked about at the beginning of the call and our ongoing growth initiatives. Construction is going well on our large-scale projects, which will not only bring us new capabilities but also allow us to more efficiently and sustainably serve our customers. Improved productivity is at the heart of investments at dozens of our existing facilities around the world. The strategic use of capital, along with the implementation of the Bunge production system, is enabling our teams to set new performance records each quarter. We're also pleased with our performance on our sustainability priorities. A major step forward in November was when we became the first global commodity exporter capable of 100% traceability and monitoring of both our direct and indirect soy purchases for Brazil's priority regions. We're proud to reach this major milestone in our ten-year journey to achieve traceable and verifiable supply chains. As we think about our business in 2025 and beyond, regardless of how the macro environment evolves, we're confident that our team has the experience, skills, and agility to navigate the changes that drive performance. With the addition of Viterra, we'll be an even stronger Bunge Limited, with further diversification in assets, geographies, and crops, providing us with even more capabilities and optionality to help address the world's food security needs. With that, I'll turn to Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question and answer session. If you are using a speakerphone, please pick up your handset before pressing the keys. And today's first question comes from Manav Gupta with UBS. Please proceed."
},
{
"speaker": "Manav Gupta",
"content": "Good morning, Greg. Good morning, John. My first question relates to the 2025 guidance. What are the puts and takes if you could get a little more details? And the reason for the question is that, historically, you start at a number and as the execution is better than expected, the number rises. So I'm trying to understand what kind of conservatism is built into the guidance. And my follow-up, I'll ask it upfront also, is how are you accounting for the fact that there is policy uncertainty of 45Z? So how are you accounting for that in your annual guidance? Thank you."
},
{
"speaker": "Greg Heckman",
"content": "Well, let me start, and John can follow up. So as we look at 2025, we definitely heard it is an environment that has less visibility than normal with the trade disruptions and some of the uncertainty around U.S. biofuels. But what we did factor in is that really global oil supply and demand is pretty constructive, right? We've got less palm oil and less softseed competing with soy. So soy is very competitive right now, and it's taking a bigger share of global flows. And we are seeing more global biofuel demand when you look at it in total outside the U.S. Soybean meal demand has been very good, and that's driven, of course, by the profitability in the animal protein. There's also less wheat with a little bit tighter supply and demand, so less wheat competing with soybean meal and less competition from the mid proteins. Then in South America, we really expect improvement in Brazil. The industry in 2024 fought the logistical commitments in take-or-pay, which really created a lot of demand on supply, which kind of hurt margins across the platform for the industry. Those are exited in 2024 and won't be fighting that in 2025. And then, of course, Argentina, we've seen the export tax reductions, and that economy continues to stabilize. So that'll that that should drive a change in farmer behavior and farmer selling. Now we do expect lower margins in North America and Europe. And of course, as I believe John said, Viterra, CJ Selecta, and share repurchases are not factored into 2025."
},
{
"speaker": "John Neppl",
"content": "And, Manav, I might just add there that, you know, relative to 45Z and uncertainty around policy, we've got, you know, we're making the assumption today that U.S. crush margins are lower, as Greg mentioned, but also expect refining premiums to be more challenged in 2025. Obviously, as we get more clarity around policy and get the right demand for soybean oil relative to renewable fuels, that should be helpful for refining premiums. But now we're making assumptions they'll be down, certainly."
},
{
"speaker": "Manav Gupta",
"content": "Thank you for a detailed response. I'll turn it over."
},
{
"speaker": "Operator",
"content": "The next question comes from Heather Jones with Heather Jones Research. Please proceed."
},
{
"speaker": "Heather Jones",
"content": "Thanks for the question. I just don't want to start with, so given the fact that you expect South America to be better this year as far as on take-or-pay and Argentina, just wondering what is the offset that y'all are expecting to be softer in 2025."
},
{
"speaker": "Greg Heckman",
"content": "You said you're breaking up a little bit during the beginning, Heather. If I got the question right, it was as we see South America better, what are the offsets globally?"
},
{
"speaker": "Heather Jones",
"content": "Yes. In merchandising specifically."
},
{
"speaker": "Greg Heckman",
"content": "Oh, in merchandising specifically. Yeah. I think, you know, and if you look, John can restate even versus the model, merchandising is pretty conservative, and I think it reflects what we're seeing as a more balanced supply and demand situation globally, really across grains and oilseeds. And as we've talked about, that is always the toughest to, you know, to be able to predict from a timing and size of the magnitude of the opportunities. It would be hard to imagine that the situation will be more complex than we're dealing with right now. And we expect things to kind of get more clear in the second half. The watch out on merchandising, you know, versus the opportunity really is it does make it tougher for our suppliers, the farmers, as well as the consumers, to plan in these uncertain times. So they may draw back and be a little bit more spot here in the first quarter, first couple of quarters."
},
{
"speaker": "John Neppl",
"content": "I'd maybe just add, Heather, that, you know, it's also year over year right now is in ocean freight. And really driven primarily by, you know, lower flat price now versus a year ago, but those markets can get very dynamic, you know, depending on trade flows. As government policy gets more clear and trade flows could be impacted, that certainly may provide a small opportunity on the ocean freight side."
},
{
"speaker": "Greg Heckman",
"content": "The supply and demand probably is this most to be watched probably is corn. That one's probably the tightest. And so if we did have some weather problems in corn production, that's one of the ones that could contribute to merchandising as we need to work to solve some problems globally."
},
{
"speaker": "Heather Jones",
"content": "Okay. And then I don't know how much y'all can speak to this, but I just wanted to ask broadly. Your thinking on the Viterra acquisition and all, given the 45-degree model makes basically uncompetitive coming into the U.S., or at least not eligible at this time for a credit. And just the potential for export tax for tariffs on Canada. Just like, broadly, how are you thinking about that acquisition now versus, you know, maybe a year ago? And are you maybe able to offset some of those new negatives with greater synergies or greater share repo or just how are y'all thinking about those flips and takes?"
},
{
"speaker": "Greg Heckman",
"content": "I'd say that one, it hasn't all played out exactly what, you know, how the biofuels policy is gonna work out. But remember, canola is very favored by the food industry, as well as the canola meal has been very favored by the dairy industry. So that market will continue to go to a lot of the traditional demand. As you can imagine, obviously, we're watching what happens between the U.S. and Canada, except, well, that pitted back to the oil flows in the near term. But that would last forever. You know? And this is a long-term thing. So clearly, we'll be poised to deal with whatever we need to deal with in the near term, but I think the long term, you know, policy gets more clear. One thing is the market will adjust to that. And I think, you know, with the combination of Viterra, we should be in a better position globally to deal with whatever disruption might be created from policy or trade flows and changes."
},
{
"speaker": "Heather Jones",
"content": "Okay. Perfect. Thank you so much."
},
{
"speaker": "Operator",
"content": "And our next question comes from Tom Palmer with Citi. Please proceed."
},
{
"speaker": "Tom Palmer",
"content": "Good morning and thanks for the question. I wanted to maybe just start off kind of framing the earnings guidance for 2025 relative to the $8.50 mid-cycle outlook. I know it's a few years. It was laid out in 2022. I appreciate interest expenses higher, but share count's lower. So I guess just looking at, like, the segment profit pieces, could we maybe walk through expectations relative to that mid-cycle outlook?"
},
{
"speaker": "John Neppl",
"content": "Sure, Tom. I'll take that, and Greg, you can jump in if you have any other thoughts. But, you know, just a reminder, we put that together. You know, our most recent refresh was in the middle of 2022, which, of course, seems like an eternity now. But, you know, overall, how we're thinking about it on the processing side, margins are pretty steady versus what we had assumed back in the mid-cycle, but volume is down. Based on our original model, really driven by three factors. One is Ukraine has obviously been impacted with the war. And so pretty much lower volume levels there than fully anticipated. We sold our Russia business since that point in time, and then we're doing less tolling in South America. So volume is down in processing, but margins are fairly steady. On the merchandising side, we'll assume lower volatility going forward. We had modeled about $100 million a quarter in our baseline, and now, looking at the next year, we're thinking somewhere in the $50 million to $75 million per quarter range. So, obviously, that can change pretty quickly depending on what happens in the markets, but that's how we have it in the model. Net interest expense is higher, and, you know, really driven by interest rates and more debt. And I'll get to offsets in a second. And then on the sugar side, of course, we sold sugar, and we had that built into the model. But offsetting the higher interest and sugar impact is more share buybacks. And, you know, we originally in the model just assumed that pay down with any excess cash, but, of course, we've allocated a lot of that to share repurchase, which has been principally offset the loss of sugar earnings and the higher interest cost. And then we do have some higher costs, you know, than what we had anticipated at the time, really driven by growth initiatives and adding some capability investment, some money in technology, really to drive efficiency in the future. And frankly, inflation, you know, over the last couple of years is higher than what we expected in our original model. And then finally, on the favorable side, all that is on RSO. Refined Specialty Oil side, margins have been better than what we would have modeled in terms of at the time, assuming more of a baseline. On the specialty side, we performed better, but also refining premiums have stayed better than, you know, what we had anticipated in a mid-cycle. So that kind of wraps up the overall."
},
{
"speaker": "Greg Heckman",
"content": "Probably just worth mentioning, John, is mentioning the calendarization of 2025 right now. So first half, second half at 40% and 60%. And then Q1 versus Q2 on the first half would be 40% and 60%."
},
{
"speaker": "Tom Palmer",
"content": "Thank you. That was actually my next question. Maybe I'll just sneak one in quickly. Just on Viterra, I guess, what's kind of the plan once it closes in terms of communication? Is the idea to update guidance just on the next earnings cycle? Would it be more proactive than that? And just any kind of initial thoughts on how we might maybe think about Viterra's swing in earnings."
},
{
"speaker": "John Neppl",
"content": "Yeah. I think, Tom, our plan right now is to update on the Q1 call. Obviously, it depends on the timing of close because we have a lot of work to do in getting the commercial teams together and looking at the future. We've focused all our time and attention on integration and getting through regulatory. And, of course, you know, given the fact that we're not one company, and the commercial teams are limited in communication, really limited to integration discussions and not what we can do together going forward. So we're looking forward to getting those teams together to talk about the future and what we can do together. And clearly, our first order of business will be taking a recast of how we feel about the balance of 2025 post-close, and then we'll share that as soon as we can. You know, in the meantime, we're excited about it. We know we're in a very cyclical business. You know, the environment's different than it was when we signed the deal, but this is about the long term. And we're just as excited today as the day we signed the deal, and you know, knowing the long run as we've had a chance to spend more time with their teams, we're really excited about what we can do together, especially in a world that seems to be more geopolitically uncertain and with weather volatility and all the things that should play well into our model. It's gonna give us that much more ability to manage."
},
{
"speaker": "Tom Palmer",
"content": "Great. Thanks for such detailed answers, guys."
},
{
"speaker": "Operator",
"content": "The next question is from Stephen Haynes with Morgan Stanley. Please proceed."
},
{
"speaker": "Stephen Haynes",
"content": "Hey, good morning. Thanks for taking my question. I wanted to ask on the Viterra regulatory process. You mentioned some constructive comments with Chinese regulators. I was hoping if maybe you could provide more color here on those discussions. And then is it also fair to assume that any back and forth between the U.S. and China on tariffs hasn't changed anything with those discussions? Thank you."
},
{
"speaker": "Greg Heckman",
"content": "Yeah. I'd say we've had very productive discussions with the Chinese authorities, and we continue to respond to the questions and work through the process. And we feel we're getting to the later stages of that. And then as far as some of the external factors that are going on in the world, the one thing with our global footprint as well as Viterra's global footprint, we both had very good relationships with the China market, with our counterparties in China, with the regulatory authorities, and these are decade-long relationships. And it's very important, right, to be able to connect that important demand in China with the farmers, right? And that's what we do. That's vitally important to help farmers be successful and to be profitable and continue to grow. As well as it's important to China, you know, for their growing demand that we can connect them to all the different origins around the world. So those are long-term relationships and trust that's been built, and we'll just work through the process. We've seen a lot of different cycles and a lot of different situations in the world and relationships over those decades. And expect to in the coming decades, which is why we're so excited about putting these two companies together."
},
{
"speaker": "Stephen Haynes",
"content": "Okay. Understood. Thank you very much."
},
{
"speaker": "Operator",
"content": "The next question comes from Salvatore Tiano with Bank of America. Please proceed."
},
{
"speaker": "Salvatore Tiano",
"content": "Thank you very much. Firstly, I wanted to talk a little bit in more detail about the financial implications of the acquisitions that you're close to completing. So firstly, on Viterra, previously, you had said that it most likely would be dilutive in year one. And I want to see if you can put a finer point given that at this point, we're close to the completion. And also, if we have line of sight to year two or year three, whether this will be at this point dilutive or accretive. And on CJ Selecta, I think numbers that have been floated previously, we're talking about perhaps a $60 million EBIT contribution, which would be $0.30 EPS accretion on a full-year basis. Is this still the case?"
},
{
"speaker": "John Neppl",
"content": "I'll start with Viterra. We said out of the gate it was gonna be neutral to slightly positive on a pro forma basis after considering capturing first-year synergies and share buybacks. Of course, we've done a bit of the share buybacks. We have $800 million remaining on that program. I think, look, it's difficult to assess exactly how it'll have an impact in the first year because we haven't gotten together to put a forecast together for 2025. But again, we'll provide that clarity as soon as we can in 2025. And then really an outlook beyond there, we're gonna have to spend some time together and understand how the businesses will work together and how quickly we can capture the commercial synergies. I think on the cost synergy side, we feel very good about the cadence that we have, but, you know, it'll take time to get through the commercial side. So more to come on that. I think it's just gonna be a big company. It's a lot of work. We'll provide that clarity as soon as we can."
},
{
"speaker": "Greg Heckman",
"content": "You know, with respect to CJ Selecta, you know, our general assumptions are largely intact on that. It's about a $600 million acquisition. And, you know, we expect mid-teen returns on that business. And so if that holds long term, certainly, we believe that's a great acquisition. And while, you know, any given quarter or year, you know, S&Ds can drive margins, we definitely believe that it's gonna be a very good acquisition going forward."
},
{
"speaker": "Salvatore Tiano",
"content": "Perfect. Thank you very much. And also, I wanted to check a little bit on the capital allocation. So obviously, you are being more aggressive with buybacks and offsetting the dilution from the sale of the sugar JV. How should we think a little bit about that for this year? And on CapEx, I think previously you had mentioned around $2 billion for 2025. So currently, it's trending lower. And is this just finding efficiencies, taking off some projects off the books, or just being pushed back to 2026?"
},
{
"speaker": "John Neppl",
"content": "Yeah. So with respect to share buybacks, I mentioned we have $800 million left on our commitment relative to Viterra. The original commitment was doing that within 18 months of close, and certainly, that can come sooner if it makes sense. And as we look at other sources and uses of cash, we're always looking at buybacks as an option for any excess cash that we're generating. With respect to the CapEx estimate, really at $1.9 to $2 billion, and now we're down to $1.5 to $1.7 billion, driven really by kind of 50/50 between some timing pushing into early 2026 and canceling or our decision to forego some projects that we had on the slate that we decided not to pursue. So kind of a mix between the two. So overall, I think, you know, $1.5 to $1.7 billion, we feel like it's a pretty good estimate for next year, down $200 to $300 million from our original forecast."
},
{
"speaker": "Salvatore Tiano",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "The next question is from Pohren Sharma with Stephens. Please proceed."
},
{
"speaker": "Pohren Sharma",
"content": "Thanks for the question. Just wanted to hop on and get a sense of the take-or-pay. Just wanna get some granularity here. Now you said you're expecting better results out of South America because you won't see as much of an impact. I'm just wondering, in 2024, did you see, was the impact kind of centered around the first half or the second half, or was it split evenly throughout the year?"
},
{
"speaker": "Greg Heckman",
"content": "Yeah. First, I'd say it was a total industry impact that unfortunately affected margins not only in origination but also on our exporting as well. And it was really something the industry struggled with all year. It accelerated a little in Q4 as the end of the year definitely approached, and, you know, we felt it across our system in beans and corn, but definitely in our global corn business as well."
},
{
"speaker": "Pohren Sharma",
"content": "Got it. Appreciate the color there. Guess on the follow-up, just wanna get a sense of potential trade scenarios. I know the situation's fluid now, but just, you know, looking at past history, last time around, Bunge Limited's South America business, at least the fundamentals were much better because it looks like flows shifted over from China to South America. So just wanna get your sense on the setup this time around if you do get tariffs in place, do you expect to see as much of a benefit in your South America business? If you could just help me understand the puts and takes there."
},
{
"speaker": "Greg Heckman",
"content": "Yeah. One thing that I would point out as you think about it versus the challenge in the trade war in 2018, Bunge Limited is a very different company. The way we operate the global platform and the way that we've changed our operating model, I think we're much better positioned to react more quickly to the challenges and or opportunities. And we've made some improvements in the platform, right, in our asset platform. So we've got more capabilities from that standpoint as well. So that's the differentiation I would draw from 2018 to today and what we'll be dealing with here in 2025. And the other, we're a little bit battle-tested when you think about some of the things that we've been challenged with, whether it's African swine fever or geopolitical, you know, regional situations, COVID. So and the teams performed very well through all of those. So I think we're in a much better position from the capabilities and from a platform for the challenges that are in front of us."
},
{
"speaker": "John Neppl",
"content": "Yeah. I might just add that obviously, we're used to supplying China out of both North and South America depending on the time of year. Harvest in the U.S., we supply a lot of beans out of the U.S., and then that shifts to Brazil or South America later in the year. And so very much a dynamic that we're used to. And so if trade policy affects trade flows, we'll be able to adjust to that accordingly, given our experience and obviously working with China, as Greg pointed out earlier, for decades."
},
{
"speaker": "Greg Heckman",
"content": "Look, our goal ultimately, right, is to connect those demand markets with the farmers and send the appropriate signals, right, for the planting decisions that the farmers are making to be able to have, you know, the right crops and drive their profitability."
},
{
"speaker": "Pohren Sharma",
"content": "Got it. Appreciate the color, guys."
},
{
"speaker": "Operator",
"content": "The next question comes from Ben Theurer with Barclays."
},
{
"speaker": "Ben Theurer",
"content": "Good morning, Greg, John. So just wanted to follow up on one of the questions that's related to what Tom had in terms of, like, the baseline and kind of, like, tie that back into from what obviously you've shared already during the call, but I remember back roughly two and a half years ago, you also presented some of the impact that you're expecting from a growth CapEx and M&A versus share repurchases. So I think we've discussed M&A and share repurchase piece around it. But could you maybe also elaborate just given the increased CapEx that you've been seeing and what you've been putting out already last year for this year and then the probably even gonna carry over into the first half of 2026. What do you expect from that in terms of contribution as to your, let's just assume it's still the same baseline. What would that be? What's that incremental earnings that you think that can come out of that CapEx as you roll over into then the second half of 2026 and then beyond that into 2027 in a more normalized CapEx cycle, but with those assets being produced?"
},
{
"speaker": "John Neppl",
"content": "Sure. So our baseline assumption is we built our go-forward model was really built around CapEx and M&A, small amount of M&A, mostly large CapEx. And those projects are largely on track. Timing's been a little affected by weather and labor availability on a couple of them, but largely intact with our long-term team plan. And, you know, obviously, what the environment is like when those projects finish will impact maybe the near-term economics of those projects. And then CJ Selecta, for example, is one of those projects that we had had on our radar screen back when we built the model. And that, you know, hopefully, will close here soon. So I feel like, you know, we're largely on track on the growth side with what we modeled. And we had anticipated that impacting about $2.50. So we were expecting about an $11 baseline. You know, all else being equal, our baseline from $8.50 to $11. Now obviously, what the environment's gonna be like at the end of 2026, you know, when we largely expect these projects to be wrapped up, is anyone's guess at this point, but assuming a mid-cycle or relatively mid-cycle environment at that point, that's what we would expect our baseline to have reset to."
},
{
"speaker": "Ben Theurer",
"content": "Okay. Perfect. And then just real quick as it relates to, like, the cadence, how to think about your buyback. I mean, obviously, you've done about $1.1 billion now as of December. That means there's still around about $900 million missing, which is within the Viterra deal. Is that still more likely now to happen post-transaction close, or would you continue to buy shares even ahead of it just given the liquidity you have right now post the sugar closure?"
},
{
"speaker": "John Neppl",
"content": "Yeah. So we have $800 million left. And, you know, while we haven't made any specific decision on when, but certainly, it'll be opportunistic. We'll get it done. But the cadence, we haven't really settled on when, but certainly, we will if it makes sense to do it sooner, we'll do it sooner. But if we have other reasons not to do it right away, we still consider that. But we'll get it done."
},
{
"speaker": "Ben Theurer",
"content": "Okay. Perfect. Thank you. I love it too."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tammy Zakaria with JPMorgan. Please proceed."
},
{
"speaker": "Tammy Zakaria",
"content": "Hi. Good morning. Thank you so much. So my question is on the disaster aid package for U.S. farmers that was announced in December. I think they're getting assistance per acre for both corn and soybean. So do you see any potential benefits of any of this for any of your segments benefiting from this as the year progresses?"
},
{
"speaker": "Greg Heckman",
"content": "I think it's a kind of a small impact to us overall. What I think the upside and what's good is that farmers will have what they need to make the investment in this next crop in the seed and the inputs, you know, to plant the right crops and have the right productivity. So it's good that they've got that funding, and I think that support is positive, and that should be good for production."
},
{
"speaker": "Tammy Zakaria",
"content": "Got it. That's helpful. And I want to follow up on that tariff question from earlier. I know it's still fluid, but there's a narrative that increased exports of more ag commodities out of the U.S. into some of the trading partners like China could be a negotiating tactic under the current administration. So given your footprint, how would that impact your outlook if, let's say, China promises to buy more from the U.S. maybe at the expense of South America?"
},
{
"speaker": "Greg Heckman",
"content": "Yes. One thing we're very glad that we have a very balanced global footprint. So whether that's on the merch side or on the crushing, the processing side, we've been able to balance a number of situations the last few years to continue to perform. It may create regional trade-offs, like in the U.S., where that would benefit export. And it may be slightly more challenging to crush, but then we would try to adjust elsewhere in our global system to respond to that."
},
{
"speaker": "Tammy Zakaria",
"content": "Got it. Thank you. That's helpful."
},
{
"speaker": "Operator",
"content": "And our next question comes from Derek Whitfield with Texas Capital. Please proceed."
},
{
"speaker": "Derek Whitfield",
"content": "Good morning, and thanks for taking my questions. Starting with refining, we've seen the spread between RBD, SBO, and crude SBO collapse to historically low levels. With the understanding that the majority of refiners are buying crude versus refined, where should this market settle out once demand returns as I can't imagine refining costs are less than two cents per pound?"
},
{
"speaker": "Greg Heckman",
"content": "I guess I'd start by saying we all along said that as the pretreatment got built in renewable diesel, we expected to see some of the margin move from the refined into the crude. We've definitely seen that, so the crude will carry a bigger piece on the crush. We've got a little bit different footprint with our global specialty oils business. We've got a very good customer base that we've continued to help manage their challenges and grow with. We've got a nice balance between the QSR as well as the CPG and the food at home. So our account mix has been favorable as we've seen some of the changes with the consumer. And then some of our specialty business on the oil side benefited from the tight cocoa butter supply, as well as you remember, we added a plant at Avondale. And as we've ramped that up in our capabilities here in North America on specialty oils. So kind of all that rolls into when you see what our refined overages are. Probably got a little bit different package or portfolio than what someone who might just be a North American player."
},
{
"speaker": "John Neppl",
"content": "Derek, I'd just add that while the storyline is a lot of it's about energy and versus refined oil, the energy sector, we supply less oil this year not only as a percentage of our total book, but also just in actual volume, we provided less to the energy industry just because demand has been soft with all the uncertainty. So that could be upside in the future if obviously would be upside in the future if policy gets clarified and we think demand for soybean oil, whether refined or crude, is good. Either way, we want demand for that product. But refining premiums have held in there pretty well to Greg's point. It's been very resilient with the elastic demand from the food industry."
},
{
"speaker": "Greg Heckman",
"content": "And I think it's probably also worth mentioning. Right? There is a big biofuel install base that exists now. It's in place. So as we work out, you know, the RBO and work out 45Z, there's a lot of demand there that could make a difference in a hurry. And, you know, we trust that the policy is gonna get worked out. Right? There's a lot of installed capacity. The money's already been spent. It's available today to run. And those facilities, whether it's traditional biodiesel, renewable diesel, or SAF, they're underutilized today. And, you know, we get those policies right. That's also supportive to agriculture at the farm gate. That's supportive to the farmer, and we think we're gonna get, you know, eventually get those dots connected, and we hope that'll be later here this year. But that installed capacity base is there, and John said we've got upside on the amount of oil that we can provide when they're ready to go."
},
{
"speaker": "Derek Whitfield",
"content": "Great. We definitely agree with that assessment as well. And then as my follow-up, I wanted to touch on 45Z. In your view, is there merit from a carbon counting perspective for canola to have a materially higher CI than SVO when you evaluate ag and processing practices?"
},
{
"speaker": "John Neppl",
"content": "Yeah. Look. I'm not a scientist, so it's hard to understand all the math that goes into it. You know, today, it doesn't have a path. Obviously, the one we're watching more closely is winter canola because we have a program and think that obviously, the scores there should be considerably different, especially when you think about indirect land use. TBD. You know, the policy did make note that it was spring canola that they had assessed. And so we're hopeful that they'll be reviewing winter canola and treating that differently. Today, that's flowing to Europe since there is demand in Europe for winter canola seed and our program here in the U.S., it's growing. We'll see how things shake out. I mean, there's gonna be a lot of conversation certainly, but one thing we do know is that we're positioned to support wherever this stuff needs to go and stay at today, some of it's Europe. Clearly, 45Z came out. It's more favorable to soybean oil. But we do think winter canola has a place as well as some of the other novel crops we continue to work on."
},
{
"speaker": "Greg Heckman",
"content": "And I'd say what's encouraging is that we're seeing, you know, the players along the value chain work together with the policymakers to try to get, you know, the same set of facts for everyone to work together. So whether it's the energy industry, the processing industry, the farm groups, we are seeing everyone try to engage on the facts, and we believe that that will be productive over the long term."
},
{
"speaker": "Derek Whitfield",
"content": "Perfect. Thanks for your time."
},
{
"speaker": "Operator",
"content": "The next question is from Andrew Strelzik with BMO. Please proceed."
},
{
"speaker": "Andrew Strelzik",
"content": "Hey, good morning. Thanks for taking the questions. I had two questions. The first one is about some of the nearer-term uncertainties that you've been discussing, and you have, you know, cash crush that looks pretty poor versus a crush curve that gets better throughout the year. You know, what's your degree of confidence, or how do you weigh the risk that maybe some of these uncertainties kind of linger beyond the first quarter? Is there a degree of confidence that this will be more confined to the quarter, or how do you balance those two in your outlook?"
},
{
"speaker": "Greg Heckman",
"content": "I'd say when you look at the calendarization that we put together with delivering, you know, the $7.75. Right? We talked about that's approximately. So, you know, we see scenarios where that's got risk and, right? We look at where we're at right now, you know, in the cycles of harvest, got kind of second quarter, first quarter is going to be pretty tough. Second quarter will start to see some benefits from South America. Then as we get in the second half of the year, of course, from North America, perhaps. So I think that's reflected in that, expecting 40% of our earnings in the first half. And it's even more reflective when you think about in the first half, we're only expecting of that 40% for 40% of that to be in the first quarter. So that calendarization kind of shows, you know, what we expect to, you know, to roll out. And then the caveat around that being, look, tariffs, and possible retaliatory measures to the point they'll benefit one region and we'll have to manage that from another region. The one thing this does, it makes planning tougher and it may drive not only farmers but consumers to be more hand-to-mouth. That could make things, you know, delay a little bit more. So that'll be one of the, I think, factors to watch in 2025."
},
{
"speaker": "John Neppl",
"content": "If you might just add that I know we've talked a lot about ovals, but some additional certainty around where things are gonna shake out from a renewable standpoint could have a significant impact on demand for soybean oil. Greg pointed out the assets are there. The capacities are to move, and they're able to take a significant amount of volume of soybean oil when they're running and running hard. So that could change the dynamics pretty quickly. But, again, policy uncertainty, people are very reluctant to book forward, and I think that's reflective of the cash markets as a lot of hand-to-mouth right now on that side because people aren't don't have enough conviction to follow through."
},
{
"speaker": "Greg Heckman",
"content": "The other course is to watch, you know, watch the weather. Right now, it looks favorable for Brazil and how the harvest should develop there. Watching. It's a little dry in Argentina. So we wanna watch that closely. And then, you know, remember, meat economics are very good, and the animal numbers are out there. Soybean meal, priced very well, less competition from wheat and from the mid pros, and so we're at high inclusion rates on the meal side. And then John spoke to the fact about there's a lot of biocapacity out there and regulatory clarity is on the way. We hope there in the second half. And then don't forget globally, while we've got a lot of uncertainty in the U.S., right? Brazil's got fuel in the future. They'll be moving up to B15 on their way to B20. Indonesia's talked about going from B35 and on the way to B40. And then Europe has put some more favorable regulation policy in place for SAF and started to move towards maritime. There's a lot happening globally on the biofuels continuing to kind of quietly develop demand and investments continue to move forward."
},
{
"speaker": "Andrew Strelzik",
"content": "Okay. That's super helpful color. I appreciate that. And my other question, you know, I guess I'm I appreciate we just got the 2025 guide, but I'm trying to think about earnings trajectory in this business over the next, I don't know, two or three years, next several years. And obviously, this year has a lot of disruption. A lot of kind of rebalancing. And then you have, you know, everyone can make their own assumption on kind of the pro forma numbers with Viterra, CJ Selecta, but, you know, then you have synergies and you have, you know, returns on these capital projects and maybe less a lack of visibility going forward. Do you see 2025 as an earnings base maybe on a pro forma basis that you should grow from over the next several years or kind of like a troughish type of number and, you know, maybe help us with if there's any of the building blocks that I left out, kind of how you think about the trajectory of the business over the next couple of years. Thanks."
},
{
"speaker": "Greg Heckman",
"content": "Let me start. The one thing would be yes. And that's because think about, you know, we're excited about, you know, Viterra and Bunge Limited together. But I'll tell you just really excited are the teams. Right? They're engaged, and they're anxious. You know, we've continued to be competitors, and so the commercial teams have not been able to do that planning. We're excited about the commercial synergies when we're able to get those teams together and start to do the work as one Bunge Limited here into the future. So from that, that's part of where we are building off of. And then, you know, that'll also provide the cash for us to continue to invest as we go forward."
},
{
"speaker": "Operator",
"content": "This concludes today's question and answer session. I would now like to turn the conference back over to Greg Heckman for any closing remarks."
},
{
"speaker": "Greg Heckman",
"content": "I'd say thank you very much for joining us today. We appreciate your interest in Bunge Limited, and we look forward to speaking to you again soon. Have a great day."
},
{
"speaker": "Operator",
"content": "The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] |
bg | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the Bunge Global SA third quarter 2024 earnings release and conference call. All participants will be in listen-only mode. Should 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 star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Ruth Ann Wisener. Please go ahead."
},
{
"speaker": "Ruth Ann Wisener",
"content": "Thank you Operator, and thank you for joining us this morning for our third quarter earnings call. Before we get started, I want to let you know that we have slides to accompany our discussion. These can be found at the Investor Center on our website at bunge.com under Events and Presentations. Reconciliations of our non-GAAP measures to the most directly comparable GAAP financial measures are posted on our website as well. I’d like to direct you to Slide 2 and remind you that today’s presentation includes forward-looking statements that reflect Bunge’s current view with respect to future events, financial performance, and industry conditions. These forward-looking statements are subject to various risks and uncertainties. Bunge has provided additional information in its reports on file with the SEC concerning factors that could cause actual results to differ materially from those contained in this presentation, and we encourage you to review these factors. On the call this morning are Greg Heckman, Bunge’s Chief Executive Officer, and John Neppl, Chief Financial Officer. I’ll now turn the call over to Greg."
},
{
"speaker": "Greg Heckman",
"content": "Thank you Ruth Ann, and good morning everyone. Our team delivered a strong third quarter thanks to their ability to react quickly to shifting market dynamics to capture opportunities as they emerge. Our focused approach to leveraging our global platform enabled us to serve our customers at both ends of the value chain, farmers and consumers. We’re making great progress on integration planning for our announced combination with Viterra. The teams are working well together, confirming our confidence that we will be more complete as one combined company. Their commitment will ensure that we can effectively serve our customers from day one. We also continued to engage with the relevant authorities as we work towards gaining a few remaining regulatory approvals. Since our last call, we received conditional clearance from the European Commission and we’re well through the process of meeting the conditions. Conversations in other jurisdictions are constructive. We do not see any issues that would materially impact the economics of the deal. We expect to close the transaction later this year or early 2025. In addition to progressing on the Viterra transaction, we also completed other strategic priorities, including closing the sale of our interest in our non-core sugar and bio-energy joint venture in Brazil to our partner, BP. Turning to our results, we delivered another quarter of solid adjusted EBIT. We exceeded our expectations for the quarter. Great execution by the team led to stronger results in our core segments. Similar to the second quarter, we saw shifting margin environments across the globe with improved margins in some regions offsetting more muted conditions in others. Since we reported the second quarter, we’ve repurchased $200 million of Bunge shares, making progress against the repurchase plan we outlined following the announcement of the Viterra transaction. Looking ahead, many of the same market dynamics remain in place, which we expect to continue for the rest of the year. Based on what we see in the markets and the forward curves today, we now expect full year adjusted EPS to be at least $9.25. With that, I’ll turn it over to John for a deeper look at our financials and outlook. John?"
},
{
"speaker": "John Neppl",
"content": "Thanks Greg and good morning everyone. Let’s turn to the earnings highlights on Slide 5. Reported third quarter earnings per share was $1.56 compared to $2.47 in the third quarter of 2023. Reported results included an unfavorable mark-to-market timing difference of $0.16 per share and negative impact of $0.57 per share primarily related to transaction and integration costs associated with our announced business combination with Viterra. Adjusted EPS was $2.29 in the third quarter versus $2.99 in the prior year. Adjusted core segment earnings before interest and taxes, or EBIT was $561 million in the quarter versus $735 million last year. In agribusiness, processing results of $291 million in the quarter were down from last year as higher results in South American and European soy crush were more than offset by lower results in North America, European soft seeds, and Asia. In merchandising, higher results were driven by improved performance in our financial services, ocean freight and global oils businesses, more than offsetting lower results in global grades. Refined and specialty oils performed well but down from a strong prior year as higher results in Asia were more than offset by lower results in North and South America. Results in Europe were in line with last year. In milling, slightly higher results in North America were more than offset by lower results in South America, where higher raw materials costs pressured margins. Corporate and other improved from last year. The decrease in corporate expenses was primarily driven by a lower performance-based compensation. Other results were largely related to Bunge Ventures and our captive insurance programs. In our non-core sugar and bio-energy joint venture, higher sugar and ethanol volumes were more than offset by higher operating costs and lower ethanol prices. Lower results also reflected foreign exchange translation losses on U.S. dollar-denominated debt in the quarter compared to translation gains in the prior year. The first nine months of the year reported income tax expense was $236 million compared to $495 million in the prior year. The increase was primarily due to lower pre-tax income. Net interest expense of $94 million in the quarter was in line with last year. Let’s turn to Slide 6, where you can see our adjusted EPS and EBIT trends over the past four years, along with the trailing 12 months. The strong performance over the period reflects a combination of favorable market environment and excellent execution by our team. The recent trend reflects more balanced and less volatile markets translating into lower earnings. Slide 7 details our capital allocation. Year to date, we generated approximately $1.3 billion of adjusted funds from operations. After allocating $295 million to sustaining capex, which includes maintenance and environmental health and safety, we have $988 million of discretionary cash flow available. Of this amount, we paid $287 million in dividends, invested $592 million in growth and productivity-related capex, about two thirds of which relates to our large multi-year greenfield investments, and repurchased $600 million of Bunge shares. This resulted in a use of $491 million of previously retained cash flow. Based on our current progress on our greenfield projects, we now expect that we will end the year toward the higher end of the capex range of $1.2 billion to $1.4 billion, or slightly above. Moving to Slide 8, at quarter end readily marketable inventories, or RMI exceeded our net debt by approximately $2.8 billion. Our adjusted leverage ratio, which reflects our adjusted net debt to adjusted EBITDA, was 0.5 times at the end of the quarter. Slide 9 highlights our liquidity position. At quarter end, we had committed credit facilities of approximately $8.7 billion, all of which was unused at the end of the quarter, providing us ample liquidity to manage our ongoing capital needs. In addition, we had a cash balance of $2.8 billion accumulated in large part as a result of $2 billion in cash proceeds from the U.S. public debt offering that we closed in September. These amounts in addition to $6 billion in term loan commitments that we had secured last year will be used to fund the Viterra transaction. Please turn to Slide 10. The trailing 12 months adjusted ROIC was 13.8%, well above our RMI adjusted weighted average cost of capital of 7.7%. OIC was 11.3%. While returns have declined from recent highs, they remain well above our weighted average cost of capital of 7%. Moving to Slide 11, in the trailing 12 months, we produced discretionary cash flow of approximately $1.4 billion and a cash flow yield of 12.3% compared to our cost of equity of 8.2%. Please turn to Slide 12 and our 2024 outlook. As Greg mentioned in his remarks, taking into account year-to-date results, the current margin environment forward curves and the loss of income due to the sale of our ownership in the sugar JV, we now expect full year 2024 adjusted EPS to be at least $9.25. In agribusiness, full year results are forecasted to be up from our previous outlook, reflecting a better than expected third quarter but down compared to last year. Refined and specialty oils full year results are expected to be up from our previous outlook but down compared to last year’s record performance. In milling, full year results are expected to be down from our previous outlook, reflecting the lower than expected third quarter but up from last year. In corporate and other, full year results are expected to be similar to our previous outlook. In non-core, full year results are expected to be down considerably from our previous outlook due to the lower than expected third quarter and the loss of income from the sale of our ownership in the sugar JV, which closed on October 1. Additionally, the company currently expects the following for 2024: adjusted annual effective tax rate in the range of 22% to 24%, net interest expense in the range of $285 million to $305 million, capital expenditures in the upper end of the range of $1.2 billion to $1.4 billion, and depreciation and amortization of approximately $450 million. With that, I’ll turn things back over to Greg for some closing comments."
},
{
"speaker": "Greg Heckman",
"content": "Thanks John. Before turning to Q&A, I wanted to offer a few closing thoughts. Looking ahead, what impresses me most is our team’s commitment to day-to-day execution, along with continuous improvement. We’ve done a lot of hard work to strengthen our business and operations so that we can continue to provide quality products and services to our customers at both ends of the value chain. We’re always looking for additional opportunities to get better. We’ve spent significant capital improving the facilities and operations across our outstanding global footprint, and our team is making sure those investments pay off in improved efficiency and reliability. For instance, our U.S. plants had the best soy crush performance for a crop year ever, and we continue to run at high utilization rates. We also reached year-to-date record volumes in global rapeseed crushing and refining. In the quarter, we broke ground on an expansion of our palm and specialty oils facility in Avondale, Louisiana that we purchased last year. This facility, which has multi-oil capabilities, builds on our ability to provide specialty oils to our food customers in North America and is already exceeding our initial performance expectations. We’re excited to further grow our operations in this location that has significantly improved our reach across North America In today’s often complicated global environment, strengthening all areas of our business is more important than ever. Our combination with Viterra will further accelerate our diversification across assets, geographies and crops, providing us with more optionality to help address the world’s food security needs. While we always look for opportunities to improve, we are well positioned to deliver on our critical mission of connecting farmers to consumers to deliver essential food, feed and fuel to the world. With that, we’ll turn to Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question and answer session. [Operator instructions] The first question comes from Andrew Strelzik with BMO. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"content": "Hey, good morning. Thanks for taking the questions. I guess I wanted to start on crush margins - you know, there’s been a lot of concern in the market throughout this year on what would happen with crush margins, but the curve has only strengthened, at least for the U.S. for the rest of this year, and also 2025. I guess the question is how are you thinking about crush margins from here in terms of durability, the ability to capture that margin strength? I don’t know if there are offsets in other regions. Then the press release says that you passed through the 3Q processing strength to the guidance, but I didn’t know if you had made any changes to your assumptions for the fourth quarter."
},
{
"speaker": "Greg Heckman",
"content": "Let me start and John can fill in. I’d say the headline has been demand is good, so we’ve got livestock economics have been good really everywhere except China, where chicken’s been good but pork is bigger and has been the laggard, so very supportive on meal demand. Then soy oils is competitive globally, and some of the support there, of course, is palm, but just overall good demand. We’ve seen Europe, good demand, and part of that is lower soybean meal shipments out of South America. Brazil has seen a little bit of slower spot farmer selling and [indiscernible] some of the logistical commitments down there. Argentina has been margin challenged, but the margins have been good enough to cover fixed costs, so we’ve seen Argentina crushing even with farmers continuing to retain their ownership, kind of waiting for the next round of policy incentives. Then the U.S. continued to improve on strong soybean meal demand, and part of that has been less flows out of Argentina, but it’s been our own big soy crop, and I touched on China, which the margins have been very volatile there, really driven by softer and weak demand. That’s what we’ve seen carry in, and I don’t think the--you know, as usual, we don’t see a lot of visibility beyond the first half, but right now demand feels pretty good for meal and oil."
},
{
"speaker": "John Neppl",
"content": "Yes, and Andrew, maybe just to touch on the outlook for Q4 and whether we’ve had any changes, I think really the only couple of things I’d mention there, one is when we looked at--if you look at the over-performance in our core business in Q3, we think we probably pulled a little bit of earnings out of Q4, just given the market and customers and uncertainty around EUDR. We think maybe we pulled maybe $0.15 out of Q4 into Q3. Then the other one, of course, was the sale of sugar. We took about $0.15 of earnings out of our Q4 forecast."
},
{
"speaker": "Andrew Strelzik",
"content": "Got it, okay. Okay, that’s helpful. Then I guess if I zoom out, and I know you’re not giving ’25 guidance at this point, and obviously a lot of work to do around acquisitions and buybacks going forward as well, but if I just look at the base business at current levels, I guess, crush appears to be above the baseline. You see the refined continues to hold in better, so I guess just from a high level, how would you frame the set-up into 2025, I guess, relative to maybe a normal type of year for Bunge? Thanks."
},
{
"speaker": "Greg Heckman",
"content": "Yes, and I was kind of specifically speaking to soy. I probably should have mentioned soft is probably the one area that what we’ve seen in the last few years on the soft seed side, we’ve got a lot of weather impacting the Black Sea and European sun and rape production, so that’s not only hurt margins but you’ve got a farmer who’s going to be very spot there with a smaller crop. Now in Canada, we also are seeing canola margins continue to be good, but they’re off from the higher margins we enjoyed in the past, and some of that’s due to a smaller crop. Our soft seed crushing is a smaller business, but that’s definitely softer than what we’ve seen the last few years, so that would be part of the offset to the positive environment we’re seeing in soy."
},
{
"speaker": "John Neppl",
"content": "Yes, I think Andrew, in terms of the baseline, how we think about that in ’25, I would say we’ve been--refined and specialty oils have been pretty resilient, and I think probably logically will perform a little better than baseline in ’25. Crush, we’ll see. We’re off to a good start and crush margins are pretty resilient in the first half of the year, so we’ll see how that progresses, probably some opportunity there. But merchandising has been, continues to be a little performing below baseline, so that one, we’ll see what kind of volatility we get in the market and opportunity. And then of course, we’re taking sugar now out of our baseline, but with what we expect to do on share buybacks relative to sugar, that should be net neutral to slightly positive."
},
{
"speaker": "Andrew Strelzik",
"content": "Great, thank you very much."
},
{
"speaker": "Operator",
"content": "The next question comes from Salvatore Tiano with Bank of America. Please go ahead."
},
{
"speaker": "Salvatore Tiano",
"content": "Yes, thank you very much. I want to ask a little bit about your customers on the fuel side, and specifically, firstly there was an article earlier this week in Bloomberg about how you and some other big crushers are actually slowing down soybean purchases and crushing volumes, because you’re going to see less purchases from your fuel customers, so if you have any comments on that and your strategy there, what you’re seeing in terms of demand in Q4 and perhaps in Q1, as the tax credit plans could change, and also what other feedback you have, I guess. On the other hand, one of the major customers on the fuel side has mentioned that they’re using higher CI score feed stocks right now before they make a more major switch in Q1 to lower CI feed stock, so what are you seeing there? What are your thoughts on this and the risk it holds for next year?"
},
{
"speaker": "Greg Heckman",
"content": "Sure, yes. Let me divide that into a couple pieces. Let me talk first about the Bloomberg article - we did see that, and that is not accurate. We continue to have our purchases from farmers be very strong; in fact, if you compare this marketing year, it’s higher than the last several years, so that just wasn’t accurate. As far as the fuel demand and the customers, yes, we do have some uncertainty here in the U.S, and I might start at a high level and finish with the U.S.; but while we’ve had a lot of lack of clarity around U.S. policy, globally things feel better, right? You’ve got Brazil talking--you know, they put in the law and the fuel of the future, so we’re seeing them move from B14 here in ’24 to B15 in ’25, and moving towards B20 in 2030, so they’ll go up 1% annually. You’ve got Indonesia that just went from B35 and committed to go to B40, and then in Europe, there’s some support put in place now for SAF and maritime fuels, and so those have UCO caps, which will then lead to veg oils as well, so I think it feels better overall. Now back to the U.S., with our policy uncertainty and the switch from a blenders credit to a producers credit, and uncertain RVO, what we’ve got out there, we’ve got billions of dollars of assets that are proven technology in the ground on traditional biodiesel, renewable diesel, and even some SAF that’s running at really low capacity utilization because we haven’t got all the policy and the incentives right yet. We remain positive that will get worked out, right, because one of the things that the policymakers said they wanted to see is to make sure that we could have the supply there. I think what the market has shown, it’s done it’s work and we’ve shown that we do have the supply, capacity has been added, the market works, and we’ve been able to provide for that industry, so we remain positive that that will get worked out over the next year and that will be positive for demand from the fuel sector, from the renewable feed stocks here in the U.S."
},
{
"speaker": "Salvatore Tiano",
"content": "Perfect. If I may just follow up, I guess [indiscernible] new credit landscape, if someone can only use lower CI feed stocks, they would fully go away from soybean oil, but the main issue is obviously logistical and supply challenges, so do you have any views on the supply and the supply restrictions and limitations for tallow and used cooking oil, and how much essentially of the feed stock mix this could be next year or the next few years?"
},
{
"speaker": "Greg Heckman",
"content": "I think I would start again with if you look over the last few years, the market works, and so we’ve seen the low CI feed stocks as well as the vegetable oils, and as policy shifts, it finds its place to the right demand on the globe. There is more demand coming than any one feed stock can address."
},
{
"speaker": "John Neppl",
"content": "Salvatore, this is John. When you look at 45Z, of course we were hoping that would get finalized this year - it may still into Q1. A big part of that now is pushed from agricultural groups in the U.S., particularly farmers, to even the playing field and maybe provide either preference for U.S.-based supply or restrict the import of UCO and tallow and other feed stocks. That could have a pretty big impact on the farm economy, depending on the decision that’s made, and obviously we just want the U.S. farmer to have an even playing field. We think that’s important to get that right in the upcoming finalization of 45Z, but that would certainly drive how much forward feed stocks come into the U.S. It could be similar to last year. I don’t know if it will--you know, it’s hard to predict whether it’d be more than last year, but certainly if the changes come that I think the farming groups are hoping for, and I think we think is fair, it will certainly provide some tailwind for the products that we supply the industry."
},
{
"speaker": "Salvatore Tiano",
"content": "Thank you very much."
},
{
"speaker": "Operator",
"content": "The next question comes from Tom Palmer with Citi. Please go ahead."
},
{
"speaker": "Tom Palmer",
"content": "Good morning and thanks for the question. I wanted to just ask on the Viterra, and thanks for the update on expected timing. Just on the business’ recent results, does it affect at all how you look at the longer term earnings power for the business, or should we look at kind of the details you laid out last summer as still largely holding? Thank you."
},
{
"speaker": "Greg Heckman",
"content": "I would say absolutely not. We still have the confidence in this combination, it’s a great fit. They are not in the same place as we are. As we’ve had a chance to work on some of the integration planning, seeing that great team that they’ve got and seeing how these teams are working together, and they are as excited, I think, as all of us are to get this deal closed so we can all work together, because there’s just so much that we can’t do at this point in the process. We’re excited about what it means for the long term. This is going to give us a lot of alternatives and ways to grow and to continue to serve our customers in a very differentiated way, and that’s customers at both ends of the value chain."
},
{
"speaker": "John Neppl",
"content": "And Tom, I’d maybe just add, while we’re a little disappointed that things have taken this long to close, it has given us time to continue--we haven’t stopped and just sat and waited, we’ve been continuing to fine tune our planning and doing some things now that we would have maybe done after close, readiness around transition, around organizational design and integration, of course synergy capture. We’re focused on the things we can control around this transaction, and we’re very excited about that. As we’ve mentioned before, we weren’t totally surprised by Viterra’s first half performance given the broader market, but to Greg’s point, this is about a long term opportunity and we feel very good together about the things we can control, and ultimately the market environment will be what it is as we move forward. But in the long run, we think this is a hit."
},
{
"speaker": "Tom Palmer",
"content": "Okay, thank you for that. Then just one topic that had come up in previous quarters, and you did touch on it earlier, was just the lack of farmer selling in South America, I think, and how that’s maybe--you know, there’s offsets that maybe hurts margin in South America but it does seem to be helping soy crush margins as we look at Europe and North America. Just any thoughts on the pace of farmer selling? Is there a point where that should really pick up as we move towards maybe this new harvest in the first half of ’25? Thanks."
},
{
"speaker": "Greg Heckman",
"content": "Yes, we think that you probably are right - it will be in the first half of ’25, one, as the South America farmer gets a better idea in Argentina of how policy will shake out. Even if something’s communicated here in ’24, there’s not much of the year left to probably make much of a difference here, so I think first half ’25 will be key on that. Then in Brazil, where we’ve got some good rains and planting is really accelerating down there, I think we feel like we’ll see another big crop there in South America, and I think that will give some confidence to the producer. Then here in the U.S., of course, we’re harvesting a real big bean crop right now, and so as we get to the end of that, we’ll see how the producer--they never like a lower price than prior year, but ultimately you’ve got to make some decisions and manage some risk, and we’ll see that, I think, starting to move here in the first half of next year."
},
{
"speaker": "Tom Palmer",
"content": "Right, thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Manav Gupta with UBS. Please go ahead."
},
{
"speaker": "Manav Gupta",
"content": "Good morning. My question is on your growth capex. You’re obviously spending on your growth projects. Help us understand what’s the progress over there, when are the key start-up dates for these growth projects, when do you expect them to come online and start making a material contribution to the EBITDA?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, so we have four key large projects underway today, and I think that 2025 will really be the biggest year in terms of spending capex on those, as those projects move toward finalization. I think realistically on those projects, we’re looking at late ’24--I’m sorry, late ’25 commissioning to early ’26, so not probably a lot of impact on ’25 results just given the fact that you’ve got to work through commissioning and bugs as you get these plants up and going. I think really, we’ll start to look for first half ’26 for these to start contributing and expect all of them to be running by second half, so second half of ’26 is really how I’d see the addition to earnings from those projects from a run rate perspective. Then of course, once we complete those projects toward the end of ’25, early ’26, then we’ll start to see a more normalized capex level back half of ’26 and beyond."
},
{
"speaker": "Manav Gupta",
"content": "My follow-up here is a little bit--you’ve also mentioned this, that although the deal has been delayed a little, it’s given you more time to plan, so help us understand now when Viterra does close, do we expect some of those synergies to be realized earlier than expected? How has the timeline of moving the deal allowed you to plan better as you close on it?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, it’s really been around the--I’ll say the organizational design and getting things ready and right for day one with no disruption. Unfortunately despite the extended time frame, we still cannot get together commercially, and so we have not been able to accelerate any of the commercial planning and the commercial roles, but what we--you know, our role in the market together, that unfortunately we have to wait until close. But we have been able to spend more time with the teams, make sure we’re getting the right people in the right roles going forward, and I think we feel like a lot of the uncertainty sometimes that can happen right after close, we’re addressing that stuff now so that people have focus and confidence the day we close the transaction, and lower our risk of any kind of disruption in the day-to-day. But again, unfortunately we have not been able to accelerate the commercial planning side, which is really where we think the long term opportunity is."
},
{
"speaker": "Manav Gupta",
"content": "Thank you so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Heather Jones with Heather Jones Research. Please go ahead."
},
{
"speaker": "Heather Jones",
"content": "Good morning, thanks for the question."
},
{
"speaker": "Greg Heckman",
"content": "Morning Heather."
},
{
"speaker": "Heather Jones",
"content": "I had a question on bean oil and meals, but starting with bean oil, given the biofuel policy uncertainty we’ve got in the U.S., demand for bean oil could be very depressed in late Q4 and Q1. I was just curious if you think the export demand could be strong enough to offset that, given soybean oil is attractive price relative to palm and rape. Also, do you see any potential logistical constraints to the U.S. handling that magnitude of exports?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, I think you’ve got that right, that soy oil is competitive globally right now against palm and some of the soft oils, and we’ve now seen the U.S. being competitive again. I do think we can handle those logistics because the U.S. was always holding the residual stocks prior to some of the biofuels demand the last few years. We held the residual stocks for the world and we did export as it was needed, so as the market is calling for that, I think we’re in good position to do that and that’s one of the things that we feel good about on the oil demand side globally."
},
{
"speaker": "Heather Jones",
"content": "Okay, thank you. Then on meal, that demand has been much stronger than expected this year, and it seems to be because of a big step-up in feed ration inclusion, because animal numbers globally just aren’t up that much. When we look to ’25, I was wondering if you think there’s room for additional sizeable increases in ratio inclusion, assuming that pricing is relatively attractive."
},
{
"speaker": "Greg Heckman",
"content": "Yes, soybean meal demand has been very good, and you’ve got MiD proteins around, you’ve got a wheat crop that’s not as competitive for feeding on the wheat side, and you’ve got the other--if you look historically, when meal gets cheaper, people like to feed it. They like feeding meal, and when they can--when the numbers work and the animal profitability is up, which is the situation we’re in right now, we see the inclusion rates go up, and I think that’s the demand that we have seen this year in the U.S. and globally, so we kind of expect that to continue there into ’25. We can’t see much past the first half, but that’s what we see right now."
},
{
"speaker": "John Neppl",
"content": "Yes, and Heather, I would just add that I think one of our strengths on the commercial side is our ability to market meal globally, and we actually market today more meal than we produce ourselves, so we’ve got a team that’s very steeped in the experience of marketing meal globally and as things change and as market demand ebbs and flows, I think our team is usually right on top of that."
},
{
"speaker": "Heather Jones",
"content": "If I could sneak in a clarifying question, you guys probably have as good visibility as anyone into feed profiles globally. Could we see a situation in ’25 where we have an increase in inclusion rates as much as we did this year, like--I mean, I don’t know if we’re near a cap, or could we see another sizeable step-up?"
},
{
"speaker": "Greg Heckman",
"content": "I think you’ve got to continue to watch how it sets up versus the competing, and what we do know right now is less wheat feeding, less MiD proteins, we’ve got some smaller seed crops - you know, you don’t make as much meal in the soft crush, but you’ve got Europe and Black Sea with some smaller seed crops, so some less meal there. Yes, it’s all part of the factors that are setting up the current situation we’ve got, which has been constructive. You’ve all seen it in the numbers."
},
{
"speaker": "Heather Jones",
"content": "Okay, thank you so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Stephen Hayes with Morgan Stanley. Please go ahead."
},
{
"speaker": "Stephen Hayes",
"content": "Good morning. Maybe just wanted to ask kind of a follow-up question on the refined side of things. I think there was a comment before to an earlier question about it being resilient and better than baseline in 2025. I think you’re still quite a bit above baseline, where we are right now, so can you kind of help frame, I guess, what a bit better looks like and how we should be thinking about it next year?"
},
{
"speaker": "John Neppl",
"content": "Yes, I’ll start and Greg can jump in. Look - I think we certainly are seeing as expected, and what we contemplated in our long term baseline was that refining premiums would moderate and the demand would go back more toward crude edge oil, especially for the energy side. I think what we’ve seen is a very strong, somewhat of a resilient market on the food side - it’s been very good. We had about a $400 million baseline for that business, and as you pointed out, we’ve been performing above that. I think just given our increased capability in our portfolio and what we’ve seen on the food side, plus probably a little bit more resilient demand on energy, I think we feel like we’re set. It’s hard today to predict what that above baseline number is going to be - I think we have to get a better handle on where things are heading from a policy standpoint. These things around 45Z and RVO and things like that could have an impact certainly on even the refining versus crude piece of it, but ultimately we feel pretty good about that business being on probably more solid footing than it’s ever been in total, when you look at the specialty side and that refined piece. Obviously the refining - again, the energy piece of that, we did expect to moderate, but we’ve been very pleased with the food demand."
},
{
"speaker": "Stephen Hayes",
"content": "Got it. Thank you for that color. Then just on the meal side of things, there’s been a bunch of capacity that’s kind of come on in the U.S. this year, understanding you said it’s not fully running yet and it takes some time to kind of hit that run rate. Is the market feeling the impact of this yet, or how should we think about it as even more supply is expected to come on in ’25, and there’s some projects slated for ’26, yourselves included? How should be thinking about the market’s ability to, I guess, absorb the excess meal going forward?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, the thing about meal, it’s a very global market. I think John mentioned, we market more than we produce. We continue to make the investments we’ve made, investments in our PNW asset to be able to handle meal here in the U.S. and get it to export, so I think the investments will continue to be made to connect the supply to the demand globally. You know, as you’ve said, those plants, they’re not like flipping a light switch - they do come on, and so they kind of get dovetailed into the demand, and price does its work around the inclusion rates, so we think the market will do its work."
},
{
"speaker": "John Neppl",
"content": "Maybe I’d just add one thing, Stephen. Greg mentioned the PNW, where we’re adding some capacity for export of meal. We’re doing the same in the Gulf, so we have our big project, of course - our expansion with Chevron in the Gulf of Destrehan, our adjacent export terminal, we’re expanding the capacity of that to handle more meal to be exported from the U.S. We’ve anticipated this for two or three years, and the projects are well underway and moving along, and we’ll be well positioned, as well positioned as anybody to get this stuff out in the market where it needs to go internationally."
},
{
"speaker": "Stephen Hayes",
"content": "Thank you, appreciate it."
},
{
"speaker": "Operator",
"content": "Our next question comes from Ben Theurer with Barclays. Please go ahead."
},
{
"speaker": "Ben Theurer",
"content": "Yes, good morning. Greg, John, thanks for taking my question. Just a few things to--clarification, I think you said there’s a $0.15 impact on the loss that you need to book for the bioenergy, the disposal. Was that something that you expected to happen in 3Q and now it’s just moved into 4Q for that implicit downgrade of that $0.15? That would be question number one. Then just question number two related to the timing of Viterra and the pending approvals, can you remind us which are the big jurisdictions that are still pending right now?"
},
{
"speaker": "John Neppl",
"content": "Yes, I’ll start with sugar and Greg can talk about Viterra timing. We didn’t--we had a forecast the full year for sugar because we really didn’t know when this was going to actually close. The Q3 was simply underperformance, so we didn’t have a good Q3 in sugar, as we highlighted, and then Q4, we lost about $0.15 of earnings that was in our prior forecast because of selling and closing on Aug.1, but we locked that in there until we actually certainty around close. That’s just reflective of the lost earnings for Q4, and then of course as I mentioned, you can see the results for Q3, that we were well below where we expected."
},
{
"speaker": "Ben Theurer",
"content": "Yes, okay. Got it."
},
{
"speaker": "John Neppl",
"content": "Overall, second half probably down $0.35, I would say, between Q3 and Q4 from what we had originally expected."
},
{
"speaker": "Ben Theurer",
"content": "Just sugar?"
},
{
"speaker": "John Neppl",
"content": "Just sugar."
},
{
"speaker": "Ben Theurer",
"content": "Okay."
},
{
"speaker": "Greg Heckman",
"content": "With the core business stepping up and covering that in the second half, so it’s a better quality of earnings. We like the way it happened."
},
{
"speaker": "Ben Theurer",
"content": "Well said. Then on the pending approvals?"
},
{
"speaker": "John Neppl",
"content": "The regulatory - yes, on the regulatory since the last time we were all together, of course, we got the EU conditional approval, where we’ve got to do some asset sales in Poland and Hungary, so we’re working through that process currently and making good progress. In Canada, you may have seen there’s a new transport minister there - we are engaged with them and making great progress addressing all the questions and closing out the issues. We expect that to be in the relative near term. Then the other, of course, is in China, and we continue to work with the Chinese authorities. We have very productive discussions and able to respond to all their questions, so again feel that that should be hopefully here in the near term. Lastly, look forward to getting the regulatory approvals done, as we said. In those scenarios, we don’t see anything that would be material to the economics of the transaction, and we just cannot wait to put these two great companies together and get these teams to work. Everybody is excited and feels like we’ve got our hands tied behind our backs here, and can’t wait to get to the next stage."
},
{
"speaker": "Ben Theurer",
"content": "Okay, and then Argentina - I mean, obviously that’s a post-close approval process, but there was some news just recently about Argentine soy exporter that you were planning to take over, and that got kind of blocked out of bankruptcy. Has that any consequences on how you think about the post-close approval process in Argentina?"
},
{
"speaker": "Greg Heckman",
"content": "No. No, not at all. Of course, we’ve been in Argentina a long time, we work closely with the authorities there. It’s an important operation for us, so the appeal is just part of the process, the legal process down there. We weren’t really surprised by it. It’s kind of a technical issue, and we’ll continue to work through the process. But no, we’ve always thought about those processes working in parallel."
},
{
"speaker": "Ben Theurer",
"content": "Okay, thank you."
},
{
"speaker": "Operator",
"content": "This concludes the question and answer session. I would like to turn the conference back over to Greg Heckman for any closing remarks. Please go ahead."
},
{
"speaker": "Greg Heckman",
"content": "Thank you. Thanks again for joining us today, and we appreciate your interest in Bunge. I want to just close by thanking the team one more time for their dedication. Our performance is a testament to the quality of our people and the culture that we’ve built here at Bunge. It’s allowed us to execute on our day-to-day business, to maintain a relentless drive for continuous improvement, and to make great progress on the integration planning. I’m as excited as ever about the future of Bunge and what we’re going to be able to accomplish together with Viterra. We look forward to speaking with you again soon, and have a great day."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect."
}
] |
bg | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning everyone and welcome to the Bunge Global SA Second Quarter 2024 Earnings Release Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the floor over to Ruth Ann Wisener. Ma'am please go ahead."
},
{
"speaker": "Ruth Ann Wisener",
"content": "Thank you, operator and thank you for joining us this morning for our second quarter earnings call. Before we get started, I want to let you know that we have slides to accompany our discussion. These can be found in the Investor Center on our website at bunge.com, under Events & Presentations. Reconciliations of non-GAAP measures to the most directly comparable GAAP financial measures are posted on our website as well. I'd like to direct you to Slide 2 and remind you that today's presentation includes forward-looking statements that reflect Bunge's current view with respect to future events, financial performance, and industry conditions. These forward-looking statements are subject to various risks and uncertainties. Bunge has provided additional information in its reports on file with the SEC concerning factors that could cause actual results to differ materially from those contained in this presentation, and we encourage you to review these factors. On the call this morning are Greg Heckman, Bunge's Chief Executive Officer; and John Neppl, Chief Financial Officer. I'll now turn the call over to Greg."
},
{
"speaker": "Greg Heckman",
"content": "Thank you, Ruth Ann, and good morning, everyone. I want to start by thanking the team for their dedication and focus. We continue to effectively deliver on our commercial and operational priorities, making excellent progress on integration planning. I'm so impressed by this team's passion and drive, excited by the opportunities to grow our existing business, and look forward to the future combination with Viterra. Two teams are working very well together in the planning process and are identifying in many ways will be a more complete company post close. Regulatory approval process is continuing to progress. While we have the bulk of the approvals required, we are continuing to constructively engage with relevant authorities in the remaining jurisdictions. Based on ongoing discussions, we see no issues that would be material to the economics of the deal, and we expect to receive the remaining approvals and close the transaction in the next several months. Turning to our results, we delivered solid adjusted EBIT, reflecting improved margin environment in some regions during the second half of the quarter, partially offset by more muted conditions than others. Our balanced market requires a different approach. We're very proud of the team for their ability to adapt to deliver. Rest of 2024, I think the dynamics we have discussed are still in place. Demand is good, customers at both ends of the supply chain and largely in the spot market, limits visibility later in the year. We're controlling what we can amid the evolving supply/demand environment in markets around the world. We're tapping into the tremendous work we've done over the past several years to strengthen our business. Based on what we see in the markets and the forward curves today, we now expect full year adjusted EPS of approximately $9.25. I'll now hand the call over to John to walk through our financial results and outlook in more detail, and then we'll close with some additional thoughts. John?"
},
{
"speaker": "John Neppl",
"content": "Thanks Greg and good morning, everyone. Let's turn to the earnings highlights on Slide 5. Reported second quarter earnings per share was $0.48 compared to $4.09 in the second quarter of 2023. Reported results included an unfavorable mark-to-market timing difference of $0.82 per share and a negative impact of $0.43 per share related to transaction and integration costs associated with our announced business combination with Viterra. Adjusted EPS was $1.73 in the quarter versus $3.72 in the prior year. Adjusted core segment earnings before interest and taxes, or EBIT, was $519 million in the quarter, which is $893 million last year. Agribusiness, processing results of $265 million in the quarter or down from last year as higher results in Europe soy and soft seed crush, but more than offset by lower results in North and South America and Asia. Merchandising, lower results were primarily driven by global grains. Our volumes were more than offset by lower margins. Refined and specialty oils performed well, but down from a strong prior year. Higher results in Asia were more than offset by lower results in North and South America and Europe. Milling, higher results were primarily driven by South America, reflecting higher volumes and margins, both [ph] in the U.S. were in line with the prior year. Corporate and other improved from last year. The decrease in corporate expenses is largely due to lower performance-based compensation. Our results in other were primarily related to our Captive insurance program. In our non-core sugar and bioenergy joint venture, core results were due to lower Brazil ethanol prices, which more than offset higher sugar prices. Results were also negatively impacted by approximately $15 million in foreign exchange translation losses with U.S. dollar-denominated debt. Results in the prior year included a $39 million benefit, reversal of a tax valuation allowance. The first six months of the year, reported income tax expense was $147 million compared to $381 million in the prior year. The decrease is primarily due to lower pre-tax income. Net interest expense of $86 million in the quarter was in line with last year. Let's turn to Slide 6, where you can see adjusted EPS and EBIT trend over the past four years, along with the trailing 12 months. Strong performance over the period reflects a combination of favorable market environment and full execution by our team. The more recent trend reflects more balanced and less volatile markets, translating into lower earnings. Slide 7 details our capital allocation. First half of the year, we generated $895 million of adjusted funds from operations. After allocating $191 million to sustaining CapEx, which includes maintenance, environmental, health, and safety, we had $704 million of discretionary cash flow available. Of this amount, we paid $191 million in dividends, invested $342 million in growth in productivity related CapEx, half of which relates to our large multiyear greenfield investments, and repurchased $400 million of Bunge shares. This resulted in a use of $229 million of previously retained cash flow. We are in progress on our greenfield products. We could end the year with the higher end of our CapEx range of $1.2 billion to $1.4 billion, or perhaps slightly above. However, this would reduce our 2025 expectations. Moving to Slide 8. Quarter end readily marketable inventories, or RMI, exceeded our net debt by approximately $3 billion. Our adjusted leverage ratio, which reflects our adjusted net debt to adjusted EBITDA, was 0.5 times at the end of the quarter. Slide 9 highlights our liquidity position. At quarter end, we have committed credit facilities of approximately $8.7 billion, which includes $3 billion that will become available to draw upon at the close of the Viterra transaction. With the $5.7 billion available to us currently, all was unused at the end of the quarter, providing sample liquidity to manage on our ongoing capital needs. These amounts are in addition to the $8 billion of term loan commitments that we have secured to fund the Viterra transaction. Please turn to Slide 10. Trailing 12 months adjusted ROIC was 15.2%, well above our RMI adjusted weighted average cost of capital of 7.7%. ROIC was 12.2%, well above our weighted average cost of capital of 7%. Moving to Slide 11. For the trailing 12 months, we produced discretionary cash flow approximately $1.5 billion, a cash flow yield of 13.7% compared to our cost of equity at 8.2%. Please turn to Slide 12 and our 2024 outlook. As Greg mentioned in his remarks, taking into account first half results and the current margin environment forward curves, we now expect full year 2024 adjusted EPS of approximately $9.25. Note that this forecast excludes any pending transactions that are expected to close during the year. In the Agribusiness, full year results are forecasted to be in line with our previous outlook, reflecting higher results and processing, largely offset by lower results in merchandising. Notes [ph] are expected to be down compared to last year. The refined and specialty oils full year results are expected to be up from our previous outlook, due to a better-than-expected second quarter, but down compared to last year's record performance. The milling, full year results are expected to be similar to our previous outlook and up from last year. In corporate and other, full year results are expected to be similar to our previous outlook. In non-core, full year results in our sugar and bioenergy joint venture are expected to be down slightly from our previous outlook and down significantly last year. Additionally, company expects the following for 2024; adjusted annual effective tax rate of 22% to 25%; net interest expense in the range of $280 million to $310 million; capital expenditures in the range of $1.2 billion to $1.4 billion, as I mentioned earlier; and depreciation and amortization of approximately $450 million. With that, I'll turn things back over to Greg for some closing comments."
},
{
"speaker": "Greg Heckman",
"content": "Thanks John. So, before we go to Q&A, I just want to offer a few closing thoughts. As we look ahead, the fundamental drivers of our business remain strong. Long-term demand for our food, feed, and fuel product services continues to increase. With our global platform, we're very well-positioned to find solutions to meet the needs of our customers at both ends of the value chain regardless of the market environment. Our strategic combination with Viterra will help us accelerate our diversification, assets, geographies, and crops, providing us with even more capabilities and optionality to address the world's most pressing food security needs. As I mentioned earlier, both teams have been hard at work planning our integration and we look forward to unlocking this additional organizational capacity post close. We're also progressing on a range of other strategic initiatives that will strengthen our company for the future, including the sale of our interest in the sugar and bioenergy joint venture in Brazil to partner BP. I'm very pleased with the great work the team has done to become a leader in the industry. However, this business is not core to Bunge's long-term strategy, divesting it will allow us to focus those resources on our core businesses. We also recently completed a commercial pilot season in our effort to provide lower-carbon solutions for farmers and in consumers. Working with our partners, Corteva and Chevron, farmers planted over 5,000 acres of winter canola in the Southern U.S. After a successful harvest, the plan is to significantly increase acreage to 35,000 for the next crop year. We hope to build on these promising results to meet consumers' growing demand for energy, creating more environmentally sustainable future, driving additional revenue sources for farmers. In addition, we jointly tested a traceability platform using blockchain technology for sustainable soy with CP Foods, global leader in food and feed committed to nutritious, safe, and traceable products. We successfully shipped several vessels of deforestation-free soybean meal from Brazil to Asia, allowing CP Foods to trace the product from farm to processing and transportation, all the way to destination. This is another example of the work Bone is doing to increase transparency and reliability and end-to-end traceability of our customers fulfill their sustainability commitments. Our focus remains on delivering great value to all stakeholders, while investing to strengthen our business, so that we can provide customers with solutions, not only today, but over the longer term. And while we always look for opportunities to improve, we're well-positioned to deliver on our critical mission of connecting farmers to consumers to deliver essential food, feed, and fuel to the world. And with that, we'll turn to Q&A."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, at this time, we'll begin the question-and-answer session. [Operator Instructions] Our first question today comes from Ben Theurer from Barclays. Please go ahead with your question."
},
{
"speaker": "Ben Theurer",
"content": "Yes, good morning Greg, John. Thanks for the presentation. And just my first question is just around understanding the drivers behind the guidance and as you look at it. If we go back three months, you sit around $9, roughly 50/50 split, which obviously, if we just do the math, we take $4.50 for the second half, add the $4.70-something now, gets us to $9.25. But clearly, from three months ago, we've seen complete different environment in crush nearby just conditions have changed. So, I just want to understand what are you seeing in the market to what feels to be coming out with a rough conservative guidance just given where crush is right now, what have you been able to lock in or not? How the volume is? And how we should think about the usual fourth quarter skew that seems to be not as pronounced this year as maybe in prior years? So, that's just -- conceptually if you could explain that to us."
},
{
"speaker": "Greg Heckman",
"content": "Sure. Let me start and good morning. But yes, as you kind of laid out, we overperformed in the first half to what we had talked about since we were together last time. Gross margin did improve late in Q2 and that also gave us visibility into Q3 and where we have been able to lock some margins, and that gave us the confidence to roll it through. Now, that being said, Q4 margin curves are very inverted. We've got very little visibility. And while the demand oil and meal remains strong, the end customers, as everyone knows, the farmer vary spot, as well as the consumer vary spot. So, we just don't have much visibility in that Q4. And as you called out, it's historically an important one for us. So, I think had the confidence to roll it through and call it, but that's what we see now and that's why we said the approximate $9.25 million."
},
{
"speaker": "John Neppl",
"content": "And I think, Ben, maybe just to add one. When you look at the second half, while the overall forecast for second half didn't change, we've shifted a little bit more towards Q3, where we were 40/60 before. But not a lot of shift, but probably more like 45/55 at this point. So, a slight shift to Q3 from Q4."
},
{
"speaker": "Ben Theurer",
"content": "Okay, and that's good color. And then just on -- I know you might not be able to talk too much about it, but you've made some comments on the pending regulatory approvals with Viterra, and your conversations imply not any meaningful financial adversities as you potentially have to look into divestitures. Just wanted to see if you could give us a little bit more color on how the negotiations are going and what's like the kind of things you might be asked to do in order to get this deal over the finish line?"
},
{
"speaker": "Greg Heckman",
"content": "Sure. The team has been doing great work, and we have the majority of the jurisdictions have all issued clearances. We are currently engaging with the EU, Canada, China and then just a handful of others as we're kind of getting to the end of the process. The team has done a great job on the integration plans, on preparing for the financing, the capital structure and the plans of our leadership team. Those plans are in place. Now, as you know, we have to continue to operate as separate companies until we're able to close the transaction. But as I said, we're making progress, and we expect to include that in the next several months. Many of the current conversations are going on are confidential. But some of those timelines are rolling up on us pretty quiet as things become public, then we'll be able to share those."
},
{
"speaker": "Ben Theurer",
"content": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Adam Samuelson from Goldman Sachs. Please go ahead with your question."
},
{
"speaker": "Adam Samuelson",
"content": "Yes, thank you and good morning everyone. Maybe first question on the merchandising side Agribusiness. And so you kind of as you alluded crush margin environment has improved in the nearby, but the comments on the merchandising piece were a little bit more tempered. I guess I'd love some additional color on what you're seeing in terms of farmer selling in Brazil, in Argentina, and how those are influencing kind of your outlook for merchandising over the balance of the year. And then I got a follow-up question on the Refined Oil side."
},
{
"speaker": "Greg Heckman",
"content": "Okay. Sure. Yes. So, if you look at Argentina, the crop definitely has recovered, right? 2023 crop was about half of what we're going to get this year. But the selling has been very slow. And part of that, of course, is the shift to lower prices. The producers don't like that. And then with the government policy that really has an economic catalyst to driven and become selling. So, it's been a very, very slow pace there. And the second half is really going to be about the FX and the government policy to see how that develops in Argentina. In Brazil, so you ended up with a combined bean and corn crop that was about 30 million metric tons lower than, I think, what the industry expected. And I think the industry had logistics in place to be able to handle that larger crop as we saw last year in some of the tightness and strains in that. And then you end up with that 30 million metric ton smaller crop and the farmer selling, again, being very spot and very opportunistic as the farmer doesn't like the lower prices. That smaller crop than drove a lot of pressure around the logistics and that's hurt margins and especially in the merchandising. And then when you take the other piece, globally, while the demand is good for meal and oil, the consumer has been rewarded for moving to the spot, right? There aren't the same challenges in the supply chain and worried about delivery. So, they pulled down inventories, they pulled down the length of their supply chain, and they've been rewarded for by the spot if prices have become lower. And so that's been a little bit tougher for the environment in merchandising as well. And then North America, again, slower farmer selling. Again, don't like the lower prices as markets become more balanced on the S&D, although we have seen the livestock margins improving there. This will really be about weather in the Northern Hemisphere. We got soybeans entering kind of a critical window and the producer generally is when they're looking out their door and what they see and how they see that develop here in North America, and you can see how the marketing will continue. And then, of course, we're also watching, in the Northern Hemisphere, the weather and temps on the canola crop there in Canada."
},
{
"speaker": "Adam Samuelson",
"content": "That's really helpful color. And then just on the refined oil side, you talked about raising the outlook largely to reflect the second quarter performance, which the release you cited, Asia being kind of the area of year-on-year strength. Was that what surprised you relative to your expectations three months ago? And just help us think about the forward for why you don't think that strength would be persisting in the second half at quite the same level?"
},
{
"speaker": "Greg Heckman",
"content": "We received a little bit of help on the tight cocoa butter supply and our cocoa butter equivalents on our tropical oil side in the RS, so that was somewhat helpful. And then we did see some stronger energy demand, some additional energy demand come in late that we weren't expecting in the U.S. So, that was constructive. And I think when we look at the balance of the year, we don't have that visibility, but we're calling that out in the puts and takes. And I think the lower prices always drive demand, and that's, I think, true not only in the inclusion side on soybean meal, but we're seeing that drive demand in soybean oil for both food and especially on the energy side here."
},
{
"speaker": "Adam Samuelson",
"content": "I appreciate that color. I'll pass it on. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Heather Jones from Heather Jones Research. Please go ahead with your question."
},
{
"speaker": "Heather Jones",
"content": "Morning. Thanks for taking the question."
},
{
"speaker": "Greg Heckman",
"content": "Good morning."
},
{
"speaker": "Heather Jones",
"content": "I just wanted to ask about your coverage going into Q3 and Q4. Greg, you mentioned the customers and the farmers have been very slow to buy or sell. But just wondering -- because we had the soy crush in the U.S. has been markedly lower than people expected and so you had these rallies. And so as we're thinking about your Q3 and Q4, but particularly Q3, how much of that is covered? And so do you have any exposure to the robust margins that we're seeing at present?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, I think if you look at Q2 and kind of the global setup, we were pretty well hedged, and a lot of that strength came very late in the quarter. Now, I'll say the team also did a great job of executing -- as they executed the crush we have on, and then closing out the balance of the open capacity that we had. As we've seen that run up late Q2, we have been able to go ahead and hedge some of Q3 and lock that in. That's what gave us the confidence to roll the overperformance there in the first half, to roll it through the year when we went to $9.25 that being said, in Q3 and Q4, there's really no liquidity yet and very low visibility. So, I think those are the keys that we'll be watching here as things develop for the late Q3 and the balance of Q4."
},
{
"speaker": "John Neppl",
"content": "Yes. Maybe just to add there, Heather, that we're largely covered for Q3 at this point, especially on the canola side. Sun is affected a little bit by crop, so maybe not as much cover there. But really covered on soy as well here as of the end of July."
},
{
"speaker": "Heather Jones",
"content": "Okay. And another on the Argentina side. Just was wondering if you could help us understand, not only more outlook but also what happened in Q2. Because I had repeatedly heard from those in the industry and just read that there were periods during the quarter where cash margins were some of the best that industry has ever experienced. And it was around time when the farmer would sell. But clearly, you all are talking -- your commentary is very different from that. So, I was just wondering if you could help me to understand the difference between those and then how you're thinking about that business for the second half?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, I think you're right on the fact that the farmer selling came in some as -- it was slow and it came in kind of drilled out in different surges. That did provide some ability to crush above fixed costs, but I would not say we saw the robust margins that you're -- that you may have picked up. That being the case, it really depends on how the farmer reacts on the second half. Now, the offset of that, right, was lower soybean meal exports that were moving into Europe. And so we continue to see strong margins there in Europe with good demand and less meal imports. That was kind of the other side of the sword."
},
{
"speaker": "Heather Jones",
"content": "Oka, all right. Thank you so much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Salvator Tiano from Bank of America. Please go ahead with your question."
},
{
"speaker": "Salvator Tiano",
"content": "Thank you very much. So, firstly, on merchandising, I'm wondering -- I think it was two years ago when you said that your normalized merchandising earnings should be around $75 million to $100 million a quarter. So, we've been below the low end for a few quarters now and even more so this Q2. Has this made you change your normalized earnings outlook? Or is it simply that the ag situation is so bad that you're earning so much below normalized? And when do you expect us to go back to the $75 million to $100 million figure?"
},
{
"speaker": "Greg Heckman",
"content": "Yes. Remember, those were our assumptions in the model for our baseline, and we are operating below baseline today. Now, that's always the toughest one to predict. And as those opportunities come up, I think the team does a good job of capitalizing on those. But we've been in a pretty interesting time of transition, right? And when these markets generally transition from higher price into a more balanced S&D, that's when you see this adjustment and the pressure on margins, right? The farmers have good, strong balance sheets. They have a lot of storage available and they don't like selling lower prices. So, they're building inventory, if you will, and seeing how the weather plays out and how the S&Ds play out. And then you've got the consumer, which is actually reducing inventories, shrinking their supply chains and their patience is also being rewarded. So, the market gets much more spot to put pressure on the margins until we get back in balance. And I think we're getting pretty close there now, where some of the puts and takes around what could happen from a weather and what could happen from a demand start to be more of an upside on -- as opportunities develop. But I think that's really what you've seen in the transition of the market going through, and that's what we've been seeing."
},
{
"speaker": "Salvator Tiano",
"content": "Okay, perfect. Thank you. And also, I want to ask a little bit about refined products. It continues to be the one segment that quarter-on-quarter, you're -- it looks like you're topping your own expectations. And if you can say to why -- where did things go better than you expected? And also, is it mostly on the fuel side? Is it mostly on the edible oil side?"
},
{
"speaker": "Greg Heckman",
"content": "It's been both. Our food customers -- while we're seeing the customers trade down some on the brands and things that they're on -- eating at home as well as the shift of where they're eating away from home, we've probably been maybe a little bit of a beneficiary to that favorable mix for oil demand. And then also when you think about oil demand, it doesn't go one-for-one with the food demand. So, that's been pretty resilient on the food side. And then with the lower price, we've seen some improvement on the energy demand as well. And then lastly, as I was talking about on the tropical side, we've definitely been a benefit of the tighter cocoa butter supply with our cocoa butter equivalents, and helping some of our customers solve problems on the supply side and/or lowering their cost for -- when they reformulate into our products. So, the team has been doing a great job, the technical team and the execution team, working with our customers as they're deal with a little bit of a challenging environment."
},
{
"speaker": "Salvator Tiano",
"content": "Thank you very much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tom Palmer from Citi. Please go ahead with your question."
},
{
"speaker": "Tom Palmer",
"content": "Good morning. Thanks for the question. I wanted to ask on capital allocation. Are you done with share repo until the Viterra transaction closes? Or might we see something sooner, just given the slightly extended timeline? And if not repo, what's kind of the use of the excess free cash flow? Would it just be for debt?"
},
{
"speaker": "John Neppl",
"content": "Thanks Tom, this is John. Yes, I think -- look, we're not going to probably commit to any share repurchases prior to Viterra close, mainly because we've got leverage commitments and targets that we want to hit going into the close process, because we're expecting a ratings upgrade relative to the -- is related to the transaction. But we are still very committed to that program and expect to execute that post close. We did give ourselves an 18-month window post close, but we'll obviously do what makes sense when it makes sense. And I would just add that with the announcement of sugar, we're hoping to close that maybe late this year. Certainly, proceeds from that will -- could play a meaningful role in the repurchase program, increasing it by some meaningful amount of that those proceeds."
},
{
"speaker": "Tom Palmer",
"content": "Great. Thanks for the color there. And then I just wanted to ask on kind of capital plan for the next couple of years. You've got this multiyear CapEx cycle. I think we're getting a little bit longer in the tooth here in terms of price -- will start opening next year. Just any early thoughts on how to think about 2025 CapEx and how it might compare to what we're seeing this year? And again, this is -- I understand for Viterra--"
},
{
"speaker": "John Neppl",
"content": "Yes. So, our range -- I think we're going to be at the high end of our range this year. It could be a little bit above the $1.4 billion, depending on how things play out here toward the end of the year on bigger CapEx expenditures. But we do expect next year to be up from that, probably closer to the $2 billion range, $1.9 billion to $2 billion, just given all of these projects are going to really be in full swing in terms of development. Then -- and we should make great progress next year on getting those close to commissioning. But commissioning will really be probably in 2026 on the four major projects that we're working on today, but we'll see a significant drop off. Probably as of today, absent any other opportunities coming along, we do expect CapEx to drop potentially up to 50%. This is all excluding Viterra, but we could see a 50% drop in CapEx in 2026 versus 2025."
},
{
"speaker": "Tom Palmer",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Manav Gupta from UBS. Please go ahead with your question."
},
{
"speaker": "Manav Gupta",
"content": "Good morning. My first question is, since the time you announced the Viterra transaction, until now, there has been some financials reported by Viterra. And I'm just trying to understand if those numbers that were reported met your expectations or maybe even exceeded the expectations."
},
{
"speaker": "Greg Heckman",
"content": "Yes. As you know, we've got to run the companies separately until close. So, the Viterra team, I think, continues to do a very good job in running their business. Definitely got the extra strain, as anyone does, of the integration planning as well as all the work being done on the regulatory side. And we're doing that all during a pretty challenging environment. But it's a great platform, the engagement that we have had with their people. We continue to just be very impressed by the quality of their people and the capabilities, and their ability to really step-up with the challenges of all the work that's being done. So, we continue to feel very good about the transaction and really look forward to the future."
},
{
"speaker": "Manav Gupta",
"content": "Perfect. My quick follow-up is the divestment of the Non-core business. It had been marked for non-core for some time. So, how did this particular deal can come about? And were you happy with the transaction price?"
},
{
"speaker": "Greg Heckman",
"content": "Yes, I'll start and John can finish. But look, we -- very early on when we got here and we're able to put sugar into the joint venture with BP, declared then that we would eventually exit the business when we thought that was the right time for our shareholders and for the stakeholders. And in the meantime BP and ourselves supported that team, which did a fantastic job of really improving that business with the combination that we did there and really becoming an industry leader. And we're very proud of that, but that didn't change our long-term strategy. And so when the timing was right and the values lined up, than we've done the second part of that transaction and to exit. So, we do look to -- as John said, we look forward to closing that transaction hopefully later this year, and releasing those resources, not only the capital but even some of our folks that are focused there in supporting the JV."
},
{
"speaker": "John Neppl",
"content": "And Manav, I'd just add that, yes, we were pretty happy with where we end up from a value standpoint."
},
{
"speaker": "Manav Gupta",
"content": "Thank you so much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Steven Haynes from Morgan Stanley. Please go ahead with your question."
},
{
"speaker": "Steven Haynes",
"content": "Hey good morning. Thanks for taking my question. Wanted to ask a quick one on farmer selling. You alluded, I think, before you -- the idea that it might be a source of upside going forward. I was just hoping maybe you could put it in a little bit of a broader context of like where you think we are in the evolution of farmer selling slowing down through the course of the year. I guess what kind of gives you confidence that it's not going to be kind of a more prolonged slow farmer selling cycle, like we might have seen in some past down-cycles? Thank you."
},
{
"speaker": "Greg Heckman",
"content": "Sure. I think if you look at the overall setup, we've been making that transition, right, to a lower price environment. I think the producers are getting used to that. At the same time, as we said, they've definitely built some inventories, and then as the next crops get produced, right? Much bigger crop in Argentina. We still got to develop the crop here in North America, but the weather looks good. And I think as you see that North American crop develop, we'll see some more farmer marketing there. And then as we also know, South American farmers are often watching North American price development and what's happening in the futures market to drive some of those. Currency is still a driver, of course, in Brazil and mostly in Argentina, where the farmers are watching the government very closely for what their policy action will be and any FX activity. So, I think it's all unfolding kind of as would be expected. And what I feel good about is the team remains very focused on executing and ensuring that we manage the risk that's appropriate for the environment that we're in. And pretty proud of how we're executing."
},
{
"speaker": "Steven Haynes",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andrew Strelzik from BMO. Please go ahead with your question."
},
{
"speaker": "Andrew Strelzik",
"content": "Hey good morning. Thanks for taking the questions. You talked about the inverted curves. And so I was curious, are there internal levers you can pull in an environment where U.S. crush margins get more challenged across operations or, I guess, growth CapEx would probably be more delayed? But any other levers that we should think about that you might have at your disposal as the environment plays out potentially in that inverted way?"
},
{
"speaker": "Greg Heckman",
"content": "I would just say, I mean, the one thing that we've seen in the last five years -- all the different things have been thrown at us, we love that we're running a very global platform because we would be over-weighted in one region versus another, this would have been much more challenging. And I don't think that's going to change going forward. So, the optionality and the flexibility that we have in our system to run hardest where the margins are there and to be able to react to whether it's farmer selling or whether it's demand. And then I think the change that we've made in the company and the operating model has allowed the execution and discipline to be much better, which is really key when you get in these tougher markets. So, the team is doing a great job staying focused on the things that we can control as the market develops. And I've got the confidence that as we see the balance of the year play out, that we'll get those opportunities to the bottom-line."
},
{
"speaker": "Andrew Strelzik",
"content": "Okay, that's helpful. And then I guess kind of related to that, as you've gotten a little bit farther out from the really elevated crush margin environment, I know there's been obviously some recent strength, but are you better able to decouple the internal events to the business from the last several years away from kind of the operating environment and the strength of that over the last couple of years? And do you think you've kind of appropriately captured that in the baseline assumptions? Or has your thinking evolved at all? Thanks."
},
{
"speaker": "Greg Heckman",
"content": "I think, one, we're never done, right? We're constantly thinking about continuous improvement. So, whether it's the assets where that are getting the capital, whether it's the debottlenecking or the brownfields or the greenfields, but also thinking about over the long-term, what we believe in what assets may not fit the footprint. It's the investments we're making in our systems and digitalization, and some of the things in the crushing plants that are improvements in the metrics that are a multiyear program. So, I think it's just a very different company than we were in the way that we approach things. And so these are the times, as the markets kind of reset in these transitions, that you really find out how good you're executing. And so we're very, very pleased with the team that -- we're never focused. And we're doing it in a challenged external environment and while renewing an enormous amount of integration planning and providing an enormous amount of information on the regulatory front. So, really proud of the execution."
},
{
"speaker": "Andrew Strelzik",
"content": "Thank you."
},
{
"speaker": "John Neppl",
"content": "I would say, Andrew, that we still feel -- we set out an 850 [ph] baseline a couple of years ago and we're still performing above that, even in a little bit more challenged environment we're in this year. So, to Greg's point earlier, I think we're a different machine than we were. And I think it's -- we're going to be able to show that here despite a little bit more challenging environment. I think we're performing pretty well versus what we had set out as a baseline."
},
{
"speaker": "Andrew Strelzik",
"content": "Great, absolutely. Thank you very much."
},
{
"speaker": "Operator",
"content": "And our next question comes from Carla Casella from JPMorgan. Please go ahead with your question."
},
{
"speaker": "Carla Casella",
"content": "Hi. My question relates to financing. You got the question about the dividends and buybacks ahead of the Viterra transaction, but are you -- what are you thinking in terms of pre-financing that transaction and how much you may want to come to market for? Or would you wait--"
},
{
"speaker": "John Neppl",
"content": "Yes. We've already syndicated out the debt on that, and so we've got the commitments in place to finance the transaction itself. There is some obviously nuances that will take place around some of the Viterra bonds and things ahead of close, but we're pretty much set in terms of the initial allocation of financing and the commitments are all in place. There'll be some fine-tuning post close, I'm sure, but -- and then when we decide exactly how much we need. That could have an effect on the total amount, but it's all pretty much ready to go."
},
{
"speaker": "Carla Casella",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "And ladies and gentlemen, with that, we'll be ending today's question and your session. I'd like to turn the floor back over to CEO, Greg Heckman, for any closing comments."
},
{
"speaker": "Greg Heckman",
"content": "Thank you very much. Thanks everybody for joining us today. And we'd just like to say we're really excited about the longer term here, bringing the post-close, and bringing Bunge and Viterra together. We're going to be a more complete company. And we're going to have more capabilities to serve our customers in what continues to be a more complex environment. With the population continuing to grow, load and per capita continuing to increase, climate volatility making things more challenging, and what looks like a policy environment to continues with more uncertainty. And customers that all want more transparent and sustainable feedstocks. So, we feel we're very well-positioned and uniquely focused on this space and we really look forward to the future. So, thanks for joining us. Have a great week."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, that does conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines."
}
] |
bg | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to Bunge First Quarter 2024 Earnings Release and Conference Call. [Operator Instructions] Please note, this event is being recorded."
},
{
"speaker": "",
"content": "I would now like to turn the conference over to Ruth Ann Wisener. Please go ahead."
},
{
"speaker": "Ruth Wisener",
"content": "Thank you, operator, and thank you for joining us this morning for our first quarter earnings call. Before we get started, I want to let you know that we have slides to accompany our discussion. These can be found at the Investor Center on our website at bunge.com under Events and Presentations."
},
{
"speaker": "",
"content": "Reconciliations of non-GAAP measures to the most directly comparable GAAP financial measure are posted on our website as well. I'd like to direct you to Slide 2 and remind you that today's presentation includes forward-looking statements that reflect Bunge's current view with respect to future events, financial performance and industry conditions. These forward-looking statements are subject to various risks and uncertainties. Bunge has provided additional information in its reports on file with the SEC concerning factors that could cause actual results to differ materially from those contained in this presentation, and we encourage you to review these factors."
},
{
"speaker": "",
"content": "On the call this morning are Greg Heckman, Bunge's Chief Executive Officer; and John Neppl, Chief Financial Officer. I'll now turn the call over to Greg."
},
{
"speaker": "Gregory Heckman",
"content": "Thank you, Ruth Ann, and good morning, everyone. I want to start by thanking the team for delivering another quarter of strong results, which reflect continued focus and great execution. We're off to a good start in 2024 amid a more balanced market environment than we've experienced over the past few years."
},
{
"speaker": "",
"content": "Our team's capabilities and our global platform, again demonstrated we can navigate shifts in supply and demand with agility and speed. Our focus remains on delivering great value to all stakeholders while investing to strengthen our business so that we can provide customers with solutions not only today but over the longer term. We are making excellent progress on integration planning for our announced combination with Viterra. We're very pleased with how well the teams are working together, and our confidence in our ability to hit the ground running on day 1 has only strengthened as we've moved through the planning process. We still expect the transaction to close midyear, and we continue to engage with the relevant regulatory authorities as we work toward gaining the remaining approvals."
},
{
"speaker": "",
"content": "We progressed on other growth projects that will improve our ability to supply the renewable fuels market. We announced a strategic partnership with Repsol, a global multi-energy company in Spain, and we broke ground on our previously announced oilseed processing switch plant in Destrehan, Louisiana, with our joint venture partner, Chevron. We also successfully commissioned our state-of-the-art edible oil refinery in India, enabling us to more efficiently serve our food customers in a growing region."
},
{
"speaker": "",
"content": "Turning to our results. We delivered another solid quarter, driven by strong performance across our core businesses. We also saw good results in our noncore sugar joint venture. In addition, since we reported the fourth quarter, we repurchased $400 million of Bunge shares, making meaningful progress against the repurchase plan we outlined following the announcement of the Viterra transaction."
},
{
"speaker": "",
"content": "Looking ahead to the rest of 2024, our visibility into the back half of the year remains limited, and many of the dynamics we discussed last quarter remain in place. We're continuing to manage the evolving supply-demand environment in markets around the world, demonstrating the benefit of the work we've done to strengthen our business. Based on what we see in the markets and the forward curves today, we are maintaining our guidance for full year adjusted EPS of approximately $9."
},
{
"speaker": "",
"content": "I'll now hand the call over to John to walk through our financial results and outlook in more detail, and then we'll close with some additional thoughts. John?"
},
{
"speaker": "John Neppl",
"content": "Thanks, Greg, and good morning, everyone. Let's turn to the earnings highlights on Slide 5. Our reported first quarter earnings per share was $1.68 compared to $4.15 in the first quarter 2023. Our reported results included an unfavorable mark-to-market timing difference of $0.94 per share and a negative impact of $0.42 per share related to transaction and integration costs associated with our announced business combination with Viterra. Adjusted EPS was $3.04 in the quarter versus $3.26 in the prior year. Adjusted core segment earnings before interest and taxes, or EBIT was $719 million in the quarter versus $756 million last year."
},
{
"speaker": "",
"content": "In Agribusiness, processing results of $411 million in the quarter were up slightly from last year, as higher results in Europe and Asia crush value chains were partially offset by lower results in North and South America. In merchandising, lower results were primarily driven by our global grains and oils value chains where higher volumes were more than offset by lower margins. Refined and Specialty Oils had a solid quarter, but down from a strong prior year. Higher results in Europe were more than offset by lower results in North America and Asia. Results in South America were in line with last year."
},
{
"speaker": "",
"content": "In Milling, higher results were driven by South America, reflecting improved margins in milling operations and a more favorable origination market environment. Corporate and other improved from last year. The decrease in corporate expenses primarily reflected the timing of performance-based compensation. Higher other results are related to Bunge ventures in our captive insurance program. In our noncore Sugar & Bioenergy joint venture, higher sugar volumes and prices more than offset lower ethanol prices."
},
{
"speaker": "",
"content": "For the quarter, reported income tax expense was $117 million compared to $183 million in the prior year. The decrease was primarily due to lower pretax income. The higher effective tax rate of approximately 32% in the quarter reflected a discrete tax adjustment related to the Argentine peso devaluation. As a result, we have increased slightly the midpoint of the range of our estimated annual effective tax rate."
},
{
"speaker": "",
"content": "Net interest expense of $66 million in the quarter was down slightly compared to last year due primarily to average debt levels."
},
{
"speaker": "",
"content": "Let's turn to Slide 6, where you can see our adjusted EPS and EBIT trends over the past 4 years, along with the trailing 12 months. The strong performance reflects our team's continued excellent execution while also delivering on a variety of initiatives to position the company for long-term growth."
},
{
"speaker": "",
"content": "Slide 7 details our capital allocation. In the first quarter, we generated $514 million of adjusted funds from operations. After allocating $101 million to sustaining CapEx, which includes maintenance, environmental health and safety, we had $413 million of discretionary cash flow available. Of this amount, we paid $95 million in dividends, invested $135 million in growth in productivity-related CapEx and repurchased $400 million of Bunge shares, achieving our commitment to repurchase $1 billion of shares prior to the closing of our announced combination with Viterra. This resulted in the use of $217 million of previously retained cash flow."
},
{
"speaker": "",
"content": "Moving to Slide 8. At quarter end Readily Marketable Inventory, or RMI, exceeded our net debt by approximately $4 billion. Our adjusted leverage ratio, which reflects our adjusted net debt to adjusted EBITDA was 0.1x at the end of the first quarter."
},
{
"speaker": "",
"content": "Slide 9 highlights our liquidity position. At quarter end, we had committed credit facilities of approximately $8.7 billion, which includes $3 billion that will become available to draw upon at the close of the Viterra transaction. Of the $5.7 billion available to us currently, all was unused at quarter end, providing us ample liquidity to manage our ongoing capital needs. These amounts are in addition to $8 billion of term loan commitments that we have secured to fund the Viterra transaction. Further, as part of our capital structure planning, we recently doubled the size of our CP program from $1 billion to $2 billion."
},
{
"speaker": "",
"content": "Please turn to Slide 10. For the trailing 12 months, adjusted ROIC was 17.7%, well above our RMI adjusted weighted average cost of capital of 7.7%. ROIC was 13.9%, also well above our weighted average cost of capital of 7%."
},
{
"speaker": "",
"content": "Moving to Slide 11. For the trailing 12 months, we produced discretionary cash flow of approximately $1.9 billion and a cash flow yield of 16.9%."
},
{
"speaker": "",
"content": "Please turn to Slide 12 and our 2024 outlook. As Greg mentioned in his remarks, taking into account first quarter results, the current margin environment of forward curves. We continue to expect full year 2024 adjusted EPS of approximately $9. Note that this forecast excludes any pending transactions that are expected to close during the year."
},
{
"speaker": "",
"content": "In Agribusiness, full-year results are forecasted to be similar to our previous outlook and down from last year, primarily due to lower results in processing where margins remain compressed in most regions."
},
{
"speaker": "",
"content": "In Refined and Specialty Oils, full-year results are expected to be similar to our previous outlook and down from the record prior year, reflecting a shift in supply environment, particularly in the U.S. In Milling, full-year results are expected to be similar to our previous outlook and up from last year. And corporate and other, full-year results are expected to be similar to our previous outlook and up from last year."
},
{
"speaker": "",
"content": "In noncore, full year results in our Sugar & Bioenergy joint venture are expected to be in line with our previous outlook and significantly down from last year, reflecting lower Brazil ethanol prices."
},
{
"speaker": "",
"content": "Additionally, the company expects a following for 2024, an adjusted annual effective tax rate of 22% to 25%, net interest expense in the range of $280 million to $310 million, which is down from our previous expectation of $300 million to $330 million; capital expenditures in the range of $1.2 billion to $1.4 billion; and depreciation and amortization of approximately $450 million."
},
{
"speaker": "",
"content": "With that, I'll turn things back over to Greg for some closing comments."
},
{
"speaker": "Gregory Heckman",
"content": "Thanks, John. Before turning to Q&A, I want to offer a few closing thoughts. As we look ahead, we remain confident in our team's ability to capture opportunities as we work to find solutions allow us to even better serve the needs of customers at both ends of the value chain, farmers and in consumers."
},
{
"speaker": "",
"content": "We're proud of the work we've done to strategically position our business with the increased efficiency of our global platform. Our combination with Viterra will help us further accelerate our diversification across customers, assets, geographies and crops, providing us with more optionality to help address the world's food security needs."
},
{
"speaker": "",
"content": "This combination will also enhance our role as a bridge between growers and end consumers to adapt and prioritize new sustainability practices that produce low CI products while bringing value back to the farm. For example, we recently announced a $20 million investment in Brazil to more than double our regenerative ag program to 600,000 hectares. The investment would be used to pay premiums to farmers and will also finance the provision of free technical assistance, precision agricultural tools and measurement technologies that help producers adopt techniques to reduce emissions."
},
{
"speaker": "",
"content": "In the Southern U.S., we also successfully established a commercial pilot of winter canola hybrids in partnership with Chevron and Corteva Agriscience. These crops have environmental and soil health benefits similar to cover crops and can be an additional source of revenue for growers, also helping meet sustainability requirements of our end customers."
},
{
"speaker": "",
"content": "We're committed to significantly growing the program for the 2025 harvest season. I continue to be impressed by the innovation, collaboration and commitment of the Bunge team as we work together to deliver on our critical mission to provide essential food, feed and fuel to the world."
},
{
"speaker": "",
"content": "And with that, we'll turn to Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question today comes from Adam Samuelson with Goldman Sachs."
},
{
"speaker": "Adam Samuelson",
"content": "So Greg, John, I guess, first question, just thinking about the first quarter results in the context of the full year and an unchanged outlook. Would you characterize the forward kind of environment for the balance of the year is actually weaker than what you had been looking at 3 months ago? Or would you just view this as a just appropriate level of conservatism given limited forward book and kind of where the curve sits today? And kind of with that, can you just maybe give us your view on oilseed processing margins just around the world as you see them today?"
},
{
"speaker": "Gregory Heckman",
"content": "Yes. No, we really don't see it differently. What we talked about last time, of course, when we talked about the approximately 9 for the year was really kind of seeing it 50-50 between first half and second half, which we continue to see. What we did see was a little stronger Q1 and some of that will come out of Q2. So Q2 will be a little bit softer, but we still see the halves is about 50-50 and still see the year the same at approximately 9."
},
{
"speaker": "",
"content": "And then as far as current crush as you kind of walk around the world, if you look at soy, the setup right now, farmers of course, are responding to lower prices as we get more in balance on supply and demand. They responded to those lower prices by being pretty stubborn about selling. So you've got higher farmer retention. And that's kind of what happens as you transition from multi-years at higher prices."
},
{
"speaker": "",
"content": "So the market has gone to very spot, not only for the farmers on selling, but the buyers, right? The buyers of the finished products have now been paid to wait to buy in the spot as prices have moved lower. And the other transition that, of course, we're seeing is you've got a supply chain that really the stresses off of. So as people pull down inventories as they're not really holding those safety inventories anymore."
},
{
"speaker": "",
"content": "So Brazil and Europe have recently improved as we came through Brazil harvest and saw a lot of origination and with the little pushes of origination, we have seen improve have been around FX change and the pace of harvest at the end there in Brazil. So that did help Brazil and Europe."
},
{
"speaker": "",
"content": "Argentina, we are expecting those margins to pick up later in the year. They've been a little better here as we got started on harvest, but that will really be as the producer watches the government, what happens as far as the valuation in Argentina and then any other government programs, and as we see the farmer marketing is there, that will be the key on the margins."
},
{
"speaker": "",
"content": "U.S. has been okay in the nearby. The curves definitely are weaker into Q2 and 3 and then kind of as usual, expecting new crop Q4 the curves get better."
},
{
"speaker": "",
"content": "And then China, crush margins continue to be volatile, kind of similar story you heard last year. Spot has held up okay but very, very low price discovery forward. So the team has been doing a nice job of managing through that."
},
{
"speaker": "",
"content": "And then while soy seeds are down versus last year, but they're still good in Europe and in North America, and that's really led by the strong oil leg and pretty good supply of seeds. So that's kind of how we see things sitting up right now."
},
{
"speaker": "Adam Samuelson",
"content": "If I can just pick up on that last point on the oil leg. And I'd just love to get your view on renewable diesel demand for vegetable oils and feedstock versus other waste fats and oils. It does seem like supply a waste fat in particular, out of Asia have been accelerating pretty meaningfully. How are you looking at RD feedstock demand kind of over the balance of the year? And how -- does that start to transition to '25 with the implementation of the 45C credit in the U.S."
},
{
"speaker": "Gregory Heckman",
"content": "Yes. And I might start at a slightly higher level on the oil. If you look at palm, some of the benefit on the strength in the soft oil is coming. Palm from a supply has really been flat. And so that growth in palm supply has stopped while domestic demand has continued to grow. So the exportable volumes of palm have been going down globally. So that from a high level is some of the support for oil."
},
{
"speaker": "",
"content": "And then to get more specific to your question around the S&D in North America, yes, it has not been quite as tight in North America as we've seen the low CI feedstocks and primarily UCO, be imported into the U.S. So One of the things that we did talk about in the past is we believe that there was enough supply for the food market as well as the fuel market and that the market would do its work by adding capacity and importing palm to go into food as we saw switching as well as seeing other low CI feedstocks and UCOB imported."
},
{
"speaker": "",
"content": "So I think we've seen that and you've seen while we're continuing to process record amount of vegetable oils into the fuel market, we've seen it a little softer as the RD margins are not as good and the big influx of the UCO. So we've got 1.4 billion gallons coming online here in '24. So we're still on track to have 5 billion gallons in '25. We've got one new plant up and running. We're expecting another plant to come up in Q2 on RD and then another plant in Q4. So there is demand coming here later in the year."
},
{
"speaker": "John Neppl",
"content": "Adam, I just say -- this is John. In terms of 45C, things are still in process there. I think we're optimistic that veg oil will certainly have a meaningful role going forward. But there's still a few things under -- as you know, under review. So we're like everyone watching that closely. And I think the logical follow-on to that will be would RVO levels get reset in the future because, clearly, the industry is found ample supply for RD and BD and ultimately [ SA ]. So we're hopeful that the EPA sees that as well."
},
{
"speaker": "Operator",
"content": "The next question comes from Ben Bienvenu with Stephens."
},
{
"speaker": "Ben Bienvenu",
"content": "I want to follow up on Adam's question around the guidance and focus on kind of the level of visibility that you expect to have through the year. Recognizing we're in a more balanced market environment, is the byproduct of that, that visibility is inherently reduced through all points of the year? Or are there key milestones and triggers as we move through the year that might enhance your visibility into the back half of the year? And if so, maybe give us some insight into what those things are and when you expect to have that visibility?"
},
{
"speaker": "Gregory Heckman",
"content": "Yes. You're correct. There's definitely less visibility into this year than we've had for a couple of years. So not much at all kind of beyond 3 months. I think that will change as we see the farmer behavior as things kind of sort out and send the signals, whether that's the progress of the North American crop that then changes the marketing behaviors of the farmer here in North America as they think about that next crop coming off and rolling their stocks and from a marketing."
},
{
"speaker": "",
"content": "As we see the safrinha crop come off in Brazil, and again, farmer making decisions about what they're storing, what they're moving, the logistical challenges in coordination in Brazil. And then in Argentina, it will be the producer who's been marketing the corn and holding the soybeans, which is pretty historical in Argentina. You've got new regime in place there in the government, so the way you see what government programs and if there's valuation."
},
{
"speaker": "",
"content": "So it will be an interesting year. It definitely is a year of transition of the markets as they get more in balance on the supply and demand. And the other -- the end consumer, right, as well. You continue to see the consumer, what we hear from our customers to trade down to private label and store brands from the brands. And then we're finally seeing a little less traffic in foodservice, where they've been more of a switch to QSR and seeing that slow down a little bit and finally seeing a shift back to eating at home."
},
{
"speaker": "",
"content": "So everyone's kind of finding their way here on the supply and demand side. But it feels like we're starting to get it sorted out and we'll see how these crops, finish getting harvested in the southern hemisphere and how we get the crop planted and how it progresses in the Northern Hemisphere."
},
{
"speaker": "Ben Bienvenu",
"content": "Very good. Makes sense. John, you made a lot of progress on the share repurchase program, $400 million of stock repurchased during 1Q, $1 billion in the last 3 quarters. I believe your goal was to repurchase half of the $2 billion of stock to expected to repurchase by middle of 2024. Given that you're ahead of schedule of it, does that mean we pull forward the timing of the $2 billion repurchase or we pause here in the short term? What's your expectation to the best you can communicate around cadence of the remaining buyback activity?"
},
{
"speaker": "John Neppl",
"content": "Yes. It's going to really depend a little bit on how things progress on the Viterra transaction and timing around that. But I think it's possible we could pull some of that forward. I think it's hard to commit to that today because with the close of the deal, as you know, we've got target leverage ratios we'd like to make sure we hit at the close of that transaction. And we've got other projects in play today as well, not only CapEx, but as you know, we've always got a pipeline of M&A stuff going on."
},
{
"speaker": "",
"content": "So we'll watch it closely. It's an important part of the allocation, and we'll keep looking for opportunities here as we go forward, whether it's before or after the close of this transaction."
},
{
"speaker": "Operator",
"content": "The next question comes from Salvator Tiano with Bank of America."
},
{
"speaker": "Salvator Tiano",
"content": "So firstly, I wanted to ask about Canada, I guess, announcement yesterday about their view that the transaction of Viterra would be anticompetitive. I think they said negative for procurement on the west side of Western Canada and anticompetitive on the Eastern side on the production of canola oil and meal. So given their -- I guess, their view, can you talk a little bit firstly about what are the milestones here? And what could be -- how do this impact the transaction's timeline?"
},
{
"speaker": "",
"content": "And also, what are the potential outcomes to resolve these issues? Is there a chance that you may have -- you can get away with divesting nothing? Or do you have to negotiate with them and provide some remedies?"
},
{
"speaker": "Gregory Heckman",
"content": "Yes. I might start kind of at a higher level, we are pleased with the progress we're making. I mean if you look, we got to file in a little 40 jurisdictions and 28 of those have issued unconditional clearances at this point. Of the remaining 13, of course, we've got some of the big ones, U.S., Canada, Brazil, China and the EU. If you remember, Argentina is post-closing review. So while overall, we don't know exactly when we'll get the green light, but we sure haven't seen anything that indicates any material risk to the economics of the deal."
},
{
"speaker": "",
"content": "From a Canada specific, look, it's good that, that step of the regulatory process is completed and that the Competition Bureau Report as you look through it, the good news in there is they had no concerns with much of what we're doing on the grain purchasing side, the meal sales at ports, the majority of our refined and special oil product sales. So on where there were concerns and topics raised, we look forward to discussing those in greater detail, and we'll be happy to engage as we have been with all the regulators as they raise concerns."
},
{
"speaker": "",
"content": "So when you boil it down, at the end of the day, this transaction is good for Canada, right? Will be more efficient and resilient throughout all of our supply chains. Markets aren't getting any easier. We'll continue to maintain Canadian leadership in ag and food, and we'll be able to increase our capacity to invest and continue to provide thousands of Canadians with good jobs. So feel good about where we're at, and it's just -- it's -- we don't really see any need for remedies in Canada. It would be too early to speculate on that, but we look forward to engage on the details."
},
{
"speaker": "Salvator Tiano",
"content": "Okay. Perfect. And I also wanted to ask about the cover crops. You mentioned that the trial this winter went very well. I'm just wondering, at which point do you think you can start commercializing these products and actually start seeing some benefit to the bottom line? And what's kind of the thinking with regard to the economics, like how could this type of products be monetized?"
},
{
"speaker": "Gregory Heckman",
"content": "You broke up right at the beginning. Was the question on winter canola?"
},
{
"speaker": "Salvator Tiano",
"content": "Yes, exactly."
},
{
"speaker": "Gregory Heckman",
"content": "Yes. Look, we were in the trial phase, running the pilots on winter canola, and we've been very pleased with the producer reaction. We've been pleased with the production and the performance of the winter canola. And so the plan now will be to scale that up in the coming campaign. And as we get visibility to the uptake by the producer and our ability to scale that up, then we'll eventually get to the point to be able to talk about any, any impact to the financials, but it's a little bit early for that."
},
{
"speaker": "",
"content": "And winter canola and the cover crops, I might add, those, of course, we're building those programs towards -- to serve Destrehan and our expansion there in the Gulf. So that's a little bit off in the future as well. So we've got a little bit of time as we build that capacity."
},
{
"speaker": "Operator",
"content": "The next question comes from Steven Haynes with Morgan Stanley."
},
{
"speaker": "Steven Haynes",
"content": "Earlier, we kind of talked a bit about the oil side of the equation. I was just wondering if we could come back to the meal side of it. There's some more crush capacity coming in the U.S. this year as your comments before, Argentina potentially kind of a bit more of a factor in the global market. So how are you thinking about both kind of domestic inclusion and export opportunity for meal in the second half?"
},
{
"speaker": "Gregory Heckman",
"content": "No. Thank you. So far here in '24, soybean, meal demand appears pretty good. I mean the lower prices are doing their work. And I think you called it out there, seeing a higher inclusion. The other thing it feels like profitability for the animal segment has bottomed, and as profitability gets better, we probably expect some expansion there. Right now, global animal numbers are stable. When you look at pork and poultry together, they're roughly flat, with poultry up maybe a little and pork down a little bit. And then if you look globally, the hog margins really are up in all regions except China and the poultry margins are better."
},
{
"speaker": "",
"content": "So I feel like the meal demand is okay there. You talk about Argentina, of course, last year, the rest of the world had to make up for Argentina when it didn't run as that crops harvested and the farmer starts to sell and liquidate the crop. We expect to run harder in Argentina this year, and so it will perform better, and that may come at the expense of some other areas, which could possibly be in Europe. So there will be some trade-offs."
},
{
"speaker": "",
"content": "But I think that's what we've shown in the last few years is that's the beauty of our global platform is that we can adjust and maximize where the margins are as we run our system and serve our customers."
},
{
"speaker": "Operator",
"content": "The next question comes from Tom Palmer with Citi."
},
{
"speaker": "Thomas Palmer",
"content": "I wanted to just ask on the second quarter, you did note maybe a little bit of incremental softness. Just what's driving that, in particular? Is it certain segments we should be thinking about or certain regions where maybe it's come down a bit?"
},
{
"speaker": "John Neppl",
"content": "Yes, Tom, this is John. If you look at the -- when we cadence the quarter, it's kind of 60%, 40% for the first half. We ended up a little bit more tilted toward Q1 versus Q2. But largely, the makeup of the quarter hasn't really changed so much in total. And even by segment, it's been more timing. And so where we saw a little bit of over-delivery in Q1 across merchandising and processing. We're seeing a little bit of softness in Q2 in those 2 items. So really more of a view on some of that was timing. It's always hard to predict that."
},
{
"speaker": "",
"content": "But we'll see a little bit -- based on our current forecast, we'll see a little bit down in processing, merchandising, in Q2 versus Q1. I think everything else will hold fairly steady. And there's still time here. We're only really right at the end of April. So we've got a couple of months here yet to see how things shake out."
},
{
"speaker": "Thomas Palmer",
"content": "Understood. And then maybe we could just kind of shift over to 4Q where you do expect a little bit of an uptick, consistent with a quarter ago. What's really driving that? Is there visibility at this point that really guides that? And then is there any read through, I guess, of that as maybe the environment being improved in later this year that kind of pulls into '25?"
},
{
"speaker": "Gregory Heckman",
"content": "A couple of things on Q4, of course, historically in North America. If you look at where our planted acres are, you assume that soybean crop gets grown, you've got new crop coming off. And also with the amount of stock that U.S. producers carrying, the marketing coming up as close to that new crop being harvested and then the new crop harvest."
},
{
"speaker": "",
"content": "And then the other, like we talked about the like UCO has put pressure on the oil market here in North America with those imports. That's not as economical at this point, while at the same time, you've got another plant coming up on the RD side in Q2 and then another plant in Q4. So you kind of feel like that could be constructive for oil demand as we get out there in Q4."
},
{
"speaker": "",
"content": "And then we talked a little bit earlier about just globally overall with palm fairly tight. That's what's been supported for oils globally, the SMEs are pretty tight everywhere outside of North America and especially with the pull on the soft oils."
},
{
"speaker": "Operator",
"content": "The next question comes from Heather Jones with Heather Jones Research."
},
{
"speaker": "Heather Jones",
"content": "I want to stick with oil demand. So Greg, you mentioned about the Chinese UCO. And yes, it seems like that [ arb ] is closed? And also you have soybean oil that seems to be trading at a unusually -- just out of whack relative to historical values relative to palm oil and canola and the animal fats. And so just wondering if you think there is an opportunity for soy to price itself back into food rations or will that take a longer period?"
},
{
"speaker": "Gregory Heckman",
"content": "No, I think one of the things that we have seen from our food customers is as prices have come back, the programs we're working on with them are really driven around driving volume now, whether it's new products or product enhancements. So whereas we saw when we had kind of the inflationary, all the projects were really focused around cost reduction, they're now looking at driving volume."
},
{
"speaker": "",
"content": "The other thing is with the profitability on the animal side, we may see more of that come back into the feed rations as well. So we think we could -- the one thing historically we know, lower prices are generally good for demand. I think you're on the right track. It's how quick will we see it kick in, but I think we'll get some support from both the food and the feed markets."
},
{
"speaker": "Heather Jones",
"content": "Okay. And then I have a two-part question. So I was just wondering how you all are thinking about the full year. And like you noted, there's little visibility beyond 3 months. But when you're thinking about the full year, how are you thinking about the magnitude of Argentine crush for the year? And I asked because you mentioned that you think U.S. crush margins should be okay. I'm just wondering what you think, with Argentina come into the market with increased meal flows and then several new plants coming on in the next few months. Just wondering, do you think those margins are going to be lifted by the oil side? And just how you're thinking about how those all -- the interplay there?"
},
{
"speaker": "Gregory Heckman",
"content": "Yes. I think there'll be a little bit of a balance, right? Of course, we've put all this in our outlook currently. But some of what we talked earlier with animal profitability, a little bit of an uptake on the meal demand side from some expansion on the animal side. And then we've got on the oil side, we talked about palm situation from a tightness, some demand growth on feed and food side from the lower price. And then RD continuing to come on. And then the other is seeing whether these other low CI feedstocks at what pace they can continue to be competitive."
},
{
"speaker": "",
"content": "We don't know if some of that was where their stocks being pulled down and they really can't compete at the same pace, or the other thing is, remember, the big picture is that everyone's trying to take carbon out of their liquid fuels supply chain globally. There are projects going on kind of around globally. So some of the low CI feedstocks that have been moving around the globe as projects get developed, then demand develops in country or in continent. So these flows are constantly changing. So we do expect it to be -- continue to be pretty dynamic on the oil side, and we're really glad we're operating from a global footprint, both on meal and oil."
},
{
"speaker": "Operator",
"content": "The next question comes from Ben Theurer with Barclays."
},
{
"speaker": "Benjamin Theurer",
"content": "Greg, John. Just wanted to follow up on just other capital allocation. I mean, obviously, we have the Viterra pending, but I know you have a bunch of other projects pending in terms of growth investments, productivity increase, et cetera. Can you update us as to for the CapEx for this year, which still seems obviously somewhat elevated. What are like some of the projects you have out there? And when do you think they're going to be playing a relevant role as the contribution to the current results. So just around that framework. That would be my first question."
},
{
"speaker": "John Neppl",
"content": "Sure. Yes. And so Ben, as you know, we've got a number of projects, obviously, going on globally. Greg mentioned the Krishna plant, which is a relatively small one that was commissioned here recently. But in addition to the Destrehan plant expansion that we announced a groundbreaking finally on that a few weeks ago. We've got the other ones that we've mentioned, Morristown SPC plant in Morristown, Indiana underway. Of course, our greenfield oil, specialty oils plant in the Netherlands in Rotterdam, or in Amsterdam, specifically that's underway. And barge unloading expansion in the port in Destrehan, that's going to complement the expansion at Destrehan at the facility."
},
{
"speaker": "",
"content": "Those are -- and then, of course, recently, we had the Avondale plant acquisition that we're also working on an expansion project there. So those are some of the bigger things on the CapEx side because all of those are really underway other than the completion of Krishna. The rest of those really are in process. And Avondale expansion will probably come online a little sooner, but the rest of those are really -- we're talking really 2026 before those are commissioned."
},
{
"speaker": "",
"content": "Those are all multiyear builds. And so we're still very optimistic about the progress there. They're all on track and things are looking good, but it is going to be probably late '26 before those are up and running. And then, of course, we have CJ Selecta sitting out there on the M&A side that we announced previously that we're hoping to close yet later this year. Whether that happens before or after the Viterra deal is yet to be seen, but that's progressing as well."
},
{
"speaker": "Benjamin Theurer",
"content": "Okay. Perfect. Very clear. And then my second question, within Agribusiness merchandising, how do you think about the cadence of merchandising, because it feels like it was a little softer into the back half of last year and kind of stabilized now into 1Q actually improved sequentially."
},
{
"speaker": "",
"content": "So as we think about it and the onset within your guidance of Agribusiness being down and you said predominantly driven by the processing side, is it fair to assume that like the annual kind of cadence and what you have at like 1Q that would nicely get you to more or less the same levels of last year within merchandising. Is that a good way to think about it? Is this more stable now? Or what are the puts and takes to that business?"
},
{
"speaker": "John Neppl",
"content": "Yes, that's always a tough one. But I -- right now, I'd say we're expecting to be fairly on track with where we were a year ago in merchandising in total. We were off to, as you pointed out, a sequentially good start versus Q3, Q4 of last year. Right now, we're -- we've pulled some of that forward from Q2, so we still call the first half, I'll say, relatively modest, but a good start. And we'll see. We've got a couple of months here to go, so there's always opportunity."
},
{
"speaker": "",
"content": "And then the second half of the year, we feel like there should be some opportunity out there. I don't think we're at all overly aggressive in our view for the year. It's pretty -- like I said, it's pretty consistent with the year ago. It's just going to be timing quarter-to-quarter."
},
{
"speaker": "Operator",
"content": "The next question comes from Andrew Strelzik with BMO."
},
{
"speaker": "Andrew Strelzik",
"content": "I know we've talked a lot about the soybean oil side, but I just wanted to go back to that one more time. And I guess I'm just trying to think about outlets from a demand perspective, given the market seems to be -- investors seem to be a little bit concerned about inclusion in renewable diesel as a feedstock moving forward."
},
{
"speaker": "",
"content": "So I guess my question is more on the export side. Do you see the opportunity for the U.S. to become a more meaningful soybean oil exporter later this year? You talked about the tightness on vegetable oils globally outside the U.S. So do you view that as an opportunity with as South America comes from more online? Or any other outlets from a demand perspective globally as we think about soybean oil supply demand?"
},
{
"speaker": "Gregory Heckman",
"content": "Yes. The U.S. does have the ability to switch quickly. I mean if you think about it, prior to RD, we held the residual stocks for the world, and we're there to export as the world needed it and called on oil from the U.S. And then as we were building capacity on the crush side as well as building capacity to import other oils and other low CI feedstocks, right? We pulled stocks down and then drove imports into North America. So I think when you think about the U.S., it will continue to be probably the most dynamic on the oil side to help balance things globally."
},
{
"speaker": "",
"content": "So again, glad we're operating from a global platform and are able to see those different shifts and be able to respond to help serve our customers and balance our crush margins depending on where we're going to run to maximize those. But should be, should be a pretty dynamic year. And then, of course, we continue to see strong demand in India. I don't think I mentioned that, but that's one of the other keys on the oil side as well."
},
{
"speaker": "Andrew Strelzik",
"content": "Got it. Okay. That's helpful. And then I guess I just wanted to ask about the crush capacity expansions that have been announced over the last several years. Obviously, when those announcements were made, for a number of players, the margin environment was much stronger."
},
{
"speaker": "",
"content": "So I guess, do you see risk that some of those plants don't get built as the margin environment has gotten a little bit more compressed, not so much for folks like yourself that have the end market demand built in. But I guess I'm just curious if you're hearing that or if you think there is risk that some of those, that capacity doesn't ever come online?"
},
{
"speaker": "Gregory Heckman",
"content": "Look, I -- when I look at it through our lens, I mean, things definitely got more expensive to build for a period of time, and that's why we slowed down our Destrehan project. Did the work and we're patient to get the cost down before we did build that."
},
{
"speaker": "",
"content": "Now we're building a switch plant. We're building it at a port to help drive export economics on the meal side. We're at a port and in a location where we can receive domestic oil seeds, whether that's going to be -- and being a switch plant, whether it's going to be soy or whether that's going to be winter canola or whether that's going to be a cover crop as we develop things like cover crest or if it makes sense to import seeds. We're at the port and have the ability to do that. We're also doing it at a brownfield site, so we have lower costs, and we're plugging it into our global network."
},
{
"speaker": "",
"content": "Now I will tell you we are really glad that we are doing that. So personally, I wouldn't want to be a stand-alone plant or building a stand-alone plant today just as an investor. We like where our position is. And I guess what we're doing is being very thoughtful where we put capital in the ground that's going to exist for decades is that we're putting it in a place that continues to improve our global footprint for our cost position for the long term."
},
{
"speaker": "John Neppl",
"content": "Andrew, maybe I'd just add there that as you could imagine, we watch this fairly closely. And those projects that were well underway are going to continue and get completed, but really, anything that was -- that is proposed or early stages, we've seen a number of those put on hold, at least for now. And I think the expectation on our part would be that with where we are today in the margin environment that those things would probably not get done unless things change."
},
{
"speaker": "Operator",
"content": "This concludes the question-and-answer session. I would like to turn the conference back over to Greg Heckman for any closing remarks."
},
{
"speaker": "Gregory Heckman",
"content": "I just like to thank everyone for joining us today and for your interest in Bunge. We look forward to speaking with you again soon. So have a great day."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
biib | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Jennifer and I will be your conference operator today. At this time, I'd like to welcome everyone to the Biogen Fourth Quarter and Full Year 2024 Earnings Call and Business Update. 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] Today's conference is being recorded. Thank you. I would now like to turn the conference over to Mr. Tim Power, Head of Investor Relations. Mr. Power, you may begin your conference."
},
{
"speaker": "Tim Power",
"content": "Thanks, Jennifer, and good morning and welcome to Biogen's fourth quarter and full year 2024 earnings call. During this call, we make forward-looking statements which involves risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. We provide a comprehensive list of risk factors in our SEC filings, which I encourage you to review. Our earnings release and other documents related to our results, as well as reconciliations between GAAP and non-GAAP results discussed on this call can be found in the Investors section of biogen.com. We've also posted slides to our website that we'll be using during the call. On today's call, I'm joined by our President and Chief Executive Officer, Chris Viehbacher, Dr. Priya Singhal, Head of Development; and Mike McDonnell, Chief Financial Officer. We will make some opening comments, and then move to Q&A. And to allow us to get through as many questions as possible, we'll kindly ask that you limit yourself to just one question. And with that, I'll hand over to Chris."
},
{
"speaker": "Chris Viehbacher",
"content": "Thank you, Tim. Good morning, everybody. Perhaps before we get started, just like to note that this is Mike McDonnell's last quarterly presentation as CFO of Biogen. Mike, I believe this is your 97th quarter as a publicly quoted CFO. So congratulations on that amazing career. And I'll just take the opportunity to thank you. You've been a terrific partner and team member and it's been great working with you and we will miss you. And we, of course, are joined here also by Robin Kramer. I'm also proud to say that we've been able to promote from within. It's a great source of pride that we have that level of talent within the organization. So let's turn to Q4. As you all know, we have been faced with increased competition for our multiple sclerosis franchise. And really all of our priorities are thinking about how do we now build a new Biogen, how do we build a new phase of growth? And we are focused really around three core priorities. The first are clearly the four products that we launched last year in Alzheimer's, Friedreich’s ataxia, depression, and ALS. Each of those products is not only a first-in-class but first disease modifying agent in each of these diseases. That's a source of pride in the level of innovation that Biogen is capable of but equally from a commercial point of view this is a significant challenge since the level of education when you're a pioneer in an area is so much greater. And we'll come back on and talk a little bit more about that. The next is we have really reprioritized the pipeline. It's certainly been my experience over the years that focusing on a number of key projects is core to business success. And I'm pretty grateful to both Priya Singhal and Jane Grogan because they have both really, I think, cleaned out the pipeline for development in Priya's case and research in Jane's case. And we are actually excited now by the products that are in there. We've got a number of key developments that'll start reading out in 2026. We think this is a multi-billion dollar portfolio. And we're probably one of the few companies that can look at a pipeline that could be more than our current biopharmaceutical business when it gets to peak sales, if it all obviously comes to market. So if we could go to the -- and the third point, of course, is we have redesigned the company with a reduction of operating expenses, not just saving costs for the sake of cost, but the ability to release resources for investing in growth. And that's what we're continuing to do. We're excited about our pipeline, but we've also freed up an awful lot of cash flow, as you'll see later. And that cash flow we're investing for more substrate in growth. So yes, now Dan, please next slide. So, you know, the race really that we are faced with is seeing the erosion of our multiple sclerosis product revenue. But I'm particularly happy to see in 2024 that the revenue from our launch products really offset the more than offset the decline in our multiple sclerosis product revenue. And indeed when you actually look at total revenue decline by $160 million, and you note that contract manufacturing declined by $247 million. It meant that really our core pharma business actually grew. And that's for the first time in four years. And that's really what we're all about in the near-term is trying to make sure that the revenue can exceed the multiple sclerosis product decline. Multiple sclerosis product decline is obviously driven by a number of factors going forward, including the timing of a TYSABRI biosimilar in the U.S. And timing of TECFIDERA generics in Europe. Go to the next slide, please, Dan. So as I said, you know, we've got actually four very innovative pioneering products. LEQEMBI will come on and talk about it in some detail. SKYCLARYS and Friedreich’s ataxia, again very first treatment for Friedrich's ataxia. We have been able to determine from basically medical claims data that there are approximately 4,800 patients in the US. That's about what we thought. One of the complexities is that it's harder to find these patients because you could have a primary care physician in a rural setting that one single patient, and you have to go find them. And we are talking to primary care physicians, talking to cardiologists, talking to pediatricians. So it's quite a large prescriber base for a very narrow patient population. But that, of course, is the core of what rare [diseases us] (ph). I remember years ago when we acquired Genzyme when I was at Sanofi and the marketing folks were saying our marketing strategy is looking for needles and haystacks. And that is exactly what rare disease is all about and it's what Biogen is also very good at. And of course today we've got a lot more technology, we can use tools such as AI and genetic testing to help find those patients, but by its very nature it is unfortunately not going to be the nice smooth progression quarter-on-quarter. That said, we're particularly proud to say that we have been able to double the number of patients on treatment in the past year. Not all of those are yet being reimbursed. We are able to get a lot of patients on drug and then negotiate with governments, particularly in Europe, to get the reimbursement and once we do that the patients flip from being free goods patients to actually revenue generating treatments. There is always a bit of a, in each country, a number of patients who are diagnosed, who haven't been waiting for treatment and you can get those quite easily. There are a number of older patients who actually have lived with this disease for 30, 40 years. And they're the ones we actually have to go hunt for. We will see another growth driver this year and that we expect to get approval for SKYCLARYS in Latin America. I was in Brazil last year and there are quite a number of patients in Latin America. So, as we started with the US, we moved to Europe, and then we are moving to South America, and indeed areas of the Middle East, you know, we expect to see continued steady growth out of SKYCLARYS, but again, I can appreciate that it's going to be hard for some of you to model on a quarterly basis. ZURZUVAE was a very nice launch last year and certainly exceeded our expectations. One of the things that was different from our expectations was that the main prescribers actually OBGY – and OBGYN. We had actually been targeting originally high prescribing psychiatrists. We still see some of those, but as you can see, 80% of the prescriptions are driven by OBGYNs. This is also an area where you could have potentially more people who have ever prescribed for PPD than you actually have patients. And again, targeting and thinking about multi-channel marketing commercial approaches are extremely important. We have filed in Europe and would hope to see an approval sometime later this year. QALSODY is not necessarily a big revenue generator, but this is really a breakthrough treatment in ALS. This is the first time we've been able to demonstrate that neurofilament can really help predict drugs early in development as to whether or not they are likely to work or not. And that allows just the whole research and development in ALS to be accelerated. So we're particularly proud of that. The impact on patients is absolutely extraordinary. And so we may not be making a big impact on revenue. We're certainly making a big impact on patients' lives. Go to the next slide, please, Dan. Now, I showed this slide in a JPMorgan, and there were several investors who looked at that chart and said, this is not the chart of a small product. And we've all been in this business and looked at a lot of launch curves and we all know that we like to see an acceleration in the curve. But any curve that goes from bottom left to upper right is in my books good unless we're talking about operating expenses. And this is good, steady, quarter-on-quarter progress. We have seen some questions on the ex-US launch. Clearly the ex-US launch is contributing more than we have seen in prior launches in other areas. I think part of that is, first, I think Asia is extremely strong in Asia and they are leading that launch there. But second, I think the single payer system removes a lot of the obstacles that we're dealing with in the US. When you have a single payer, you are not having to negotiate quite so much on terms of PET scans and MRIs and fusion beds and that has facilitated the progress. And it's as strong in China as it is in Japan, not necessarily patient numbers, but we're seeing very strong growth in China and that is a cash pay market and goes to really a demonstration of how people value the importance of LEQEMBI. So we'll go to the next chart please. Now, I talked about some of those obstacles and we certainly see that making this easier for both patients and physicians is going to accelerate the launch. And we have a number of these catalysts. The first one has already been achieved. So we have the LEQEMBI IV maintenance that's now FDA approved. You know, we now have the first patients who are hitting that 18-month mark. They've cleared their plaque. But as the data have demonstrated, you've got to stay on treatment. Otherwise, some forms of the plaque actually come back. And we have demonstrated three-year data to show that actually staying on treatment patients do better than those who stop treatment. And that's an important message because our competition is actually not able to say that. And so this is also important for the education of the disease. It's not just about [thought clearance] (ph), it's about maintaining that clearance. The second is really the introduction of blood-based diagnostics. Certainly LabCorp and Quest continue to see rising sales of these diagnostics. What I think will really make a difference is getting FDA approval for some of these diagnostics with an evidence base that will give physicians the confidence to be able to confirm diagnosis without the need for a PET scan or a lumbar puncture. And so again, this is something that could not only facilitate the work of the neurologist, but we might also be able to see this being used increasingly to triage patients. Something like 50% of patients who actually manage to get into a neurologist are actually not eligible for treatment because they're too far advanced in their disease. So if we could actually triage some of these patients, particularly at the primary care level, then we can actually get a higher quotient of patients who visit a neurologist actually being eligible for treatment. The subcutaneous form for maintenance, we would expect now on – we have a PDUFA date on August 31st. That again will really facilitate the journey, both for the patient as well as for the physician, no longer needing the infusion beds and patients can actually take the drug from the comfort of their own home. A major game changer we see as the subcutaneous for initiation, which we expect to have in the first half of next year. And that obviously would also facilitate that for the same reasons of not having to deal with infusion beds and patients can have that in the comfort of their own home. The AHEAD 3-45 study is fully recruited. We expect a readout in 2028. This is a landmark study because this is where we could see the promise of potentially prevention of Alzheimer's. We know that before patients actually exhibit symptoms, they've been accumulating plaques in their brains for many, many years. And unfortunately, a lot of damage is done already by the time patients actually exhibit symptoms. So if we can get patients earlier, we think that we can actually have even better efficacy. And in fact, Priya is going to show shortly, again, the low tau patients, which is a marker for earlier stage patients. And there we see dramatically improved efficacy versus just the 27% on the CDR Sum of Boxes that was demonstrated in the CLARITY study. So Next slide, please. So those are the four products. Clearly, we're also looking at our pipeline. And I think there are three key areas in this to look at. The first is continued investment and commitment to Alzheimer's. We gather some of the top leading experts in Alzheimer's from around the world. They are the ones who are telling us, one that nobody is really doing so much research in a broad area of modalities as Biogen. But the other is they are extremely excited about the opportunity to reduce tau and the impact that -- that could have on Alzheimer's. So Alzheimer's is going to be a core franchise for Biogen for decades to come. You know, we had very positive data on the Dapirolizumab back in September. And we've already initiated the second Phase 3. But we also have Litifilimab in both CLE and SLE. So we got a nice lupus portfolio of acids coming along. I'd remind everybody, yes, people are looking at a lot of potential competitors in Phase 1, Phase 2. But out of the dozens and dozens and dozens of molecules that entered the clinic, only three molecules have ever demonstrated a positive Phase 3 result. Two are already on the market and Dapirolizumab is the third. So, you know, we know that you can get excited about a lot of things, but it's not until you actually see Phase 3 results that you can really have conviction. But that's a potentially significant market and fits nicely with Biogen because we can take a lot of the learnings from MS and apply that to lupus. And of course, the third area are really these auto-antibodies. We have our anti-CD38. We are entering -- expect to enter into three Phase 3 trials and three separate indications with auto-- antibody mediated resistance, the IgAN and the PMN. And we have very compelling Phase 2 results here. There are no guarantees anytime in research and development, but I think we feel particularly excited about Felzartamab and the potential that this could have in rare kidney disease. And of course, then we have a whole phase of readouts coming along and I think that will become the story of Biogen as we get increasingly more data and people can gain increasing confidence and excitement, share our excitement in our pipeline. And so with that, I think I'm going to, let's continue the story on R&D, Priya, and I'll turn it over to you."
},
{
"speaker": "Priya Singhal",
"content": "Thank you, Chris. Biogen's development organization had another very productive quarter. We achieved several important milestones across key strategic areas for the company. I would like to begin with immunology where in collaboration with UCB, as Chris mentioned, we initiated the second Phase III study for dapi-pegol in SLE. This follows the positive readout of the first Phase III study and sharing of detailed study results as a late breaker at the ACR Annual Meeting last year. Dapi-pegol, as Chris mentioned, is only the third agent with a positive global Phase III study in SLE. Additionally, Felzartamab was granted orphan drug designation in the EU for both solid organ transplantation and IgA nephropathy. We believe this designation, which is intended to support development of treatments with significant unmet medical need, underscores the potential for Felzartamab to become a meaningful new therapy for serious immune-mediated diseases like AMR, IgAN and PMN globally. In rare disease, we continued unlocking new geographies for SKYCLARYS. In Friedreich’s ataxia and QALSODY in SOD1-ALS. Leveraging the results of the SKYCLARYS-positive MOXIe trial, we obtained approval in Chile and currently have 13 additional regulatory filings under review. This includes additional filings in Latin America, where we expect regulatory decisions this year in countries such as Brazil and Argentina as we continue our global rollout. Importantly, we also took significant steps towards expanding the value of key portfolio products for patients. In SMA, regulatory filings for high-dose nusinersen have now been accepted in the U.S. and EU, and we expect an FDA decision in September of this year. And in Alzheimer's disease, we recently received FDA approval for LEQEMBI less frequent IV maintenance dosing. This is both a significant step for LEQEMBI and a meaningful advancement in the evolution of Alzheimer's treatment more broadly. I would like to briefly review why there is an urgency to treat now and why maintenance is important based on LEQEMBI data that we have obtained to date. First, the CLARITY AD study is unique in that it did not exclude patients based upon tau brain pathology. Therefore, we have placebo-controlled clinical trial data across the full early Alzheimer's disease population, including individuals with no and low tau, which represents the earlier stages of AD. In this population, 76% of patients showed no decline and 60% showed clinical improvement at 18 months. as assessed by CDR Sum of Boxes. What this means is that in over three-fourth of early AD patients, their disease was stabilized and more than half the patients showed improved symptoms when treated with LEQEMBI. The reason why this is important is that this data suggests that patients treated early in their disease can see a profound benefit, which underscores the importance of initiating treatment early. Furthermore, this data also supports the potential of our ongoing presymptomatic AHEAD 3-45 trial. And now that I've shown you why early treatment initiation is important, let me remind you why the new maintenance IV approval is also very critical. And that is because data shows that Alzheimer's does not stop after plaque removal. Importantly, prior data from the LEQEMBI Phase II study and its open-label extension show that discontinuation of treatment is associated with reaccumulation of Alzheimer's biomarkers, including amyloid plaques and importantly, a reversion back to the placebo rate of clinical decline. With its differentiated mechanism of action, we believe LEQEMBI's uniquely positioned, as it is the only disease-modifying therapy in Alzheimer's today to show additional benefit with continued treatment after plaque reduction. As you can see from this slide, the three-year data from the CLARITY AD study and its open-label extension support the potential for long-term benefit to patients by showing that continued LEQEMBI treatment resulted in a doubling of the clinical benefit observed at 18 months, as compared to a matched natural history cohort. With these findings in mind, we are working with Eisai to deliver additional options for patients with the aim of maximizing both the convenience and the clinical benefit of the LEQEMBI. This includes a subcutaneous formulation with the potential for at-home administration to further add to patient optionality and convenience. For subcutaneous maintenance dosing, we now have a PDUFA date of August 2025. Next year, in 2026, we aim to introduce subcutaneous dosing for treatment initiation, which we believe will allow even more patients to get started on therapy. And building upon the encouraging results we obtained in the no or low tau population in Clarity AD. We continue to advance evaluating AHEAD 3-45, evaluating LEQEMBI in individuals who have amyloid plaque pathology in the brain, but before the onset of symptoms, which has the potential to further expand the use of LEQEMBI. Turning now to the pipeline. We have previously discussed our efforts to augment our pipeline with the objective of rebalancing the risk profile and investing to win in key areas of expected future growth. As a result, we have focused our development efforts on a smaller set of clinical stage programs that we believe are high conviction and well-positioned to deliver a regular cadence of pivotal readouts and potential launches. This includes key late-stage programs that have the potential, as you see on this slide to deliver innovation to benefit patients across Alzheimer's and immunology. We will continue to remain disciplined in our approach, as we continue to assess inflection points for our internal development pipeline but also as we evaluate potential external innovation opportunities that we believe can help support Biogen's goal of sustainable growth. With that, I would now like to hand the call over to Mike for a financial update."
},
{
"speaker": "Mike McDonnell",
"content": "Thank you, Priya. Good morning to everyone. I'd like to begin by providing some highlights from the reported results. Total revenue for the quarter was $2.5 billion, which represents 3% growth from the fourth quarter of 2023. Fourth quarter non-GAAP diluted EPS was $3.44 and that's 17% higher than the fourth quarter of 2023. For the full year of 2024, total revenue of $9.7 billion represents a decline of 2% from the -- from 2023, consistent with our most recent guidance of a low single-digit decline. And full year 2024 non-GAAP diluted EPS was $16.47 and that's 12% higher than the full year 2023, also consistent with our most recent guidance range of $16.10 to $16.60. EPS growth and operating income expansion in both the fourth quarter and full year was supported by our Fit for Growth and R&D prioritization initiatives. We’re pleased that this performance allowed us to generate $722 million of free cash flow in the quarter, which brought us to $2.7 billion for the full year and that's an improvement of $1.4 billion from $1.3 billion generated in 2023. Now I'll turn to a few comments on revenue and commercial dynamics from the fourth quarter. Our MS product revenue declined roughly 8% at actual currency and 9% at constant currency as compared to the fourth quarter of 2023. And that was driven primarily by competition in the space, partially offset by some seasonal channel dynamics. Interferons continued to be impacted by competition as patients transition to higher efficacy therapies and TECFIDERA continued to be impacted by generic competition globally. TYSABRI has seen some impacts from a biosimilar entrant in Europe. And although a biosimilar has not yet launched in the U.S., we continue to see competition increasing in the high-efficacy class. VUMERITY saw an increase in demand in the quarter and also benefited from some seasonal channel dynamics. Next, our rare disease franchise produced revenue of $535 million in the fourth quarter and that represented a growth of 13% at actual currency and 15% at constant currency from the fourth quarter of 2023. Global SKYCLARYS revenue in the fourth quarter was $102 million, an increase of 83% versus the fourth quarter of 2023 with nearly double the number of patients on therapy. U.S. SKYCLARYS revenue in the fourth quarter was $71 million. We continued to add patients in the quarter, but revenue was sequentially impacted by an inventory build in the third quarter that was drawn down in the fourth quarter as well as some Medicare discount dynamics. Global SPINRAZA revenue of $421 million in the fourth quarter grew 2% year-over-year, including growth in the U.S., up 6% year-over-year. We are encouraged by the performance here and look forward to a potential future launch of the high-dose option. ZURZUVAE delivered approximately $23 million of revenue in the quarter, and that was driven by an increase in demand, partially offset by channel dynamics. And we again saw steady sequential growth for LEQEMBI with fourth quarter global in-market sales booked by Eisai of approximately $87 million and that's up approximately 30% sequentially from the third quarter of 2024. LEQEMBI fourth quarter end-market sales in the U.S. were $50 million and that's up roughly 28% sequentially from the third quarter of 2024. I'll now turn to a few comments on dynamics from a few key expense lines. Non-GAAP cost of sales as a percentage of revenue improved 300 basis points in the fourth quarter as compared to the fourth quarter of 2023, and that was driven primarily by lower idle capacity charges. Fourth quarter non-GAAP core operating expense or R&D plus SG&A expense increased 4% year-over-year, as the benefits from our R&D prioritization and Fit for Growth initiatives allowed us to mostly absorb incremental spend associated with our launches. Non-GAAP other expense was $72 million in the quarter, and that was driven primarily by net interest expense. Non-GAAP diluted EPS was $3.44 in the fourth quarter, representing growth of 17% versus the fourth quarter of 2023. Now a brief update on our balance sheet. We generated $2.7 billion of free cash flow in 2024 due to strong operating income. Please note that the timing of certain cash tax payments in 2024 also benefited free cash flow. We ended 2024 with $2.4 billion of cash and roughly $3.9 billion of net debt and continue to believe that our balance sheet remains strong and allows us to continue to invest in both internal and external growth opportunities. Turning now to our full year 2025 guidance ranges and assumptions. We expect full year 2025 non-GAAP diluted earnings per share of between $15.25 and $16.25. This guidance range, which is based upon FX rates on February 7 of 2025, includes a $0.35 EPS headwind from foreign exchange when compared to average exchange rates in 2024. Total revenue for 2025 is expected to decline by a mid-single-digit percentage. This is driven primarily by an increased decline in our MS business as compared to 2024. The pressure on our MS business is expected to be driven by potential biosimilar entry for TYSABRI in the U.S. this year and potential generic entry for TECFIDERA in certain European markets. We expect this decline to be partially offset by continued strong and increasing revenue growth from our new product launches. Please note, this revenue range also includes a roughly 1% headwind from foreign exchange. In 2025, we expect an impact from Medicare Part D redesign at the total company level to be limited approximately $50 million to $100 million. We expect approximately one-third of this impact to be related to SKYCLARYS with the remainder coming from MS. On operating expenses, we remain on track to deliver the $1 billion of gross and $800 million of net savings from our Fit for Growth initiative by the end of this year. With this in mind, we expect full year 2025 combined non-GAAP R&D and SG&A expense to total approximately $3.9 billion. And as it will take time for the savings to crystallize we expect to see higher OpEx in the beginning of the year. We expect non-GAAP operating margin percentage to remain relatively flat in 2025 as compared to 2024. And on the non-operating side of expenses, I would highlight the components of our non-GAAP other income and expense line. This line includes interest expense on our debt and some other expenses, partially offset by interest income on our cash balances. For full year 2025, we expect other income and expense to be a net expense of approximately $180 million to $220 million. And finally, some additional considerations as you think about your models. As has been the case in previous years, we expect the first quarter to be pressured due to seasonality, driven by higher discounts and allowances as well as channel dynamics in the U.S., and that will mostly impact our MS business. I would also note with regard to FAMPYRA that we terminated the license and collaboration agreement effective January 1, 2025. And as I just mentioned, our current year guidance takes account of the stronger dollar today compared with the same time last year. For modeling purposes, each cent change in the euro versus the U.S. dollar impacts revenue by approximately $15 million. I would also refer you to the current slide, as well as our press release for other important guidance assumptions. And in closing, we welcome Robin Kramer, as Biogen's CFO, following my retirement later this quarter. This orderly transition plan has been in process for some time now, and I have full confidence that Robin will be a great CFO. I'm excited about Biogen's future and will remain a supporter and shareholder of Biogen in the years to come. And with that, we will now open the call up for questions."
},
{
"speaker": "Tim Power",
"content": "Thanks, Mike. Jennifer, can we go to the first question, please?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question comes from the line of Salveen Richter with Goldman Sachs."
},
{
"speaker": "Salveen Richter",
"content": "Good morning. Thanks for taking my question. What is your latest thinking on the capacity preference and potential time lines for external BD? And in terms of your growth outlook, just help us understand the balance between the existing pipeline and the assets you could bring in? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Thanks, Salveen. I mean I think we’ll get Mike to give you an update on capacity. As I said, we are very excited about the pipeline that we have. But I think one of the things that we'd like to do is continue to reinforce that pipeline. Over the years, I've come to the conclusion that you can never have enough pipeline. First element is we've done a major restructuring of research because I think as companies in our industry, it is very expensive to bring in late-stage assets. And we would like to have research be our primary source of innovation, obviously, internally, but also externally. And so I think we have completely restructured research to create the financial capacity as well as the talent capacity to do more collaborations and bring assets in, particularly pre GLP tox. Beyond that, we are looking at virtually every phase, the early phase development. Right now, I would say, Priya probably would agree with me that our early-stage development pipeline is still relatively thin. But even if we can find things in Phase 3, if it's got a really solid Phase 2, I'm not big on taking a lot of risk on Phase 3 clinical trials because that gets expensive. And in terms of acquisitions, we have been migrating in new areas such as immunology and rare diseases. And if we can find acquisitions that can bolster our positions in that we will do so. We don't have a particular size that we're looking for. It could be late-stage development. It could be early stage commercial the one thing it has to do is make financial sense. I think where we are as a company, we don't need to be taking a huge amount of risk on acquisitions. That said, we are always looking. We always have about at least 15 to 20 different projects that we're looking at, at any one time. But as you know, you kind of have to look at 100 things before you find something that is of interest. And Mike, maybe you want to talk about capacity?"
},
{
"speaker": "Mike McDonnell",
"content": "Yes. And Salveen, on capacity, the balance sheet remains in excellent shape. As we mentioned in the prepared remarks, we ended the year with $2.4 billion of cash on hand. The EBITDA run rate is north of $3 billion a year. So with $6.3 billion of gross debt and $3.9 billion of net debt. You're in the ZIP code of maybe two turns gross and 1.5 turns net. And we were very pleased with the free cash flow results this year in -- or last year, I should say, 2024, $2.7 billion. So that cash balance will continue to grow. So when you look at the modest amount of leverage, the $2.4 billion of cash on hand and the growing free cash flow, the balance sheet is in an excellent position. As Chris said, the plan will be to stay very disciplined and only do things that make good financial sense, but we've got significant capacity to do a series of smaller things or perhaps a larger thing if it does make good financial sense."
},
{
"speaker": "Tim Power",
"content": "Thanks Mike. Let’s go to the next question please."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Michael Yee with Jefferies."
},
{
"speaker": "Michael Yee",
"content": "Thanks. Priya, you mentioned that on the LEQEMBI slide, one of the important developments is the potential for blood-based diagnostics. And my understanding is that, that's coming this year. Can you walk through how important that is in terms of any bottlenecks and specifically whether that totally would be able to replace pet or how that actually works since diagnostics are a little bit complicated. Thank you."
},
{
"speaker": "Priya Singhal",
"content": "Yes. Thanks, Mike. So overall, I think that accurate diagnosis of Alzheimer's disease and confirmation of amyloid remains very important. And it is the entry point for the kind of care pathway here. So it's important. I think with the advent of the anti-amyloid therapy, we've seen amazing momentum there. And as Chris mentioned, we have tests available today that are at Triage sort of level. The question here is what is the -- what is going to be the availability in the near-term an in vitro diagnostic approved by the FDA that can be used widely and can also be reimbursed and give physicians and neurologists confidence that they can actually trust that outcome and that result versus a pet. And we think that this is likely going to happen in the near-term. Fujirebio is already filed. We know there are a couple of others like C2N and Roche that are sort of working on these IVDs or in vitro diagnostics. And one was already filed -- Fujirebio filed last year. We believe that usually the time frame is about 6 months. I think the next stage will be generating data so that payers and others are confident that it can adequately represent the Medicare population, which tends to be the broader population. So I think concordance is important as is reimbursement. But we think this is moving really fast, and we think we'll see quite a few milestones occur in the near term."
},
{
"speaker": "Tim Power",
"content": "Thanks Priya. Let’s go to the next question please Jennifer."
},
{
"speaker": "Operator",
"content": "The next question comes from Tim Anderson with Bank of America."
},
{
"speaker": "Tim Anderson",
"content": "Thank you. On your spend guidance, you're saying $3.9 billion combined R&D and SG&A which is about $200 million lower than consensus. Revenues are also a little bit lower than consensus. So it offsets each other. My question is how much does the Royalty Pharma deal take out of the R&D line in 2025, specifically? I know it's $250 million in aggregate that they'll fund, but what's that relief to 2025 R&D? And then on Royalty Pharma, can we expect Biogen to do more of these off-balance sheet types of transactions with pipeline programs over the next one years to two years."
},
{
"speaker": "Mike McDonnell",
"content": "So Tim, Mike speaking. On the Royalty Pharma transaction, our current expectation is that the $200 million that we would receive in 2025 from Royalty Pharma would be accounted for as a reduction to R&D expense. So that would be a dollar-for-dollar reduction that is in the mix of our guidance."
},
{
"speaker": "Chris Viehbacher",
"content": "Well, just in terms of other deals, the remuneration to those provided financing is usually through royalties. And it's not easy to make work for every product. So I think at the moment, we look at this as a one-off transaction. But it is a useful model to take risk off the table and be able to spread the investment across more assets. I mean it is essentially a way of getting more shots on goal."
},
{
"speaker": "Tim Power",
"content": "All right. Thanks Chris. We’ll go to the next one please."
},
{
"speaker": "Operator",
"content": "Go next to Brian Abrahams with RBC Capital Markets."
},
{
"speaker": "Brian Abrahams",
"content": "Hi, good morning. Thanks for taking my question. On SKYCLARYS can you elaborate a little bit more on the dynamics you're seeing in the U.S.? Like are there ways to accelerate patient identification to meaningfully grow revenue there? Should we be expecting this to more be an ex U.S. international growth product? And how big are the hurdles in terms of reimbursement outside the U.S? Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "Both U.S. I think there have been already a number of creative approaches. One is using AI and looking across social media to be able to identify where patients are as I said before, there's quite a large number of potential prescribers you could go to. So the question is how do you zero that down to a geography and a type of physician that makes the visit efficient. And so we say we've used the AI. Obviously, as whenever you develop a treatment for a disease, there is a greater interest in diagnosing it. And so I think one of the things that we're seeing is a much greater use of genetic testing. Genetic testing does have a cost and physicians have not always been interested in using it, if it wasn't going to lead to a treatment. But now that SKYCLARYS is there, we are seeing that increased utilization. The final thing is using multi omnichannel marketing to be able to reach physicians just to educate them about what is Friedreich's ataxia. There are also multiple ataxias out there. And so that's where the genetic testing can become important. But when you listen to the patient journeys, it can take often three years, four years before a patient gets a definitive diagnosis. A lot of particularly younger people are just kind of thought to be clumsy for a period of time and then progressively lose mobility and it takes a while because there are a lot of physicians who've never even heard of, as I said Friedreich’s ataxia. So that's where the education is needed. I would say today with the technology we have, we have a lot of tools that we didn't have even 15 years ago. But it is still finding patient by patient. We look at how many patients we found every week. And then it's -- the reimbursement isn't really an issue in the U.S. There are hurdles to it. This is where Biogen is particularly good. We have a very adept group that can help patients navigate the reimbursement system. In Europe, I don't think we are necessarily seeing any -- going to find any issues of reimbursement. It's mostly getting through the whole process, presenting the cost-effectiveness data but we are very encouraged by the uptake. And once you have uptake, then that's a good demonstration of the value of the medicine when it comes to discussing things with reimbursing countries. So it will be progressive. I think there are 10 countries today in Europe, which reimburse and every quarter, we'll be adding more countries. And the same will be true ex Europe and Latin America, for example."
},
{
"speaker": "Tim Power",
"content": "We’ll go to next question please Jennifer."
},
{
"speaker": "Operator",
"content": "We’ll go to next to Marc Goodman with Leerink Partners."
},
{
"speaker": "Marc Goodman",
"content": "Yeah, good morning. Could you give us a little more flavor on what's happening with SPINRAZA in the U.S. and the U.S. dynamics and how much inventory is mattering what's happening with pricing? Just a little more color there. Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "Mike take the inventory question. SPINRAZA. So this is a very competitive market with a very limited number of patients. So you've got a gene therapy, an oral therapy and an intrathecal therapy, all competing for a relatively small patient number there are actually quite a number of patients who have not been diagnosed or treated. So we tend to be in younger patients -- but there is actually a much larger adult patient population. And getting at those is a lot like the same process that I just described for Friedreich's ataxia. So we are doing that. So the interesting thing is how do you compete in the market like that? And we've all grown up in this business and we say okay, one pill a day, beats two pills a day, a pill beats an injection. But the actual reality is in a lot of these devastating diseases, efficacy that matters. And that's really the story of SPINRAZA. The high dose, I think, will be important because you can get to the therapeutic levels of drug that you need much faster and in a neurodegenerative disease, that's extremely important. So we will be able to cut the number of loading doses, if you like, from four to two and then you go to three injections per year. One of the things that I think will be important is we are developing a device that hopefully will hit the market about, I think 2026 for you. And it is a port that you can insert under the skin pretty much anywhere on the body, but certainly around the abdomen, as an example and has tiny catheters that lead to the spinal column. And that means that you can actually just do the injection directly under the skin. That has had huge patient positive response and that could actually make intrathecal injections a whole lot more patient friendly, not just in SMA, but pretty much for all of the intrathecal products that we are developing. So I think that one will also be a game changer going forward and Mike, do you want to talk about the inventory dynamic?"
},
{
"speaker": "Mike McDonnell",
"content": "Yes. Mark, nothing to call out on inventory. We did see some lumpiness in SPINRAZA revenue throughout 2024, due to some shipment timing and so forth outside of the U.S. But the fourth quarter, the global 2% growth and the 6% in the U.S., nothing material to call out in terms of inventory or channel dynamics."
},
{
"speaker": "Tim Power",
"content": "Let’s go to next question please."
},
{
"speaker": "Operator",
"content": "Paul Matteis with Stifel."
},
{
"speaker": "Paul Matteis",
"content": "Hi, good morning. Thanks so much for taking my question. Chris, if you take a step back now, you got to be at a point, I would think, with ZURZUVAE, SKYCLARYS, lecanemab, to some degree, although maybe the variance of outcomes there is a little bit wider. Or at least for the next couple of years, you probably have a pretty good window into the range of outcomes for these products. So I guess taking a step back, do you feel like you can get back to sustainable revenue growth based on what you have internally and what you have high visibility into? Or how important, I guess, is getting a big upside win from the pipeline or buying growth externally via BD. Thanks so much."
},
{
"speaker": "Chris Viehbacher",
"content": "Right. Well, we've got about -- if you add in the -- everything, there is probably about $4.5 billion of revenue in MS left and probably about $3 billion of profit. So that's going to be the headwind over the next 5 years to 10 years because actually, some of these products are actually quite sticky with patients because patients do well on these products and tend to stay on them. So it is a slower decline. So that's the problem we're solving for. When you look at it, the #1 product that has the most potential to offset is that is clearly LEQEMBI. And there, I think we are encouraged by the more recent results, and I think we feel pretty confident that these catalysts could offer the potential to see some acceleration of growth. So we do believe that there is a tremendous unmet need in Alzheimer's. People forget that this is a fatal disease. And when you look at the data that Priya showed, if you could get 76% of patients stabilized on this, this is -- this is data that I think we really need to do more of in demonstrating the value proposition of LEQEMBI. So we have a number of different approaches. We've I think, had extremely productive discussions with our partner, Eisai, on the commercial approach. And there was an awful lot of effort at the start, just to explain care pathways and the side effects and the reimbursement and I think now we can actually focus a lot more on the value proposition and why treating patients. I think there is a huge opportunity in expanding the prescriber base, we have focused on a smaller number just because of the effort involved by the neurologist. But I think with things like the subcutaneous formulations and the maintenance, we have an opportunity to go broader, there is about 13,000 physicians who are targets, and we have a small fraction of those today. We are actually prescribing. So there is a lot there, and SKYCLARYS will continue to grow, as we said. ZURZUVAE is certainly an interesting, I would call it kind of a two-base hit in baseball terms in the U.S. Europe will probably be a more limited set of markets that will actually be able to reimburse this product. I think we've got a lot that we can be doing. I think the real growth story is when you start to see the pipeline coming through because as the MS portfolio declines and the new products become a bigger part of the equation, then suddenly you add a pipeline product on top of that. And the nice thing about Biogen is that $1 billion really moves the needle. So we don't need a lot here to really have a meaningful impact on our growth. And so I think it is a combination of all of the above, Paul. We will see an increasing percentage of our business coming from these new products and the pipeline we can only augment that."
},
{
"speaker": "Tim Power",
"content": "Thanks Chris. Let’s go to the next question please."
},
{
"speaker": "Operator",
"content": "We'll go next to Umer Raffat with Evercore."
},
{
"speaker": "Umer Raffat",
"content": "Hi, guys. Thanks for taking my question. I want to say thank you to Mike for all your help over time, and welcome to Tim. I have two questions today, if I may. First, maybe for Priya. In a scenario where Lilly hits Trailblazer Alzheimer's three in preclinical on the progression endpoint how does that factor into your thinking around how you could accelerate time lines for AHEAD 3-45? And also your comfort with the endpoint being used there. And secondly, Chris, maybe a big picture question. It seems like where the valuation stands today around $20 billion in market cap relative to the amount paid for Reata as well as the amount of balance sheet available for an additional deal coming up. I guess, market is almost reflecting somewhat of a view that the M&A choices in the last couple of years may not have been what market was expecting or perhaps the expectations were higher. I guess how do you think about all of that? And what learnings are you taking from that into additional capital deployment? Because it will be a very significant move if there were to be a $10 billion deal again."
},
{
"speaker": "Priya Singhal",
"content": "I can get started. Thanks, Umer. So I think, overall, we remain excited, as I shared in my prepared remarks about the potential for AHEAD 3-45. Just a reminder is that we completed enrollment last year. It's a four year therapy. And so we expect an Eisai has recently actually reiterated the outcome expected in 2028. Now that said, we always retain and we always continue to evaluate optionality for earlier readouts and earlier cuts, and we continue to engage with regulators like the FDA very closely on this, and all of that is progressing well. Now the most -- so that's kind of the acceleration piece. I think the important piece here is the way we've designed the trial. It is quite specific for amyloid load. And as you know, it's two sister trials, one with a lower amyloid load that's AHEAD 3 and then 4, 5, which is a higher amyloid load. Now in the AHEAD 3, we have a biomarker outcome, which is amyloid clearance essentially. But in the 4, 5, where patients have a higher load of amyloid, we are looking at a very important endpoint that's called the back 5, which is the preclinical Alzheimer's cognition composite. This comprises elements of memory the intelligence test, MMSE and other components. And it is supposed to be quite sensitive and specific for preclinical AD. Trailblazer III has different outcomes like CDR, some of CDR global score and is also doing a time to event. So I think we'll wait to see more on how that unfolds. But I think we feel very confident about the design of this trial and what it can actually tell us about preventing or slowing down on set of Alzheimer's disease. Over to you, Chris."
},
{
"speaker": "Chris Viehbacher",
"content": "Yes. I mean, Umer, look, there's a human factor here, right? One of the things I have seen over the years is that your interest in doing significant acquisitions is kind of inversely proportional to your level of confidence in what you've already got in your pipeline. So if you don't think you have a lot in your pipeline, you're more likely to be interested in spending more externally. And whether that's logical or not, it is tended to be where you are. And I have to say coming into Biogen, we tended to go after the hardest problems to solve, where we didn't understand the underlying disease biology, where we didn't really have Phase 2 data that could really predict where we were in Phase 3. And at that point, you sort of say, well if you don't know what you've got, you're more interested in looking at things. I would say where we are now two years down the road is I think Priya with her Steely-eye really taken a lot of the stuff out of our pipeline that either was never going to make it to market or if it did make it to market, it was never going to have much impact. And what we do have, and we've got more data now, gives us a whole lot more confidence. I mean, when you got a dapirolizumab now with a Phase III, I mean, litifilimab has advanced -- the High Bio acquisition, we see as pretty transformative for our pipeline because that is exactly what we would like to see more of is data and Phase II that really gives you a sense of some level of conviction into Phase III recognizing that there are never any guarantees in R&D. So I think where we are is we could continue to do more of the high biotype transactions. We actually like the Reata transaction. Maybe the Street had a different view, but I don't think. The Street really completely understand how some of these rare diseases really work. For us, over time, we believe that SKYCLARYS is going to be a significant product. I think it is already a significant product. If we found another Reata where we -- you've got a product that is about to be launched on the market, and you could buy it for a price that generates a return for our shareholders then we would do it. But I think part of the problem is I don't think the people who are selling companies have quite integrated a lot of the pressures that are on this industry. The IRA is a de facto reduction in patent life for our industry, and there's a lot of pricing pressure from around the world. So the total commercial return for any one molecule today is not what it was even five years ago. And yet, I don't see really any shift in the premiums being paid or the price being paid. And there's always an asymmetry between the products that you know and the products that you're going to buy and so I think right now, we say we will look, if we could find another Reata, we would probably do it. We don't particularly want to do one deal that takes all of our cash flow because I think there is an interest in building the pipeline with multiple assets. If we could do more high bios, that's probably a nice sweet spot for us. We've kind of concluded that actually, we can probably manage quite nicely until the pipeline matures even further. So we don't feel any particular pressure to do things but I do think it's a job of every leadership person in this business to constantly look outside if we can find other sources of innovation. But I'm actually feeling very good about where Biogen is. Our share price may or may not reflect it, but I'm certainly not alone in this interest in thinking that the share price doesn't reflect where we are. And I think that's -- as a function of a lot of the uncertainty around our industry. But we are just keeping our heads down and executing on our launches and making sure these products get to market. And finding if there are shareholder value-enhancing transactions that can be done at pretty much any stage of the value chain."
},
{
"speaker": "Tim Power",
"content": "Let’s go to the next one please Jennifer."
},
{
"speaker": "Operator",
"content": "We'll go next to Chris Schott with JPMorgan."
},
{
"speaker": "Chris Schott",
"content": "Great. Thank so much for the question. Just I want to come back to the OpEx space. I know the company is wrapping up its Fit for Growth program and there is some moving pieces here with the royalty pharma deal. But as we think about the P&L going forward, is this kind of $3.9 billion or so OpEx space, a good rough number to think about for Biogen going forward? Or is there any other color about how to think about margin progression as we think about the next few years? Thank you."
},
{
"speaker": "Mike McDonnell",
"content": "Yes, Chris, I think that's right. The Fit for Growth program was designed to take our OpEx to a level that supports our revenue expectations. And I think that as we exit 2025 and go into future years. Obviously, if we have launches to support and other things, we'll need to invest in those appropriately. But I think the way that you described it is correct. And the program will be completed at the end of this year and the $3.9 billion base rate is a good number to use as your baseline model."
},
{
"speaker": "Chris Viehbacher",
"content": "Yes. And clearly business development, every time you do a deal, you bring in potentially new R&D expense. But I think what you've seen us do is prioritize. We've actually stopped a number of internal programs, which actually creates the financial capacity to bring other assets in. One of the biggest problems of business development typically has been is that the R&D budget is full, and there isn't any room to bring in new things. Well, we are actually making some of those difficult choices and the same is true on research. We have dramatically reduced our research budget but the idea was not necessarily to just save cost. The idea was that we wanted a different mix in there. And by prioritizing, we can actually do business development without having to increase our overall expenditure, at least that is what we've been able to do so far."
},
{
"speaker": "Tim Power",
"content": "And then we are running short on time. Maybe to squeeze 1 or 2 last ones and let's go to the next one."
},
{
"speaker": "Operator",
"content": "We'll go next to Evan Seigerman with BMO Capital Markets."
},
{
"speaker": "Evan Seigerman",
"content": "Hi, guys. Thank you so much for taking my question. Mike, congrats on your retirement. You will be missed. Robin. I'm really looking forward to working with you. And Tim, congrats on your first [bit in] (ph) the earnings call, I got that all in. I want to touch very briefly on the use of GLP-1s in Alzheimer's disease. Novo Nordisk has talked a lot about the EVOKE trial, high risk, high reward. What happens if that hits, and this could evolve the standard-of-care for the kind of prevention of Alzheimer's disease, Priya maybe would love your thoughts there. Thank you."
},
{
"speaker": "Priya Singhal",
"content": "Yes. Thank you, Evan. It's a very interesting hypothesis. And it's supported by some preclinical data, as well as meta-analysis that was looking at all-cause dementia and then some subsets, which also had Alzheimer's disease. And really, the scientific hypothesis behind it is thinking through about how glucose metabolism or regulation of that can impact neuro inflammation, vascular health all of that and contribute to kind of more brain health situation. And I think that, that is a -- it's worthy of exploring. I mean I think we need to remember that some randomized controlled trials have failed in the space, Takeda with pioglitazone and then actually Novo with liraglutide, small trial, 72 subjects, the ELAD trial, they didn't meet their primary endpoints. That said, I think we look forward to seeing the outcomes. What I think is really important to continue to remember is that when you are tackling something like Alzheimer's disease, you need to tackle the central pathology. We also note that the central pathology is not an overnight buildup, but build up over years. So for that reason, we continue to believe that an anti-amyloid agent like LEQEMBI that really addresses plaque but continues to address soluble toxic species after plaque clearance will have an important role to play. So I think we are looking forward to the results of EVOKE and EVOKE+ just like everybody. But I think we continue to believe that this is going to be -- LEQEMBI is going to play and continue to play an important role."
},
{
"speaker": "Tim Power",
"content": "Okay. Let’s go to our last one please."
},
{
"speaker": "Operator",
"content": "Our last question comes from Phil Nadeau with TD Cowen."
},
{
"speaker": "Phil Nadeau",
"content": "Good morning. Thanks for fitting as in. Let me add our congratulations to Mike Robin and Tim on their transitions. Just to drill down on the LEQEMBI short-term trajectory a little bit more closely. In Q4, revenue was up 30%, but the revenue recognized was only up $1 million. Can you talk about the dynamics behind that? Were there one-time issues? Or is there an increase in spend that we should project into 2025? And looking at 2025 trends, growth in 2024 was largely driven. Not entirely driven but largely driven by ex-U.S. is that replicable in 2025? Or are the low-hanging fruit of those markets already picked? Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "Well, I think LEQEMBI in the U.S. was certainly up 200% Q4 on Q1. And so we’re seeing significant growth in the U.S. Yes, the ex-U.S. has certainly been strong as well. But I think it's both. So I think for 2025, in the absence of anything else, we see pretty much continuing trends would be our best guess at this. There may be some acceleration with the IV maintenance but we are not going to get the subcutaneous for maintenance until really in the last part of the year. Blood-based diagnostics could play a role, but we all know that it takes a while to get diagnostics to be actually accepted and reimbursed. So I think we are going to just see good, steady progress quarter-on-quarter. There hasn't been that much impact of [lecanemab] (ph) that could have a role at some point, but I think they're dealing with the same issues that we are. I think the big thing is really to as I say, to expand the prescriber base. I think really focus on the benefit of treatment and roll out these new formulations. So I think it's going to be continued progress. We obviously continue to believe that Alzheimer's can be a significant market, and that's why we're investing not only in tau, but in other modalities. The unmet need is incredible, 500,000 new patients every year. It is one of the leading causes of death. Certainly amongst over 65 year olds, but it's even a top 10 cause of death just in the general population. So not to mention the devastation that this causes to family. So the unmet need is huge. It is clear that in the short term, we have a lot of capacity constraints, but I think we've made a lot of progress in relieving some of those. And so I think now with these new formulations such as subcu and with the blood-based diagnosis, we have an opportunity to accelerate our growth, I would say, over the next two years to three years."
},
{
"speaker": "Mike McDonnell",
"content": "Yes. And Phil, on the numbers just to reiterate something we said in the prepared remarks, the LEQEMBI fourth quarter end market revenue was $87 million globally. That's up about 30% sequentially from the third quarter of 2024. In the U.S., it was of the $87 million, $50 million in the U.S., and that's up about 28% sequentially."
},
{
"speaker": "Tim Power",
"content": "Thanks, Mike, and thanks, everybody, for your time today. The IR team is available if you’ve got questions later today. Thank you."
},
{
"speaker": "Operator",
"content": "This does conclude today's conference. We thank you for your participation."
}
] |
biib | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Cynthia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Biogen Third Quarter 2024 Earnings Call and Business Update. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be question-and-answer session. [Operator Instructions] Today's conference is being recorded. Thank you. I would now like to turn the conference over to Dr. Stephen Amato, Senior Director of Investor Relations. Dr. Amato, you may begin your conference."
},
{
"speaker": "Stephen Amato",
"content": "Thank you. Good morning, and welcome to Biogen's third quarter 2024 earnings call. During this call, we'll make forward-looking statements, which involve risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. We provide a comprehensive list of risk factors in our SEC filings, which I encourage you to review. Our earnings release and other documents related to our results as well as reconciliations between GAAP and non-GAAP results discussed on this call can be found in the Investors section of biogen.com. We have also posted the slides on our website that will be used during this call. On today's call, I'm joined by our President and Chief Executive Officer, Chris Viehbacher, Dr. Priya Singhal, Head of Development; Mike McDonnell, Chief Financial Officer; as well as our Head and President of North America, Alisha Alaimo who will be available for Q&A. We will make some opening comments, and then we'll move to the Q&A session. To allow us to get through as many questions as possible, we kindly ask that you limit yourself to one question. I will now turn the call over to Chris."
},
{
"speaker": "Chris Viehbacher",
"content": "Thank you, Steve. Good morning, everyone. I'll start first by thanking you, Steve for stepping up as Interim Head of IR and done a great job of preparing us for this quarter. Also earlier this week, we announced the retirement plans of our CFO, Mike McDonnell, and also the appointment of his successor, Robin Kramer. But Mike is still very firmly in the saddle as CFO, and we will be recognizing his significant contribution to Biogen with the fourth quarter earnings call later. So I think Biogen has made significant and very strong progress over the last two years. And I do think the company is well positioned for the future. Our launches are progressing well with good sequential quarter-over-quarter growth. Our cost base has been significantly reduced, but more importantly, a value-for-money approach to spending, I think, has been embedded in our culture. The acquisitions we've done to date have been well received and are already creating value. And I think we have a strong late-stage pipeline emerging. So if we turn first to the launches, let's start talking about LEQEMBI. Now although LEQEMBI revenue in the US continues to be below the expectations of our collaboration and the prescriber base is not expanded to the extent that we had anticipated, global revenue still grew by 66% in the third quarter as compared to the second quarter and we've got continued uptake outside the US and new prescriber growth of nearly 40% in the US The collaboration continues to refine the commercial strategy, and we are seeing benefits from an increase in our sales force, really who started out there in the field from first of September. And we continue to evaluate opportunities to potentially accelerate our business. Now we've continued to see some health care systems who are treating expand and extend and extending their treatment sites in the US. And more recently, we're starting to see large infusion networks activating in high-population geographies to help absorb patient demand. We've been encouraged by the rate of uptake outside the US, including Japan, where revenue nearly doubled from the previous quarter. And I think there's been terrific launch activities in particular, Japan and China. It does seem like a single payer system has also enabled that kind of growth. And overall, we expect continued sequential growth quarter-on-quarter for LEQEMBI over the near term. We believe there are a few future potential catalysts that could accelerate uptake, including the potential availability of IV maintenance as soon as next year, a subcutaneous formulation for maintenance and eventually induction, and more widespread utilization of blood-based diagnostics. Just to underline how much of a lift this is for physicians, some of you may have noted an opinion piece in JAMA Neurology, dated October 14, that was written by Katherine Possin of UCSF, Jeff Burns at University of Kansas and Brent Forester at Tufts. They talk about the unprecedented time of advances. But equally, they say the challenge and the importance of translating scientific advances in diagnostics, treatment and care into practice in a timely and equitable manner cannot be overemphasized. Innovation at the clinic healthcare system and policy levels is necessary to equitably translate advances at scale. So we continue to believe that this is going to be an important market. But again, we don't believe that we have a demand issue. It is just taking the healthcare system time to actually adapt to treating this number of patients. Turning to SKYCLARYS. We saw increased demand globally as we broadened our footprint, particularly in Europe. SKYCLARYS is now generating revenue from both commercial and other paid mechanisms in 15 markets outside the US. This includes a number of countries in the EU, where we are seeing increased demand quarter-over-quarter. Now at this point, I'd like to say there is a difference between how we generate revenue in the US and how we're seeing demand develop in Europe. In the US, our revenue is rising at the rate we find patients. In Europe, we are actually already out there commercializing the product. And we have a number of early access programs in place. But the strategy for a lot of products in Europe is to get patients on board while you're negotiating with governments to get reimbursement. And at some point, then the governments reimburse those patients and you have an immediate population of patients ready to go because they are already on treatment. So when you're looking at the progression quarter-on-quarter, the ex-US piece is not going to be a reflection of growing demand, but it's going to be a reflection of at what point in time do we get reimbursement for governments. But I can tell you that we are adding patients every day, every week in Europe at a pace that has exceeded our expectations. Now, we are looking to expand access to more patients, and there are now 11 regulatory filings that have been submitted globally. So we're looking now beyond the US and Europe, and they could start generating revenue as soon as next year. ZURZUVAE continues to outperform our expectations commercially in the US where we saw $22 million of revenue in the third quarter, and that's an increase of 49% over the second quarter, driven in part by a 40% increase in patients this quarter. I think the team has done an outstanding job with this launch. In all of the cases we've been talking about, LEQEMBI, SKYCLARYS and ZURZUVAE, I'd just remind everybody that these are not pre-existing markets. We are building these markets in each case. And that always takes longer than having incremental innovation where you go in and you just are looking to take some market share from a pre-existing market. So if we could change the slide, Steve. Our goal is really for sustainable growth. And there’s short term and there's medium-term growth. When I came to the company, I had really three major objectives. One is to put Biogen back onto a sustainable growth pattern for revenue, to build a pipeline that can sustain that growth for Biogen well into the 2030s and also to build a pipeline of leaders who will take this company to even more success in the 2030s. So as we look at the pipeline, I have to say, I think we are very excited about what we see emerging. Again, we are Biogen. We don't do incremental innovation. But I think there are some really interesting products that we feel very good about because unlike a lot of products in the past with Biogen, where we go into Phase 3, and we don't really know whether they're going to work, I think we've seen an awful lot in biomarkers, in data and other indications that suggest there’s a -- we have a growing conviction in these assets. So BIIB080, one of the things that excites me is that although this is an intrathecal as Priya will say, we recruited early on this one and were finished recruiting. And to me, as someone who's had commercial experience over 35 years, when I see a clinical trial recruiting early, particularly in a competitive space where there are existing therapies, that augurs well for the product downstream. Dapirolizumab, we saw positive Phase 3 results, and I'd like to congratulate Priya because Priya had already thought about this and it's worked with UCB and there's actually a Phase 3 protocol ready to go. And so we'll be starting Phase 3 very soon. Lupus is an area of huge unmet need, and we have not only dapi, but we have litifilimab in two indications. And behind that, we have also felzartamab actually in lupus nephritis. In felza, we had some very encouraging data at San Diego in IgAN, and we've had breakthrough status on AMR. This is a game changer for us in terms of our pipeline because, again, here, we've got Phase 2 data that look very compelling. We all know that there are no guarantees in pipeline development. But at least we have, I think, reason to believe that these products could come to market and make a big difference. And as we start to look at the peak revenue for each of these products, the cumulative of all of these, if they all actually made it to market and got approved, have peak sales cumulatively of about $14 billion. And when you consider that our pharma business today is about $7.5 billion, this late-stage pipeline could really transform Biogen over the longer term. But I shouldn't really be talking about pipeline. The real expert is Priya. And so with that, I'm going to turn it over to Dr. Singhal."
},
{
"speaker": "Priya Singhal",
"content": "Thank you, Chris. Over the last two years, we have focused heavily on augmenting our pipeline, as Chris noted, with an eye towards transforming innovation into novel and impactful medicines. As a result, I believe our current pipeline has several programs that are both supported by encouraging clinical data and have the potential to deliver meaningful value to patients. This includes dapi in SLE, litifilimab in both SLE and CLE, Felzartamab in multiple immune-mediated diseases, and our tau ASO BIIB080 in Alzheimer's, as Chris suggested. While advancing these programs remains our top priority, we are also working to implement acceleration strategy across the broader portfolio to expedite decision-making while continuing to focus on execution. An important example of this is BIIB080, where we recently completed enrollment in the amended Phase 2 trial design and now expect a readout in 2026. Additionally, with the positive Phase 3 results last month, we are moving very quickly with our collaboration partner, UCB, to initiate a second Phase 3 study for dapi in SLE this year. We are also implementing innovative new clinical development strategies to enhance clinical execution and accelerate cycle times. This includes initiatives like using AI to help optimize clinical trial participation and site selection. In parallel to these efforts and aligned with our ambition of continuing to build the pipeline, we are working also with our research and corporate development colleagues to evaluate external innovation opportunities across the development stage and several indications. Overall, we believe that through these objectives, we have the opportunity to execute on a meaningful opportunity that Chris has laid out for Biogen. Turning to the quarter. I would like to begin with Alzheimer's, where we are working with Eisai to continue generating important insights on LEQEMBI in early AD. This includes areas like long-term treatment effect and real-world evidence, such as that presented at CTAD, but importantly, we are also working to provide optionality for patients. Encouraged by data showing expanded benefit with continued LEQEMBI treatment and beyond just the removal of plaques, we continue to pursue maintenance storing options. We expect regulatory decisions on maintenance dosing for both the IV and the subcutaneous auto-injector next year in 2025. Furthermore, the AHEAD 3-45 study, evaluating the ability of LEQEMBI to prevent or delay Alzheimer's in preclinical or presymptomatic AD enrolled well, and we just completed enrollment this month in October. I look forward to us providing updates as this trial advances. We are also working to expand our leadership by advancing novel treatment approaches, including shuttles across different disease states and targets such as [Technical Difficulty] with BIIB080. Moving to immunology. We believe we are building an industry-leading late-stage pipeline comprised of programs with established proof of concept. These programs cover a range of immune-mediated diseases that are characterized by significant unmet need. This includes our recent acquisition of felzartamab, where we expect to initiate three Phase 3 studies next year in AMR, IgAN and PMN while continuing to evaluate other indications where this mechanism of action may be relevant. Additionally, we have multiple programs in SLE where it is estimated that over 3 million individuals worldwide are affected and current standard of care are associated with suboptimal efficacy and various treatment-related toxicities, leading to lasting negative consequences such as organ damage. SLE is also the number one cause of death in women aged 15 to 24 in the US and treatment options for before, during and after pregnancy are limited due to safety concerns and contraindications for most common therapies. Underscoring the potential of our immunology pipeline, we are pleased to report that the Phase 3 study of dapi plus standard of care met the primary endpoint, showing a statistically significant greater improvement in disease activity as assessed by the BICLA endpoint at 48 weeks versus placebo plus standard of care. Importantly, we also saw clinical improvements on key secondary endpoints assessing disease activity and flare prevention, two areas that represent key treatment goals for the management of SLE. Following the prior Phase 2 study, Biogen, along with our collaboration partner, UCB, spent time analyzing the results in an attempt to design and derisk a Phase 3 study and demonstrate a potential treatment effect. These learnings, combined with our understanding of the underlying disease biology inform the design of the Phase 3 study which included updated screening criteria to ensure patients had active disease in need of a biologic therapy on top of standard of care. The success of this approach is punctuated by the fact that dapi is only the third molecule to show positive Phase 3 results in a global study in SLE over the last 20 years. We look forward to presenting detailed results from this Phase 3 study as a late breaker at the ACR annual meeting next month and together with UCB, expect to initiate the second Phase 3 study this year. Turning to SMA. Our priority has always been on continuing to improve outcomes for patients. We were pleased to present detailed results from the DEVOTE study evaluating the investigational higher-dose regimen of nusinersen at the World Muscle Society meeting earlier this month. The higher dose regimen consists of 250-milligram loading doses followed by 28 milligrams maintenance doses every four months. This regimen of high dose delivers more drug in the first administration than the entire two-month loading phase of the approved SPINRAZA 12-milligram regimen. Consistent with the more rapid loading regimen, higher-dose nusinersen slowed neurodegeneration faster than SPINRAZA 12 milligrams as measured by neurofilament at day 64, an objective biomarker. The pivotal infantile onset cohort in Part B of DEVOTE met the primary endpoint of change from baseline to six months in the CHOP INTEND compared to the prespecified match sham group, demonstrating a clinically and statistically significant improvement. We also observed trends in reduced risk of death or permanent ventilation versus both sham control and the currently approved regimen. In addition, we shared initial results from the open-label Part C portion of the study with participants aged 4 to 65, transitioning from SPINRAZA 12 milligrams after an average of nearly four years on treatment. This group showed improvement in motor function after transitioning to higher dose. These are exciting results as we seek to help patients currently on disease-modifying therapies. Importantly, the high dose regimen was generally well tolerated and showed a safety profile similar to the approved 12-milligram regimen. We believe these results highlight the unique potential of SPINRAZA to help address remaining unmet need in individuals with SMA, and we aim to submit global regulatory filings later this year. In conclusion, this past quarter, I believe we continued to execute well and achieved several important development milestones that highlight the potential of our pipeline to deliver meaningful new therapies to patients. In addition to late-stage readouts in lupus and SMA, we also submitted ex US filings for zuranolone and PPD and obtained approvals for SKYCLARYS and QALSODY in Switzerland and China, respectively. We also presented new data insights across multiple disease areas, at multiple medical meetings, including Alzheimer's, neuromuscular and renal disease. Today, we believe that the pipeline is well positioned to deliver a regular cadence of pivotal readouts and potential launches. We continue to aspire to bring transformative medicines to patients' lives while we deliver on Biogen's objective of achieving sustainable growth. Furthermore, I believe that the same core capabilities and deep disease area expertise that enabled us to reshape our current pipeline and established leadership foothold in areas like Alzheimer's, immunology and rare disease also uniquely position us to evaluate external innovation as we look for opportunities to augment our pipeline. With that, I would now like to hand the call over to Mike for a financial update."
},
{
"speaker": "Mike McDonnell",
"content": "Thank you, Priya, and good morning to everyone. And I'd like to provide some color on our third quarter results and all the comparisons that you'll hear me make are versus the third quarter of 2023, unless you hear me note otherwise. Total revenue for the quarter was $2.5 billion. Both total revenue and core pharmaceutical revenue were down 3%. Non-GAAP diluted EPS was $4.08 and that's down 6%. In just a moment, I'll provide some additional detail on some key dynamics to note from the third quarter. Non-GAAP operating income increased 4% versus the third quarter of 2023 as we continue to benefit from our R&D prioritization and Fit for Growth initiatives. We are pleased to again be raising our full year 2024 guidance range. And in just a few moments, I'll provide some additional color on our raised guidance range for 2024. Few comments on revenue for the third quarter. Our MS product revenue declined by approximately 9%, and that was driven primarily by competitive dynamics in the space, along with some channel dynamics. Importantly, we announced last week that the European Patent Office upheld the validity of Biogen's TECFIDERA related patent covering DMF dosing, which expires in February of 2028. We are pleased with the decision. However, generics are challenging this patent, and we do anticipate further challenges. TYSABRI has seen impacts from a biosimilar entrant in Europe, and although a biosimilar is not yet launched in the US, we continue to see increasing competition in the high-efficacy class. Next, our rare disease franchise produced revenue of $495 million, and that represents growth of 10%. The SKYCLARYS launch continues to progress in the US, where revenue of $82 million increased 8% from the second quarter, and that was driven by increased demand. SKYCLARYS is now generating revenue in 15 countries outside the US with third quarter global revenue of $102 million. This was up modestly from the second quarter, driven by an increase in demand, and that was partially offset by some pricing and reimbursement dynamics in some newly launched markets. Global SPINRAZA revenue of $381 million declined $67 million or 15% and that was impacted by the loss of an annual tender in Russia, which resulted in an unfavorable impact of approximately $45 million in the third quarter. It is important to note that this tender which occurs and contributes to revenue only once each year affected Q3 2024 results, but we do not expect further revenue impact for the rest of this year. The global decrease was also impacted by the timing of shipments and some foreign currency. SPINRAZA US revenue was up 2% to $153 million, and we remain encouraged by the performance here. ZURZUVAE delivered $22 million of revenue in the quarter, and that's up 49% from the second quarter, and we continue to be encouraged by an increase in demand. We again saw sequential growth for LEQEMBI with third quarter global in-market sales booked by Eisai of approximately $67 million, and that's up 66% versus the second quarter. LEQEMBI in-market sales in the US were $39 million, that's up 33% versus the second quarter. And finally, contract manufacturing, royalty and other revenue was $250 million. That was notably lower year-over-year as expected due to the completion of certain batch commitments in 2023. Now, I'll turn to a few comments on third quarter expenses. Non-GAAP cost of sales as a percentage of revenue decreased 2 percentage points, and that was driven primarily by product mix, particularly the year-over-year increase in revenue from new product launches and the decrease in contract manufacturing revenue as well as lower idle capacity charges. Non-GAAP R&D expense decreased $48 million as we continue to see benefits from our R&D prioritization initiatives. Non-GAAP SG&A expense increased 1% in the third quarter as benefits from our Fit for Growth initiative allowed us to absorb most of the $45 million of incremental costs in the third quarter associated with our launches. We continue to believe we can garner $1 billion of gross and $800 million of net savings associated with our Fit for Growth initiative by the end of 2025. Non-GAAP EPS was $4.08 in the third quarter. EPS was unfavorably impacted by certain non-operating items, including a decline of approximately $80 million of net interest income on lower cash balances as a result of the Reata and HI-Bio acquisitions. This was partially offset by some favorable tax items in the quarter, which added about $16 million to our net income. Now a brief update on our balance sheet. We ended the quarter with $1.7 billion of cash and marketable securities and approximately $4.6 billion of net debt. We were able to generate approximately $901 million of free cash flow, and that was our highest free cash flow since the second quarter of 2021. Third quarter 2024 free cash flow benefited in part from some favorable working capital dynamics. We continue to believe that our balance sheet remains strong and provides us the capacity to continue to invest in both internal and external growth opportunities. Turning now to guidance. We're pleased that the business performance year-to-date, again supports raising our full year 2024 non-GAAP diluted EPS guidance range from between $15.75 and $16.25 to a new range of between $16.10 and $16.60. This new range reflects expected growth of approximately 11% at the midpoint of the range compared to full year 2023. I'd like to highlight a few of the key assumptions relevant to this guidance. First, on the top line, we continue to expect that our total revenue will decline by a low single-digit percentage. And as we've communicated throughout the year, we expect to continue to ramp investment behind our new product launches and key R&D programs which includes felzartamab following our acquisition of HI-Bio. And lastly, as is typically the case with our business, we expect seasonally higher SG&A spend in the fourth quarter as compared to the rest of the year. I would refer you to this slide as well as our press release for other important guidance assumptions. In closing, we remain focused on advancing our ongoing product launches and key areas of our late-stage pipeline. We believe our efforts in these areas will help position Biogen for long-term sustainable growth, which continues to be our number one goal. And with that, we will open up the call for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question comes from the line of Brian Abrahams with RBC Capital Markets."
},
{
"speaker": "Brian Abrahams",
"content": "Hey, good morning. Thanks so much for taking my question. I'm curious on LEQEMBI, when you might expect to see more pull-through from the expanded commercial efforts, whether you're starting to see any of those signals in October. And you mentioned as well the potential for some other commercial acceleration strategies in your prepared remarks. Can you maybe expand on that a little bit more and characterize your overall alignment with Eisai on the commercial plans? Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "Yeah. I'll take the second part of the question, Brian, and then pass it over to Alisha can give a little more color on the expanded field force. I think we have learned an awful lot really in the year since we launched the product. I mean, the product launch really started really last fall, I mean we had to get all of the commercial team in place, but we also needed clarity around things like reimbursement of the PET scans. So for us, I think this is about the anniversary really of the launch. And there are a lot of things that we are now understanding, the time it can take for IDNs to really get their protocols in place and the care pathways. But there are also a number of things like who's the right patient? And we have also an awful lot more data coming along. We're going to have the subcutaneous formulation, hopefully, next year for maintenance, the IV for maintenance sometime next year. And so it seems opportune for the two partners now to come together and just review what's working well and what could we be doing more. So we'd probably be able to give you some more color on that. I would say the teams are working very well together. We both understand that this is a very complicated launch. I think more complicated than most that I've certainly seen, I think, most people have seen. And yet, we do see a lot of physicians, again, who are really putting an awful lot of work in to make all of this happen to triage the patients as to who's really the right patient, a high percentage of patients coming into the neurologists are not eligible for treatment. Then organizing the PET scans are the lumbar punctures, the MRIs and the infusion beds. So we've seen an awful lot of real effort out there in the marketplace, and we add prescribers every week and we see more sales every week. And so I think that's the way it's going to progress probably until we get the subcutaneous for induction. I think that could be quite a game changer. And again, more use of the blood-based diagnostics in place of the PET scan. Both of those would, I think, dramatically reduce the workload of physicians. But Alisha, maybe you can talk about the expanded field force and anything else you think might be helpful."
},
{
"speaker": "Alisha Alaimo",
"content": "Yeah. Thank you, Chris, and thanks for the question, Brian. As all of you have seen in Q3, we did have steady launch progress as we've seen in prior quarters and that's including in the new number of patients. Also encouraging what you don't see in the trends that we're able to see is the total prescribers writing and actually in Q3 the new number of writers increased by 40% versus Q2. So you are seeing these physicians come on every single week, IDNs expanding every single week as well. However, at the end of the day, just like in the beginning of the launch and even today, fast forward after we've been out in the field for a while, what shows up in market research as the key barrier is still these infrastructure challenges, as Chris alluded to. However, now with the new Biogen team on Board, we're also able to confirm that, especially with physicians who haven't written yet, that is really one of their main concerns. Our second concern, of course, is still ARIA, even though it's not as big of a concern as it was prior. However, once they work through some patients and they work out their protocols, you do see that alleviate. However, we now have our full field force out there. And as a reminder, we were very intentional as an organization as to who to hire. We were in a little bit of a luxury situation at the time when we posted these roles, we had over 1,000 applicants and we only had a little over 25 roles that we had posted. So we were really able to pick those individuals who either had history in Alzheimer's disease or a history in these territories and already had built-in relationships. And so now the teams have been out there for several weeks. We are starting to see in the offices specifically where Biogen has overlaid with Eisai. Where we are engaging, we do see a little bit more accelerated growth than what you do see in the rest of the nation, we're able to reach more targets and also, doors are opening up a little more easily for us because, again, those representatives did have prior relationships with physicians. And so in the longer term, we obviously are going to continue with doing frequency in depth. But at the end of the day, for example, we can say in the Pacific Northwest, we had a rep that's been -- had a relationship that actually prior with MS for 17 years, they're able to help the physician right away. Another physician in the Southeast they had a relationship over 20 years. They were able to unlock over 30 patients, I think, in less than a two-week time period. So the relationships we've seen has mattered. Also the history has mattered, and we are starting to see some acceleration, even though they've only been out there fully for about a month or so."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Alisha. Next question, please."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Phil Nadeau with TD Cowen."
},
{
"speaker": "Phil Nadeau",
"content": "Good morning. Thanks for taking our question. Chris, you've referenced the subcutaneous formulation a couple of times already this morning. Could you give us a bit more of an update on the status of the subcu filings both for maintenance as well as for induction? Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "Sure. I'll turn that over to Priya."
},
{
"speaker": "Priya Singhal",
"content": "Yes, thank you for that question. So we remain on top to really complete our subcutaneous maintenance filing as Eisai has indicated, and we expect that to be imminent. And then moving on to the initiation, we are working to generate the data, analyze the data. This is part of the CLARITY open-label extension study in the subcutaneous sub-study. And as Eisai has indicated, we remain on track to expect a regulatory outcome on subcutaneous initiation therapy by Q1 of 2026 calendar year."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Priya. Next question please, operator."
},
{
"speaker": "Operator",
"content": "Your next question comes from Marc Goodman with Leerink."
},
{
"speaker": "Marc Goodman",
"content": "Yes. Could you comment a little bit more on SKYCLARYS OUS. There was a comment in the opening remarks about pricing and reimbursement dynamics. And if you could just give us a little more color there to the challenges. Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Yeah. So as you know, you get approval in Europe, but then you have to go country by country to negotiate for reimbursement. And basically, what we are already doing is seeing physicians, and we're getting patients on treatment. But the actual revenue generation of those patients varies by country. So there are some countries, for instance, where you can charge for an early access program. There are countries where you can't, there are some countries where you can get reimbursement much earlier than other European countries. So we are in that process. What we have not done is really started the revenue generation -- sorry, the patient demand generation with reimbursement. We are active in all countries and signing up patients. And so we're tracking patient numbers, which are growing considerably every month. What you will see in the quarterly revenue numbers is when those patients convert to revenue-generating patients. And that is, by definition, going to be a little lumpy because the patient demand is actually in advance of when we generate revenue. And on the -- on those programs where you have early access that you can pay for, you have to establish a price. But in some cases, there is a clawback if the reimbursed price is going to be lower than what the prices you're charging. And obviously, as we go into countries and have a better idea where the price point is, we've had to make some adjustments on revenue that we have booked and those programs where we can charge for an EAP. And that's just really a normal process in most launches in Europe."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Chris. Next question, operator."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Salveen Richter with Goldman Sachs."
},
{
"speaker": "Salveen Richter",
"content": "Thank you, good morning. Chris, you spoke to the efforts with regard to the late-stage pipeline in R&D, but you've also noted the lever with regard to business development. Any updated thoughts here as to the strategy for the latter on the [ford] (ph)?"
},
{
"speaker": "Chris Viehbacher",
"content": "Yeah, I mean we're in one of those classic situations in our industry where we've had a legacy portfolio of assets that is facing increased competition. And on the horizon, we see an extremely promising pipeline and how do you bridge across that. And some companies choose to simply wait that out and wait for the arrival of the pipeline. And our business is likely to grow between now and 2028, but I would say that the growth is not necessarily satisfactory for us. So we are looking and continue to look, I spent personally quite a lot of time on this. Are there assets that we could bring in that could enhance our revenue growth in the near term but also that still create value for shareholders. We're not really interested in just buying revenue. If we can buy growth, and we can make a very good return on investment, then we'll do so. But as you know, assets get pretty highly priced as they get close to the market. So you have to do an awful lot of digging and an awful lot of looking, and that's what we are doing. We have a whole team of people that look at both public and private companies. And I think we still have considerable financial capacity. And Mike, you may want to comment on that. But we are active in that, but we are also disciplined fiduciaries of shareholder money. I've always said we get paid to make our shareholders wealthy, not somebody else's shareholders."
},
{
"speaker": "Mike McDonnell",
"content": "Yeah. So, Salveen, just on capacity, just to give you a frame of reference. We ended the quarter with about $1.7 billion of cash on hand. And when you think about our capital structure, about $6.3 billion in total debt on an EBITDA run rate of about $3.3 billion to $3.4 billion. So it's below 2 times gross, that's a very modest amount. And when you think about capacity, we're pleased with about $2 billion of free cash flow year-to-date, $901 million in the quarter. So with a couple of billion dollars plus of free cash flow per year and less than two turns of gross leverage, you can see over the next couple of years, if you added a reasonable amount of incremental debt at some point in time plus the free cash flow and the cash on hand, there's comfortably $8 billion to $10 billion of capacity that you've got over the next year or two in order to collaborate and transact and look at acquisitions and other things that we can do to help supplement our growth."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Mike. Next question please, operator."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Michael Yee with Jefferies."
},
{
"speaker": "Michael Yee",
"content": "Thank you, good morning. We noticed that you completed the enrollment of the AHEAD 3-45 study. And I just wanted to ask Priya, if you could remind us what the timeline would look for that, more specifically, if there is a potential for an interim analysis handle what that would be based on? My understanding is that these are pretty early presymptomatic patients. Is there an enrichment of the population? And why would you be expecting that this can be positive? Thank you."
},
{
"speaker": "Priya Singhal",
"content": "Thank you, Michael. Yes, we're excited about the fact that AHEAD 3-45 has completed enrollment in October. Just to remind everyone, it's two trials, and one is really looking at early intermediate stages, patients with early intermediate stages of amyloid and the other is with higher load amyloid. And these are very large trials. So it's about 400 patients in the AHEAD 3, which is the earliest intermediate stage and about 1,000 patients in AHEAD 4, 5 and the timeline, the trials have a 216-week time point. Having said that, we are continuing in parallel to engage with regulators and look at all options of when these might be ready to read out. So we'll continue to provide more updates, but we're very excited about having completed enrollment, specifically because the data that we've shared from the CLARITY study shows that treating early and with patients with low tau or no tau, really, you see a lot of benefits in terms of stabilization and actually even clinical improvement. So it continues to really be a very exciting space for patients to have therapies, and that's why we're very excited about where we are today."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Priya. Next question, please."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Umer Raffat with Evercore ISI."
},
{
"speaker": "Umer Raffat",
"content": "Hi, guys. Thanks for taking my questions. I thought I'd focus on a slightly different topic for a quick second. It does look like there's a very significant amount of R&D investment going into lupus between your felzartamab, as well as your BDCA molecule and possibly the CD38 as well. And I guess my broader question is this. You hit a Phase 3, which is obviously good news. But separately, we're seeing incredible remission data from some CD19 CAR-Ts, which might even possibly manifest in some CD19 bispecifics as well. So it seems like you have a lot of exposure, not on that area, which is CD19 bispecific. And I guess, how should we weigh by the time you guys do get to this market relative to some of the emerging data from potentially CD19 bispecific or the T cell engagers? Thank you very much."
},
{
"speaker": "Priya Singhal",
"content": "Thank you, Umer. Yes, we continue to watch the innovation in the space, and it's exciting for patients. But I think when you step back and you think about the potential, the dapi can offer. And with the data that we shared and we'll be sharing more data at ACR in a few weeks here, and it is embargoed, we're very excited by what we've seen in this moderate to severe population. So just stepping back, when you look at SLE, it is really a chronic disease, very heterogeneous, high global burden of disease, specifically in women and underserved population. And we believe that many options will be required. So I think while the bispecifics and the CAR-Ts may show efficacy in small population, we've got to keep in mind that these are very small data sets and likely may not be relevant to the entire population. And I think that here is where the scientific hypothesis and continuing to generate data sort of in Phase 2 that makes us believe that we could have a high probability of success in Phase 3 becomes really important. And with dapi, we're really addressing and inhibiting the CD40 ligand, which has the ability to reduce B and T cell activation, downregulating interferon pathways. And then with litifilimab, we're going after the Type 1 interferon signature and really looking at inhibiting BDCA2 in the plasma delta itself. So we believe that this is going to be really important and probably many options are required, but we remain really optimistic about the data that we've seen so far and the momentum that we have with our trials. So we continue to be believers in these pathways and these programs. With litifilimab, as you know, we're also addressing cutaneous lupus where really there has been no innovation in 70 years. So again, we have high scientific conviction, as Chris mentioned, and we'll continue to prosecute these."
},
{
"speaker": "Chris Viehbacher",
"content": "And I'll just add, Umer, I was at GSK when we were developing BENLYSTA over 15 years ago, and we almost killed that program because of modest efficacy until we realized that everything else was failing, and this was the last product standing. And to date, only two products have been approved. Dapi would be the third. And I can tell you, over the years, we've seen an awful lot of data in small populations as Priya has said. And so I think we have to wait and see who actually gets to the finish line. On CAR-T, some interesting data, but the logistics of CAR-T are not yet such that you're going to be seeing significant numbers of patients being treated in my personal opinion. So I think as Priya said, there's a need there today. We have a product that has demonstrated results we're going full speed ahead. And just given the nature of this disease, I think you're going to find that there's not going to be any one product that ultimately is a winner. It's going to take different approaches."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Chris. Next question please, operator."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Jay Olson with Oppenheimer."
},
{
"speaker": "Jay Olson",
"content": "Hey, congrats on the quarter, and thank you for taking the question. We're curious about the $14 billion of peak revenue potential from your four key pipeline programs. Can you talk about the relative contribution and timing of the four products in terms of which ones are the largest and nearest term? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "I don't want to get into giving individual revenue forecast. I think the idea was to give a sense of what's the magnitude of pipeline. We all know that not everything can always succeed. But I do think if you look at where are there going to be significant programs, if you look at BIIB080 in Alzheimer's, we do believe, and I think Biogen is not the only one. I see Lilly and Roche continue to invest significantly. You've seen AbbVie lay out quite an awful lot of money for a very early-stage asset in Alzheimer's. So I think we all believe that as the healthcare system is ultimately able to adapt to the significant demand for treatment that this becomes an important market. And what we can see, and I was just at a major world-class medical school last week, spent a day there with a lot of researchers in Alzheimer's, they are excited about tau in a way that we have not seen always at a beta. Alzheimer's severity really varies with the level of tau and people really believe -- a lot of people in the field really believe that going after tau will really have a significant benefit for patients. So we do think that BIIB080 is certainly a product with a tremendous amount of potential. And as Priya said, we have dapi, but we also have litifilimab and also felza in lupus nephritis. So we do see that lupus is going to be a significant market. And again, you look at you look at BENLYSTA that is selling at about $3 billion a year. And then there's an AstraZeneca product that hasn't done as well, but you look at the numbers of patients, this is still a market where there's considerable room for expansion. In felza, we have three Phase 3 programs going in, and we see all of those three indications as being a significant opportunity. So again, you add them up. 14 is kind of like the top number, but somewhere between 9 and 14 is what our teams have estimated. Again, we have to wait and see what the clinical trial data looks like in the actual profile. But if you look at the potential of these markets and the unmet need and the potential for differentiation, we're becoming increasingly excited about this emerging pipeline."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Chris. Next question, please."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Evan Seigerman with BMO Capital Markets."
},
{
"speaker": "Evan Seigerman",
"content": "Hi guys. Thank you so much for taking my questions. I know in the past we've talked about the potential for SPINRAZA returning to growth. Given the softer numbers this quarter, can you just talk about how you think that this is achieved. Is it predicated on high-dose nusinersen? Or are there other factors and levers that you can pull to accelerate -- reaccelerate the growth of this product? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Well, so globally, actually, if we take out some of the onetime effects of -- or sort of the exceptional effects of the ex US, ex European markets, actually, we did see a growth for SPINRAZA. It's clearly a very competitive marketplace. And -- but it turns out that even though we have an intrathecal administration, that efficacy is really what matters in really severe diseases. And that's what we compete on. We had a study that has demonstrated, for example, the benefit of adding SPINRAZA on to ZOLGENSMA as gene therapy and we know that the oral therapies have limitations in terms of which patients can be treated. I think that our teams believe that DEVOTE is extremely important because we can get to the -- through the loading doses and get to the right level of therapeutic benefit faster than we could previously. And that actually reduces the number of intrathecal injections at least for the loading phase. So I think this is really an efficacy gain, but I'll ask Alisha, at least from a US perspective, how you see that?"
},
{
"speaker": "Alisha Alaimo",
"content": "Thank you, Chris. And hello, Evan, thank you for the question. SPINRAZA has really been a very strong contributor, especially in the US business. So when you look at rare disease, we believe that SPINRAZA has really set that benchmark for what really excellent efficacy looks like and then it translates down to a patient. And so growth year-over-year, which my team has seen, and even that's during a time we've had two very strong competitors. We had oral launch during stay-at-home orders and the team is still really leading the way with SPINRAZA. And we do believe it's for a few reasons. One, the efficacy of the product is obviously very strong. And a lot of our growth also comes from switchback. There's a lot of patients that are returning back to SPINRAZA once they've switched away to a competitor, and they realize that maybe the efficacy isn't there. And so we do see quite a bit of that in the US. And secondly, you fast forward eight years, we are still finding new patients in this space, and that's with three major biopharma companies putting money into this rare disease. And so you do see new patients still coming online. And we believe at least on the Biogen side, we are very good at patient finding. We're able to find them quite quickly. We have an excellent AI sort of machine that we use along with the field force. We're able to locate them in centers of excellence and physicians are able to reach out and find these patients. And so with high dose coming, one of the pieces of feedback you do get from physicians and patients, as you know, we just wish we had more. And so with that, we're preparing right now for that, obviously, the filing and the potential approval going into label, and we do believe that high dose will also support growth quarter-over-quarter, year-on-year for at least the US organization."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Alisha. Next question please, operator."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Paul Matteis with Stifel."
},
{
"speaker": "Paul Matteis",
"content": "Hey, thanks very much for taking the question. In connecting some of the dots here, Chris, as it relates to the hires you've made and some of your portfolio decisions around certain legacy high-risk assets, it feels like more and more Biogen is bolstering its expertise in neurology and maybe shifting away from neurology. Is that the right way we should think about things going forward? In other words, when you look at business development, do you have any appetite any more to take on risk in neuroscience or do you feel like immunology, rare areas that you have a lot of experience with historically are going to be the sweet spot going forward? Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "I would say, first, we're already long in neurology and neuroscience. I mean we have very significant investments, obviously, with the BIIB080 program, continued significant investment in LEQEMBI. We're still spending hundreds of millions of dollars every year on the LEQEMBI R&D. And we have actually a number of programs coming behind that in early-stage development. We're working on brain shuttle technology, but looking at other modalities in Alzheimer's, we still have earlier-stage programs in MS and ALS, a significant program in Parkinson's in partnership with Denali. So I think we see neuroscience as somewhere where we already have a significant commitment. But to me, I think it's not a good idea to just be in one therapeutic area. And in addition, I think we actually already have capabilities beyond neuroscience. The whole MS franchise is really an immunology franchise. You treat MS through the immune system. And I do believe we have an awful lot of immunology capability and that certainly gave us the confidence to do the HI-Bio acquisition. I&I, I go to a number of biotech conferences and venture conferences. I&I has now become the second most important area in R&D after oncology. And so you're going to have an awful lot of emerging opportunities for BD in this space. Biogen has a tremendous capability in small volumes and high-value products, highly differentiated scientific cell. And I think immunology fits that build. Rare disease is really more of a commercial description than a scientific one, but we do have a commercial model in rare diseases that has an awful lot of capability that not everybody does. And so expanding into that area with that commercial model almost being, I would say, indication agnostic is an area that we can go. And I don't think we're stretching our capabilities. There are some capabilities that we have to build. And in some ways, Fit for Growth was as much shifting some of the focus away from a traditional heavy focus on MS and being able to adopt some of these other capabilities. But I wouldn't -- we don't really want to get into those areas where we'd have to go up against really large pharma companies in the commercial model. We're not really into incremental innovation in Biogen. So I feel pretty comfortable that we can expand our horizons in certain areas of immunology, probably more related to rare diseases and neurological conditions in immunology, not necessarily things like RA or atopic dermatitis. But we have a legitimacy to play there, and we have the capability and we can really take advantage of a lot of the really smart people within Biogen."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Chris. Can we move to our last question please."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Terence Flynn with Morgan Stanley."
},
{
"speaker": "Terence Flynn",
"content": "Thanks for taking the question. Mike, I was just wondering if you can help us think directionally about margins for 2025 and some of the puts and takes. Thank you."
},
{
"speaker": "Mike McDonnell",
"content": "Sure. And I'm going to assume, Terence, that you're referring primarily to our operating income margin. But I think we've made really good progress. The improvement in the third quarter, it was a little bit less than what you've seen. There's a little bit of lumpiness to it. And I think it's probably -- and some of that was driven by the revenue dynamics that we talked about in the quarter and some of the higher margin revenue like SPINRAZA, SKYCLARYS. But I think if you look at it on a year-to-date basis, that's probably the best way. We're 7% up year-to-date on the operating income line, a 7 percentage point improvement, I should say, it's 23% growth year-on-year. In our guidance, we talk about mid-single-digit improvement for the full year and high teens growth for full year. And I think that we feel good about the improvement that we've made. We still feel confident that we can garner the $1 billion gross and $800 million net savings, which will continue to help our margins. And we're not guiding beyond this year, but as we exit 2024 and head into 2025, I think it's important to remember that we've said that the $800 million of savings we expected to get half of that by the end of this year and the other half next year. So that will continue to improve our margin profile as we go."
},
{
"speaker": "Stephen Amato",
"content": "Thank you, Mike, and thank you, everyone, for joining us today. Of course, the IR team will be available to answer any additional questions. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes today's call. Thank you for your participation. You may now disconnect."
}
] |
biib | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Anna and I will be your conference operator today. At this time, I would like to welcome everyone to the Biogen Second Quarter 2024 Earnings Call and Business Update. 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] Today's conference is being recorded. Thank you. I would now like to turn the conference over to Mr. Chuck Triano, Head of Investor Relations. Mr. Triano, you may begin your conference."
},
{
"speaker": "Chuck Triano",
"content": "Thank you. Good morning, good afternoon, and welcome to Biogen's second quarter 2024 earnings call. During this call, we'll make forward-looking statements which involve risks and uncertainties that may cause actual results to differ materially from those in our forward-looking statements. We provide a comprehensive list of risk factors in our SEC filings, which I encourage you to review. Our earnings release and other documents related to our results, as well as the reconciliation between GAAP and non-GAAP results discussed on the call, can be found in the Investors section at biogen.com. We have also posted the slides on our website that will be used during this call. On today's call, I'm joined by our President and Chief Executive Officer, Chris Viehbacher; our Head and President of North America, Alisha Alaimo; Dr. Priya Singhal, Head of Development; Mike McDonnell, Chief Financial Officer, and we'll be introducing Dr. Travis Murdoch from HI-Bio on the call. We'll make some opening comments and then we'll move to the Q&A session. And to allow us to get through as many questions as possible, we ask that you limit yourself to one question. With that, I'll now turn the call over to Chris."
},
{
"speaker": "Chris Viehbacher",
"content": "Thanks, Chuck. We got a lot to cover this morning, but first, in addition to our regular team of Priya, Alisha, and Mike, I'd like to welcome a new member to our team, Dr. Travis Murdoch. Travis is a physician who trained as a gastroenterologist and then studied immunology as a Rhodes Scholar at Oxford. Following a career at McKinsey, Third Rock, and Softbank, he became the founder and CEO of HI-Bio. I'm pleased to welcome Travis and the HI-Bio team to Biogen. We now have, again, a presence on the West Coast. And the HI-Bio team, working in collaboration with their Biogen colleagues on the East Coast, will drive forward the development of felzartamab. So we're announcing really strong quarterly results this morning, but I would say this is really a quarter that has lasted 18 months. I think the results we're presenting really reflect the hard work of team Biogen to transform our company. 18 months ago, we were a company that had been declining for four years in revenue and profit. And we have been working pretty tirelessly for the last 18 months to really turn that around and create a new future for ourselves. At the Q4 earnings in February of 2023, we outlined five priorities. First one was focus on new launches. Second was to reduce our cost base and align resources with growth opportunities. Third was to focus our investments in R&D on the most promising assets and improve the risk/reward profile. Four was to optimize our existing portfolio. And five was external growth. We've had a few setbacks along the way, but nonetheless, I think the results today really show that Biogen has done what it said it would do. And that to me has been always important in business. So if I take each one of those, I think if we look at our new product launches, all of the launches are either in line or ahead of expectations. I'm particularly happy to see the very strong results for LEQEMBI, not only in the US, but there's been a very successful launch in Japan. And the early data from China are also extremely promising, and Alisha will talk more about that. Last year, we set out to reduce our cost base and we are more than on track on delivering on those results and you can see that in the not only the reduction in OpEx but the very strong improvement in margins and Mike will talk about that. But one of the things that you don't see in the P&L that I'm particularly proud of is although we've really reduced our cost base and improved our margins, we have invested massively where we need to for growth opportunities, both in LEQEMBI and the other launches, but also on really trying to turbocharge some of the key assets in R&D. And, Priya will talk more about that, but one of the beneficiaries of that is BIIB080, and another one is litifilimab. We also have -- although we have seen a declining MS portfolio due to increased competition, particularly from biosimilars and from generics, we still had a number of products where we still had long patent protection. And one was SPINRAZA. And I think we've seen some very good performance. This is a very competitive space. And SPINRAZA has been able to hold its own. I think when I first joined the company, most people thought we were predicting the decline of that. Today, I would say the bumpiness tends to be in some countries where we only ship every now and then. I think in Russia, for example, we do one shipment per year. So that business has always been a little bit bumpy. But if you look at market share, I think SPINRAZA has done extremely well. And I'm very pleased to see VUMERITY growing at double digits again now in the US. This is the only patent protected product in the oral segment of MS. We see an awful lot of movement in the injectable part, but the oral segment has stayed pretty much constant and it's a great opportunity and I'm glad to see Alisha and her team really taking advantage of that. And then, we always said we were going to be open to external growth and I think the Reata transaction last year is really starting to pay dividends. We're seeing a very strong launch not only in the US, but now also in Europe. As you know, we tend to get patients on access programs and then the reimbursement follows. But we are expecting to be approved in 20 countries by the end of this year. And I think we're extremely happy with that. ZURZUVAE addresses a huge unmet need and that launch is also well in excess of expectations. So as I sit here today, I would say, the results that you're seeing are not, as I say, just the results of what we've done in the second quarter, but really, I think we're putting up scores on the scoreboard here that really now are starting to demonstrate all of those initiatives that we put in place last year and we're starting to deliver on them. Now of course we're not done yet and I think there's a real opportunity to continue to develop a sustainable growth platform. And we'll do that in two ways. The first is really, now that we have prioritized R&D, I see the Alzheimer's portfolio as being a core franchise for us for the coming years. We're obviously continuing to invest heavily in LEQEMBI with the maintenance indication, the subcutaneous, but also I think the AHEAD study, if we can really get the evidence that it will really demonstrate the importance of early treatment. Priya will talk about it, but the 36-month data that we showed at AAIC this week are extremely important for the future growth of LEQEMBI. But we've always known there will be other modalities, and I think tau is emerging as an extremely important modality for the treatment of Alzheimer's, and I think Biogen is a clear leader in that. And again, Priya will say more about that. We're also seeing an emerging lupus portfolio. We'll have a readout later this year with dapirolizumab that we share with UCB. But we're quite excited about litifilimab, both for SLE as well as cutaneous lupus. And we add another element to the lupus portfolio with felza because that is actually in Phase 1 for lupus nephritis. And to me, and Travis will go into this more, but the acquisition of HI-Bio is extremely important for our longer term growth outlook. This is an opportunity to present a set of opportunities that have a different risk-benefit profile. We have very strong Phase 2 results, which gives us a whole lot more confidence in Phase 3 results than some of the other assets that we have in our portfolio. Neuroscience is an area of a very important unmet need, but it's also one of the riskiest and hardest areas. And so I think we get a little bit more balance in our portfolio by pursuing things in immunology. And so I personally am extremely excited about felza and what Travis and his team can do. The other axis to this is we're going to continue to look at business development. I think you have seen that we're pretty disciplined. I think both of the acquisitions that we've done so far with Reata and HI-Bio will drive an awful lot of shareholder value and that is certainly top of mind as we look at business development. So I think Biogen is in a much different place than we were 18 months ago. We still have a number of challenges like any other company, but I think we're really positioned for longer-term growth now at the company. And with that, I'd like to turn it over to Alisha to give us a little more color on the successful launches."
},
{
"speaker": "Alisha Alaimo",
"content": "Thank you, Chris, and good morning, everyone. Thank you for joining the call today. Today I'll provide our perspective on the progress with LEQEMBI, SKYCLARYS and ZURZUVAE. So I will begin with the Alzheimer's market. We believe we're continuing to build momentum with more health systems across the country, now having the capability to treat a higher volume of Alzheimer's patients. And in Q2, we saw these promising trends continue. Notably, we sustained new patient growth. Nearly 40% of all commercial patients on therapy since launch, started treatment during Q2. The number of physicians prescribing LEQEMBI also grew by 50%. Depth of ordering at our priority 100 IDNs continued to accelerate, and the total order volume more than doubled again in Q2 compared to Q1. It's important to know that based on the data we've seen to date, these trends continued into the first weeks of July, demonstrating that we are sustaining launch progress. We also believe we're seeing positive signals that health system capacity may be increasing. For example, last quarter, I described how some IDNs are expanding and extending their sites of care. Through Q2, nearly 70% of the activated priority 100 IDNs expanded beyond their flagship sites to treat patients at their trial sites. And we have seen this dynamic play out beyond the priority IDNs as well. We believe this growing real world experience with LEQEMBI’s efficacy and safety further strengthens its unique profile in a newly competitive market. Specifically, some HCP share that because LEQEMBI was studied in the broadest and most diverse population of any anti-amyloid drug today, it removed some of the complex considerations about which potential patients are appropriate for Alzheimer's treatments. Alzheimer's is a chronic, degenerative, and fatal disease that does not stop even after plaque is removed. In fact, our long-term data show that patients who stopped LEQEMBI treatment experienced rapid re-accumulation of key plasma biomarkers that indicate Alzheimer's disease biology was returning. Importantly, the rate of decline in most patients who stopped therapy were averted to the rate of decline observed in patients who took placebo, which is why we believe patients deserve a therapy with a benefit-risk profile that enables them to remain on treatment to stay ahead of disease progression, even after removing plaques by preventing ongoing damage and plaque buildup. Recent data that Priya will describe reinforces that in patients with three years of continuous treatment, LEQEMBI showed continued benefits. And finally, though there are no head-to-head studies comparing the available therapies, the FDA has been clear that the incidence and timing of ARIA vary among drugs in this class. Observed ARIA rates in patients who receive LEQEMBI were the lowest reported among any Phase 3 trial for a drug with traditional FDA approval in the class, with LEQEMBI rates nearly 50% lower. To reinforce LEQEMBI's unique profile with our customers, Biogen deployed our expanded field force just last month. This team increases our focus and frequency, engaging with high-value sites, and expands our reach to 30% more HCPs. We've been receiving positive feedback since the launch of this team. Biogen's field force is working even more closely with our partner Eisai, and we believe this is deepening our customer insights and we will enable accelerated growth. We're encouraged by two strong quarters of growth and the sustained progress in July, and we look forward to providing more support to the healthcare community and people living with Alzheimer's disease. Now, moving on to the SKYCLARYS update, where we continue our strong launch momentum reaching more Friedreich's Ataxia patients globally. In the second quarter, we delivered $100 million in revenue globally and remain ahead of our internal expectations. Europe launch is ahead of internal forecast and along with rest of world builds on the success in the US. SKYCLARYS is now available in 12 markets outside the US including the EU where we are initiating new patients in the catch-up population. These patients and their HCPs are highly engaged in their care and often awaiting SKYCLARYS approval, as is typical for rare disease launches. In the US, we have moved beyond the catch-up population as SKYCLARYS has been in market for more than a year. The team continues to leverage our strong rare disease capabilities and we are encouraged by the early results of engaging patients and physicians in this next phase. In Q2, roughly one-third of new patient start forms came from new writers tied to our AI program, which analyzes hundreds of thousands of de-identified patient journeys. This includes a meaningful share from community neurologists and PCPs. Globally, our outlook in FA is promising in both the short and long term. We anticipate driving strong growth by making SKYCLARYS available in additional geographies, potential expansion into pediatric populations, and with our years of experience identifying patients, we believe we can help. Turning to ZURZUVAE, we continue to outperform our expectations in the first six months of launch. We saw strong growth in the second quarter with US revenue growing 19% and patient demand nearly doubling versus the first quarter. OB-GYNs continue to lead prescribing and patients are sharing positive early experiences with their physicians and on social media platforms. Based on our recent market research, we believe we've achieved higher than average aided awareness of ZURZUVAE among providers, outperforming [messaging recall] (ph) analogs in the women's health and psychiatry markets. To achieve the next phase of growth and advance our vision to transform the care of postpartum depression, we are working to more deeply understand how to realize the patient opportunity in this market and drive real behavior change. In conclusion, while each launch is unique, we are pleased that we remain on track or ahead of our expectations across all three therapies. We know we have more work to do to help people living with Alzheimer's, Friedrich's Ataxia, and postpartum depression, and we are working with urgency to help these patient communities. I will now pass to Priya."
},
{
"speaker": "Priya Singhal",
"content": "Thank you, Alisha. Over the last year, we have focused heavily on reviewing our existing pipeline with an eye toward improving its risk profile. The focus now is on building the pipeline through a combination of both internal and external opportunities with an eye towards risk diversification and creating value. We also remain focused on investing to win in Alzheimer's disease, where we believe we have a differentiated product in LEQEMBI, as well as an industry-leading R&D pipeline of potential next-generation therapies. Beginning with LEQEMBI. LEQEMBI is the only approved anti-amyloid antibody with, first, a dual mechanism of action targeting both amyloid plaques and highly toxic protofibrils. Second, clinical data across the full early Alzheimer's disease population, including individuals with no and low tau. And third, extensive real-world evidence. Importantly, as Alicia mentioned, Alzheimer's disease is a chronic progressive disease and we believe the dual action of LEQEMBI and the option for continued treatment is a unique advantage for patients looking to maintain or further clinical benefit. To this point, at AAIC earlier this week, Eisai presented three-year data from the Phase 3 CLARITY study and its open-label extension, which shows continued clinical benefit with longer duration LEQEMBI treatment. Shown on the left, this includes data from the early start group or individuals who started LEQEMBI during the 18-month placebo-controlled portion of the study, delayed start group or patients from the placebo arm who switched over to LEQEMBI at the start of the open label extension, as well as a baseline matched natural history cohort from ADNI. The early start group shows that three years of continuous leukemia treatment reduced clinical decline by negative 0.95 on CDR sum of boxes as compared to the natural history cohort, resulting in a clinically meaningful benefit for early AD patients. This represents an expansion of the benefit observed at 18 months. It is very important to keep in mind that a change from 0.5 to 1 on the CDR score domains of memory, community affairs, home and hobbies is the difference between slight impairment and loss of independence. We believe these results are significant as the majority of individuals, approximately 70%, had already successfully cleared plaque by the 18-month time point. Furthermore, data from the lecanemab Phase 2 study, shown on the right, which included a treatment gap of approximately two years on average, shows that Alzheimer's disease continues to progress when treatment is stopped or interrupted even after plaques are removed. Also at AAIC, Eisai presented data which showed that 51% of patients in the Clarity AD study with either no or low tau representing an early stage of Alzheimer's showed improvement from baseline in cognition and function over a three-year period as assessed by CDR sum of boxes. Taken together, these data suggest that earlier initiation of treatment with lecanemab may have a significant positive impact on disease progression and may provide continued benefits to patients with early Alzheimer's disease over the long term. We continue to focus our efforts on LEQEMBI with a goal of characterizing dosing for its long-term benefit, providing optionality with subcutaneous formulation, as well as evaluating its role in preclinical AD population, as Chris mentioned. Lastly, while we were disappointed to learn that lecanemab received a negative opinion from the CHMP, we believe that the clinical data supports a clear favorable benefit risk profile with a meaningful clinical benefit to patients. Furthermore, thousands of patients have now been treated with lecanemab globally, providing further real-world evidence on the efficacy and manageable safety profile. We are continuing to work with Eisai as they plan to request a re-examination of the EU filing as we work to enable access for people suffering from Alzheimer's globally. We continue to also invest in our broader Alzheimer's pipeline, including our investigational anti-tau ASO BIIB080. Based on the encouraging data from the Phase 1b study, we have now implemented a protocol amendment for the ongoing Phase 2 CELIA study with the aim of accelerating a potential proof-of-concept outcome. We are excited that this amendment, combined with the robust enrollment trends observed to date, may enable a readout in 2026. Beyond amyloid and tau and under Jane's guidance in research, we are advancing a preclinical AD pipeline that encompasses diverse targets and modalities, including active transport approaches. As communicated today in our earnings release, we decided to exit the ATV:Aβ collaboration with Denali. We continue to see merit in modalities that can actively transport therapeutic agents into the brain. And we continue to prioritize these efforts as we work to build upon our existing leadership in AD. Looking back over the last few months, while we discontinued three mid-stage programs based on readouts, we continued to make progress across several other areas of our pipeline. The first patient has received a dose of SKYCLARYS in Biogen's Phase 1 dose finding study for pediatric Friedreich's Ataxia. This is the first step in potentially expanding SKYCLARYS access to the pediatric population. And once a dose is identified, we plan to conduct a Phase 3 study to assess the benefit/risk in pediatric patients. We also expect the DEVOTE study evaluating high dose SPINRAZA to readout in this second half of the year. We have also made meaningful progress in immunology where the first patient was dosed in the litifilimab Phase 3 portion of the operationally seamless Phase 2/3 Amethyst study in CLE following the completion of the Phase 2 enrollment. As Chris mentioned, we continue to view immunology as a significant potential driver of Biogen's future growth and the recent acquisition of HI-Bio is an example of this importance. With that, I would like to hand over the call to Travis, who will dive a bit deeper into felzartamab."
},
{
"speaker": "Travis Murdoch",
"content": "Thank you, Priya. I'm very excited to be here speaking today as part of the Biogen team. I believe we have a unique opportunity to combine HI-Bio's expertise in immune mediated indications with Biogen's global development and commercial experience in specialized immunology and rare diseases. I believe this synergy will have significant benefit as we work to accelerate our lead asset, felzartamab, or felza, into late stage development. As an anti-CD38 antibody, we believe felzartamab has a differentiated molecular design that specifically targets and depletes plasma cells responsible for producing pathogenic antibodies, while sparing the broader B-cell lineage. This is different from other programs currently in development for antibody-mediated diseases that more broadly impact B cells. Compared to other mechanisms, we believe the specificity of felza's MOA may allow for a differentiated and more desirable clinical profile characterized by more durable efficacy and improved safety profile. As Chris mentioned, one of Biogen's goals is to optimize the risk/reward of the pipeline and I believe the acquisition of felza significantly advances that effort. Through its cell depletion approach, felza has already demonstrated clinical proof of concept across multiple rare immunology indications. Antibody mediated rejection, AMR, IgA nephropathy, IgAN, and primary membranous nephropathy, or PMN, are serious conditions that lead to severe consequences for patients such as transplant failure or end stage kidney disease and available treatment options leave significant unmet need. And so, we see significant potential commercial opportunity here. Now I'd like to briefly review the felza data generated to date across these indications to highlight the potential value we see for patients. AMR is the leading cause of kidney transplant loss in the US, with no approved treatments and prior investigational agents have not demonstrated significant resolution of AMR on biopsy. The consequences here can be dire, ending with graft failure, dialysis, and a need for retransplantation in many cases. In the Phase 2 study, which we published in The New England Journal of Medicine, nine doses of felza IV administered over a five-month period resulted in greater than 80% AMR resolution at week 24 versus 20% for the placebo group. Furthermore, two-thirds of responders maintained AMR resolution out to 52 weeks. So we believe these results, if replicated in a registrational study, are potentially transformative for this disease. Next, I'd like to discuss IgA nephropathy, or IgAN, which is the most prevalent chronic glomerular disease worldwide and another indication where we believe felza has the potential to deliver a treatment option for patients with important differentiation. Felza directly depletes CD38 positive plasma cells, the producers of both galactose-deficient-IgA1 and its autoantibody, which are believed to be the most upstream causes of IgAN. As shown here on the slide, felza treatment resulted in durable reductions in IgA up to 24 months, which is more than 18 months after the last dose. Importantly, this pharmacodynamic effect was selective for IgA, with IgG and IgM levels rebounding to baseline after the completion of the five-month felza treatment. These results, paired with the emerging clinical efficacy data, suggest that felza could have a durable selective effect on IgA and thus impact IgAN disease biology, while potentially allowing for the maintenance of general protective immunity conferred by IgG and IgM antibodies over a prolonged period on therapy. Similar to the effects we saw in IgA, interim results from the Phase 2 IGNAZ study showed a durable reduction in proteinuria as measured by UPCR. Specifically, we saw there was a dose dependent reduction in UPCR, durable out to the 24 month time point. Now in terms of potential differentiation, it's important to note that this improvement is after more than 18 months of being off therapy, supporting the potential for felza to be the first non-chronic treatment option in IgAN. Furthermore, in line with the selective targeting of plasma cells, administration of felza was generally well tolerated with the safety profile consistent with prior studies. We believe these interim results potentially provide for a wide therapeutic window and may ultimately lower the risk of chronic immunosuppression, which could be a significant benefit for IgAN patients. Moving to PMN. So this is a severe antibody mediated disease in the kidney that's a leading cause of nephrotic syndrome, which is a severe syndrome resulting from excretion of too much protein in the urine and which causes symptoms such as swelling and fatigue and increased risk of infection. Current standard of care, which includes immunosuppressive and chemotherapeutic agents, has proven insufficient as up to 40% of patients do not achieve remission and many progress to end stage kidney disease. It's estimated that up to 80% of patients with PMN have auto antibodies against PLA2R, which is a kidney antigen and which provides us with a key biomarker both for patient stratification as well as treatment response. In the Phase 2 M-PLACE study, which evaluated felza in both newly diagnosed and relapsed patients as well as patients refractory to immunosuppressive therapy, a 24-week felza treatment resulted in rapid, deep and durable reduction in anti-PLA2R antibodies in both patient cohorts at the one-year time point. Many patients retained immunologic complete response more than six months after the last dose of felza, which highlights the durability of felza's treatment effect. Importantly, the effect on anti-PLA2R was mirrored when examining reductions in proteinuria. And in line with prior studies of felza, TEAEs were generally mild or moderate in severity. Based on these results, we believe that felza has the potential to provide a meaningful new treatment for patients suffering with PMN. In summary, we believe the data generated to date highlight the potential for felza to be a best-in-class treatment option across multiple serious immunologic diseases with significant unmet need. Phase 2 data across AMR, IgAN, and PMN have provided proof-of-concept and highlighted a potentially differentiated clinical profile on the basis of efficacy, treatment durability and safety. I'm looking forward now to combining the strengths of the joint HI-Bio and Biogen team as we work to incorporate these learnings and further refine our Phase 3 plans. Now we expect to initiate Phase 3 studies across AMR, IgAN, and PMN next year, beginning with AMR in the first half of the year. I'd now like to pass the call over to Mike for a financial update."
},
{
"speaker": "Mike McDonnell",
"content": "Thank you, Travis, and good morning, good afternoon to everyone. I'd like to start by acknowledging the entire Biogen team for a strong second quarter. I'm pleased to provide some color on the results and please note that all the comparisons that I will make are versus the second quarter of 2023. Total revenue of $2.5 billion was up marginally versus the prior year at actual currency and grew 1% at constant currency. But importantly, we grew our core pharmaceutical revenue 5% at actual currency and 6% at constant currency. This was driven by the performance of our four recent launches, which more than offset the revenue decline in our MS business. Non-GAAP diluted EPS grew 31% to $5.28 and included a one-time benefit of $0.52 from the sale of one of our two priority review vouchers. Absent the PRV sale, non-GAAP EPS would have grown 18% to $4.76. We also reported a 43% improvement in non-GAAP operating income, which was a 30% improvement excluding the PRV sale. We continue to benefit from our R&D prioritization and fit for growth initiatives, where I'll provide more detail in a moment. We are pleased to be raising our full year 2024 guidance range. And in just a few moments, I will also provide some additional details on our guidance. Now a bit more color on our revenue for the second quarter. Our MS franchise revenue declined approximately 5% in the quarter, and there are a few dynamics in this business that are worth highlighting. First, we continue to see erosion of our interferon business as the entire class is seeing a shift to higher efficacy or oral therapies. Regarding TECFIDERA in the EU, we have now seen most generics exit the market, which helped drive ex-US growth of 11% at actual currency and 12% at constant currency to $208 million this quarter. We continue to believe that we are entitled to market protection in the EU until February of 2025. VUMERITY had its best quarter since launch as global revenue grew 13% at actual and constant currency to $166 million. VUMERITY remains the number one branded oral in terms of share in the United States. US TYSABRI revenue of $249 million declined 4% and benefited from the timing of shipments in the quarter, which was offset by declines due to competition within the high efficacy class. Next, our rare disease franchise produced revenue of $534 million and that represented growth of 22% at actual currency and 25% at constant currency. SKYCLARYS global revenue was $100 million. Global SPINRAZA revenue of $429 million declined 2% at actual currency and was flat at constant currency. US revenue was up 1% to $157 million, and we remain encouraged by the resilience here. And on LEQEMBI, we saw significant sequential growth with second quarter global in-market sales booked by Eisai of approximately $40 million, which included $30 million of US in-market sales. I'll turn now to a few comments on expenses. We continue to see lower non-GAAP cost of sales as a percentage of revenue, which was driven by a more favorable product mix, notably growth in SKYCLARYS replacing lower margin contract manufacturing revenue. We also had no idle capacity charges during the quarter versus $34 million in the second quarter of 2023. As mentioned previously, our R&D prioritization and fit for growth programs have begun to significantly improve our profitability. Second quarter non-GAAP R&D expense decreased from the second quarter of 2023 by $120 million or 21% as we continue to focus our spend on programs with the highest probability of success. Non-GAAP SG&A expense increased 1% in the second quarter. We have significantly reduced selling costs for legacy products and also significantly reduced our general and administrative cost base, which has allowed us to absorb most of the approximately $100 million of Q2 2024 incremental launch costs for LEQEMBI and SKYCLARYS. Now, a brief update on our balance sheet. We ended the second quarter with $1.9 billion of cash and marketable securities. As a reminder, we utilized $1.15 billion of this balance in July when we closed the HI-Bio acquisition. We ended the quarter with approximately $4.4 billion of net debt. During the quarter, we fully repaid the remaining balance of the $1 billion term loan that we put in place at the time of the Reata acquisition. And we continue to generate strong cash flow in the second quarter with approximately $592 million of free cash flow, which brings us to approximately $1.1 billion of free cash flow in the first half of 2024. We continue to believe that our balance sheet has the capacity for us to invest in both internal and external growth opportunities. Turning now to guidance. We're pleased that the operating performance of the business year-to-date supports raising our full year 2024 non-GAAP diluted EPS guidance from a previous range of $15 to $16 to a new range of between $15.75 to $16.25. This new range reflects expected growth of approximately 9% at the midpoint of the range compared to the full year of 2023. I would like to highlight several important things to remember for the second half of 2024 as you update your models. In terms of revenue, with our key products all performing generally in line or slightly ahead of expectations, there is a slight increase to the previous expectations for the year. We now expect full year total revenue to decline by a low-single-digit percentage when compared to 2023. We also expect core pharmaceutical revenue to be roughly flat year-over-year as recent launches are expected to progress and provide an offset to some key potential dynamics in the second half of the year. These include expected continued pressure on our MS franchise, which incorporates the potential for a biosimilar entrant in the US for TYSABRI, and we continue to monitor the timing of shipments for SPINRAZA in certain ex-US markets. Next, the sale of one of our two priority review vouchers is a non-recurring item. And since we expect to reinvest the proceeds of this sale and growth initiatives later this year, we do not expect this benefit to impact our full year EPS. Also, some key points to consider regarding our operating expenses. In the second half of the year, we expect to continue to ramp launch spending on our new product launches. This will include the 30% increase in the LEQEMBI field force, which is coming online as well as additional spend for some targeted direct-to-consumer campaigns. In addition, we expect incremental OpEx, primarily on the R&D line, of approximately $50 million in the back half of the year related to HI-Bio as we execute plans on three potential Phase 3 starts. We continue to expect full year 2024 combined non-GAAP R&D and SG&A expense of approximately $4.3 billion. We reported approximately $2 billion of spend in the first half of the year, implying higher spend in the second half of the year due to the reasons I just mentioned, along with some typical phasing of expenses throughout the year. I would also note that we now expect 2024 operating income to grow at a mid to high teen percentage versus the previous guide of a low double-digit percent growth. This improvement factors in higher expenses in the second half of the year versus the first half of the year, partially offset by higher revenue due to our new product launches. I would remind you that we expect a reduction in interest income of approximately $20 million for the remainder of 2024, and this is due to lower cash balances and associated lower interest income resulting from the HI-Bio acquisition. As always, our guidance does not consider the impact from any potential acquisitions or large business development transactions or pending and future litigations as these are often difficult to predict. I would refer to you to our press release for other important guidance assumptions. And just before we open it up for Q&A, I wanted to provide a brief update regarding the strategic review of our biosimilars business. After a comprehensive review of potential externalization options compared to retaining the business, we believe that the best value for shareholders going forward is to retain the business within our portfolio and to optimize the business with an aim to maximize profitability. And with that, we will open up the call for questions."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Mike. Operator, can we please poll for questions?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question comes from the line of Salveen Richter with Goldman Sachs."
},
{
"speaker": "Salveen Richter",
"content": "Good morning. Congratulations on the quarter. At a high level, there's been significant focus on 2024 as a turning point for the company, both product wise for the launches and operationally, given the cost savings programs and pipeline prioritization. Just given the raised guidance here of 9% year-over-year EPS growth for this year, can you just speak to your confidence around 2023 being the trough year for earnings and what needs to play out from here for clean growth through the end of the decade? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Yeah, thank you for the question, Salveen. And our mission at Biogen remains to bring ourselves to sustainable growth on both the top line and the bottom line. Obviously, our original guidance, which implied growth of 5% on the bottom line at the midpoint and now 9% at the midpoint, shows that we've now turned the corner on the bottom line and we're very focused on our cost savings program, which importantly not only improve our operating performance, but also free up capital for growth initiatives. So that's real important. Obviously, we don't guide beyond 2024, but I would say that, when you look at our guidance this year, we're pleased with the fact that we've been able to get our top line somewhat much more stabilized and we've got the bottom line growing again as we look to next year. We're pleased with the progress of the launches. Our ability to restore the top line is going to be somewhat dependent on how those launches continue to perform along with how the MS franchise continues to sustain and be durable. And what I can say is that we're very focused on bringing the company back to growth. And we're certainly hopeful that 2023 was the trough year. And obviously, we're doing a nice job growing the bottom line in 2024 and we'll have more to say about the out-years as we move to the latter part of this year and into early next."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Mike. Can we take our next question, please, operator?"
},
{
"speaker": "Operator",
"content": "Yes. The next question will come from Mohit Bansal with Wells Fargo."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi, this is [indiscernible] on for Mohit. Thanks for taking our questions. I had a question on the EMA decision on LEQEMBI. Do you plan to submit additional evidence on efficacy or safety from trials or from real world evidence to reverse this position? And what's your confidence that the decision can be reversed? And what should we think about for timeline for the EMA to reconsider and would a SAG need to be convened for this process? Thanks."
},
{
"speaker": "Priya Singhal",
"content": "Thank you. This is Priya Singal. We are very disappointed, along with Eisai, at the outcome of the negative opinion for LEQEMBI. We continue to believe that the benefit/risk is positive and favorable. As you know, it's been approved in major regions of the world like the United States, China, Japan, and recently, we've also communicated approvals in Hong Kong, Israel as well as South Korea. So, yes, we have communicated publicly and I can reaffirm that we will be applying for a reexamination process. The way the reexamination process works is that you can continue to work with a newly appointed rapporteur and co-rapporteur for the process. So, right now, we would wait to receive the assessment report from the CHMP, the new rapporteur and co-rapporteur would be appointed and then we would work with them to understand what are the issues that are driving the decision. And currently, based on the opinion that was rendered, we believe these are addressable with the data that we've generated. Specifically, we have generated long-term data as we shared at AAIC and we would look to be engaging with the EMA and CHMP to see how we can submit additional data and the extensive real-world data that we have in the real world because thousands of patients now have been treated. So we have long-term continued benefit as we showed in the three month -- three year data at AAIC and also long-term safety. So we're continuing to work very closely with Eisai on the reexamination process and strategy. It is possible that a new SAG-N would be appointed and this process would generally move faster than the original application."
},
{
"speaker": "Chuck Triano",
"content": "All right. Thanks for the details, Priya. Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, that will be from Kevin Seigerman with BMO Capital Markets."
},
{
"speaker": "Evan Seigerman",
"content": "Hi there. It's Evan Seigerman. Question for Priya. Can you walk me through some of the rationale on opting out of the Angelman Syndrome Program with Ionis? How has your approach to evaluating partnerships evolved recently and what aspects of a program do you now more closely scrutinize when you're thinking about what to do with a partner?"
},
{
"speaker": "Priya Singhal",
"content": "I think just stepping back, I want to point us to comments we've made externally before as well that we have really -- we really looked at our readouts as important inflection points which allow us to double down, accelerate in those programs if the data are objectively clear and compelling. And then the other option would be that we can pivot and pivot to other programs that we may be considering. So overall, our process is that we develop up a priority go/no-go criteria. And based on that, we decide what the probability technical and regulatory success is in a particular program. And that is exactly the approach that we applied with the Angelman Syndrome, the BIIB121 data. That is going to be continuing to be the way that we look at all our readouts and we try to be very disciplined. I think things that we find very compelling are biomarkers, established regulatory pathways, clinical tractability as well as our confidence in regulatory endpoints or on our interact -- based on interactions with regulators. So we look at all of these and that's how we think about investment in Phase 3."
},
{
"speaker": "Chris Viehbacher",
"content": "If I could just add, I think, in addition to what Priya said, we're also looking at the ability to launch products globally. And so, we also are interested in the level of evidence and regulatory endpoints as they may be acceptable to payers and regulators around the world and not just in the US."
},
{
"speaker": "Chuck Triano",
"content": "Great. Thank you both. Next question, please, operator."
},
{
"speaker": "Operator",
"content": "Yes, sir. That next question will come from Michael DiFiore with Evercore ISI."
},
{
"speaker": "Michael DiFiore",
"content": "Hi, guys. Thanks so much for taking my question, and congrats on the quarter. So I was wondering if there's any updates on the subcu induction dose optimization work you're doing and whether this could lead to a more optimal risk/benefit ratio that the EMA is looking for?"
},
{
"speaker": "Priya Singhal",
"content": "Yes. So, overall, as Eisai and Biogen have communicated, we continue to -- we've already filed for the IV maintenance and we have a fast track and a rolling submission in place for the subcutaneous maintenance dosing. With the initiation of subcutaneous dosing, we are looking at optimizing the dose. We're continuing to work with FDA on this effort. And currently, we are on track, as we've communicated, to have an outcome on this from the FDA in the US by Q1, calendar year Q1 2026. Now with regards to your specific question about how this could impact the application in Europe, I just want to be really clear that the application in Europe that's currently -- we're going to pursue re-examination is dependent on the original application, which is really for intravenous LEQEMBI. We would hope that we can get that -- a favorable outcome at the end of the reexamination process. And if so, we would continue down the path of again providing options to patients as well as in Europe with subcutaneous formulation."
},
{
"speaker": "Chuck Triano",
"content": "Thank you, Priya. Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, that will be from Chris Raymond with Piper Sandler."
},
{
"speaker": "Nicole Gabreski",
"content": "Thanks. This is Nicole Gabreski on for Chris. Maybe just one on LEQEMBI. So some of our survey work we've done recently with neurologists and Alzheimer's specialists has kind of indicated maybe a less favorable view of the risk/benefit and cost/benefit ratios for LEQEMBI in recent quarters. And I guess we're starting to see some feedback from docs also questioning the amyloid hypothesis as a whole. I guess maybe just given this, could you speak to the interactions and/or feedback that reps are having in the field? I guess, are you starting to maybe experience any pushback as you move from HPPs who are sort of ready and waiting to prescribe LEQEMBI soon after approval to those who are in the next wave of uptake?"
},
{
"speaker": "Alisha Alaimo",
"content": "Thank you for the question. This is Alisha. Whenever we look at market research, I think it's important to understand who you're asking in the market research. And so, when we look at what's happening in the field, at least on the ground, when you're asking the physicians, if you were to parse out market research and ask the physicians who are currently obviously prescribing, and the ones who aren't, the ones who are prescribing are the ones that we've been working really hard on over this past year. They're the ones that understand the data, they've been visited by MSLs, they've been visited by representatives and then it takes them time to obviously get up and running with their facility. You also then see across the board that other physicians see this happening and some in, like, a nearer location will also start obviously picking up the product. And so, on the ground and with our representatives, they go from office to office. We're obviously expanding now as well with the additional field force. And what we've seen is the ones that you call on are the ones that actually start writing. And there's a lot of dynamics at play here. I think that understanding this data is important. I think understanding all the mechanics in order to get a patient diagnosed is important and having them set up their capacity is important. And so, we don't really hear any pushback about cost/benefit. I can say that. And I think more importantly, what we're hearing now is because we are a year out, we're starting to really get the real world experience feedback from physicians on the impact this is having on patients and the caregivers and the families. And I think that alone has really also accelerated some of these physicians to try and treat patients even more quickly. And so, for now, we're not really hearing that pushback."
},
{
"speaker": "Chris Viehbacher",
"content": "And if I could just add to that, after decades of this, I tend to pay more attention to what physicians do versus what they say. And this is a very heavy lift for physicians to introduce this treatment into their practices and institutions. And when you look at the number of -- the increase of 50% of physicians writing this and the depth of ordering from the IDNs, we're seeing a lot of physicians investing huge amounts of time and energy to actually get through all of the processes, schedule the PET scans or the lumbar punctures, the MRIs. And to me, you don't do that if you don't have a strong conviction in the importance of this treatment to patients. So, personally, as I look at this, I'm extremely encouraged by where we are. I think now, for the first time since the launch, we can look forward to the growth of this market, not just because of the prescriptions, but I look at the evidence base that we are building with our partners at Eisai on LEQEMBI. It's very clear now from the three year data that it probably is not going to be enough to just remove the plaque. We'll need to continue to treat patients. And again, as I was saying earlier, with the AHEAD study, we hope to show that there is a benefit to treating earlier. So this market is going to grow and the evidence base is going to grow. It is market building that we're doing and that certainly takes time and patience. But as I say -- I've said in the past that it's difficult to predict where we're going to go. With this quarter, I think we're seeing we're on a very solid track. And I think the entry of Lilly will only accelerate the development of this marketplace."
},
{
"speaker": "Chuck Triano",
"content": "Thank you. Let's take our next question, please."
},
{
"speaker": "Operator",
"content": "Yes, our next question will come from Brian Abrahams with RBC Capital Markets."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi, everyone. This is Nevin on for Brian here. Congrats on a good quarter and thank you in advance for taking our questions. I just wanted to ask a little bit more about the SKYCLARYS dynamics that we're seeing, specifically what you're seeing on patient persistence or potential discontinuation rates there. Some of the educational efforts that you're taking to kind of convince the patients to remain on therapy even if they're not seeing the efficacy of the therapy right away. And maybe if you could speak a little bit more to some of the perceptions that patients and doctors may have on the cardiac safety and benefits there as well. Thanks."
},
{
"speaker": "Alisha Alaimo",
"content": "All right. Thank you for the question. This is Alisha. First, we are very pleased with what we're seeing right now, especially globally and in the US with SKYCLARYS. And as I've mentioned before, we're past the catch-up population and we're now really into the patient identification phase. We look at every metric from discon, compliance, adherence, start times. And when it comes to discons, we do not see anything outside of what you see in the clinical trials. And so, the discontinuation rate is not anything more than obviously what we also saw in trials. I think when it comes to efficacy of the patients, physicians have been really good on setting expectations with patients on what to expect from SKYCLARYS. The field teams do a really good job of also educating both physicians and educational materials with patients on what to expect when you start this product. And so, you do see that patients tend to stay on product and physicians are very good also about saying to patients, at least stay on it for a year and let's talk about how you're feeling and where we're going and what we're seeing as adherence has been actually very good. I think the other dynamic that's playing out that you could be referring to is because we're now in the patient identification phase, you are going to see a little bit of difference from week-to-week and month-to-month. And we are adding patients every single week. We're also adding them every single month. And we acquire new data on a regular basis. And what we're seeing, at least recently, and I was sharing this with Chris the other day, we have this new AI engine that we've been deploying and we have identified significant number of additional coded FA patients that we didn't even have at the beginning of launch because we're starting to see that patients are engaging even more with their physicians. And so, now we're able to reach them with more efficiency and with more certainty across the board. And I think it's been very promising as we find new patients to come on."
},
{
"speaker": "Chuck Triano",
"content": "All right. Thanks, Alicia. Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, that will be from Paul Matteis with Stifel."
},
{
"speaker": "Paul Matteis",
"content": "Great. Thanks so much for taking my question. I think over the past year, Biogen's commentary on business development capacity has evolved a couple of times. And more recently, I think you said around $10 billion, maybe minus the HI-iBio deal. I guess just kind of going forward in 2024 or the near to mid-term, what's Biogen's appetite for bigger transactions or Reata-like transaction and what's the updated thinking on specific therapeutic areas or types of assets of interest? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Yeah, I'll take that one. I think first in terms of where we're looking, I think we're already long neuroscience. So we're probably looking outside of that space, immunology, rare diseases. As I look at Biogen, I would say we have an extremely high scientific and medical capability within the company. We have been historically a company that is in the low volume, high value area. We really understand the necessity to assist patients and physicians for some expensive products to get through a reimbursement, provide and sponsor genetic testing, for example, thinking about studies and real-world evidence becomes extremely important in this. So I think there's a capability of Biogen in rare diseases. Immunology is really an area we've been in since we started with multiple sclerosis. So I think we have the capabilities to go into those areas. I think where we are now is we're on a growth pattern. If we could find another Reata type acquisition, I think we would look for that. But those come along pretty rarely. It's rare that you can find a company that is that close to the market. In fact, it already launched by the time we actually had acquired that. But acquire that for price that still creates shareholder value. And we will continue to look, but they don't come along every day. And we're not in a position where I think we are desperate to do a deal. So we -- I think if you look at what we've done with HI-Bio, for example, as an alternative to that, being able to launch more products in the sort of 2027 to 2030 timeframe is a priority for us. And that's why we're really also focused on the mid to late stage development process. But we can be picky. I think also where we look is not necessarily where everybody else is looking. You really don't create value if you enter into these auction processes. And so, I think by being able to stick to those areas where we think this is -- this is a really -- this is a space where Biogen can really be a strong player, we'll avoid overpaying. I think the other thing I would say is, Biogen is a nice size. $1 billion moves the needle hugely in our company. There are a lot of bigger companies where $1 billion doesn't move the needle. And so, I think we can look at assets where we have the capital that might be too small for some of the bigger players, but be too expensive for some smaller players. So I think in some ways, we're in a position where we can look for assets and not necessarily be in such competitive places where, again, you risk overpaying. But we're looking. We take a systematic view. We're not going to take any sudden left turns strategically just because I'm not sure that that's really where the sweet spot is for Biogen. But I do think there's a number of opportunities out there. We also are doing a lot more in research on collaborations. And I think one of the things I'd like to see us do is really bring a lot more assets in from an early stage because the earlier you can acquire these assets, the more shareholder value you can create."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Chris. Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, that will be from Michael Yee with Jefferies."
},
{
"speaker": "Michael Yee",
"content": "Hey, guys. Thank you. Earlier in the call, you commented about an emerging lupus portfolio and I know that you do have some upcoming lupus data. We've looked at the prior data. There are reasons to believe that longer treatment and a bigger study could help here. Can you just speak to your expectations? What are you looking for, what needs to happen to move forward, et cetera, et cetera? Thank you."
},
{
"speaker": "Priya Singhal",
"content": "Yes, thank you. This is Priya Singhal. So, overall, we are excited about the readout for dapi. It is upcoming in the next several weeks. This is a partnered program with UCB and the collaboration is in very good -- in a very good place. We are expecting a headline or top line results of the first global Phase 3 trial. And specifically, I want to be clear that this study is investigating, in this very high unmet disease area, the safety and efficacy of dapi as an add-on to standard SLE therapy versus placebo as an add on to standard SLE therapy. We are conducting the study in patients who have persistent active or frequent flaring despite stable standard of care. And very similar to the Phase 1 and Phase 2, we will be looking at efficacy assessed by BILAG based Composite Lupus Assessment, or BICLA, but different than the Phase 2 study, it will take place over the 48 weeks to demonstrate the long-term effect. We also increased the sample size to provide a substantial dataset on safety and efficacy. Eventually and ultimately, we'll be looking for a meaningful change on the primary endpoint and key secondaries such as severe flare prevention, patients achieving low dose activity. And we really think that BICLA is a sensitive clinically meaningful composite for SLE disease activity that requires disease improvement across all body symptoms with moderate or severe baseline activity without the need for escalation in steroids or other background medications as well as without worsening. So we're looking forward to this. In addition to an acceptable safety and tolerability profile, we think this could be really meaningful for patients suffering from SLE. So if the results warrant continuing development, at this point, we expect to have the need to run another Phase 3, but we are planning some of this at-risk right now."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Priya. Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, we'll now move to Eric Schmidt with Cantor Fitzgerald."
},
{
"speaker": "Eric Schmidt",
"content": "Thanks for taking my question. Maybe for Chris, this call today seems to be like a relative high watermark in your tenure as CEO, given some of the initiatives that are now well in place and all that you've accomplished. And you certainly called that out in your prepared remarks. You also called out that you've got some challenges and you're not done. So what in particular is top-of-mind there? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Well, thanks for the question. I would hope it's not the high watermark because we're aiming much higher here, I can tell you. I think, clearly, we've got still an MS franchise that is -- we're not done yet in terms of seeing the competitive threats. There's potentially a biosimilar for TYSABRI, we have an important patent litigation that we'll see in the fall for TECFIDERA in Europe and there is the market exclusivity that expires in February. So shorter term, there's always some chop in the water. But I think where we have an opportunity is, we have an amazing talent base inside of Biogen. As you all know, I've been in this business a long time, seen a lot of companies, I continue just to be impressed by the scientific and medical capability that we have in the company and we've got capital. And so, I think we can do smart things with that capital. We've been busy transforming essentially passive capital into active capital. We had two priority review vouchers sitting on the shelf. The innovative nature of Biogen's products is such that we don't really need those vouchers because of the innovative products we bring to market anyway. So we had this one priority review voucher sitting on the shelf for six years that we've now converted hopefully into an active asset. We sold it, but the objective is to spend that on milestones in business development in the second half. If I look at HI-Bio, we took a year-and-a-half of fit for growth savings out of operating expense and transformed that into a growth opportunity with the acquisition of HI-Bio. So where I see us is, I think we're -- we've been able to change the trajectory of the company. We've been able to release resources from the business and reinvest them intelligently and we've got great people that I think can do that with tremendous results. So, I think as we look towards the future, it's really building out now the R&D portfolio, both internally and externally. I'd like to make sure we are still an innovation company going forward that we're not just acquiring our future, but really investing in that. So I think I'm now focused on the 2025 to 2030 timeframe. I think we're in good shape to grow through that period, but I think we can do more to really take advantage of the capability in R&D. And I think you'll see us continue to deploy capital with a lot of discipline but I think be able to turn passive capital into active capital and then into active growth."
},
{
"speaker": "Chuck Triano",
"content": "All right. Thank you, Chris. And thank you, everybody, for joining us today. IR team will remain available for any additional questions. Thank you."
},
{
"speaker": "Operator",
"content": "And once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect."
}
] |
biib | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Jennifer, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Biogen First Quarter 2024 Earnings Call and Business Update. 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] Today's conference is being recorded. Thank you. I would now like to turn the conference over to Mr. Chuck Triano, Head of Investor Relations. Mr. Triano, you may begin your conference."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Jennifer. Good morning, good afternoon, good evening, everyone, and welcome to Biogen's first quarter 2024 earnings call. Before we begin, I'll remind you that the earnings release and related financial tables, including our GAAP financial measures with a reconciliation to the GAAP and non-GAAP financial measures that we will discuss today are in the Investors section of biogen.com. Our GAAP financials are provided in Tables 1 and 2 and Table 4 includes a reconciliation of our GAAP to non-GAAP financial results. We believe that non-GAAP financial results better represent the ongoing economics of our business and reflect how we manage the business internally. We have also posted the slides on our website that will be used during this call. I'd point out that we will be making forward-looking statements, which are based on our expectations. These statements are subject to certain risks and uncertainties, and our actual results may differ materially. I encourage you to consult the risk factors discussed in our SEC filings for additional detail. On today's call, I'm joined by our President and Chief Executive Officer, Chris Viehbacher; our Head and President of North-America, Alisha Alaimo; our CFO, Mike McDonnell; and Dr. Priya Singhal, Head of Development is with us and will be available for the Q&A session. Chris, Alisha, and Mike will each make some opening comments and then we'll move to the Q&A session. And to allow us to get through as many questions as possible, we kindly ask that you limit yourself to one question. With that out of the way, I'll now turn the call over to Chris."
},
{
"speaker": "Chris Viehbacher",
"content": "Thank you, Chuck. Good morning, everybody. Well, it is certainly great to be able to announce earnings per share growth in our first quarter. This is the first time in several years that the underlying business performance of Biogen has allowed us to actually demonstrate earnings per share growth, and that's a major achievement. We've clearly still got a lot of work to do, but I think it feels like we're turning the corner in the company. And with that, I'd like to actually take the opportunity to thank my Biogen colleagues. We have instituted an awful lot of change within the company and I'd like to thank them for their commitment, passion, and patience throughout this process. But I think you're seeing some of that change that has occurred now in the numbers. We have tried to bring a lot more focus and discipline to really putting our resources behind those things that do good and drive value. And one of the things that you may not see is that, there is an awful lot of reinvestment going on. One of my early bosses in my career once told me, you can't save your way to prosperity in this business, and that is absolutely true. And that's not really what we set out to do. The Fit for Growth project, which is, as you can see from the numbers, on track to achieve its $1 billion in gross savings and $800 million in net cost savings and by the way, [$100] (ph) million of increased cash flow as well by the end of 2025. But what we really tried to do was redesign the organization. We have been so focused as a business for decades on our multiple sclerosis franchise, and here we are launching four first-in-class new medicines and we really needed to make sure we're supporting those launches. And in fact, despite the cost reductions and margin improvements that Mike is going to go into in more detail, but behind that, there are hundreds of millions of dollars being invested in new launches. And while our overall expense in research and development has decreased, this focus has actually enabled us to increase the investment in those assets where we have the most conviction. So, this is much more than a cost-savings exercise. This has been a redesign and a change in our culture to a degree. So, let's look at some of these new launches. And obviously, the one that everybody is most interested in is LEQEMBI and if we can move to that slide. You can look at this in a number of different layers. Obviously, first, we're seeing really good quarter-on-quarter trends. As you've seen, the number of patients on drug has increased to 2.5 fold compared to where we finished the fourth-quarter. Our in-market revenue almost tripled in Q1 versus Q4 of last year, and that's obviously important. But the thing that really is important to me as I look at this is not so much just that. I've been in this business for 3.5 decades. I've lost count of how many launches I've seen, but this is an extraordinarily difficult launch, really because the amount of change that physicians are facing with this is really profound. And as I go around to hospitals and talk to doctors and talk to those who are seeing other doctors, it really becomes evident that there are an awful lot of challenges to getting that -- even that first patient on treatment. We were at one hospital, it was going to take -- it took them three months to get approval just to hire a nurse to help navigate the system. At another major medical center, they're having to develop a five-year business plan, just to be able to access the infusion beds. And when you look at some of the uncertainty around PET scan reimbursement, and although CMS had clarified that and a lot of the MACs have pulled it through, there was still a lot of difficulty getting that clarity all the way through the channel. You know why I'm really encouraged by when I look at these numbers is, when -- although there are a lot of challenges, it's a lot of time investment for physicians and I think a lot of those physicians to their credit are investing that time and not necessarily getting reimbursed for that, but they're getting it done. They're overcoming these challenges and barriers. And that is, I think, what is so important. They see the need when they look at patients who are accomplished people, who are loved by their families, and seeing this dreaded disease pull the patient away from that on a day-by-day basis. So, I do think we are seeing an awful lot of momentum here. And again, I think there's an awful lot of credit to the neurologists and to these centers to overcoming these challenges and I think that is going to allow us to continue to see quarter-on-quarter growth. It may not be completely linear, and Alisha will go into more detail on that, but it takes time to get these protocols in-place and even when you get the first patient, there has been a tendency that let's have a handful of patients so we get comfortable with the system. But then, once they've done all that, then, we're starting to see volume pull through. And one of the interesting things about this launch is that, generally, we look at revenue as a surrogate for demand. And here there's -- that linkage is not quite so clear because it has taken this upfront time before you see revenue pull through. And I think that's one of the other things we're now seeing in this first quarter is that, we're actually seeing a little bit more of that linkage between demand and revenue. And behind all of this, once those processes are in place, and once physicians are ready, there is clearly an underlying demand behind that. So, I think that has given us a lot of confidence to now invest more, and we have a 30% expansion in our US field force plan. But I would also say, this is a launch that really didn't start until 1st of September. And even then, you could argue we weren't fully in the mode of being able to launch because the PET scan reimbursement hadn't been cleared. But our US teams for both Eisai and Biogen have done an awful lot of work to look at the data from the first seven months of the launch. And really, we're now looking at redeploying some resources here and there as we see what's important and what's not. I think the teams are really working well together. And we have a number of new elements of our promotional mix that will start to come into play as we progress through the second quarter. So, from a Biogen point of view, I think it's too early to put out any forecast. We're going to be looking at those month-over-month new patient starts and the increase in revenue. But I would certainly say I'm extremely encouraged by the progress that has occurred. And if I could switch gears to another key growth driver, which is SKYCLARYS, and Alisha, again, will go into more detail and I think also just show investors how we're progressing versus other analogs because the rare disease market doesn't behave so typically as in other markets. There is always a catch-up population in rare disease. And so, it takes a while for that catch-up population to work through the system and then have a look at what's the underlying demand. Remember that these are not patients sitting in waiting rooms and that there is a huge amount of work that goes into finding patients. And I think that is actually one of Biogen's strengths. That's I think what gives me the confidence to continue to invest more because I do think there is a know-how within Biogen and that's one of the reasons we want to build out a rare disease franchise. But we've got 1,100 patients now on therapy in the US. That's a really significant number. But I'm also really encouraged by the launch in Europe. We've already got -- and remember, this drug was only approved in the -- at the end of January and yet we already have 300 patients on treatment. Now, you all know Europe. We have to go country-by-country to get reimbursement and we have early access programs, some of those we can charge revenue for, some of them we can't, but we have already submitted reimbursement dossiers in five countries in the US. So I think Europe will increasingly add to the revenue. It's probably more of a 2025 story than a 2024. But I think if I'm looking at the acceptance and the uptake, then, that launch is also off to a successful start. And we know that there are an awful lot of patients in Latin America and we've already submitted in Brazil, for example, submitting in Argentina. And I think that actually is going to be a major benefit and opportunity for us as well. Remember, there are no patients in Asia because this is a genetic disease that really affects people of European descent. And in fact, it was quite interesting. I was talking to a key opinion leader in Germany who is actually done genetic studies. And you basically just follow where the explorers went and that's where you're going to find the patients. So I think with that, let's dive in a little bit deeper and I'll turn it over to Alisha."
},
{
"speaker": "Alisha Alaimo",
"content": "Thank you, Chris. Good morning to everyone that's able to join the call today. I'm Alisha Alaimo. And as Chuck shared, I lead our business in North America. This is a really unique period in Biogen's history with multiple first-in-class drug launches in the US, which gives us an opportunity to drive our return to growth. And for our team, it's also meaningful to support more people living with Alzheimer's, Friedreich's ataxia, and postpartum depression. We thought it might be helpful to provide a perspective on the market dynamics of the launches and share how we're seeking a tailored approach to help provide patients with access to our therapies. Let me begin with the Alzheimer's market. As Chris mentioned, we are seeing many major health systems across the country take a deliberate staged and phased approach, meaning, they are setting up their pathways to get patients started with diagnosis, treatment and monitoring. We believe we are now seeing a dynamic where some IDNs are turning the page and they are focusing on expanding and extending their model. In Q1, we saw several IDNs across regions scale their patient volume. Among our priority 100 IDNs, units more than tripled in quarter one compared to quarter four, which contributed to the overall estimated patients on therapy increasing approximately 2.5 times in quarter one versus quarter four. We believe this acceleration in new patients really began to emerge at the end of the quarter. For example, more than 20% of new patients since launch were added in March. Today, among our 100 priority IDNs, more than 80% have approved LEQEMBI through their P&T process and nearly 85% of those IDNs with approval have placed an order. Chris also mentioned that we're seeing more physicians gain experience with LEQEMBI. We saw the number of unique prescribers in quarter one double compared to quarter four. We believe that we're still in the early phases of unlocking the potential to treat a high volume of patients at the priority IDNs, and I thought it might be helpful to share some examples of these dynamics at the site level. There is one large health system in the Midwest that added LEQEMBI to its formulary in July of last year. Six months later, entering Q1, this system had ordered only 300 units. However, by the end of March, they had ordered 2,700 units. Similar to the example I just shared, there is also a health system in the Southeast that added LEQEMBI to its formulary in August of 2023. Five months later, entering Q1, this system ordered about 560 units. By the end of Q1, this system ordered more than 1,750 units to treat their patients. For context, a local neurologist network in that same region ordered 3,000 units through the same time period, perhaps because they've been able to scale their processes to treat more patients. However, we believe this well-known Southeast IDN is planning to move beyond their flagship side of care to treat at multiple locations, which is another example of the expand and extend trend at the IDNs. We believe many systems just now appear to be completing the staging phase, and we think the recent trends observed support our continued belief that LEQEMBI represents a significant commercial opportunity over the mid to longer term. With access and infrastructure progressing and patient volume accelerating, we believe this is also the right time to expand the field force. Biogen leaders are working to hire a customer-facing field team, which will join Eisai. Simultaneously, to activate the patient community, Biogen and Eisai have launched new direct-to-patient and caregiver omnichannel marketing campaigns. These digital programs and point-of-care resources are focused on the already diagnosed patients, who we believe are under the care of a neurologist. With these promising signals emerging, we look-forward to providing more updates in the future. Now moving to SKYCLARYS. We believe we're driving strong performance with the launch as we continue to exceed market penetration rates of most rare disease launch analogs. As of April 19, we now have over 1,100 patients on therapy. With an estimated 4,500 addressable Friedreich's ataxia patients in the US, we have achieved 24% market penetration, which exceeds our own strong SPINRAZA launch. As is typical with rare disease launches, we believe we are now moving beyond the catch-up population, to reach additional patients who previously received a diagnosis of, or are suspected to have Friedreich's Ataxia. Though patient numbers may be uneven, we anticipate adding patients each month. Last quarter, we shared how we've integrated some of our sophisticated rare disease capabilities to drive improvements in access, logistics, and patient support. Notably, our market access team continued to make progress by securing favorable policies in quarter one. Today, nearly 80% of all US pharmacy lives now have SKYCLARYS reimbursement. These patient support and access efforts are critical to help patients start therapy as soon as possible, and remain on treatment for the long term. With a meaningful foundation of patients on therapy, we are focusing on two key areas in this next phase of our launch. First, educating community neurologists and PCPs about Friedreich's ataxia and SKYCLARYS, and second, engaging additional appropriate patients. I'll begin with our focus on HCPs. Remember with Friedreich's ataxia, in addition to patients being concentrated at the top centers of excellence, we believe they are also being treated in the community. To support these physicians, we've expanded our field footprint and we are using AI to analyze data to help reach the HCPs who may have untreated patients, with insights into the relevant sites of care and when patients last engaged with their physician, we believe we can help more patients even sooner. And with genetic testing, we anticipate patients can confirm a potential diagnosis and determine if SKYCLARYS is a treatment option. As far as our patient activation focus, we are encouraged by real-world experiences that patients are sharing on social media as, in our experience, these stories can help other diagnosed patients. Many of these stories about the impact of SKYCLARYS include reports of slowing of disease progression and in some cases, even an improvement in their symptoms long term. In addition to these organic stories, we anticipate launching our SKYCLARYS social media campaign soon. So, we believe we're off to a strong start, but we know there are more people living with Friedreich's ataxia that we can help, and we look forward to supporting them, which now brings me to ZURZUVAE. As Chris mentioned, we are encouraged by the performance of the launch to date, and we think we are seeing several positive trends with providers, patient experience, and reimbursement. First, let me begin with providers. Across multiple physician types, we believe many providers are demonstrating an urgency to treat. Notably, OB-GYNs led overall prescribing in quarter one, which we believe is encouraging as they are often the first to see PPD patients. Furthermore, breadth of adoption has continued to grow. In March, nearly double the number of HCPs prescribed ZURZUVAE compared to just January. We've seen that some early prescribers require only a few calls before they treat. Keep in mind that ZURZUVAE is a scheduled product available through a specialty pharmacy. While we believe psychiatrists are generally familiar with working with specialty pharmacy, this could be a new process for many OB-GYNs. We're working to educate these providers on the steps required, so that they can support their appropriate patients. Second, some HCPs have early experience with ZURZUVAE, have shared that some of their patients reported significant improvement in depressive symptoms within days of starting treatment. Several patients are sharing their personal 14-day treatment experiences on platforms like TikTok, and we believe their courage to tell their story will help educate other women living with postpartum depression. Third, we believe we're making good progress with government in commercial access. Many payers already have policies in place, the majority of which have been favorable, while some others continue to cover ZURZUVAE, even without formal policies in place. Two of the three national pharmacy benefit managers are providing coverage for ZURZUVAE without overly burdensome restrictions. We are in active discussions with the third national PBM as we await their decision. And while Medicaid tends to take longer, almost half of the states, including several of the largest, accelerated reviews into quarter one, which we believe is unusual for a process that can typically take-up to a year after FDA approval. We are encouraged that approximately two-thirds of Medicaid lives with published policies appear to have minimal access restrictions. We anticipate the remaining states will review coverage throughout 2024, and we will continue to support their reviews as much as possible. Before handing it over to Mike, I want to underscore that we have an important responsibility to help people living with Alzheimer's, Friedreich's ataxia, and postpartum depression. And we are working with urgency to help these patient communities. We believe we're making significant progress in that mission, and we look forward to continuing to share updates with you. With that, I'd like now to pass it over to Mike."
},
{
"speaker": "Mike McDonnell",
"content": "Thank you, Alisha, and hello to everyone. I'd like to start with a high-level overview of our financial profile, and how we are seeing this progress in the context of our Fit for Growth program. We maintain a sharp focus on improving profitability as we endeavor to return the company to not just EPS growth, but revenue growth as well. Please note that any financial comparisons that I make are versus the first quarter of 2023. Regarding our top line, our four recent launches contributed revenue in the first quarter, which more than offset the 4% decline in our MS business. And as we noted during our previous earnings call and at a recent webcast investor conference, we expect that this year's revenue will be skewed more towards the second half of the year, and we expect this to be due to both the timing of shipments for SPINRAZA outside the US, as well as the expected growth profiles for our recently launched products. On gross margin, we saw improvement of 5 percentage points in the quarter as our revenue mix has shifted. This is due to increasing high-margin product revenue replacing lower-margin contract manufacturing revenue. We also had $45 million of idle capacity charges in the first quarter of 2023, and none in the first quarter of 2024. Our R&D prioritization and Fit for Growth initiatives had a clear impact on our non-GAAP R&D and SG&A expenses, which we refer to as core OpEx during the quarter, and that resulted in a 13% decrease year-over-year. These savings contributed to meaningful growth of our non-GAAP operating income of 24% year-over-year. Our operating margin was 31% in the quarter as compared to 23% in the first quarter of 2023. And while these are encouraging improvements so far, we believe there is still more work that can be done to continue to improve these metrics. Now, a bit more color on revenue dynamics during the first quarter. Total revenue was $2.3 billion, which was a decrease of 7% at actual and constant-currency. Our MS franchise revenue declined approximately 4% driven by competition and the usual channel seasonality that we see in the first quarter. Within MS, VUMERITY revenue grew 18% and benefited from global patient growth as well as some favorable channel dynamics during the first quarter. Regarding TECFIDERA in the EU, we have now seen most generics exit the market, which drove ex-US growth of 5% for TECFIDERA this quarter. We continue to believe we are entitled to market protection in the EU until February of 2025. And now, a quick double-click on our rare disease revenue for the quarter. SKYCLARYS delivered $78 million of revenue, including approximately $5 million in Europe, where we have launches in several countries underway. For SPINRAZA in the US, revenue was up 1% in the quarter, and we remain encouraged by the resilience here. SPINRAZA revenue outside the US declined 35%. The majority of this year-over-year decline was due to shipment timing in certain emerging markets. We continue to generally see stable patient numbers globally, and we would expect the shipping dynamic outside the US to largely normalize throughout the remainder of 2024. We also saw some modest negative impacts from competition and foreign exchange in the quarter. For the full year 2024, we expect global SPINRAZA revenue to decline by a low-single-digit percentage. ZURZUVAE delivered $12 million of revenue, which we believe is inclusive of some channel stocking in anticipation of increasing demand, which is common for any new launch. And lastly, contract manufacturing revenue was notably lower year-over-year, and as we reflected in our guidance for the full year, we continue to expect contribution from this line to be significantly lower than last year, due to completing a number of batch commitments in 2023. First quarter non-GAAP cost of sales was 22% of total revenue, and that's an improvement of 5 percentage points. As I previously mentioned, this improvement was driven by a more favorable product mix, as revenue from new product launches replaced lower margin contract manufacturing revenue, and it also was related to having lower idle capacity charges. We did not have any in the first quarter of 2024. First quarter non-GAAP R&D expense decreased $124 million, which was driven primarily by savings achieved from Fit for Growth, where we remain on track to achieve cost savings of $1 billion gross and [$8 million] (ph) net of investment by the end of 2025. We also saw savings as a result of our R&D portfolio prioritization, which has had a meaningful impact as we discontinued some programs and have focused our spend on areas we believe have a higher probability of success. Non-GAAP SG&A expense decreased approximately $33 million in the first quarter, and this was primarily due to $50 million of G&A-related cost reductions, which were realized in 2024 in connection with our Fit for Growth program, and that was offset by an increase in operational spending on sales and marketing activities in support of the LEQEMBI and SKYCLARYS launches. I will also note that the prior year included $31 million related to the termination of a co-promote agreement for our MS project -- products in Japan. All of this together contributed to non-GAAP operating income growing 24%, with non-GAAP operating margin now above 30% and improving and non-GAAP EPS growth of 8%. Next, a brief update on our balance sheet. We ended the quarter with approximately $6.5 billion of debt, $1.1 billion in cash and marketable securities, and net debt of roughly $5.5 billion. As of March 31, 2024, the $6.5 billion of total debt included $250 million of the $1 billion 2023 term loan, which was put in place at the time of the Reata acquisition. As of March 31, 2024, we had repaid $750 million of this $1 billion facility. The remaining $250 million is expected to be repaid during the second quarter of this year, so this quarter, earlier than our original expectation, which was by the end of this year. I'd note that this cash and marketable securities figure does not include a $437 million payment from Samsung, which we received earlier this month. We continued to generate strong free cash flow during the first quarter with approximately $507 million of free cash flow. So overall, our balance sheet remains in a strong position, with increasing capacity to invest in growth initiatives. And regarding our strategic review of the biosimilars business, at this point, we have not received an acceptable offer from a third-party. Our process remains ongoing and we will remain disciplined as we continue to explore all options including retaining the business. Next, I'd like to discuss our full year 2024 guidance ranges and assumptions. We are reaffirming our expectation of full-year 2024 non-GAAP diluted earnings per share of between $15 and $16, which reflects expected growth of approximately 5% at the midpoint of the range as compared to 2023. All of the previous assumptions to our guidance, including those you see on this slide, remain unchanged. I'd like to remind that we have potential R&D success milestone or opt-in payments associated with the upcoming clinical data readouts, and we have made an allowance for some of these potential payments in our guidance. Of course, whether or not they are paid will be dependent on the data and our resulting decisions. And finally, we just announced the completion of a sale of one of our two priority review vouchers for $103 million. At this point, we expect to earmark these proceeds for business investment, or to support business development opportunities as they arise. And in closing, we remain committed to our number one goal of returning Biogen to sustainable top and bottom-line growth, and creating long-term value for our shareholders. We will now open up the call for questions."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Mike. Jennifer, can we go to questions?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Eric Schmidt with Cantor Fitzgerald."
},
{
"speaker": "Eric Schmidt",
"content": "Oh, hi. Thanks so much for all the updates and for taking my question. I guess on LEQEMBI and maybe for Priya, we had a couple of updates in the last month or so, the EMA delay on the CHMP recommendation. And also, I know this is your partner's doing, but Eisai announced that they couldn't submit for the subcu approval until they finished the immunogenicity study. I was hoping you could just update us on timelines for both of those initiatives going forward? Thank you."
},
{
"speaker": "Priya Singhal",
"content": "Yes. Thanks, Eric. So maybe I can just start off by saying that we are working with Eisai to really provide patients with the optionality of a subcutaneous formulation. Our approach is entirely data driven. So we were very encouraged to see the bioequivalence we met last year and we shared that at CTAD. This was the most important milestone. Thereafter, we've engaged with the FDA. And currently, just to characterize how we are approaching this, we've split our strategy for subcutaneous formulation. First and foremost, we are working to submit a rolling submission for subcutaneous autoinjector for maintenance. This we're going to do at earliest. Eisai has already submitted a fast track application. We're awaiting that. And as soon as we get it, we will make the submission, while we continue to generate the data for the three-month immunogenicity that the FDA has required. Second, because our exposure with subcutaneous formulation was higher than the IV formulation, we believe it's in the interest of patients to optimize dose, and that will lead to more convenience. So, we are optimizing this dose and that is something that is already ongoing and is currently ongoing this year. In terms of timelines, if we get the fast track for subcutaneous maintenance, we will file immediately for rolling review, and that we expect would be in this year even if we don't get the fast track because we have completed the three-month immunogenicity data by Q4. Second, for the subcutaneous induction therapy, we expect that we would file by the first quarter of 2026. That is what Eisai has already communicated in their investor comments early March. I'd also like to remind us that we completed our intravenous maintenance filing by Q1 2024 as we [indiscernible]. Thank you."
},
{
"speaker": "Chuck Triano",
"content": "Thank you, operator. Next question, please."
},
{
"speaker": "Operator",
"content": "We'll go next to Paul Matteis with Stifel."
},
{
"speaker": "Paul Matteis",
"content": "Good morning. Thank you for taking my question. I was wondering if we could get your updated perspective on business development as it relates to capacity, therapeutic area, stage of development, or commercial? And just in the context of this, how the kind of uncertain -- promising, but uncertain trajectory of lecanemab influences your appetite to execute on something now versus maybe wait a bit until 2025? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Thanks, Paul. I think this year, we're going to be focused on business development to bring in some new assets, both into early-stage research and development. We have always called ourselves a neuroscience company, but the reality of neuroscience is that, this is a high-risk area. We don't always understand the underlying disease biology, the diseases progress slowly, that leads you to some very long and expensive trials. You can't often do a proof-of-concept study in Phase 2. And so, while we remain committed to neuroscience, my personal view is that I think that is to -- that is not diversified enough for a company of our size. And so, already last year, we signaled that we'd like to go into some adjacencies in rare disease. I think we actually have a tremendous commercial capability in rare disease. There are special commercial requirements, the need sometimes to support diagnosis, all of the hurdles with payers that have to be overcome and of course, finding the patients. And there are an awful lot of tools that I think we have to be able to do that. And then immunology, we've been an immunology company since the get-go since some -- MS is really an autoimmune disease. So, I think we'll use the opportunity with licensing collaborations to expand that. I think where our balance sheet is, if something really extraordinary came along, I suppose we look at it, but I don't think where we sit right now, we'd be thinking about doing anything this year on an acquisition front, not certainly of any size. But Mike, maybe you can talk to the balance sheet capability."
},
{
"speaker": "Mike McDonnell",
"content": "Yes. So, Paul, I would just comment that our balance sheet is in a very good spot. If you look at our net debt position at the end of the first-quarter, and then you pro forma that for the Samsung payment and the paydown that we'll make in the second quarter on the term loan, it's about $5 billion of net debt. We generate about $3 billion of EBITDA. So, it's only about a -- somewhere between 1.5 turns and 2 turns of leverage. So, we certainly could add another turn of leverage for something that we liked, at least temporarily, and we generate a couple of billion dollars of free cash flow per year. So, I think about it in the context of 2024 as maybe a $4 billion to $5 billion of capacity sort of number for things that we might be really interested in. And then, if you were looking at something more Reata-like, that's probably a little more logical, capacity wise in 2025 or beyond."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Mike and Chris. Can we take the next question, please?"
},
{
"speaker": "Operator",
"content": "Yes. We'll go next to Salveen Richter with Goldman Sachs."
},
{
"speaker": "Salveen Richter",
"content": "Good morning. Thanks for taking my question. For SKYCLARYS, could you speak to the 2024 outlook and any bolus dynamics that has impacted this? And specifically, you've talked being 24% US market penetration. How are you thinking about peak penetration in the US and then the expectations for pace of uptake in Europe and net pricing there? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "Alisha, you want to take US and I can follow up with Europe?"
},
{
"speaker": "Alisha Alaimo",
"content": "Yes. I think when you look at the US and the market penetration, and you probably saw in the analogs on the slide that the launch has gone very well thus far. And as I also said, we've made it through sort of the catch-up population. We have a lot of really good things in-place right now that we are launching in parallel to identify and hopefully get to the rest of the population. The way in which we think about this market though is, we do have two sets of patients. You have a set that are highly engaged with their physicians, and you have another set who haven't been engaged, probably over the last two to five years. We have enough data and analytics to understand exactly where these physicians are, and how the patients have moved through them. And so, with that, we are now identifying a lot of these offices, especially in the community who could have a patient or two that might be diagnosed with general ataxia, but not Friedreich's. And so, what I referred to earlier on the call is expanding the field force footprint. We have a very targeted approach to these offices in order to, again, increase the market penetration. Now, as you see with something like a SPINRAZA, we've also performed very well, and also have driven quite a good market penetration with that product, even though there's competitors in the marketplace. With SKYCLARYS, with no competitor really in the market, we expect to continue over the next several years to penetrate this for as far as we can go. We know that there are 4,500 approximate patients that could have Friedreich's ataxia. And so, what we're doing is planning everything that we can to get to as many of them as quickly as possible."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Alisha."
},
{
"speaker": "Chris Viehbacher",
"content": "Yes. And on Europe, in some ways the single-payer systems actually are really ideal for rare diseases. A lot of patients in the US, even if you have reimbursement, even if you have insurance coverage, there are an awful lot of hurdles that the US healthcare system imposes upon patients. And a lot of those, we don't really see in Europe. And so, I think we're seeing a rapid uptake. Again, there's -- there is a catch-up on population. So there's -- and there's a difference between patients on treatment and revenue-generating patients. So first, we have -- we have actually the commercial launch in Germany because we can get reimbursement relatively quickly. Other countries will come online as we go through the individual country reimbursement processes, but our objective is actually build up the patients. So there's a number who are on free drug at the moment through these EAPs, some of the EAPs you can charge for. So, it's going to be a little lumpy as we look at the revenue line. But I'd say we're extremely encouraged by the uptake of patients. And then, ex-US in Latin America, that could well be a story for 2025. I think you may see our first launch in Brazil in early part of 2025."
},
{
"speaker": "Chuck Triano",
"content": "Great. Thanks, Chris. Can we move to the next question, please?"
},
{
"speaker": "Operator",
"content": "Yes. We'll go next to Umer Raffat with Evercore."
},
{
"speaker": "Umer Raffat",
"content": "Hi, guys. Thanks for taking my question. I have one for Priya, if I may. I know there's the late-stage lupus readout with the CD40 ligand antibody this summer. I also realize the time point on this readout is week 48 instead of week 24. And I guess my question is, knowing that there wasn't a clear dose-response on efficacy in the prior trial, could you speak to how the B cell impact was different between doses and whether the prolonged duration could actually help the B cell impact on this upcoming readout? Thank you."
},
{
"speaker": "Priya Singhal",
"content": "Thanks, Umer. We have looked at the Phase 2 study very carefully, and we have decided and we included the 48-week endpoint on BICLA for this Phase 3 study. And ultimately, we're looking for a meaningful change on the primary endpoint, and the key secondary endpoints for SLE such as severe flare prevention and patients achieving low disease activity. We also think that the BICLA is a sensitive, clinically meaningful composite measure of SLE disease activity, and requires disease improvement across all body systems with moderate or severe baseline activity without worsening and the need for escalation in background medications. So we modified the trial, we are -- we have refined the population, and we think that this is going to be really important as we kind of look forward to the readout. The other piece I think here to keep in mind is that we considered how we can modify the population for this study and get to an answer really quickly to bring potentially dapi to patients. So I hope that answers your question."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Priya. Let's go to the next question, please."
},
{
"speaker": "Operator",
"content": "We'll go next to Michael Yee with Jefferies."
},
{
"speaker": "Michael Yee",
"content": "Hey, guys. Thanks. I wanted to revisit SKYCLARYS comments. I know you said you were planning to add patients month-to-month. Can you just talk about the trajectory of SKYCLARYS this year as it relates to also any offsets like discontinuation rates, et cetera, et cetera, how does that factor into it? And also, will you book Germany revenues this year? So just talk about the dynamics of revenues for SKYCLARYS. And if I may sneak in one clarification. Priya said subcu induction filing for LEQEMBI Q1 2026. I just wanted to clear that's what she said? Thank you so much."
},
{
"speaker": "Priya Singhal",
"content": "Yes. The outcome and the filing will be in that period, but we'll communicate more on this once we optimize the dose and we go forward."
},
{
"speaker": "Michael Yee",
"content": "Okay. And SKYCLARYS?"
},
{
"speaker": "Alisha Alaimo",
"content": "Yes. So for SKYCLARYS, it is quite complicated month-to-month, I will say, because you have patients, obviously, that we're getting via the start forms, which I will say for the highly engaged population we are pretty much maxing that out now. We absolutely know who they are and we've captured them through the physicians. But then, you're also going to have a discontinuation rate as you have noted, and you're going to have patients that are being pulled off the start forms, putting on to product. And then of course, you may have them miss a dose or two, right? So then, there's compliance. So month-to-month, it will be lumpy because you can say you add 50 patients, but then you have other dynamics going on in the patient population. But what our outlook is for the year, which I can't give you a specific number, is that we are going to continue to add every single month. We are able to find those patients in the community, and there are other puts and takes in those numbers. But at the end of the day, we will ensure that we are still leading the rare disease analogs and that we're going to generate market penetration."
},
{
"speaker": "Chris Viehbacher",
"content": "Yes. And in Europe, we're booking revenue now for Germany and actually -- we've actually launched in Austria and the Czech Republic as well. And in some countries, we're actually able to charge for the early access programs in Europe and some of that revenue will come down too, but you probably see more full EU as a region revenue in 2025, but there will be certainly revenue contributions in 2024 from certain countries in Europe."
},
{
"speaker": "Chuck Triano",
"content": "Great. Thanks, Chris. Let's go to the next question, please."
},
{
"speaker": "Operator",
"content": "We'll go next to Colin Bristow with UBS."
},
{
"speaker": "Colin Bristow",
"content": "Good morning and thanks for taking the questions. Maybe one on the LEQEMBI commercial setup. So, one investor concern and important feedback we've been hearing from physicians is around, there being less sales and marketing presence than perhaps had been expected. I heard in your prepared remarks you're saying you expect a 30% increase in the US footprint. Are you able to sort of quantify the current US commercial footprint? And was the 30% increase always planned, or was it based on some review that the current footprint wasn't adequate? Thank you."
},
{
"speaker": "Alisha Alaimo",
"content": "Thank you very much for the question. If you really take a step back and look at how we strategically looked at this launch, we always said that we were going to do in a stepwise approach. We knew from the beginning that sites were going to take a while to get up and running. We had to wait for several indicators from CMS giving full approval and NCD being overturned for PET. And so with that being said, we didn't want to go out of the gate with a really huge field force that wasn't able to actually impact or penetrate the market. So instead, what was decided is we went in with a very focused approach. We focused on really the top accounts that we think handle the majority of the diagnosed patients, especially that are under neurology care. And we said once the market gets to a place where we think it's ready for expansion, then we will expand. Now, to your comment about physicians coming back saying they're not seeing a lot of sales efforts, I think, we also have to have really the context of getting these sites up and running takes a lot of effort. And you also don't want to have three, four, five different people going into these accounts to support. And so, we've been very focused on really getting the large IDNs up and running. Some of these centers that have come forward that really could move quite quickly, we got them up and running. And now as you see the expansion take place with the 30%, we are going to focus mainly on the large IDNs that are now opening up their expand and extend satellite offices, where they're now going to allow a larger cohort of patients to come through for diagnosis and treatment. And so, with this next phase of a build, which we believe we've done a lot of analytics behind it, and we've had a lot of third parties weigh-in on what is the appropriate sizing, we and Eisai believe that this is going to be the right footprint to drive the next acceleration of growth."
},
{
"speaker": "Chuck Triano",
"content": "And let me just turn it to Priya for a clarification back to Mike Yee's question on subcu."
},
{
"speaker": "Priya Singhal",
"content": "Thank you. Thank you. Just wanted to clarify that it's the outcome by fiscal year -- Eisai's fiscal year 2025, which is Q1 2026 for the subcutaneous induction. Of course, that -- it could be a range because it would involve sBLA, a prior -- potentially a priority review and other such aspects, which could shift it, but that is the -- that is what Eisai has communicated. I just wanted to reaffirm that. Thank you."
},
{
"speaker": "Chuck Triano",
"content": "So, the outcome and not the filing?"
},
{
"speaker": "Priya Singhal",
"content": "Yes."
},
{
"speaker": "Chuck Triano",
"content": "Obviously earlier?"
},
{
"speaker": "Priya Singhal",
"content": "Earlier."
},
{
"speaker": "Chuck Triano",
"content": "Yes."
},
{
"speaker": "Priya Singhal",
"content": "Thank you."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Priya. Let's move to the next question, please."
},
{
"speaker": "Operator",
"content": "We'll go next to Brian Abrahams with RBC Capital Markets."
},
{
"speaker": "Brian Abrahams",
"content": "Hi, there. Good morning. Thanks so much for taking my question. With regards to LEQEMBI subcu, on the FDA request for immunogenicity data, I'm curious if you have a sense as to what drove that request. Your level of confidence that the PK will be linear using half the subcu dose? And then, when are you proposing that patients in their course of treatment should transition from an IV to a subcu maintenance? Thanks."
},
{
"speaker": "Priya Singhal",
"content": "Sure. Thanks, Brian. So overall, we -- as you know, we had tested the 720 milligrams in the naive patient population that was in the Clarity AD open-label extension sub-study for subcutaneous. Now, from that -- in addition to that, we had modeling data and this is what we are proposing for 360 milligrams to be the weekly maintenance, and the FDA is just requiring additional immunogenicity data. We see this as a reasonable request, and we are already in the process of generating it. So overall, we don't expect that the bioequivalence is going to be in question. This is now really about the immunogenicity and actually generating on patients who would be tested for this. So, that's what we expect with that. Can you remind me what was the second aspect of your question?"
},
{
"speaker": "Brian Abrahams",
"content": "When are you proposing that patients transition from the IV to the subcu maintenance? Is there data supporting what -- when in the course of treatment that transition should happen?"
},
{
"speaker": "Priya Singhal",
"content": "Yes. And I think that's important because we have filed for an intravenous maintenance like -- we've already completed this filing Q1 2024, and really that has come from three lines of evidence. The Study 201, which was the Phase 2 study, the GAAP period modeling, as well as open-label extension in the Phase 3. So that's what's informed our maintenance IV filing. And really, it will be decided along with the FDA on what is the appropriate time for transition from IV biweekly to weekly now -- up to four-weekly. And in addition, following that, we'll have the subcutaneous maintenance discussion. So really, it's very systematic and we need to first get through all the IV maintenance. And in parallel, we have the SC maintenance. I hope that makes sense."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Priya. Let's move to the next question, please."
},
{
"speaker": "Operator",
"content": "We'll go next to Jay Olson with Oppenheimer."
},
{
"speaker": "Jay Olson",
"content": "Oh, hey. Thanks for providing this update. It seems like compared to previous quarters, you're focusing more on your three commercial launches and relatively less on the R&D pipeline. Is there any particular reason for that shift in focus? And how much more work do you plan to do to optimize your R&D portfolio? Thank you."
},
{
"speaker": "Chris Viehbacher",
"content": "I'll start. I mean, I think we have first -- four data readouts coming in midyear. So, I think, we felt we'd have more data when we -- it makes sense to bring back the R&D when we've got more data. I would say actually from a prioritization point of view, and Priya, you can weigh-in here, but I think we've largely done the job of having projects that are either projects of conviction, or projects where we're waiting the data outcome. They're in-flight and just given the nature of neuroscience projects, we wait -- we need to wait and see what the data say. I think you're going to find us much more disciplined about whether we progress or not. Our go/no-go decisions, I think have all been clearly defined for those. I think the next job is really now to build out the pipeline, as I talked about earlier, that we want to diversify our business a little bit more than we have in the past. So, Priya is certainly working along with Jane on thinking about what things we can additionally bring into the pipeline from outside. But, Priya, I don't know whether you want to add anything there."
},
{
"speaker": "Priya Singhal",
"content": "Thanks, Chris. I think you covered it. That's exactly right. We are very excited about our four readouts. We are preparing for them. We have already worked through go/no-go criteria. And we continue to remain very excited about the rest of the pipeline that's in mid and late-stage, particularly our anti-tau ASO BIIB080, as well as our two Phase 3 programs in SLE, litifilimab as well as dapi that we just talked about, and with litifilimab also in cutaneous lupus. So, we have a number of projects in early phase development, and we're trying to be very disciplined about making sure that we make evidence and data-based decisions."
},
{
"speaker": "Chuck Triano",
"content": "Thanks. Thanks, Priya. Next question, please."
},
{
"speaker": "Operator",
"content": "We'll go next to Chris Raymond with Piper Sandler."
},
{
"speaker": "Chris Raymond",
"content": "Thanks. Just maybe a strategic question on your biz dev strategy. So, Chris, I heard your comments around diversifying away from neurology. You guys have been saying that for a while and your deals are focused on areas other than MS. But there is actually, if you look across the industry, some decent early innovation in MS. Even with your business on the decline, our checks still indicate that Biogen remains a trusted company and there's an awful lot of value, I would argue with that market presence. I guess maybe just the question here strategically is, is your activities in business development, is that due to your view of the need to diversify away from MS strategically? Or is it a view that you just haven't seen an early asset worth licensing, or is there some other underlying dynamic of the MS market that has led you guys to prioritize other areas? Thanks."
},
{
"speaker": "Chris Viehbacher",
"content": "Yes, well, there's a little bit of a lot of the above in there. I think the first is, we haven't abandoned MS. We do have programs in research early. The unmet need in MS has really narrowed. It's really the progressive form, which is a very tough indication really to go after. But we have programs still in ALS. And in fact, I think the fact that QALSODY was approved has actually proven to be an enormous scientific achievement. It may not be a major financial achievement, but this really opens up the field to having a biomarker where you can tell whether something is working or not in ALS. And so, we have a number of programs in ALS. We're in Huntington's. We have a program in Parkinson's, as you know. We've got TAU, which I think between TAU and lupus, we see as programs of high conviction within the company. So, we feel that -- I think you're right. We are very well-placed. Neurology, I wouldn't just say MS, but neurology. But the reality is that, we sit there with programs that are very difficult to predict, very expensive, very long running. And when you actually look at the ability to do external deals, that field is also very narrow. There's just not that many people working in the CNS space. So we're by no means abandoning it. And in fact, the fact that we go after these really tough diseases is really a source of pride within Biogen. And I have to say, I continue to be amazed at the capability and talent we have within the organization. But the reality is, we need to have more predictable results out of R&D. And I think we do have a lot of that capability within the company. I don't see us ever -- moving -- going left turn into oncology or something like that. But I do think we have a legitimacy and being in rare diseases and expanding into immunology. And in fact, I think what we've been doing in MS and in fact lupus is really an indicator of that. So, I think we're going to continue to branch out, but it also branches out our opportunity set for collaboration, and not just diversifying our portfolio."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Chris. And can we take our last question, please, operator?"
},
{
"speaker": "Operator",
"content": "Yes. We'll go next to Terence Flynn with Morgan Stanley."
},
{
"speaker": "Terence Flynn",
"content": "Great. Thanks for taking the question. Maybe a two-part on LEQEMBI. Just wondering, obviously, you talked about the number of unique prescribers more than doubling this quarter. Just wondering how much more breadth you're expecting from the field force expansion here as we think about the forward through 2024? And then, any early insights on duration of treatment that you're seeing so far? Thank you."
},
{
"speaker": "Alisha Alaimo",
"content": "Yes. So thank you for the question. My outlook for the rest of the year is, when you really think about the phases that these IDNs are in, and even you see these small accounts that they do move fast out in the community. And if you really take a step back and look in context for the IDNs, we got an approval -- full approval in July. It took about six to eight months for these very large systems to get organized, which is that staged and phased approach I talked about. And the fact that now they're actually opening up these other sites for diagnosing and prescribing, I believe that you're going to also see the number of physicians prescribing increasing, and it will continue to increase throughout the rest of the year. If you look at how many physicians that we are targeting and the numbers that are actually prescribing, we still have a good delta there. And so, I do see that continuing, especially with the field force coming in, if they're covering, our goal is really to drive the acceleration at these large IDNs. I talked to you about the Priority 100, but keep in mind, we actually target quite more than that. I just keep referring to the priority. And there are many other IDNs that are also prescribing and are also expanding and extending. The second part of your question was around --"
},
{
"speaker": "Chuck Triano",
"content": "Duration."
},
{
"speaker": "Alisha Alaimo",
"content": "Duration. What's interesting with this and there's been a lot of conversations with many of these prescribing sites. Physicians lay very specific and explicit expectations with patients that when they go on this therapy, their expectation is they come in, every two weeks, to get their IV infusion and that they stay on product. And what we've seen thus far, and what we believe to be happening thus far is patients are staying on product. We hear that as feedback from the physicians. We also hear that as feedback from the numbers that we see the data that we see. So, so far with duration, the plan is that they're keeping patients on product. I think there are questions out there as to what to do about duration, but in the absence of any data, physicians are keeping patients on."
},
{
"speaker": "Chuck Triano",
"content": "Right. Thanks, Alisha, and thanks to all of you for joining us today for the call and the IR team, of course, is available for follow-ups. Have a good rest of your day."
},
{
"speaker": "Operator",
"content": "This does conclude today's conference. We thank you for your participation."
}
] |
bk | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good afternoon, and welcome to the 2024 Fourth Quarter Earnings Conference Call hosted by BNY. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference call and webcast will be recorded and will consist of copyrighted material. You may not record or rebroadcast these materials without BNY's consent. I will now turn the call over to Marius Merz, BNY Head of Investor Relations. Please go ahead."
},
{
"speaker": "Marius Merz",
"content": "Thank you, operator. Good afternoon, everyone, and welcome to our earnings call for the fourth quarter of 2024. I'm joined by Robin Vince, our President and Chief Executive Officer; and Dermot McDonogh, our Chief Financial Officer. Robin will start with a strategic update, followed by Dermot with his financial update and outlook. Both will reference our quarterly update presentation, which can be found on the Investor Relations page of our website at bny.com. I'll also note that our remarks will contain forward-looking statements and non-GAAP measures. Actual results may differ materially from those projected in the forward-looking statements. Information about these statements and non-GAAP measures is available in the earnings press release, financial supplement, and quarterly update presentation, all of which can be found on the Investor Relations page of our website. Forward-looking statements made on this call speak only as of today, January 15, 2025, and will not be updated. With that, I will turn the call over to Robin."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Marius. Good afternoon, everyone, and thank you for joining us. Before we get into our results, I want to address the ongoing wildfires affecting parts of Los Angeles. We are heartbroken by the tremendous loss being suffered by the community where we have several offices. As always, our primary concern is for the safety and wellbeing of our employees and clients located in the effective areas. And we have also committed matching employee donations to eligible non-profits, providing relief and recovery to those impacted by the fires. Turning now to our quarterly update presentation. 2024 was an exciting year for BNY and we are entering 2025 with strong momentum on the right path to unlock the opportunity embedded in our company. Building on the solid foundation that we laid in 2023, we accelerated the pace of our ongoing transformation and closed out 2024 with a strong performance, delivering record net income of $4.3 billion on record revenue of $18.6 billion and generating a return on tangible common equity of 23% for the year. Aligned to our three strategic pillars to be more for our clients, to run our company better and to power our culture. At this time last year, we laid out a set of medium-term financial targets as well as our action plan to drive sustainably higher revenue growth over time. We're executing against these plans and targets every day. As you can see on Page 3 of our presentation, we made very tangible progress in terms of delivery in 2024. For our clients, the rollout of our new commercial coverage model was an important milestone. Effectively cross-selling and leveraging the breadth of our business platforms is the single most compelling growth opportunity for the company. And so our commercial model is designed to deliver from across the company at an accelerated pace, improve the client experience and ultimately deepen our relationships. This is the operationalization of One BNY. But our growth is not just about more of the same. Delivering innovative solutions to the market that leverage the powerful combination of capabilities we have at BNY is another important way for us to be more for our clients and drive topline growth. This is One BNY version 2.0. Our acquisition of Archer is a good example for BNY becoming an end-to-end solutions provider, in this case across the entire managed account ecosystem, be it manufacturing and BNY investments, distribution through perching or servicing through Archer. Over the course of 2024, we also developed numerous new client solutions such as CollateralOne, Alts Bridge, a NextGen ETF servicing platform and new capabilities on Wove. This new product momentum is an important investment for the years ahead. Continuing the investment theme, over the course of the year, we further increased our investments to drive both revenues and scalability, and we generated approximately $0.5 billion of efficiency savings as we continue to digitize workflows and begin to leverage new technologies, including AI. We also commenced the phased transition to our strategic platform's operating model in the spring and over the course of 2024 transitioned approximately 13,000 employees or roughly one quarter of the company into this new way of working. Zooming out for a moment, the wrapper for much of our work is culture. Powering our culture remains essential to everything else and we are starting to see the benefits of our people around the world working more closely together. Celebrating our company's 240th anniversary in 2024 with colleagues, clients and many other stakeholders around the world felt even more special at a moment in which our people could start to see their hard work, leaving a positive mark on this iconic institution. Considering the transformation underway at our company, we decided that the time was right last summer to simplify and modernize our brand and logo to improve the market's familiarity of who we are and what we do. The benefits of BNY's improved visibility in the market have also supported our recruiting efforts. Throughout the year, we've been successful in attracting top talents across the firm from recruiting our largest intern and analyst classes to further rounding out our executive leadership team and the targeted investments we've been making in the employee experience across learning, benefits and facilities are being recognized and valued by our people. Another important aspect of powering our culture is to deliver on our commitments. We've worked hard to say what we do and to do what we say. And so, turning to Page 4, I'm pleased that in 2024, we once again met or exceeded our financial goals for the year. We are confident that BNY can deliver positive operating leverage across a wide range of scenarios and so we started 2024 determined to at least breakeven from an operating leverage perspective. That was an ambitious goal at the time, considering that our revenue outlook at the beginning of the year foresaw an approximately 10% NII headwind to largely offset growth in fee revenue. Therefore, we had to set up to keep expenses, excluding notable items roughly flat, while at the same time self-funding incremental investments in the business. Dermot will discuss the financials in more detail, but in summary, in 2024, we delivered 968 basis points of positive operating leverage on a reported basis and 288 basis points, excluding notable items. We grew fee revenue by 6% year-over-year and NII was down 1%, outperforming our outlook from the beginning of the year by approximately 9 percentage points. Despite higher-than-expected revenue, expenses were down 4% year-over-year on a reported basis and up 1% excluding notable items. And finally, consistent with our outlook, we returned 102% of 2024 earnings to our shareholders. Taken together, we delivered record financial results in 2024. Significant positive operating leverage resulted in pre-tax margin expansion and improved profitability and we delivered attractive capital returns to our shareholders, all of which underscored the execution of a reinvigorated BNY. But now, let's look forward on Page 5. We are entering 2025 with strong momentum and determination to deliver further value for our clients and shareholders. BNY plays a central role in global capital markets with $52 trillion of AUCA, $14 trillion of debt serviced, $3 trillion of wealth assets, and $5.6 trillion of assets on our collateral management platform. We manage $2 trillion of AUM and on an average day, we settle over $15 trillion worth of securities and roughly $2.5 trillion worth of payments for clients around the world. This exceptional client franchise and leadership across our diversified financial services platforms positions us well to capture market beta and capitalize on evolving market trends, several of which we describe on the left hand side of the page. Some of our fastest-growing businesses in 2024, treasury services, clearance and collateral management and corporate trust demonstrate our gearing toward economic growth and higher capital markets activity, both public and private. And through Pershing and Wealth, we are a leader in serving one of the fastest-growing segments in financial services, the US wealth market. Within that market, our wealth business is focused on the faster-growing ultra-high net worth space. Our Pershing business, on the other hand, leverages the size and scale of our platforms to power advisors' businesses, helping them navigate an increasingly complex operating environment using the power of our technology. Relevant for both retail and institutional investors, the trend toward private markets represents an opportunity for BNY to support our clients end-to-end from servicing to distribution, cash investment, FX hedging and lending across traditional and alternative asset classes. Last year also saw the mass adoption of digital assets exchange-traded products in the US, which grew to more than $100 billion in assets under management. BNY has been an early mover in the digital asset space. Today, we provide fund services for the vast majority of digital asset exchange-traded products in both the US and Canada and over the long term, we believe digital assets and the technology underpinnings have the transformative potential to help solve client and market needs. And finally, on this list of important market trends, as global markets evolve and become ever more complex, both buy-side and sell-side firms are looking to outsource certain functions and consolidate providers in order to gain scale and reduce risk, and we expect the strength and connectivity of our platforms to be a differentiator in this regard. As we think about the operating environment in 2025, just a month ago, there were clear signs of optimism with the US election behind us, inflation moderating and the Fed having begun its path toward lower rates. But with the turn of the year, we view the outlook for 2025 as a little more uncertain with persistent tail risks across geopolitical tensions and conflicts, uncertainty about trade and fiscal policies and volatility in markets. Against this backdrop, being positioned conservatively with a strong balance sheet and operational resilience allows us to remain focused on executing our ongoing transformation. While we've made good progress against our strategic priorities over the past 12 months, we have a lot more work ahead of us. As I've said before, strategy is important, actually doing it and how we do it matters the most. And so on the right-hand side of this page is the reminder of our strategic priorities and underneath each are some indicators for the progress that we're making. The makeup of our new business wins in 2024, we highlighted some of them on our earnings calls over the past year, validated for us that there is real demand in the market for the type of integrated solutions that BNY can deliver. For example, last year, we've seen a 30% year-on-year increase in sales from clients buying from three or more lines of business. This remains a work in progress but with real runway ahead. Our commercial model enables our client coverage teams to more effectively deliver integrated solutions from across BNY to our clients and our platform's operating model realigns how we work and organize ourselves across the entire organization in furtherance of that commercial opportunity. 2025 will be a milestone year for BNY's adoption of the platform's operating model. This transition is not just about driving efficiency, it is also about enabling topline growth. By simplifying, streamlining, and collaborating through cross-functional teams, we create more intuitive client journeys, improve our ability to anticipate unmet needs, and accelerate speed-to-market. This quarter, we're planning to activate our largest wave of platforms yet, so that by the end of March, more than half of our people will be working in the model. We believe that our transition into this model will have a meaningful impact to BNY over the years to come, and so we've included in the appendix of this presentation a summary of the program and the timeline for implementation. Next, our investments in digitization and AI over the last couple of years have laid a solid foundation for us to become more efficient and to drive topline growth over time. We're embracing the power of AI to make it easier for our employees to do their jobs and channel their energy towards new innovations. To summarize this broader alpha and beta theme, we believe that we are well-positioned to capture market beta and capitalize on evolving market trends, while we remain focused on generating Alpha through the continued transformation of the company. I'll wrap up on Page 6 by reminding you of the value proposition that we laid out for our clients, our shareholders, and our people at the beginning of last year. Our strategic priorities and financial goals are clear, and we remain focused on consistent execution. Before I turn the call over to Dermot for our financial update and outlook, I'd like to close by thanking our teams around the world. I'm proud of what our people have accomplished over the past two years and grateful for everyone's continued dedication to the hard work that's ahead of us. And with that, over to you, Dermot."
},
{
"speaker": "Dermot McDonogh",
"content": "Thank you, Robin, and good afternoon, everyone. I'm picking up on Page 9 of the presentation and will first touch upon 2024 highlights before diving into the results for the fourth quarter. Total revenue of $18.6 billion was up 5% year-over-year. Fee revenue was up 6%. Investment services fees grew 7%, reflecting net-new business, higher market values, and client activity across our Security Services and Marketing and Wealth Services segments. Investment management and performance fees from our Investment and Wealth Management segment were up 3%, driven by higher market values, partially offset by the mix of AUM flows and lower performance fees. Despite a year of relatively muted volatility, foreign exchange revenue was up 9% on the back of higher client volumes. Net interest income was down 1%, reflecting changes in the deposit mix, partially offset by higher investment securities portfolio yields and balance sheet growth. Expenses of $12.7 billion were down 4% year-over-year on a reported basis, largely reflecting the net impact of adjustments for the FDIC special assessment. Excluding notable items, expenses were up 1%, reflecting higher investments, employee merit increases, and revenue-related expenses, partially offset by efficiency savings. On a reported basis, pre-tax margin was 31% and return on tangible common equity was 23% for the year. Excluding notable items, pre-tax margin was 33% and return on tangible common equity was 24%. We reported earnings per share of $5.80. Excluding notable items, earnings per share were $6.03, up 19% year-over-year and we returned 102% of earnings to common shareholders through dividends and share repurchases in 2024. Now turning to Page 11 for the financial highlights for the fourth quarter. Total revenue of $4.8 billion was up 11% year-over-year. Fee revenue was up 9%. This includes 9% growth in investment services fees, reflecting net-new business, higher client activity, and higher market values. Investment management and performance fees were also up 9%, driven by higher market values, partially offset by the mix of AUM flows. Firmwide AUCA of $52.1 trillion were up 9% year-over-year, reflecting higher market values, client inflows, and net-new business, partially offset by the unfavorable impact of a stronger US dollar. Assets under management of $2 trillion were up 3% year-over-year, primarily reflecting higher market values, partially offset by the unfavorable impact of the stronger dollar. Foreign exchange revenue increased by 24%, driven by higher client volumes. Investment in other revenue was $140 million in the quarter. As a reminder, the fourth quarter of 2023 included a $144 million reduction in investment and other revenue related to a fair-value adjustment of a receivable. Excluding notable items, the year-over-year decrease primarily reflects the absence of strategic equity investment gains recorded in the fourth quarter of last year. Net interest income increased by 8% year-over-year, primarily reflecting higher investment securities portfolio yields and balance sheet growth, partially offset by changes in deposit mix. Expenses of $3.4 billion were down 16% year-over-year on a reported basis, primarily reflecting the FDIC special assessment recorded in the fourth quarter of 2023. Excluding notable items, which were primarily severance and higher litigation reserves in the fourth quarter of 2024, expenses were up 2%. This reflects higher revenue-related expenses, employee marriage increases, and increased investments, partially offset by efficiency savings. Provision for credit losses was $20 million in the quarter, primarily reflecting reserve increases related to commercial real estate exposure. Pre-tax margin was 30% and return on tangible common equity was 23%. Excluding notable items, pre-tax margin was 34% and return on tangible common equity was 26%. We reported earnings per share of $1.54 and excluding notable items, earnings per share were $1.72, up 33% year-over-year. Turning to capital and liquidity on Page 12. Our Tier 1 leverage ratio for the quarter was 5.7%. Tier 1 capital decreased by 4% sequentially, primarily reflecting a decline in accumulated other comprehensive income and capital returns through common stock repurchases and dividends, partially offset by capital generated through earnings. Average assets were up 1%. Our CET1 ratio at the end of the quarter was 11.2%. CET1 capital decreased by 5% sequentially and risk-weighted assets increased by 1%. We returned $1.1 billion of capital to our shareholders over the course of the fourth quarter. Moving to liquidity. The consolidated liquidity coverage ratio was 115% and the consolidated net stable funding ratio was 132%. Next, net interest income and balance sheet trends on Page 13. Net interest income of $1.2 billion was up 8% year-over-year and up 14% quarter-over-quarter. The sequential increase was primarily driven by the reinvestment of maturing investment securities at higher yields, partially offset by deposit margin compression. Average deposit balances increased by 1% sequentially. Non-interest-bearing deposits increased by 7% in the quarter and interest-bearing deposits decreased by 1%. Average interest-earning assets were flat quarter-over-quarter. Our cash and reverse repo, loan, and investment securities portfolio balances all remained flat. Turning to our business segments, starting on Page 14. Security Services reported total revenue of $2.3 billion, up 7% year-over-year. Total investment services fees were up 6% year-over-year. In Asset Servicing, investment services fees grew by 7%, primarily reflecting higher market values, client activity, and net new business. We're pleased with the broad-based momentum in asset servicing. Clients are increasingly looking to leverage the scale of BNY's platforms and utilize the differentiated breadth of our capabilities and at the same time, we continue to see particular strength in ETF and alternative servicing, validating the multiyear investments we've made into these platforms. ETF AUCA of $2.8 trillion were up over 60% year-over-year with inflows into ETFs on our platform once again outpacing the market and alternatives AUCA were up 20% year-over-year. In issuer services, investment services fees were up 4%. Healthy net-new business and higher client activity in corporate trust was partially offset by lower depository receipt fees, reflecting a higher level of corporate actions and cross-border activity in the prior year quarter. Over the course of 2024, we've maintained our market-leading share in straight stat servicing and by increasing our market share in CLO servicing, further strengthened our number 2 position. In this segment, foreign exchange revenue was up 25% year-over-year, reflecting growth from higher client activity. Net interest income for the segment was up 7% year-over-year. Segment expenses of $1.7 billion were up 1% year-over-year, reflecting higher litigation reserves, employee marriage increases and higher investments, partially offset by efficiency savings. Pre-tax income was $643 million, a 39% increase year-over-year, and pre-tax margin was 28%. Next, Market and Wealth Services on Page 15. Market and Wealth Services reported total revenue of $1.7 billion, up 11% year-over-year. Total investment services fees were up 12% year-over-year. In Pershing, investment services fees were up 9%, reflecting higher market values and client activity. Net-new assets were $41 billion, including a large client onboarding in the quarter. In Clearance and Collateral Management, investment services fees increased by 13%, primarily reflecting higher collateral management fees and clearance volumes. We continue to see strong US securities clearance volumes on the back of US treasury issues as well as trading activity across the platform. And we remain focused on increasing market connectivity by expanding our global collateral platform to new markets. In Treasury Services, investment services fees were up 15%, primarily reflecting net-new business. In November, the US Department of the Treasury's Bureau of the Fiscal Service selected BNY as the new financial agent for the Direct Express program. This decision to appoint BNY speaks to our organization's strength in driving commercial outcomes that broaden access to the financial ecosystem. The program leverages our innovative and resilient payment capabilities to provide disbursement services at scale. Net interest income for the segment overall was up 9% year-over-year. Segment expenses of $852 million were up 2% year-over-year, reflecting higher revenue-related expenses, investments, and employee merit increases, partially offset by efficiency savings and lower litigation reserves. Pre-tax income was up 28% year-over-year at $806 million, representing a 48% pre-tax margin. Turning to Investment and Wealth Management on Page 16. Investment and Wealth Management reported total revenue of $873 million, up 29% year-over-year. In our Investment Management business, revenue was up 41%. Excluding a notable item in the prior year quarter, revenue was up 5%, reflecting higher market values, partially offset by the mix of AUM flows. And in Wealth Management, revenue increased by 9%, reflecting higher market values and net interest income, partially offset by changes in product mix. Segment expenses of $700 million were up 2% year-over-year as higher revenue-related expenses and employee merit increases were partially offset by efficiency savings. Pre-tax income was $173 million and pre-tax margin was 20%. As I mentioned earlier, assets under management of $2 trillion increased by 3% year-over-year, primarily reflecting higher market values, partially offset by the unfavorable impact of the stronger dollar. In the fourth quarter, we saw net outflows of $15 billion. This includes $27 billion of net outflows from long-term strategies and $12 billion of net inflows into cash. Wealth Management's client assets of $327 billion increased by 5% year-over-year, reflecting higher market values and cumulative net inflows. Page 17 shows the results of the other segment. Next, on Page 19, our current outlook for 2025. Positive operating leverage continues to be our North Star and so once again, we have set ourselves up to drive positive operating leverage consistent with our medium-term financial targets. Starting with NII, based on current market implied forward interest rates, we expect full-year 2025 NII to be up mid-single-digit percentage points year-over-year. We expect fee revenue to be up year-over-year and we expect approximately 1% to 2% year-over-year growth in expenses, excluding notable items for the full year 2025. Specific to the first quarter, I would like to remind you that staff expenses are typically elevated due to long-term incentive compensation expense for retirement-eligible employees. And then on taxes, we expect our effective tax rate for the full year 2025 to be in the 22% to 23% range. And finally, our philosophy for capital deployment and distributions remains unchanged. We anticipate to continue to pursue growth opportunities and deliver compelling capital returns to our shareholders through dividends and buybacks. Based on what we are seeing today, we expect to return 100% plus or minus 2025 earnings over the course of the year. As always, we will calibrate the pace of our buybacks considering factors such as balance sheet growth opportunities as well as macroeconomic and interest rate environments, which are real considerations in 2025. Our Tier 1 leverage ratio management target remains unchanged at 5.5% to 6% and against the backdrop of continued interest rate volatility, we will continue to manage ourselves to the upper end of that range for the foreseeable future. To wrap up on Page 20, in January of last year, we shared our firmwide medium-term financial targets, which were to improve BNY's pre-tax margin to equal to or greater than 33% and our return on tangible common equity to equal to or greater than 23% over the medium term while maintaining a strong balance sheet. We have made solid progress towards these targets over the past 12 months and are excited about the year in front of us as our people harness the momentum and continue to embrace our pillars and principles in order to consistently meet or exceed our targets through the cycle. As Robin said at the top of the call, we're pleased with our performance this past year and we're heading into 2025 with good momentum, confident that we're on the right path to unlock the opportunity embedded in our company. And with that, operator, can you please open the line?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll take our first question from Ebrahim Poonawala with Bank of America."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Hey, good afternoon."
},
{
"speaker": "Robin Vince",
"content": "Hey, Ebrahim."
},
{
"speaker": "Ebrahim Poonawala",
"content": "I guess -- hey, Robin. I guess first question and it's with the lens of -- I'm trying to -- you'll hit your pretax margin ROE targets on an adjusted basis this year. I guess I understand it's equal to or greater than. But I'm trying to get a sense of the resiliency of these numbers as we think about, I mean, you have done a great job executing over the last year or two of what the runway is and is it reasonable for us to assume that those pre-tax margins being higher than where you are today is actually achievable, assuming no big market shock. So maybe if you want to at a very high level, address that, Robin and then I can follow up."
},
{
"speaker": "Dermot McDonogh",
"content": "Hi, Ebrahim, it's Dermot here. So I would say as it relates to the medium-term targets that we gave this time last year and I think you collectively as a group liked those targets that we gave you. And since Robin has taken on the role as CEO, we've kind of have eight quarters where we've executed very well. And I'd like to think that we've established a track record of execution and holding ourselves accountable as Robin said in his prepared remarks, say what you do and do is what you say. And so we feel confident that we're going to hit those targets sustainably through the cycle. So you're going to see more of the same from us and what you've seen in the last couple of years into '25 and beyond."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Understood. And I guess if I look at Slide 5 and just this whole conversation around 80% of employees being on sort of the platform model by end of '25, if you could address that in two ways in terms of does that result in a lot more resilience to your fee revenue growth relative to whatever may happen to markets? One, like the resiliency that provides in terms of the synergies you're getting from moving to that model. And again, that flows through in terms of these targets, could you actually do much better than where we've been for the last few quarters on the back of the -- and maybe that's a '26 event. But I'm just wondering if the platform allows for more resilient fee growth and actually an improvement relative to where we are on margins and ROE?"
},
{
"speaker": "Robin Vince",
"content": "So the way I think about this is if you kind of look at the three pillars of the strategy, be more for clients, run our company better and power our culture and then underneath that, which we talk about less, but are very important in terms of how we run the company internally or the pillars and how we show up in terms of behaviors every day. The platform operating model, which we've laid out a page for you, page 22, really is the mechanism by which we kind of drive the three pillars. So I do really believe quite strongly that the platform operating model will drive incremental topline growth, will make the topline growth more resilient, but also will allow us to run the company better and become more efficient with that. And that then in turn, we used the words over the last couple of years de-siloing, bringing our businesses closer together and that really speaks to on the topline side, the launch of the commercial operating model that we kind of went out with in the middle of last year. So you take all those discrete elements together and you add it together, you kind of go, okay, fee revenue is going to kind of incrementally grind higher from here with the tools that we're deploying and executing."
},
{
"speaker": "Dermot McDonogh",
"content": "And, Ebrahim, I'd add one thing to it, which is just this concept that we've talked about before on the call about short, medium and long term and we have consistently been investing both for the topline and also for expense efficiency with all three-time horizons, and we've been trying to do that pretty consistently over the past two years and that's relevant for your question because it isn't just a '26 story, it's actually going to be a '27, '28, and '29 story as well in our opinion, because some of what the platform's model enables is really a foundational point that then allows us to do other things. Retiring systems comes after that. We've retired some, we can retire more. Being able to do more solutioning for clients, we've done some, but we can do even more. So it's quite a bedrock thing for us and given the fact that we won't even be fully into the model until 2026, I think you can expect that there's more payoff to come, '26, '27, '28 through the end of the decade, quite frankly, if we do this well."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Got it. And that’s a great slide, the Slide 27. So good job. Thank you."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Betsy Graseck with Morgan Stanley."
},
{
"speaker": "Betsy Graseck",
"content": "Hi, just two things. One, just to wrap up on that last topic. Given that '23, '24, you got to 25% of the folks in the operating model, the platform model. And in '25 you're putting on an incremental 60%. I get that the benefits of all of this is multi-year but that's a step-up in the percentage of employees that are going to be joining the platform in '25. So should we expect that operating leverage will also increase given this large slug of folks coming in '25?"
},
{
"speaker": "Robin Vince",
"content": "I would say the two things on a direct correlation in terms of the way that you're linking it because -- Betsy, because as you go back to the beginning of our platform's operating model, we're already three years into this if you include the very thought at the beginning of the process because we started actually looking at this and thinking about this during my transition into the CEO role. We then designed, we then started to test, we then started to actually execute and so the deliberateness with which we've gone about this has been very important because we knew that it was a very fundamental change for the company and we wanted to make sure that we were doing it progressively and although there are some benefits from employee satisfaction and speeding up some of the ways that we work as people go into the model, the real benefits so far we've observed based on the pilots that we actually started doing in 2022 come more like a year or so afterwards as the teams are getting into their new rhythms of working [Technical Difficulty] and then -- so there's a phased delivery. And then you have the benefit of, okay, now you've got a really tight team operating at a higher velocity. Now what can you do with that, better in control of their design of their systems, better in control of the design of their client products, rationalizing the back end in terms of the multiple potentially duplicative things and so we see the lead time associated with it and I think that the payoffs that you and Ebrahim were sort of scratching at are there, but they're not there as immediately as you're talking about. Now notwithstanding that, we've got other things back to my short, medium and long-term observation that we have invested in that we feel quite confident will deliver us the expense benefits in 2025 that are part of our guide."
},
{
"speaker": "Betsy Graseck",
"content": "Yeah, it just feels like going from 25% to 60% to 80%, right, in one year should over time bump up that operating leverage rate. Anyway, that's okay. All right. Thank you so much. Appreciate it."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Betsy."
},
{
"speaker": "Operator",
"content": "Our next question comes from Brennan Hawken with UBS. Brennan, your line is now open."
},
{
"speaker": "Brennan Hawken",
"content": "Sorry, had the mute button pressed. Okay. Thanks for taking my questions. So we saw a really solid rebound in net-new assets at Pershing this quarter. So curious if you could maybe compare and contrast how that would look like for net-new assets in prior quarters ex the offboarding, which we were dealing with. And, Robin, I believe you spoke to ultra-high net worth as like a client segment driving or wealth strata driving some of this. But could you speak to maybe what type of firms are driving this growth? Is it RIAs? Is it broker dealers, any particular sources of strength? Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "So thanks for the question, Brennan. Look, '24, it was a noisy year given the large offboarding and we had, as I said in my prepared remarks, a large onboarding in Q4 and look, we kind of -- I guess the way to think about it is, we would like to reiterate our -- we think we have a good ability and the right to win and grow our net-new assets at mid-single digits through the cycle and that's across the space, whether it's RIAs, whether it's broker-dealers, banks, that's -- and we have the team and the technology in place. And if you just look at Wove this time last year, we kind of gave a guide on Wove, we executed the guide on that. We've re-guided higher again this year on Wove. We've now got 36 clients on the platform. We have 41 signed contracts. So all in all, we feel like we have kind of really, really big momentum on Pershing in the forward and it's one of the bigger pieces of business that's going into the platform operating model in Q1. So we [seek] (ph) to see incremental benefits for that. So Pershing continues to be a very, very strong business for us and we continue to see it growing. And like Robin will touch on the wealth tech sector, but that is one of the fastest-growing areas in the market and we are a big player in that space."
},
{
"speaker": "Robin Vince",
"content": "Yeah. And the thing that I'd add, Brennan, is just you made the point about ultra-high net worth. That's really in our BNY Wealth business. We like that business. It's been a solid performer. We think there's more upside in that over time and then Pershing is really across the high net worth space and that's got its focus on $1 billion plus RIA firms and that's where we're investing. Together, they're about $3 trillion worth of wealth assets and so when we think about what is the market trend, we think the US wealth market is a big trend and we're actually approaching it through both of those businesses, one ultra-high net worth, one real software and service approaching the broader retail market."
},
{
"speaker": "Brennan Hawken",
"content": "Great. Thanks for that color. That's helpful. And then shifting gears a bit on the NII expectations. Certainly, our outlook looks better this year than it did a year ago. Could you maybe help us understand what you would think the trajectory would look like? Do you still think you're largely very neutral? So should those -- should that cadence be largely stable? And you made a reference to changes in the deposit mix. Are there any notable shifts in deposit mix that you're assuming as you model out the year?"
},
{
"speaker": "Dermot McDonogh",
"content": "Okay. So in order to answer the question, Brennan, I'd like to maybe spend a couple of seconds just reflecting on '24 where we kind of gave the guide down 10%, we came in down 1%. When I think back on that year, for me, it was really kind of broken into three years in one. When we sat here at this time last year, I think the market implied forward curve was pricing in about six to seven rate cuts. And then clearly, the Fed was kind of signaling higher for longer that kind of in the spring and that's the way we were kind of positioned at the time. And then clarity over the summer, you had Jackson Hole kind of around the time of the Fed pivot and we kind of were very proactive on the asset side of the balance sheet there in terms of repositioning the book in terms of taking advantage of the higher rates at the time before the Fed started the easing cycle, which we've kind of factored into our guide for this year. And then as we went into the fall and kind of we had a very strong finish to the end of the year and that was really kind of the strength of the franchise, clients doing more with us, which led to higher balances overall, particularly NIBs, particularly in the corporate trust space where we had more clients doing kind of year end activity. Now on balances overall, we've kind of seen that moderate a little bit at the beginning of the year, as you would expect, particularly on the NIB side. And so as you know, like the whole NII is made up of balances, it's made up of the forward curve, it's made up of clients doing stuff with us and it's made up of what we're doing on the asset side. And I've said this many times on prior calls, like I really do believe that we have a unique strength in terms of the tripod in terms of the interaction between our CIO, the GLS leadership and then our treasurer and that team is working really, really well to deliver the strength of the franchise, which shows up in that strong guide of mid-single digits for this year."
},
{
"speaker": "Brennan Hawken",
"content": "Thanks for that color."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Mike Mayo with Wells Fargo Securities."
},
{
"speaker": "Mike Mayo",
"content": "Hey. I'm torn on this financial services platform company transformation. On the one hand, I mean, I guess it's great if everyone's on the same platform, you can have the One BNY. On the other hand, it just seems like a lot of work to go from 25% employees to 80% with all -- looks like you're ripping the guts out of the company, maybe you have to run parallel systems, maybe you have training, and so I'm just -- when you add it all together, in the short term, are you guiding for positive fee operating leverage in '25? And if -- I mean, it's -- when you're going through a transformation like this, it's tough to show any positive operating leverage. So I get that and then what are you really playing for in the end? I mean, I get One BNY, I get one platform. I just -- it's just a little too conceptual. Could you just put a little more meat on the bones?"
},
{
"speaker": "Robin Vince",
"content": "Absolutely, Mike. Happy to. So to make this a little clearer, let me just take you back for a moment to something that we talked about two years ago on the call when we were describing the work that we had done to really underwrite who BNY was, what we do, who does it, how we do it and we came to this point of view that the essence of the company is that we really provide technology, services and software for clients to build their businesses on. We have these market-leading platforms, number one in collateral, number one in securities lending, number one in issuer services. Yeah, we're the number one -- world's number one custodian as well. We've got this big $3 trillion wealth platform that we just talked about. These things are essentially a combination of technology and software and services. And so, allowing our clients to be able to build business, rent the scale of that platform is the very heart of our growth and you can see it in the numbers because market and wealth services, where we've got a lot of those platforms, not all of them, is the part of the company that is the most profitable with the highest margin and it's the fastest growing. And so with that said, recognizing who we are, we had to do two things around how we approach it. Number one, we had to get serious and organized around the commercial front end of that, that One BNY, the new commercial model, the stats that we gave you in the presentation around how we're driving to do more things for those clients. We're doing more solutions as well as adding new products. But the other thing that we had to do is you just can't run a siloed back-end organization with multiple versions of everything and I'm not just talking about systems platforms, I'm talking about the very organization of the people. We had -- we've joked about this before, we had eight call centers. We had multiple custody pieces of technology. We onboarded clients in every individual bit of the company separately. That just doesn't work for the nature of the company that we are and where we're headed. So we determined that we had to operate and organize differently. That's what platform's operating model is about. But to Betsy's question, we've been very deliberate about organizing it over a multiple time frame. We don't want to create disruption. We don't think we are. We don't think we've had any setback in terms of who we are in grinding through the year because of this. We actually think at the margin, it's been a tailwind each year. It can just be an even bigger tailwind in the out years and with three key metrics in mind, one, employee satisfaction has gone up as people have been in the model and operated in it. The second thing is we've delivered better for clients and the velocity of that new deliver -- delivery has gone up and then the third thing is the efficiency with which we're operating those groups has also improved. So we're in -- you're right, it's a big change. This is not something you drift into. It's not something you do if you've got a kind of quick cleanup mentality for a couple of years. But if you're trying to make BNY the very best that it can be with a medium to long-range mindset, this is the sort of fundamental thing you do. The good news is, we've also been delivering all along the way and that's important."
},
{
"speaker": "Mike Mayo",
"content": "And do you have an example outside the banking industry, software-as-a-service, I mean, when I hang out with my tech colleagues, they'll use phrases like you're using. Is there any example or maybe another bank somewhere else around the world or fintech or is it something brand new?"
},
{
"speaker": "Robin Vince",
"content": "So this is in -- this is borrowed, broadly speaking from the technology industry. I've sat down with CEOs of large tech-titan companies and this is essentially how they've built or reorganized themselves. As you say, if you sit down with the CEO of a technology firm, it might be a fintech, a large fintech firm, it might be a pure tech firm. This is how they've organized themselves and we're not doing it because it's tech and trendy. We're doing it because the nature of what we do is more platforms like. Now there are examples in the bank space of some banks who sort of for little bits of their business have gone after this. There are also examples in the broader fintech space, plenty of examples of firms who've adopted this concept because of who they are. But we think it's a particularly good fit for us. I wouldn't encourage every other bank. I think if you're an investment bank or a big trading house, or a big retail bank, this doesn't necessarily fit. But we're different than that. We are a bank, we have bank form, but the nature of our businesses is quite different and we think quite well-suited to it. And importantly, the early pilots that we've done, remember, we're into this thing already and we've got a lot of measurement of how it's been going and that's what gives us our confidence. It's not just theory."
},
{
"speaker": "Mike Mayo",
"content": "And then last follow up, tech spending, '24 compared to '25 and how much -- do you feel better, worse, the same about your AI efforts?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, like, the zip code of tech spending, Mike, we're in the kind of $3.8 billion range of numbers and we have roughly earmarked $0.5 billion for investment this year. I feel like, yeah, really, really good about where we are on the AI journey. We spent the last couple of years building out the infrastructure. We've got really good relationships at with the West Coast and we have a seat at the table and learning what to do and how to do it. So I think you're going to hear a lot more from us in the coming quarters about how we deploy AI to run the company better."
},
{
"speaker": "Robin Vince",
"content": "And as a broader statement, this concept of running the company better has different seasons to it. Season number one has been a lot of blocking and tackling. Season number two is really the platform's operating model, implementation and then harvesting the benefit. That lasts a few years. And then AI and we think AI is very important and so within the mix of that 3.8 that Dermott mentioned, there's a gradual pivot that's occurring under the hood around uplifting basic capabilities and infrastructure, which was the past through to making our systems better through AI and I think that evolution is quite important. So it may feel like a static number, but it's actually not a static composition."
},
{
"speaker": "Mike Mayo",
"content": "Got it. All right. Thank you."
},
{
"speaker": "Operator",
"content": "For our next question, we'll move to Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Hey, good afternoon. Thanks for the question. Another one for you guys on operating leverage. So obviously, great progress so far. Here you are loud and clear on 2025 and more importantly beyond. I guess in that context, how important is fee operating leverage to the firm? I know you talk about total, which is right and NII is a helper in 2025, but for whatever reason if the fee outlook falls short, how much wiggle room do you guys have against that 1% to 2%? And again, maybe talk about the fee operating leverage as well as a metric that you care about or not?"
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks, Alex. So we do talk about total and we're very focused on delivering that consistently through the cycle and I also think about it in terms of fee operating leverage and we're also focused on delivering positive fee operating leverage as well. But look, as I said in my prepared remarks, total operating leverage is the North Star. There are a number of factors that go into that. NII, fees, expenses and with each of those categories, we have multiple levers that we can toggle. So we feel like we have flexibility over the inputs in terms of how we end up with that number and so I kind of think if you kind of take last year, 288 was a very good year and look, there was a reasonable amount of kind of positive contribution to that from NII and so we expect to deliver positive fee operating leverage through the cycle as well as well as total."
},
{
"speaker": "Alex Blostein",
"content": "Got it. All right. Super helpful. And then a small nuanced follow up for you guys just around NII. We've seen stronger results in the repo business for a handful of quarters now, and I think there's still some expectation for that to normalize, but clearly that hasn't happened yet. So maybe talk a little bit about the factors that contributed to the stronger performance in that part of the model within the quarter, but also maybe within the year. What could change that given where you are in the sort of the environment and the outlook? And what do you think is the appropriate run rate, I guess, for that contribution to NII going forward? Thanks."
},
{
"speaker": "Robin Vince",
"content": "So for Clear to Repo, look, strong performance in Q4. The only context I would give you on that, Alex, is it's kind of -- it's roughly 5% of the overall NII. So how we talk about it, it's still kind of small in the context of the bigger number. We've invested a lot in it in the last couple of years in terms of technology, better products, being more for clients, etcetera. So on balance, expect it to grow, but it's not a meaningful part of the overall number."
},
{
"speaker": "Alex Blostein",
"content": "Okay. Thanks very much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Great. Good afternoon, folks. Thanks for taking my question. Just on a couple of assumptions on the financial outlook for '25. Maybe just to start with net interest revenue and appreciate all the commentary you made, Dermot, on the factors on that. It looks like it's more based on the asset and deposit side on mix as opposed to growth in deposits and growth in earning assets. So I just want to get your sense of, you know, all else equal, do you -- to what extent do you think you can actually grow the deposit base via all the client initiatives you have?"
},
{
"speaker": "Dermot McDonogh",
"content": "So for '24, like we kind of -- I think we outperformed on the balance side. But as we look out into '25 and you kind of talk about and if you reflect on Robin's remarks in terms of starting in the year, a little bit more uncertainty in kind of post the election. So for now, we kind of in the way we've come up with the guide, we expect balances to be roughly flat and the mix-shift underneath kind of from Q4 to Q1 expect NIBs to moderate a little bit and kind of touch down. We're kind of in the zip code of kind of $44 billion to $46 billion of NIBs is kind of -- it's what is embedded in the outlook. But we still have a reasonable amount of the book to roll off at kind of 2% and yielding assets into current market rates. So you're correct, David, in terms of like a lot of proactive management of the balance sheet on the asset side is given us confidence around that mid-single-digit guide."
},
{
"speaker": "Brian Bedell",
"content": "Okay. Okay, great. And then shifting to the fee side. It looks like this guidance is sort of an alpha guide. You talked about the drivers of being higher organic growth as you make progress on the platform strategy, of course, partially mitigated by -- by current currency headwinds. But does this assume generally flat markets? I guess that would be in line with your uncertainty commentary and then I guess if we do have very strong equity markets, say, if we're up just 10%, what would be the rough delta to revenue on that?"
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks, Brian. So what I would say is roughly kind of 5% on markets from here is about kind of $70 million in fees. That's the rough sensitivity and to your kind of the first part of your question, we kind of given the last couple of years have, as you say, really strong performance in markets. We are kind of more neutral on kind of market growth in terms of our guide."
},
{
"speaker": "Brian Bedell",
"content": "Okay."
},
{
"speaker": "Dermot McDonogh",
"content": "[indiscernible]"
},
{
"speaker": "Operator",
"content": "We'll take our next question from David Smith with Truist Securities."
},
{
"speaker": "David Smith",
"content": "Hi, good afternoon. You managed to hold your -- hi you managed to hold your AUCA flat despite a big decline in fixed income markets in the fourth quarter. Can you remind us just how much of that $52.1 trillion might be showing off of the lag and not reflect the full decline in markets we saw later in the quarter? Either way, it seems like inflows to the asset servicing business were really strong in the quarter. Could you comment on the competitive environment that you're seeing there as well, please?"
},
{
"speaker": "Dermot McDonogh",
"content": "So look, I'll start with the competitive environment. I think very pleased with where asset servicing is in terms of competitive strength, in terms of new business, one over the last year. We came into '24 with strong momentum and we executed very well and we talked about a number of the deals that we won on prior calls. We've invested in the infrastructure. I think we're showing up well for clients and we exit the year feeling very good about the business and I think you know in some ways, asset servicing, everybody looks at asset servicing as the bellwether of the firm and so we kind of enter into 2025 with continued momentum and our right to win and winning our share and the world's largest custodian, I think we're going to do just fine in '25."
},
{
"speaker": "Robin Vince",
"content": "And there's not a ton of lag."
},
{
"speaker": "David Smith",
"content": "Okay. And then just to clarify, you mentioned $44 billion to $46 billion of NIBs embedded in the outlook. Is that the average for the first quarter or for the full year?"
},
{
"speaker": "Dermot McDonogh",
"content": "For the full year."
},
{
"speaker": "David Smith",
"content": "All right. Thank you."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll take our next question from Gerard Cassidy with RBC."
},
{
"speaker": "Thomas Leddy",
"content": "Hi, good afternoon. This is Thomas Leddy standing in for Gerard. Aside from the obvious geopolitical risks we all see in the news, what are the primary risks you guys are monitoring for your businesses?"
},
{
"speaker": "Robin Vince",
"content": "Well, there are a lot of risks in the world at the moment. I've been asked this question a bunch of times over the course of the past few months and as you can imagine, we got wars in and it's essentially two different continents. We've got uncertainty in terms of policy in many countries. We've got some countries, important major economies that have really been struggling to be able to find growth. We've just gone through the great year of elections, and so we've got a lot of new teams in place in countries around the world. There's clearly at some point the risk of a downturn or recession in the US, it's not something that we see around the corner right now. There's the impact of higher rates. If we lock in rates at higher levels, maybe even 10 years at 5%, 5.25%, who knows, certainly possible, those things can create complexity as well. So the market is really contending with a long list of things which today are probably each fairly low probability, but there are a lot of them. So the chances of something happening are probably out there. So we're not in the predictions business. We're just trying to prepare. I think our platforms give us the ability to help clients navigate these uncertainties. And so that's clearly our focus. But that -- if you had to pick a couple, you're going to say geopolitical risk probably curve risk, absolute levels of issuance, which is true for several different countries, and cyber risk. Now on the flip side of that, I should -- I think it's important to mention it, we're a capital markets-oriented company. We're a financial services platform company and so we're pro-growth, we benefit from growth and it's very encouraging, including particularly here in the US with the new incoming administration to hear this pro-growth mantra because growth is A, important for our business and B, it enables so many other things. And so on the flip side of the risks, I think there is this undertone of this sort of sense of possibility of the year, which we certainly haven't lost sight of all the while we're managing for the risks that are out there."
},
{
"speaker": "Thomas Leddy",
"content": "Got it. That's helpful. Thank you. And sort of sticking to the theme of many cross currents, can you give us some color on how increased trading volatility attributed to the dynamic interest rate environment might impact your servicing fee revenue growth?"
},
{
"speaker": "Dermot McDonogh",
"content": "Well, definitely -- if you just look at last year, if you just pick one business in particular, clearance and collateral management, which really benefits from increased treasury issuance, increased volatility, clients doing more activity and we just process much more volume on the platform and when you hear us talking about increased volume, we mean talking about increased fees and last year, there were a number of times where we had records and records on records in terms of what's going through the pipes. So I think treasury issuance has been a real tailwind for us over the last couple of years."
},
{
"speaker": "Robin Vince",
"content": "And there were two things that I'd add just quickly on composition of revenues because to the prior question, the absolute levels of assets does matter in some parts of our business. To your question, transaction volumes matter, elsewhere we have revenues from direct software sales. That's a growing part of who we are and part of this sort of platform's concept. But if you just take something like fixed income and this goes to the gearing to capital markets that we laid out in one of our trends pages in the presentation, take fixed income, what's happening in public markets, private markets, in credit touches so many of our businesses, our clearance business, our collateral management business, our asset servicing business, our corporate trust business, our debt capital markets business, our investment management fixed-income business, our investment management LDI business, our cash strategies and so the firm across the breadth of who we are is really able to capitalize in a lot of different ways back to this point on growth and activity."
},
{
"speaker": "Thomas Leddy",
"content": "Thank you. That's helpful and thank you guys for taking my question."
},
{
"speaker": "Dermot McDonogh",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our final question comes from the line of Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks for taking my follow-ups. Just wanted to circle back on Wove. I think, Dermot, you mentioned -- and maybe I missed this, you said you had a revenue guide. I saw the $75 million of exit in exit rate annualized in '24. Did I miss the actual guide for '25 or is that the off-boarding point? And maybe if you can just talk about just general progress that was?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, incremental revenue for '25 of $60 million to $70 million and I would say we're very pleased 36 clients on the platform, 41 kind of signed contracts and in the prepared remarks, we kind of talked about the proliferation of products that we announced at Insight last summer. So becoming more sophisticated and clients really liking what they're seeing."
},
{
"speaker": "Brian Bedell",
"content": "Got it. And then 67 is incremental to the 30 of '24. Is that correct?"
},
{
"speaker": "Dermot McDonogh",
"content": "Yeah, that's correct."
},
{
"speaker": "Brian Bedell",
"content": "Got it. Okay. Great. Thank you."
},
{
"speaker": "Operator",
"content": "And with that, that does conclude our question-and-answer session for today. I would now like to hand the call back over to Robin for any additional or closing remarks."
},
{
"speaker": "Robin Vince",
"content": "Thank you, operator, and thanks, everyone, for your time today. We appreciate your interest in BNY. Please reach out to Marius and the IR team if you have any follow-up questions. Be well."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today's conference and webcast. A replay of this conference call and webcast will be available on the BNY Investor Relations website at 4 o'clock P.M. Eastern Standard Time today. Have a great day."
}
] |
bk | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the 2024 Third Quarter Earnings Conference Call hosted by BNY. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference call and webcast will be recorded and will consist of copyrighted material. You may not record or rebroadcast these materials without BNY's consent. I will now turn the call over to Marius Merz, BNY Head of Investor Relations. Please go ahead."
},
{
"speaker": "Marius Merz",
"content": "Thank you, operator. Good morning, everyone, and welcome to our third quarter earnings call. I'm joined by Robin Vince, our President and Chief Executive Officer, and Dermot McDonogh, our Chief Financial Officer. As usual, we will reference our financial highlights presentation, which can be found on the Investor Relations page of our website at bny.com. I'll also note that our remarks will contain forward-looking statements and non-GAAP measures. Actual results may differ materially from those projected in the forward-looking statements. Information about these statements and non-GAAP measures are available in the earnings press release, financial supplement and financial highlights presentation, all available on the Investor Relations page of our website. Forward-looking statements made on this call speak only as of today, October 11, 2024, and will not be updated. With that, I will turn it over to Robin."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Marius. Good morning, everyone. Thank you for joining us. I'll start with a few remarks on the quarter, and then Dermot will take you through the financials in greater detail. In short, BNY reported strong third quarter results, reflecting growth across our three business segments and consistent execution on our strategic priorities. Stepping back, on the macro side for a moment. At the beginning of the year, markets had priced in significant monetary policy easing in anticipation of economic slowdowns. Despite numerous shifts in the macroeconomic outlook since then, we've now seen the start of the easing cycle in several markets around the world, including a 50-basis-point reduction in policy rates in the U.S. as the Federal Reserve recalibrates its policy stance to balance employment, inflation and growth. Following increased market volatility and a sell-off in equities in early August, markets recovered, and both equity and fixed income values ended the quarter higher. A little more micro, but relevant for markets. Around the most recent quarter-end, the market saw simultaneous flows into the Fed's reverse repo facility alongside the first meaningful usage of the standing repo facility, both of which we administer. At the same time, sponsored cleared repo volumes increased on the back of higher repo rates, possibly signaling a transition from abundant to ample reserves in the system, with potential implication for the pace of QT going forward. More broadly, while markets have been constructive, there are clearly risks and uncertainties ahead. And so, we constantly prepare and position for the many tail risks that exist from geopolitical tensions and conflicts to fiscal deficits and the impact of impending regulations and elections. Now, referring to Page 2 of the Financial Highlights presentation. As I said earlier, BNY delivered a strong financial performance in the third quarter, with strong EPS growth on the back of broad-based revenue growth and positive operating leverage. Reported earnings per share of $1.50 were up 22% year-over-year. And excluding notable items, earnings per share of $1.52 were up 20%. Total revenue of $4.6 billion increased by 5% year-over-year, and reported expenses of $3.1 billion were flat. Excluding the impact of notable items, expenses were up 1% year-over-year, as we continue to invest in our people and technology, while we also generate greater efficiencies from running our company in new and better ways. Pre-tax margin and return on tangible common equity improved year-over-year to 33% and 23%, respectively. For the first time in our history, we reported over $50 trillion of assets under custody and/or administration at the end of the quarter. Now, custody is not something we are, but it is something important that we do. This number one market position improves our unique vantage point as a global financial services company, and it provides opportunity to drive value across our portfolio of adjacent businesses to deliver more of BNY to our clients. We increasingly see that the true power of BNY's client franchise exists in the combination of capabilities across our leading Security Services, Market and Wealth Services, and Investments and Wealth businesses. We have the ability to enhance this and to deliver more to our clients by bringing new innovative solutions to the market from across the seams of these businesses. As an example, we recently announced the planned acquisition of Archer, a leading technology-enabled service provider of managed account solutions to the asset and wealth management Industry. Archer provides comprehensive technology and operational solutions that allow asset and wealth managers to access one of the fastest-growing investment vehicles in the industry, managed accounts, at scale, expanding distribution, streamlining operations, launching new investment products and delivering personalized outcomes for their clients. The integration of Archer should produce a positive impact across several of our lines of business. In addition to augmenting our asset servicing capabilities for managed accounts, Archer will provide our investments business as well as our Wove wealth advisor platform in Pershing with expanded distribution of model portfolios and access to Archer's multi-custodial network. Buy it once, use it many, if you will. The transaction is expected to close before the end of the year, and we look forward to welcoming the Archer team to BNY. Another one of the fastest-growing areas in financial services, alternatives, also presents a promising opportunity for us to deliver new client solutions across One BNY. We already have relationships with hundreds of alternatives managers as well as roughly $3 trillion of wealth assets on our platforms. We believe there is more for us to do to mine the opportunity and build the technology to reach across our franchise and unlock the fast-growing alternatives market for wealth intermediaries, advisers and the investors they serve. Last month, we introduced Alts Bridge, a comprehensive data, software and services solution built for wealth advisers. Alts Bridge aims to make investing in alternatives easier for advisers through a streamlined end-to-end experience and direct integration into advisers' existing desktops, starting with our Pershing NetX360+ and Wove platforms. As we continue to deliver new innovative products, we are also addressing the significant opportunity from enhancing our commercial model, making it easier for clients to navigate BNY. In order to accomplish this, we are promoting an enterprise approach to client coverage, and we are operationalizing our new commercial model. For example, over the summer and for the first time in recent memory, we brought together several hundred of BNY's client-facing commercial leaders from around the world as well as members of our executive committee for a two-day event we called Commercial Lift Off. This program enabled our top client coverage people and their business partners to take a One BNY view to account planning, creating a shared vision for serving each of our clients holistically across the entire relationship, generating new ideas to meet the clients' objectives and developing action-oriented plans to deliver on those goals. During the quarter, we also made progress toward running our company better, including the ongoing transition to a platform's operating model, enhancing the connectivity across our teams and empowering our people to drive change across the company. In September, we went live with the next step on our multiyear plan to unite related capabilities around BNY and elevate our execution by doing things in one place and doing them well. We now have about 13,000 or about one-quarter of our people working in our new operating model. As we've said before, powering our One BNY culture in order to be more for our clients and run our company better requires not just words, but action. I want to thank our people around the world for their hard work and for collectively pulling together as a team to create the change for our clients, for our shareholders and for one another. To wrap up, the combination of our talented team, our portfolio of leading businesses working together and the strength of our balance sheet gives us a great foundation to deliver more to our clients and drive sustainable long-term shareholder value. While our results in the third quarter demonstrate continued execution against our strategic priorities as well as progress toward our medium-term financial targets, our team remains focused on the work ahead. With that, over to you, Dermot."
},
{
"speaker": "Dermot McDonogh",
"content": "Thank you, Robin, and good morning, everyone. Starting on Page 3 of the presentation, I'll begin with our consolidated financial results for the quarter. Total revenue of $4.6 billion was up 5% year-over-year. Fee revenue was up 5%. This includes 5% growth in investment services fees, reflecting higher market values and net new business across our Security Services and Market and Wealth Services segments. Investment management and performance fees from our Investment and Wealth Management segment were up 2%, driven by higher market values, partially offset by the mix of AUM flows and lower performance fees. Firm-wide AUC/A of $52.1 trillion were up 14% year-over-year, reflecting higher market values, net new business and client inflows. Assets under management of $2.1 trillion were up 18% year-over-year, primarily reflecting higher market values and the favorable impact of a weaker dollar. Foreign exchange revenue increased by 14%, driven by higher volumes. Investment and other revenue was $196 million in the quarter, reflecting continued strength in fixed income and equity trading. The year-over-year increase primarily reflects a strategic equity investment loss recorded in the third quarter of last year and improved results from our seed capital investments. Net interest income increased by 3% year-over-year, primarily reflecting improved investment securities portfolio yields and balance sheet growth, partially offset by changes in deposit mix. Expenses of $3.1 billion were flat year-over-year on a reported basis and up 1% excluding notable items. This reflects higher investment and employee merit increases, partially offset by efficiency savings. Provision for credit losses was $23 million in the quarter, primarily reflecting reserve bills related to commercial real estate exposure. As Robin mentioned earlier, we reported earnings per share of $1.50, up 22% year-over-year. And excluding notable items, earnings per share were $1.52, up 20% year-over-year. Pre-tax margin was 33%, and return on tangible common equity was 23%. Turning to capital and liquidity on Page 4. Our Tier 1 leverage ratio for the quarter was 6%. Tier 1 capital increased by 4% sequentially, primarily reflecting capital generated through earnings and improvement in accumulated other comprehensive income, partially offset by capital returned to our shareholders through common stock repurchases and through dividends. Average assets increased by 1%. Our CEQ1 ratio at the end of the quarter was 11.9%. CEQ1 capital increased by 5% and risk-weighted assets increased by 1%. We returned $1.1 billion of capital to our shareholders over the course of the third quarter. Year-to-date, we returned 103% of our earnings through dividends and buybacks. Moving to liquidity. The consolidated liquidity coverage ratio was 116%, a 1 percentage point increase sequentially due to a favorable change in our deposit composition. And the consolidated net stable funding ratio was 132%, unchanged sequentially. Next, net interest income and the underlying balance sheet trends on Page 5. Net interest income of over $1 billion was up 3% year-over-year and up 2% quarter-over-quarter. The sequential increase was helped by higher sponsored cleared repo activity [indiscernible] market volatility and increased client demand. Average deposit balances remained flat sequentially. Noninterest-bearing deposits decreased by 2% in the quarter and interest-bearing deposits were flat. Average interest-earning assets were [up 4%] (ph) quarter-over-quarter. Our investment securities portfolio balances as well as loan balances increased by 1%, and cash and reverse repo balances remained flat. Our broader liquidity ecosystem reached an all-time high at the end of the quarter of over $1.5 trillion worth of client cash across deposits, money market funds, securities lending, sponsor cleared repo and other short-term investment alternatives. Turning to our business segments, starting on Page 6. Security Services reported total revenue of $2.2 billion, up 6% year-over-year. Total investment services fees were up 4% year-over-year. In Asset Servicing, investment services fees grew by 5%, primarily reflecting higher market values. For the third quarter in a row, the impact of repricing was de minimis. ETF AUC/A of $2.7 trillion was up more than 70% year-on-year, and the number of funds serviced was up 20% year-on-year. Inflows into ETFs on our platform remained strong this quarter with growth across all asset classes. As the ETF industry continues to grow, we are dedicated to scaling our best-in-class ETF service offering. For example, we have successfully onboarded several new liquidity providers to our electronic order execution platform to advance digital adoption. In Issuer Services, investment services fees were up 1%. Net new business and higher client activity in Corporate Trust partially offset by lower deposit receipt fees, reflecting corporate actions in the prior year. Against the backdrop of increased issuance activity, we continue to see strength in Corporate Trust, capitalizing on our investments in people and technology to enhance client service and scalability. In this segment, foreign exchange revenue was up 28% year-over-year, reflecting growth from newly onboarded clients as well as a higher level of client activity. Net interest income for the segment was up 2% year-over-year. Segment expenses of $1.6 billion were down 3% year-over-year, reflecting efficiency savings and lower severance expenses, partially offset by higher investments and employee merit increases. Pre-tax income was $642 million, a 38% increase year-over-year, and pre-tax margin was 29%. Next, Market and Wealth Services on Page 7. Market and Wealth Services reported total revenue of $1.5 billion, up 7% year-over-year. Total investment services fees were up 7% year-over-year. In Pershing, investment services fees were down 1%, reflecting the impact of lost business in the prior year, partially offset by higher market values. Net new assets were negative $22 billion for the quarter, reflecting the ongoing deconversion of lost business in the prior year, which is now largely behind us. Excluding the deconversion, we saw approximately 4% annualized net new asset growth in the third quarter. Wove continues to see strong client demand. We signed up 14 additional clients in the third quarter and we remain on track for the $30 million to $40 million of revenue in 2024 as we guided in January. Wove is helping us attract new clients and deepen relationships with existing ones. For example, Pershing provides custody and clearing solutions for Sanctuary, a large and fast-growing wealth manager servicing the high net worth and ultra-high net worth segments. Sanctuary will also leverage Wove portfolio solutions, trading and rebalancing and reporting for teams that custody with Pershing as well as those that use another custodian. In Clearance and Collateral Management, investment services fees increased by 16%, primarily reflecting higher collateral management fees and higher clearance volumes. Against the backdrop of a growing market and active trading, U.S. securities clearance and settlement volumes have remained strong. As you may remember, we created our global clearing platform earlier this year through the realignment of Pershing Institutional Solutions. We're pleased to see the pipeline of this platform continue to build for our full suite of institutional clearing, settlement, execution and financing solutions in over 100 markets around the world. In Treasury Services, investment services fees were up 11%, primarily reflecting net new business. The business continues to execute well against the growth agenda we presented in January. And we are seeing our investments in modernizing and digitizing our payments platform pay off in the form of growth in our strategic target markets. Net interest income for the segment overall was up 3% year-over-year. Segment expenses of $834 million were up 5% year-over-year, reflecting higher investments and employee merit increases, partially offset by efficiency savings. Pre-tax income was up 8% year-over-year at $704 million, representing a 46% pre-tax margin. Turning to Investment and Wealth Management on Page 8. Investment and Wealth Management reported total revenue of $849 million, up 2% year-over-year. In our Investment Management business, revenue was up 1%, reflecting higher market values and improved [seed capital] (ph) results, partially offset by lower performance fees and the mix of AUM flows. And in Wealth Management, revenue increased by 6%, reflecting higher market values and net interest income, partially offset by changes in product mix. Segment expenses of $672 million were flat year-over-year as efficiency savings offset employee merit increases and higher investments. Pre-tax income was $176 million, up 7% year-over-year, and pre-tax margin was 21%. As I mentioned earlier, assets under management of $2.1 trillion increased by 18% year-over-year, primarily reflecting higher market values and the favorable impact of the weaker dollar. In the third quarter, we saw strength in our short-term strategies with $24 billion of net inflows into cash, reflecting our leading position and strong investment performance in our Dreyfus money market funds. Long-term active strategies saw $8 billion of net outflows, spread across multi asset, LDI and active equity, partially offset by net inflows into fixed income. And we saw $16 billion of net outflows from index strategies. Wealth Management client assets of $333 billion increased by 14% year-over-year, reflecting higher market values and cumulative net inflows. Page 9 shows the results of the other segment. Before I wrap up, a couple of comments on the outlook for the year. Starting with net interest income. Remember, we began the year setting up for positive operating leverage despite an expectation for full year net interest income to be down 10% in 2024. While we're currently forecasting for fourth quarter net interest income to be slightly below what we saw in our strong third quarter results, the resilience of our net interest income over the first nine months of the year has positioned us to outperform our outlook for the full year net interest income growth rate from January by approximately 5 percentage points. Regarding expenses, we continue to work hard to keep core expenses, excluding notable items, for the full year 2024 roughly flat. We now expect our effective tax rate for the full year 2024 to be at the lower end of the 23% to 24% range we estimated in January. And lastly, as we said at the beginning of the year, we expect to return 100% or more of 2024 earnings to our shareholders through dividends and buybacks. And we remain on track having returned 103% of earnings year-to-date. In conclusion, our results this past quarter reflect broad-based growth across our three business segments and continued progress on our strategic priorities. We're pleased with the company's performance year-to-date and we're proud of our people who continue to execute well toward our medium-term financial targets, while we all remain focused on the work and the tremendous opportunity ahead of us. With that, operator, can you please open the line for Q&A?"
},
{
"speaker": "Operator",
"content": "Yes. [Operator Instructions] We'll take our first question from Brennan Hawken with UBS."
},
{
"speaker": "Brennan Hawken",
"content": "Good morning. Thanks for taking my questions. You flagged some of the ETF wins that you had in the servicing side. So, curious about that. Number one, how much of that was the BlackRock business that you've won? And has the revenue from that win, that big win fully turned on? And did those dynamics have something -- or like is the fee rate lower? Because fees in asset servicing were up about 5%, but AUC, 16%, and I know sometimes the ETF fee rates are a little lower, so curious to flush that out a bit. Thank you."
},
{
"speaker": "Dermot McDonogh",
"content": "So, thanks for the question. I don't really want to get into the specifics on one client or transaction, but just to take a step back on ETFs generally, it is a growing market. You may have watched Larry from BlackRock on CNBC this morning. It is a secular trend. It is a very big and growing market, and we are a key player on that. As I said in my prepared remarks, we have $2.7 trillion on the platform, that's up 70% year-on-year, and the number of funds serviced is up 20%. That's on the back of strong leadership and a real investment in technology, so we can be best in class. So, without going into specifics, we're there to take advantage of the secular trend and we'll continue to innovate and solve for our clients' needs."
},
{
"speaker": "Brennan Hawken",
"content": "Okay. Thanks for that. Maybe if I could word it a little differently, the strong ETF growth that you have seen this quarter, is the revenue fully reflected this quarter or is some of those wins still have some revenue ramp to come?"
},
{
"speaker": "Dermot McDonogh",
"content": "I would say it's the latter. It's, generally speaking, strong pipeline. We're always adding new clients to the platform and they -- because of the size of what's been on boarded, they tend to do it in a phased approach. So, some revenue is on the platform, some revenue to come."
},
{
"speaker": "Brennan Hawken",
"content": "Excellent. Thanks for that, Dermot. Thank you also for the update on NII, encouraging to see things working better. Could you speak to the deposit beta that you experienced with the first rate cut? And given that we're seeing rates coming down now, is it reasonable to think that deposits could begin to grow from here?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, the betas, I think, we've said on previous calls, we view it as symmetrical. So, for us, the first rate cut was 100% passed on. So, we feel pretty good about that. I think in terms of where we are in the Fed easing cycle, I think it's probably a little bit too early to see how that's going to feed into the deposit balance story. I think, overall, we've kind of -- we've held in there. We had a strong Q3 for a variety of different reasons. So, I would say, I expect where we are to moderate a little bit on balances in Q4 and we'll see what happens next with the next Fed meeting, but no significant change for us as we kind of sit here right here today."
},
{
"speaker": "Brennan Hawken",
"content": "Great. Thank you for taking my questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll move to our next question from Mike Mayo with Wells Fargo."
},
{
"speaker": "Mike Mayo",
"content": "Hey, how are you doing?"
},
{
"speaker": "Robin Vince",
"content": "Hey, Mike. How are you?"
},
{
"speaker": "Mike Mayo",
"content": "Good. Look, I'm just -- that's a big number, the $50 trillion of AUC, nice round number. You did beat -- it's factual that you beat expectations for the quarter and the year so far, as you've highlighted. I'm just trying to figure out how much of this is lucky versus being smart. And I imagine it's a bit of both, but the lucky part is record stock market volatility, trading, some other factors in the market that have gone your way. And I don't feel like we have enough information on your client growth, the underlying client growth, the most repeatable part of the company. So, could you give some color on whether it's growth in clients or maybe it's revenues per client or maybe it's products per client or all those adjacent businesses that you talk about, how you're managing the company better versus simply a better environment to operate it?"
},
{
"speaker": "Robin Vince",
"content": "Sure, Mike. It's Robin. I understand the question and it's obviously a very legit question. We broke through the $50 trillion. By the way, we ended at $52 trillion. So, the good news is we didn't stop at the round number. Look, I'd say that it isn't just fashionable, it's actually old-fashioned traditional just the way that we want to do it in terms of being able to have this deliberate growth and this focus. And so, we've tried to provide as much visibility as we reasonably can into the inputs of what it is that's ultimately driving this progress, because we understand we have benefited from a terrific backdrop in terms of markets. And of course, that's part of our business to be able to be well-positioned to take advantage of those backdrops. We've got parts of our business which respond to asset values, we've got parts of our business that respond to the number of accounts, we've got parts of our business that respond to software sales, transaction volumes, and having that multi-faceted set of business response functions, if you want to call it, that is actually a deliberate strategy so that we can participate in the growth of markets. And so, if you believe that overall debt issued in the world, equity valuations in the world, financial market activities are going to grow, we're trying to hitch our wagon to all of those growth trends. We think that's good. Having said that, to the heart of your question, this is the work that we've really done in the early days since this management team took over, which was to understand the components that we had and to really start to understand how they could work together, to how they could hum together in order to be able to unlock more potential. And so, we rallied the firm around three strategic pillars, this thing of being more for our clients. And that's just not just words, it's being about maturing this One BNY philosophy that we've talked before about. It's about having a different type of dialogue. It's about the movement over time to solutions as opposed to just products. It's like the examples that I gave and Dermot gave in our prepared remarks where clients are coming to us because we can do more than one thing for them. And it's not just that we're selling more things to them, it's that they actually want to take advantage of bundles of things, which actually provide a better solution to their business. And then, our second pillar of running the company better, that's been about sales rhythms and sales targets and bringing our people together and having them understand what it is that we're trying to do. And then, wrapping the whole thing is this culture of wanting to have a winning culture, wanting to push forward, wanting to make BNY of the future more than BNY Mellon was of the past. And those things are all quite deliberate, and we start -- and we believe that we're starting to see the results of that, although it's still early in our results. But Dermot can give you a couple of additional things on this which I think also would be helpful."
},
{
"speaker": "Dermot McDonogh",
"content": "So Mike, the way I -- from just thinking about it from a numbers perspective, right, we're up 5% year-on-year in fee growth, and constructive markets, and so, we've been able to take advantage of constructive markets. But a couple of important points that I would draw out is that in all three of our business segments, we've seen solid underlying growth. And in Robin's prepared remarks, he talked about the fact that we're evolving into a platform company. And when we have platforms that we're investing in at scale, so when you have high volume and you have constructive markets, we have the platforms in situ that can take advantage of that. Asset Servicing, we're winning and onboarding new business. We came into the year with a backlog. We onboarded the business throughout the year, and we're beginning to go into the Q4 with a bigger backlog than we came into the beginning of the year. So, Asset Servicing, I feel very proud of. Corporate Trust, Depository Receipts, Corporate Trust, specifically, a good margin business, but something that has been devoid of investment over a number of years and we've put money to work there in terms of leadership and scaling our technology, and that's going to be a business -- an important business for us in the future. And Treasury and Services and Clearance and Collateral Management have really kind of shown was when you have a scale platform with high volumes, strong markets, lots of issuance, lots of payments, you take advantage of that. And then, on just the client specific thing, albeit it's a small base and we can -- we've highlighted a couple of transactions this year where client -- we're able to have a much more sophisticated conversation with clients and clients are now buying from us across more than one line of business, in some cases, four lines of business. That was something that we just could not do a couple of years ago. And Robin's point about bringing the One BNY to bear on clients is really beginning to pay dividends."
},
{
"speaker": "Mike Mayo",
"content": "All right. Well, that was very comprehensive. Just last follow-up, are you implying, and by the way, on all the metrics, again, the client growth numbers, and thanks for peeling back the layers of the onion there, but always like even more layers, never enough for us, but in terms of growth in clients and more specifics going down the line. But the expense is clearly, Dermot, the flat expenses, that's very clear, that part of it. Are you implying even lower expenses in the fourth quarter based on your new guide today?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, look, the thing I would like to convey to you and to our shareholders is that we worked really hard over the last couple of years to build credibility that we are good stewards of our expense base, and we guided flat at the beginning of the year. And broadly speaking, there's been some pressure, I would say, on expenses that, for the most part, are revenue related. And so, if revenues are higher, there's some aspects that you just have to pay more expenses. So, while I've guided roughly flat for the full year, there may be a little bit of pressure over the course of that because of higher revenues. And also, as Robin said in his remarks, we've announced the acquisition of Archer and there'll be some integration costs associated with that. But I feel very good the fact that now we have 53,000 people who understand the importance of financial discipline and that goes to pillar number two of being a really well-run company."
},
{
"speaker": "Mike Mayo",
"content": "All right. Thank you."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks. Good morning, folks. Thanks for taking my questions. Maybe just on -- just sticking with the revenue dynamic, talking about the -- obviously, the commercial lift off and the enterprise approach, the early traction that you're getting, I think, you referenced some clients now doing multiple services. Can you talk a little bit more about how you think that might impact the revenue growth trajectory? And then, also, just if you can just reconfirm the general revenue delta to equity markets? I think it was like 10% equity market moves can have an impact of about 1% revenue. So, I just wanted to sort of break apart those two dynamics, just really kind of showing that you're actually generating this revenue growth aside from markets."
},
{
"speaker": "Dermot McDonogh",
"content": "So, if I take the last question first, hopefully, that was your two questions in one go, so, a 5% gradual change in equity markets is roughly $60 million in fees annually, and a 5% gradual change in fixed income markets is roughly 40% -- or $40 million in fees annually. So that's a little bit on the sensitivity analysis. And so, on just the commercial lift off that Robin talked about in his remarks, it really is -- Cathinka Wahlstrom, who's with us now for over a year, spent the first year really on a listening tour and organizing roughly our 1,200 to 1,500 leading client coverage people around the world in terms of what we want our ambition to be, what are the products that we have and how can we educate our total force to be able to [indiscernible] there with clients delivering the whole of the firm. I think -- and also, if you kind of just talk about Archer for a second, I think a couple of years ago, if we were to do that acquisition, one part of the firm would have bought it for its business. And I think, Robin's point in his remarks are really, really important where you buy it once, you use it multiple times, and it's an acquisition that's done for the enterprise that will serve multiple lines of business. And that's how you should think about how our client coverage model is going to work in a strategic way going forward. We're going to deliver holistic solutions for our clients. Clients have a better understanding of the diversified nature of our business franchise, and they're just buying more from us. And it's just going to show up in revenue, and we feel very good about where we are today in terms of planning for the budget season for Q4 and the opportunities that are going to come our way in 2025."
},
{
"speaker": "Brian Bedell",
"content": "Great. That's helpful. I'll get back in the queue for another question actually."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Thanks. Good morning, guys. So, maybe just wrapping some of the comments you made around fee in a bigger picture question, when you guys think about a number of different growth areas you outlined some of the specifics, and obviously, the approach to cross-selling has taken a whole different turn here. So, when you use them out and you look at the business holistically, how do you think about the organic fee growth that the enterprise can generate over time?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, you're trying -- so we don't guide on fees, haven't done, don't intend to do it here, but what I would say is, and I gave this answer as an earlier question, we are seeing underlying growth across all three of our business segments. Our underlying organic growth this year, we feel quite happy about, and we feel it reflects a really good nine months of the year. And there's no reason to expect that, that momentum won't continue. And I do feel the way we've set up for the back half of this year and into next year, it's a kind of flywheel of innovation, and we have a lot of growth initiatives. And we've come together and we have a group of people who are working on what we call integrated solutions. And so, we have a number of interesting things in the pipeline. Robin talked about Alts Bridge in his remarks, talked about Archer in his remarks. There are things that we're doing within specific lines of business coming together. We talked about Pershing being realigned into Clearance and Collateral Management, and that's driving growth as well. So, the decisions that we've taken over the last couple of years in terms of realigning certain activities into different parts of the firm are showing up in our revenues this year, and we will continue to do that into next year."
},
{
"speaker": "Robin Vince",
"content": "And Alex, I'd just add, Dermot really alluded to this in what he just said, but right from the beginning, we've had two approaches. One is to think about this endeavor of fully realizing BNY's potential as a multiyear endeavor, and we recognize that there are going to be different ways in which that will come together in different years. And North Star, as you know, for us, is operating leverage, and that came about in a slightly different way in 2023 than it did in '24, and it could be different again in '25 as we really get into that conversation ultimately when we talk to you in January. But we've simultaneously invested in things that we knew would be important for the shorter term and for the medium term and for the longer term. And so, both Dermot and I have talked about this platform's operating model. That's a great example. There have been some benefits that come early on in that process. We brought like things together across the company. There have been benefits on the revenue side, there have been benefits on the expense side from doing it. But then, the value of having done it creates medium-term momentum because now we're able to be more dynamic for clients. We're able to solve problems more quickly for clients. And so, there's a payoff there. And then, over the longer term, it actually makes it easier to be able to assemble these new solutions that Dermot was just talking about. And again, there's a revenue story there, but there's also an expense story. And that's how we're thinking about it. Notwithstanding, we haven't given you a specific growth target number. Make no mistake, we're invested in creating that growth."
},
{
"speaker": "Alex Blostein",
"content": "Yeah. No, fair enough. I appreciate all of that. Smaller kind of tactical question for you guys. So, the repo activity continues to be quite elevated. You mentioned that in your prepared remarks as well. Is it possible to help size how much repo contributed sort of across the enterprise? It hits you in a couple of different ways. Obviously, there's the NII benefit and there's some fee benefits. So, as you think about the more normalized level of repo activity versus what you saw in the quarter, how big of a contributor was that in kind of totality? And as you look forward, given changes in monetary policy expectations, but also some of the client behavior that you mentioned earlier, how sustainable do you ultimately think this more elevated pace of activity in this market?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, on the repo question, so at cleared repo, for sure, we saw elevated activity, particularly going into the back end of the quarter and in the early part of this quarter. And that, in large part, contributed to the outperformance for the Q3 NII. That has now moderated somewhat. And so, in my prepared remarks, and in terms of the guidance, that's why I kind of feel like roughly for NII, we're about $1 billion for the fourth quarter. In terms of cleared repo, overall, as a kind of contributor to the NII over the course of the year, it's roughly about 5% of the number. As it relates to elevated activity in terms of volume and activity, I think from what we see on our platforms, we kind of see that continuing to be the case in the medium term. There's no reason for the slowdown. It's been a very strong year, very, very active client engagement, product innovation. And particularly on the international side, we said at the beginning of the year in our kind of strategic call in January that international was going to be a key area of focus on the platform, and that's been the case, and that's shown up in the results. So, I think, overall, and I said in my prepared remarks as well, in terms of the liquidity ecosystem in total hit a high for us at $1.5 trillion. That's up from $1.2 trillion a couple of years ago, and that's in the backdrop of liquidity coming out of the system. So, we've grown quite substantially. And that, again, is coming back to connecting the dots across the firm, getting teams collaborating more, being more digital, providing innovative solutions to clients, and that is really powering the growth."
},
{
"speaker": "Robin Vince",
"content": "If I could just relate that back to a question that Mike had asked earlier on because I think these things are relevant, you got to remember that the strategy of us having roughly the right ores in roughly the right waters to be able to participate in things that are happening in the world, that's very important. So, if I just supplement what Dermot said, with the additional observation that we're the world's largest security lender that generates repo activity. We're the world's largest collateral manager, so we get to capture fees associated with people doing repo. We, obviously, play this role in the US Treasury market, which participates in the growth of US Treasury repo. We have all of these different touch points. And so, there are different ways in which we can collect across software, in some cases, services that we administer in others, and participation in different, both global markets and also product types, which align in indirect ways to that. So that's an important part of how we look at the overall system and understand how our products and services can help clients navigate those, and we can participate in the benefit of that growth."
},
{
"speaker": "Alex Blostein",
"content": "Yeah, that's a helpful framework to discuss it this way, yeah. Thank you, guys, both."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Gerard Cassidy with RBC."
},
{
"speaker": "Gerard Cassidy",
"content": "Hi, Dermot. Hi, Robin. Robin, can you give us some thoughts with -- obviously, you talked a little bit about the acquisition you accomplished in this quarter. What your outlook is for -- you, obviously, have very strong capital levels, your stock has moved very nicely this year and you get a better currency. What the outlook is for just other types of acquisitions if there are some that could be complementary to what you're currently doing?"
},
{
"speaker": "Robin Vince",
"content": "Sure, Gerard. First of all, just make a quick comment about Archer. We're looking forward to closing that transaction in the fourth quarter and welcoming the team in. And this relates a little bit to a couple of other things that we've already talked about on the call. One is participation in markets and the other one earlier on, on ETFs. If you just think about the way that we view the world construct, once upon a time, they were mutual funds. More recently in the past decade or so, it's really been the explosion of ETFs. And there's simultaneous thing going on, which is the growth of separately managed accounts. And so, in the same way that Dermot described how we've participated in sort of outsized participation of the ETF migration, Archer is a transaction that prepositions us to be able to participate hopefully in an outsized way associated with the transition to separately managed accounts. So, it relates to that strategic question of growth and participating in different markets that we talked about. Now, stepping back to the other part of your question, really, the heart of it on M&A, look, our primary focus is what we have and how we can improve on it. And Dermot and I both talk a lot about the fact that we've looked very carefully at our businesses and we love our businesses. We think we have a great set of businesses. We think they are great ones to be in, and we think that they have a lot of adjacency to each other. And we think that the spread of those things can provide a lot more services to our clients in more joined up way of solutions than maybe we have before. So, it isn't that we do M&A from a position in any way of needing to do things, it's we're able to be very opportunistic, and we obviously like that a lot. But notwithstanding that we're pleased with what we have, we don't want to be complacent. So, we keep our eyes open, and we look at things, and Archer came about as a result of a strategic business review that we did internally, looking at long-term trends, looking at how we might adapt to those trends. And then, we went out and we looked very specifically for a capability that would do that, with the key emphasis being on the word capability, digestible bolt-on things that accelerate what we're trying to do or derisk delivery of what we're trying to do. And if we can buy a piece of technology that can be more efficient or less distracting than building it ourselves with a great team, great technology, ideally like this one, an installed book of business is also helpful, then we feel very good about it, as long as it aligns with those priorities, it's a good cultural fit, it has a good attractive return. So that's our M&A thought process. And then, if that fits into the overall waterfall, which we've talked about before, which is, if we have excess capital, we're going to, of course, be prudent. And so, we like excess capital. That's not a bad thing in an uncertain world. And so that's a very important consideration. Then, we look at whether or not we could invest it. Good news, as you know, we're a pretty capital-light model, we're very capital generative, so we don't need a ton of capital to reinvest in our business to keep growing it. Then, we look at whether or not we need something -- for some type of additional need, like the Archer example and then we distribute the rest. And this has, obviously, been a good year to see all of that on display. We've been prudent. We've run at elevated capital levels, and, as Dermot indicated, we intend to return 100% plus of net earnings to shareholders, and we've been able to make an acquisition. And so, this is a pretty good model year for how we think about the world."
},
{
"speaker": "Gerard Cassidy",
"content": "Very good. Thank you for the answer. And then, just as a quick follow-up, Dermot. You gave us that sensitivity analysis about a gradual 5% change in the equity markets and fixed income and the impact it would have on revenue, was that for up markets, meaning if the gradual increase was 5% up, does that also reflect a down market, if markets were down 5%, that's the kind of impact we would expect to see?"
},
{
"speaker": "Dermot McDonogh",
"content": "That's correct, Gerard, that's correct."
},
{
"speaker": "Gerard Cassidy",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Ebrahim Poonawala with Bank of America."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Hey, good morning."
},
{
"speaker": "Robin Vince",
"content": "Good morning, Ebrahim."
},
{
"speaker": "Ebrahim Poonawala",
"content": "I have a follow-up with some of your responses. I think, I guess, depending how -- maybe starting with just capital allocation, so heard your response to Gerard's question around M&A and such. But just talk to us how you think about means when we think about the valuation of the stock on price to earnings, price to tangible book, at the same time, this year has been pretty good market backdrop wise, and as an investor shareholder, you care about ROE resilience of these firms. So, one maybe, Robin or Dermot, talk to us about your comfort around ROE resiliency? If the market backdrop is unfavorable, what's the flex in the system? And given where things stand today, like how do you think about the stock valuation versus the commitment to return 100% plus in buybacks and dividends? Thank you."
},
{
"speaker": "Robin Vince",
"content": "I'll take the second bit first, and then Dermot will reflect on the first part of your question. So, the good news is that we can also pay attention to the way that you all think about the stock and your views of our stock. And we appreciate the fact that many of you have expressed confidence in our forward direction. We believe in ourselves as well. And so, what we do, of course, consider price as one of the many inputs into our capital return framework. We don't view current prices as being problematic in terms of continuing our stock buybacks."
},
{
"speaker": "Dermot McDonogh",
"content": "Ebrahim, when I took on the role a couple of years ago, I guess, I got a lot of questions about, is this just going to be more of the same or what's different? And now we're several quarters into the new team, and Robin has really kind of bolstered that team and through the strategic pillars, communication, the principles, the medium-term financial targets has really started to evolve the culture of BNY. And so, it is our commitment to deliver to our shareholders' positive operating leverage through the cycle. And so, if you just take a step back and look at this quarter's financials, 5% revenue growth, flat expense growth, 33% pre-tax margin, upper end of Tier 1 leverage, 6%, 23% return on tangible common equity, and a 22% EPS growth, and what I would say is a solid beast. So, I don't really think about the valuation of the firm on any given day. We just care about delivering for our clients and our shareholders. And if we do that in a first-class way, the valuation will take care of itself."
},
{
"speaker": "Robin Vince",
"content": "And you asked about the returns and our sort of comfort with them, look, we've given medium-term targets, as Dermot just said, that's sort of greater than or equal to 23% for ROTCE. And so, we, obviously, appreciate touching that, but doing it consistently over time is how we really view achieving targets. And in terms of the resiliency, remember the very nature of our business is actually got this diversification. We talked about the equity markets and the fixed income markets. I talked about the fact that it is software, its services, platforms and market valuations and transaction volumes. These are all things that we participate in. Capital markets activities has been important to us in 2024. The fact that we participate through our Corporate Trust business through our debt capital markets business, those are things that are participating in the growth of capital markets generally. We participate in scale of markets, and things like the treasury market is a good example. And so, this diversification of our mix helps us to be resilient in terms of the vagaries of any one particular market or cycle. Now, of course, things will move around, and that's why Dermot mentioned the point about our commitment to positive operating leverage in almost all reasonable scenarios that we can imagine because we recognize that NII, which is part of our mix, but so too are the fees and then our ability to control expenses. We could make expenses less than they are now. We've chosen to manage them at the level that they are because we believe that investing in that business for future growth is exactly what we should be doing right now given the environment, but it wouldn't always have to be so."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Appreciate that. And if I can sneak one quick follow-up, Dermot, I think you mentioned fourth quarter NII slightly lower than 3Q. We've seen a few rate cuts in Europe, in the US now in September. Is it fair to assume that absent a dramatic change in rates, this $1 billion in quarterly NII is kind of where we are bouncing around at the bottom? And then, if deposit growth picks up, QT stops, that it should go off that base? Or am I missing something?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, if you look back at our last five quarters, we've kind of toggled between $1 billion and $1.1 billion. Q3 was a stronger quarter for us for a number of reasons, principally volatility in the market at the beginning of August and clients held more cash. And then, towards the back end of the quarter, once there was a clear view on where the Fed was going to go at rates, clients started to put money into money market funds, which ended up with us. And so, we kind of benefited from those two principal things. And so, our deposit balances have kind of leveled off here. We expect maybe NIBs grind down a little bit from here. And so, as I kind of said maybe 10 minutes ago, $1 billion for Q4 is the best guidance I can give you today. And for '25, I don't see NII being a kind of a headwind for us. And we've taken extensive action over the last several weeks in terms of repositioning our CIO book to insulate '25."
},
{
"speaker": "Ebrahim Poonawala",
"content": "That's helpful. Thank you so much."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll move to our next question from Betsy Graseck with Morgan Stanley."
},
{
"speaker": "Betsy Graseck",
"content": "Hi. Good afternoon."
},
{
"speaker": "Robin Vince",
"content": "Hey, Betsy."
},
{
"speaker": "Betsy Graseck",
"content": "Okay. Two quick questions. One is on the buyback question, and I know you said, look, you're very accretive on earnings accretion. You don't need a lot of capital for the business model, of course, as we know, and you're above your target CET1 of 11% and Tier 1 leverage target 5.5% to 6%, you're at the high end of that range. And so, when we think about the 100%-plus, how should we think about the plus part of the 100%-plus? Because it feels like totally 100% makes sense, but there's room to bring these to optimize the capital structure more. So, I'm kind of thinking about -- I'm wondering what kind of timeframe are we talking about to optimize your capital structure, do you feel?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, thanks for the question, Betsy. Last year, we returned a little north of 120%. This year, in January, we guided a 100% or more. Given the uncertainty in the markets, geopolitical, the U.S. Presidential elections, a wide range of uncertainty with Fed. In January, we thought the year was going to be very different to where it's ended up. And I think, on previous calls, we said we wanted for now stick towards the upper end of our Tier 1 leverage ratio, which is the 6% range. And so, when you take that and the Archer transaction, we kind of think we're still on track to do the 100% or more through three quarters, we're at 103%. So, I wouldn't expect that to materially change from here."
},
{
"speaker": "Betsy Graseck",
"content": "Okay. Got it. And then, the other question is you mentioned one-third of BNY is now on the platform model. And are you taking 100% of the firm there? And just wondering about implications for the runway for efficiency improvements as you execute on that? Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "So, a quarter of the firm, roughly 13,000 employees are on the platform now. It happened in two waves, March and September, with another wave going live in Q1 of next year. And so, I wouldn't necessarily think about platform operating model as a mechanism just for efficiency. It really is -- it's going to drive top-line growth and it's going to run the company better and it's going to help us have a different culture in terms of more joined-up thinking. So, it really is the mechanism by which we deliver the three strategic pillars. And so, the answer to the question about 100% is, yes. And from probably -- from here, it's probably another 18 months before the firm is fully up there. But by the end of Q1 of next year, we expect about half of the firm will be live on the model. And the feedback so far from our team around the world is extraordinarily positive. So, it's really worked well for us as a firm."
},
{
"speaker": "Robin Vince",
"content": "And Betsy, you remember the tail of benefit extends way past the 18-month point because sometimes it's not until folks are in the model and operating in that new approach that they're really able to examine some of the core questions that, that platform is confronted with in terms of how to optimize. So, we expect the benefit that Dermot was describing to be a multiyear endeavor past that 18-month point."
},
{
"speaker": "Betsy Graseck",
"content": "Got it. All right. Thanks so much. Appreciate it."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Glenn Schorr with Evercore ISI."
},
{
"speaker": "Glenn Schorr",
"content": "Hello. Just one wrap up for me. Dermot, I love you pointed out the 5% revenue growth, flattish expenses lead to 20% earnings growth. That is the power of the BK model. If you look just -- I know it's just one quarter, but if you look at the sequential numbers, the story changed a little bit with everything about flat and earnings down a little bit. I'm just -- all I'm asking is, does that inform us in any way of how we're looking at as we roll into '25? A lot of your business metrics and balance and client wins are up. So, my gut is, it's no, but I just want to see from that perspective, how you feel about that?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, I think your gut is correct. It is no, Glenn. And it's all just about timing and when we onboard clients and put people on the platform and when the revenue starts to get recognized. So, it's just in terms of the backlog across all our businesses, strong pipeline continues to grow. And, yeah, so your intuition is correct."
},
{
"speaker": "Glenn Schorr",
"content": "All right. Awesome. Thank you."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Rajiv Bhatia with Morningstar."
},
{
"speaker": "Rajiv Bhatia",
"content": "Yeah. Just a quick one for me. I guess, on the depository receipts business, and I appreciate it's a small business, but the number of sponsored programs continues to decline. Is that something we should continue to expect to decline? And is it competitive takeaways or something else that's driving that? Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "So, I wouldn't really read too much into that. That's -- we've talked about that for several years about the sponsored program going away and not being around. It's still here. Deposit receipts is a small business in the totality of it, but it is a very, very important business for us because it gives us another opportunity to connect with clients, and it has got a very good margin to it. And we have like very significant market share in that business. So, it's something that we continue to invest in. We think it's very important for our franchise, and we don't see a secular decline in that business from where we see it today."
},
{
"speaker": "Robin Vince",
"content": "We also off-boarded some of the smaller clients in that particular business. So, the headline of total number is a little bit misleading actually when -- if you were able to dig under the hood and see some of the clients that made up that decline, you'd see that they disproportionately skewed to the small."
},
{
"speaker": "Rajiv Bhatia",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Jim Mitchell with Seaport Global Securities."
},
{
"speaker": "Jim Mitchell",
"content": "My questions have all been asked and answered. Thanks."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll move to our next question from Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks for taking my follow-up. Just one more on the margins. You mostly at your 33% target in most areas. So, as you generate more sales from moving to the platform model, and as we move into, say, next year or beyond, I guess, what's the view on spending some of that and investing in the business versus actually generating -- potentially generating margins well above 33%?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, my response to that one, Jim, would be, we want to demonstrate to you that we can prove that we can deliver 33% margins through the cycle. We gave guidance for the first time in January, and then we just managed to get there pretty quickly. But we want to stay there and show that we can deliver that over a period of time. We're heading into a very -- what's going to be quite an interesting budget season for us because we've done a lot of great things this year. I know the various teams around the firm want to do great things next year. And to offset that balance, we want to be able to deliver positive operating leverage. And so, the next eight weeks and how we set up the firm for next year would inform how we communicate with you in January. But we set out those targets because we believe we could hit them. The positive is we got there earlier than we thought. And now we want to show that we can improve and maintain those margins that we've guided to previously."
},
{
"speaker": "Robin Vince",
"content": "Brian, the best clue I could give you in terms of how we think about that, it's sort of a little bit more detail is if you actually look at us on a segment-by-segment basis, you can see us prosecuting the operating leverage journey differently in our three segments. And we told you a year or so ago that, that's what we were going to do. And so, maybe to allay your concerns in terms of growth and investment, if you look at Market and Wealth Services, we aren't trying to grow the margin there. We're very happy with the margin. We just wanted to grow the total size of the business, which is exactly what we've been doing. There are -- the other segments where we said we actually do want to grow the margin towards our medium-term targets for those segments, there, we are really growing the margin. And so, you can see exactly your question at work in our segments."
},
{
"speaker": "Brian Bedell",
"content": "Yeah. That's great color. Thank you very much."
},
{
"speaker": "Operator",
"content": "And for our final question, we'll return to the line of Mike Mayo with Wells Fargo."
},
{
"speaker": "Mike Mayo",
"content": "Hi. With all this talk of the transitioning of the employees, I guess, half the employees to the new platform over the next one to two years, how much do you see AI playing a role? And can you give any metrics? I mean, keeping expenses flat, I don't know how much you're still investing in AI. When Emily presented at the Boston Bank Conference last November, it seemed like BNY was all in for AI. It was one of those bullish cases made yet you've heard out in the broader world, sometimes you have hit, sometimes you have misses. So, where -- how does AI relate to the whole platform strategy? And how committed are you to AI? And do you have any numbers that you can give us, some concrete metrics? Thanks."
},
{
"speaker": "Robin Vince",
"content": "Sure. So, just to reiterate, we've got a quarter of our people in the platform's operating model. And as Dermot said, it's sort of an 18-month trajectory from here. That's really, Mike, the way I think about platform's operating model is this concept of, if you take it that we are, in fact, more and more a platforms company in terms of these large at-scale capabilities often software and services that we deliver generally in market-leading positions, number one, in a variety of different markets. We've talked about things -- the businesses before, I won't repeat them. Then, it follows to us from that it makes sense for us to operate ourselves in a platform's operating model, which is the way that many other platform companies in the world operates themselves. And so that is a strategy around how we organize ourselves in pursuing -- being pursuant to our broader strategy. Now, AI as a -- which is, of course, part of that, we have an AI hub. We have a couple of hundred people in that AI hub. And we are absolutely investing in AI and do believe in the power of AI to be able to help our business in terms of both revenue opportunities over time for clients and also ways to make our people more effective and efficient. And we haven't made a lot of noise about it, but don't misunderstand that for a lack of interest or investment because we haven't slowed down. In fact, we've increased our AI investment. And of course, notwithstanding all of that, you can see that from running the company well on an expense line, we're not allowing that enthusiasm to distract us from the important task of expense management. And this is where -- I don't mean to be pithy, but it's very, very important learning for us is that we, as a company, can walk and chew gum at the same time. We can invest in things that matter and we can manage the company well. We make choices and AI is a choice of something we're leaning into, and we think that's important for the future."
},
{
"speaker": "Mike Mayo",
"content": "Thank you."
},
{
"speaker": "Robin Vince",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And with that, that does conclude our question-and-answer session for today. I would now like to turn the call back over to Robin for any additional or closing remarks."
},
{
"speaker": "Robin Vince",
"content": "Thank you, operator. And thanks, everyone, for your time today. We appreciate your interest in BNY. Please reach out to Marius and the IR team if you have any follow-up questions. Be well."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today's conference and webcast. A replay of this conference call and webcast will be available on the BNY Investor Relations website at 2 o'clock pm Eastern Standard Time today. Have a great day."
}
] |
bk | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to the 2024 Second Quarter Earnings Conference Call hosted by BNY. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference call and webcast will be recorded and will consist of copyrighted material. You may not record or rebroadcast these materials without BNY's consent. I will now turn the call over to Marius Merz, BNY Head of Investor Relations. Please go ahead."
},
{
"speaker": "Marius Merz",
"content": "Thank you, Operator. Good morning, everyone, and thank you for joining us. I'm here with Robin Vince, President and Chief Executive Officer, and Dermot McDonogh, our Chief Financial Officer. As always, we will reference our financial highlights presentation, which can be found on the Investor Relations page of our website at bny.com. And I'll note that our remarks will contain forward-looking statements and non-GAAP measures. Actual results may differ materially from those projected in the forward-looking statements. Information about these statements and non-GAAP measures are available in the earnings press release, financial supplement, and financial highlights presentation, all available on the Investor Relations page of our website. Forward-looking statements made on this call speak only as of today, July 12, 2024, and will not be updated. With that, I will turn it over to Robin."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Marius. Good morning, everyone, and thank you for joining us. Before Dermot reviews the financials in greater detail, I'd like to start with a few remarks about our progress in the quarter. In short, we delivered another quarter of improved financial performance with positive operating leverage on the back of solid fee growth and continued expense discipline. And we continued to make tangible progress on our path to be more for our clients, to run our company better, and to power our culture. Last month, we celebrated our company's 240th anniversary with our people and many of our clients. Even with this rich history of operating across four centuries, I believe that our best days remain ahead of us. That bank with around $0.5 million of capital in 1784 today oversees roughly $50 trillion in assets and powers platforms across payments, security, settlement, wealth, investments, collateral, trading, and more for clients in over 100 markets around the world. As the world changes and global financial markets evolve, so do we. Earlier this year, in January, you heard us lay out our strategy, which maps out what we need to get done and how we need to do it. Last month, we introduced changes to our logo and simplified and modernized our company brand to BNY to improve the market's familiarity with who we are and what we do. This rebranding better aligns the perception of our company to the substance of what we're doing to unlock our full potential as one BNY. Now referring to Page 2 of the financial highlights presentation. BNY delivered solid EPS growth as well as pre-tax margin and ROTCE expansion once again on the back of positive operating leverage in the second quarter. Reported earnings per share of $1.52 were up 16% year-over-year. And excluding notable items, earnings per share of $1.51 were up 9%. Total revenue of $4.6 billion was up 2% year-over-year. This included 5% growth in investment services fees led by continued strength in Clearance and Collateral Management, Asset Servicing and Treasury Services, as well as 16% growth in foreign exchange revenue. Net interest income decreased by 6%. Expenses of $3.1 billion was down 1% year-over-year. Excluding notable items, expenses were up 1%, reflecting further investments in our people and technology while we also continued to realize greater efficiencies. Margin was 33%. And in what is seasonally our strongest quarter, we reported a return on tangible common equity of 25%, 24% excluding notable items. These financial results were against the backdrop of a relatively constructive operating environment. The market calling for a gradual and shallow easing of policy rates, inflation pressures easing, and investor confidence growing. On average, equity market values increased, while fixed income markets finished slightly lower compared to the first quarter. A couple of weeks ago, the Federal Reserve released the results of its annual bank stress test, which once again showcased our resilient business model and our strength to support clients through extreme stress scenarios. The test confirmed that our preliminary stress capital buffer requirement remains at the regulatory floor of 2.5%. And we increased our quarterly common dividend by 12% to $0.47 per share starting this quarter. In May, the transition to T+1 settlement in the US, Canadian and Mexican markets represented one of the more significant market structure changes that our industry has seen in a couple of decades. BNY's critical role in the financial system gives us the opportunity to help clients through major shifts like this, further strengthening their trust in us and deepening our relationships with them. By running the company better, we are starting to capitalize on BNY's truly powerful combination of security services, market and wealth services, and our investments and wealth businesses to serve our clients more effectively across the entire financial life cycle. As an example, this past quarter BNY was awarded a significant mandate by a premier global asset manager with over $100 billion in assets under management. We were selected based on our ability to deliver custody, fund servicing, ETF and digital fund services, Treasury Services, and Pershing. Our holistic offering will power their future growth strategy. In another example, AIA, the pan-Asian life insurance group, announced a new collaboration with BNY and BlackRock as AIA transforms its investment platform. AIA has announced that they will implement BNY's specialized investment operations, data management services, and technology with BlackRock's Aladdin to create a connected and scalable ecosystem to support the company's evolving investment activities. We also continue to be pleased with the growing interest in our wealth advisory platform, Wove. Global Finance recently named Wove as one of the top three global financial innovations as part of its annual Innovators Awards for 2024. At INSITE, Pershing's annual flagship wealth services conference in June, we announced a suite of new solutions on the platform. Wove Investor, a one-stop client portal. Wove Data, a cloud data platform designed for financial professionals at wealth management firms, and Portfolio Solutions, a set of enhancements to the platform that will help advisors move more efficiently from researching investment products, to aligning them to a client's risk objectives and adding them to a portfolio. We also introduced a new ONE BNY offering that enables clients to easily access multiple BNY capabilities, including our managed accounts platform, asset allocation and manager selection, investment management products, customized tax solutions, the interoperable Wove platform for advisors, and custody and clearing services from Pershing. We're a comprehensive unified package leveraging the breadth of BNY to make clients' wealth advisors lives easier. And we have proof points. Example, a fast growing full service regional bank recently selected Pershing to provide custody and clearing services private wealth business. But they are also adopting [Dreyfus Cash Management] (ph), direct indexing, and private banking. As we've said many times, our culture and people are a critical part of being more for our clients and running our company better. We are pleased to see that our actions are enabling us to be a top talent destination for recent graduates and experienced leaders alike. This summer, we're welcoming our largest ever intern and analyst classes, a total of over 3,500 individuals chosen from over 150,000 applications. And we recently announced several new appointments to our leadership team. Shannon Hobbs, our new Chief People Officer joined us in June. Leigh-Ann Russell will join us in September as Chief Information Officer and Global Head of Engineering. Jose Minaya will also join us in September, lead BNY's Investments and Wealth. To wrap up, halfway through the year, we're pleased with the progress that we have made and how it is reflected in both improved financial performance to date as well as our building momentum. One of my favorite quotes comes from Alexander Hamilton, our founder, who famously said that he attributed his success not to genius, but to hard work. We have been hard at work, and we've laid a solid foundation. Our team is in full execution mode and we're starting to demonstrate the power of our franchise and of operating as one BNY for our clients and our shareholders. With that, over to you, Dermot."
},
{
"speaker": "Dermot McDonogh",
"content": "Thank you, Robin, and good morning, everyone. Picking up on Page 3 of the presentation, I'll start with our consolidated financial results for the quarter. Total revenue of $4.6 billion was up 2% year-over-year. Fee revenue was up 4%. This includes 5% growth in investment services fees on the back of higher market values, net new business, and higher client activity. Investment management and performance fees were flat. Firm-wide AUC/A of $49.5 trillion were up 6% year-over-year and assets under management of $2 trillion were up 7% year-over-year, primarily reflecting higher market values. Foreign exchange revenue increased by 16%, driven by higher volumes. Investment and other revenue was $169 million in the quarter on the back of strong client activity in our fixed income and equity trading business. And net interest income decreased by 6% year-over-year, primarily reflecting changes in balance sheet mix, partially offset by higher interest rates. Expenses were down 1% year-over-year on a reported basis and up 1% excluding notable items, primarily in the prior year. The increase from higher investments, employee merit increases, and higher revenue related expenses was partially offset by efficiency savings from running our company better. Notable items in the second quarter of this year primarily included an expense benefit from a reduction in the FDIC's special assessment, which was largely offset by severance expense. There was no provision for credit losses in the quarter. As Robin highlighted earlier, we reported earnings per share of $1.52, up 16% year-over-year, a pre-tax margin of 33% and a return on tangible common equity of 25%. Excluding notable items, earnings per share were $1.51, up 9% year-over-year, pre-tax margin was 33% and our return on tangible common equity was 24%. Turning to capital and liquidity on Page 4. Our Tier 1 leverage ratio for the quarter was 5.8%. Average assets increased by 2% sequentially on the back of deposit growth. And Tier 1 capital increased by 1% sequentially, primarily reflecting capital generated through earnings, partially offset by capital returns to common shareholders. Our CET1 ratio at the end of the quarter was 11.4%. The quarter-over-quarter improvement reflects lower risk-weighted assets coming off the temporary increase in risk-weighted assets at the end of the previous quarter, and CET1 capital increased by 2% sequentially. Over the course of the second quarter, we returned over $900 million of capital to our common shareholders, representing a total payout ratio of 81%. Year to date, we returned 107% of earnings to our common shareholders through dividends and buybacks. Turning to liquidity. The consolidated liquidity coverage ratio was 115%, and our consolidated net stable funding ratio was 132%. Next, net interest income and the underlying balance sheet trends on Page 5. Net interest income of over $1 billion was down 6% year-over-year and down 1% quarter-over-quarter. The sequential decrease was primarily driven by changes in balance sheet mix, partially offset by the benefit of reinvesting maturing fixed rate securities in higher yielding alternatives. Average deposit balances increased by 2% sequentially. Interest bearing deposits grew by 3%, and non-interest bearing deposits declined by 2% in the quarter. Average interest-earning assets were up 2% quarter-over-quarter. Our average investment securities portfolio balances increased by 3%, and our cash and reverse repo balances increased by 1%. Average loan balances were up 4%. Turning to our business segments starting on Page 6. Security Services reported total revenue of $2.2 billion, flat year-over-year. Total investment services fees were up 3% year-over-year. In Asset Servicing, investment services fees grew by 4%, primarily reflecting higher market values and net new business. We continue to see strong momentum in ETF servicing with AUC/A of over $2 trillion, up more than 50% year-on-year, and the number of funds serviced up over 20% year-on-year. This growth reflects both higher market values as well as client inflows, which included a large ETF mandate in Ireland from a leading global asset manager. In alternatives, fund launches for the quarter continued their recent activity in private markets. Investment services fees for alternatives were up mid-single-digits, reflecting growth from both new and existing clients. And in Issuer Services, investment services fees were up 1%, reflecting net new business across both Corporate Trust and Depositary Receipts, partially offset by the normalization of elevated fees associated with corporate actions in Depositary Receipts in the second quarter of last year. We're particularly pleased to see the investments and new leaders in our Corporate Trust platform beginning to bear fruit. Against the backdrop of a significant pickup in CLO issuance in recent months, we've been moving up the ranks and improved our market share as trustee for CLOs by about 4 percentage points over the past 12 months to 20% in the second quarter. In the segment, foreign exchange revenue was up 16% year-over-year, and net interest income was down 11%. Expenses of $1.6 billion were down 1% year-over-year, reflecting efficiency savings, partially offset by higher investments, employee merit increases, and higher revenue-related expenses. Pre-tax income was $688 million, a 7% increase year-over-year, and pre-tax margin expanded to 31%. Next, Market and Wealth Services on Page 7. Market and Wealth Services reported total revenue of $1.5 billion, up 6% year-over-year. Total investment services fees were up 7% year-over-year. In Pershing, investment services fees were up 2%, reflecting higher market values and client activity, partially offset by the impact of business lost in the prior year. Net new assets were negative $23 billion for the quarter, reflecting the ongoing deconversion of the before-mentioned lost business. Excluding the deconversion, we saw approximately 2% annualized net new asset growth in the second quarter, and we renewed a multi-year agreement with Osaic, one of the nation's largest providers of wealth management solutions. Pershing has supported Osaic since its founding in 1988, and we are proud to help the company drive its growth strategy for years to come. Client demand for Wove continues to be strong. In the quarter, we signed 12 additional client agreements. The pipeline continues to grow, and we are on track to meet our goal of $30 million to $40 million realized revenue in 2024. In Clearance and Collateral Management, investment services fees were up 15%, primarily reflecting higher collateral management fees and higher clearance volumes. US securities clearance and settlement volumes have remained strong throughout the quarter, supported by a grown market and active trading. And we are excited about the opportunity to do even more for clients. Having realigned Pershing's institutional solutions business to Clearance and Collateral Management, we can offer clients a choice across a continuum of clearance, settlement, and financing solutions for those that sell clear as well as those seeking capital and operational efficiency through outsourcing. This allows us to not only deepen our relationships with clients, but also drive continued revenue growth. And in Treasury Services, investment services fees increased by 10%, primarily reflecting net new business and higher client activity. Net interest income for the segment overall was down 1% year-over-year. Expenses of $833 million were up 5% year-over-year, reflecting higher investments, employee merit increases, and higher revenue related expenses, partially offset by efficiency savings. Pre-tax income was up 8% year-over-year at $704 million, representing a 46% pre-tax margin. Moving on to Investment and Wealth Management on Page 8. Investment and Wealth Management reported total revenue of $821 million, up 1% year-over-year. In our investment management business, revenue was down 1%, reflecting the mix of AUM flows and lower equity investment income and seed capital gains partially offset by higher market values. And in wealth management, revenue increased by 3%, reflecting higher market values, partially offset by changes in product mix. Expenses of $668 million were down 2% year-over-year, primarily reflecting our work to drive efficiency savings and lower revenue related expenses, partially offset by employee merit increases and higher investments. Pre-tax income was $149 million, up 15% year-over-year, representing a pre-tax margin of 18%. As I mentioned earlier, assets under management of $2 trillion increased by 7% year-over-year. In the quarter, while we saw $2 billion of net inflows into long-term active strategies with continued strength in fixed income and LDI, partially offset by net outflows in active equity and multi-asset strategies, we saw $4 billion of net outflows from index strategies and $7 billion of net outflows from short-term strategies. Wealth management client assets of $308 billion increased by 8% year-over-year, reflecting higher market values and cumulative net inflows. Page 9 shows the results of the Other Segment. I'll close with a couple of comments on our outlook for the full year 2024. Starting with NII, I'm pleased to report that the first half of the year came in slightly better than we had expected, as we saw the decline in non-interest-bearing deposits decelerate, and we continue to grow interest-bearing deposits. While we are cautiously optimistic, we remain humble as we head into the seasonally low summer months, and for now we will therefore keep our NII outlook for the full year 2024 unchanged, down 10% year-over-year. Regarding expenses, our goal remains to keep expenses excluding notable items for the full year 2024 roughly flat. As Robin put it earlier, BNY is in execution mode and we're embracing the hard work ahead of us. We continue to expect our effective tax rate for the full year 2024 to be between 23% and 24%. And lastly, we continue to expect to return 100% or more of 2024 earnings to our shareholders through dividends and buybacks. Our Board of Directors declared a 12% increased common dividend for the third quarter, and we plan to continue repurchasing common shares under our existing share repurchase program. As always, we are calibrating the pace of our buybacks, considering various factors such as our capital management targets, the macroeconomic and interest rate environment, as well as the size of our balance sheet. To wrap up, we enter the second half of the year on the back of solid fee growth, a better than expected NII performance to date, and continued expense discipline, which gives us incremental confidence in our ability to drive positive operating leverage in 2024. With that, Operator, can you please open the line for Q&A?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question is coming from Ken Usdin with Jefferies. Please go ahead."
},
{
"speaker": "Ken Usdin",
"content": "Thank you. Good morning."
},
{
"speaker": "Robin Vince",
"content": "Good morning, Ken."
},
{
"speaker": "Ken Usdin",
"content": "Good morning. Just like to go -- just ask Dermot about that NII humbleness for the second half. Can you just walk us through what the moving pieces would be, including the seasonality that you mentioned and any other things that might have been over-earning in the NII in the first quarter so that you would seemingly in your maintain guide still expect a meaningful ramp down in NII, which I don't think is what seems to be the base case given how well the balance sheet has held up so far, as you pointed out, relative to your expectations? Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks for the question, Ken. I guess the best way to answer the question is a little bit to, in some ways, look back at last year where Q1, Q2, typically strong quarters for us. Q3, typically a seasonally lower quarter, summer months, clients taking their foot off the gas in terms of activity, and then we pick back up again in Q4. Now, as you've seen from this quarter's numbers and the first half overall, we're very pleased with the performance. I guess we've outperformed our expectations for the first half, and that's in large part due to underlying activity within our core businesses, and in my remarks, I particularly called out corporate trust, where we saw like elevated activity in the CLO space which in turn drives deposits. So when our core businesses are doing well, which they've all performed well, that has a knock-on impact in the number of deposits that we have And so we outperformed our expectations in the first half. Notwithstanding that, when I look out at the rest of the year and when we gave the guidance of down 10% in January, the market at that time was roughly calling for six rate cuts. Now we're in the middle of the summer. We had a slowdown in inflation print yesterday. Let's see how Jay speaks on Monday and how he guides out of [Jackson Hole] (ph) and into a September potential rate cut. But we kind of take all of those levers and we just kind of say for now, there's no point in me changing guidance to change guidance again in September or October at the next call. So we're cautiously optimistic. I think I used the word last year in March, askew. So we're playing for the best outcome, but we do expect Q3 to be somewhat seasonally quieter. And that's why we didn't change our guidance."
},
{
"speaker": "Ken Usdin",
"content": "Okay, and then just can you -- that follow up, just on the size of the deposit, so you're just expecting the size of the deposit base to decline or is it the mix or just trying to understand what pieces of it would revert given that seasonality?"
},
{
"speaker": "Dermot McDonogh",
"content": "So when I think about deposits, I kind of -- I think there are three components to it. One is interest bearing deposits where we outperformed plan, NIBs where we outperformed plan. And so pleased with that, but that really reflects clients showing up in a different way with us and we showing up in a different way with clients. So, good. And then the third thing, and I've talked about this a number of times on previous calls, really the strength of the collaboration and teamwork between our treasurer, our CIO, and our global liquidity solutions platform, where we think about liquidity as a $1.4 trillion ecosystem. And we've been very much in offense mode this quarter. And our GLS team has really shown up in a positive way. And we've really managed to gather good, liquidity-friendly deposits, which is kind of fueling the growth of our balance sheet, and that's allowed us to do more loans. So I think in terms of specifically to your question, it's both, I think the overall balance will come down, and as a consequence, I would expect NIBs from here to grind a little bit lower, which is the main driver of the NII change."
},
{
"speaker": "Ken Usdin",
"content": "Right. Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Glenn Schorr with Evercore ISI. Please go ahead."
},
{
"speaker": "Glenn Schorr",
"content": "Hi. Thanks very much."
},
{
"speaker": "Robin Vince",
"content": "Hey, Glenn."
},
{
"speaker": "Glenn Schorr",
"content": "You alluded to the -- hello. You alluded to the higher Clearance and Collateral Management, higher clearance volumes. I'm just curious if you can parse out how much of that is just clients being more active during a more active second quarter versus winning new business and organic growth. It just might help for the thoughts on the go forward and how to model? Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks, Glenn. I think it's a combination of both. So, clients are for sure doing more. Rate volatility in Q2 was there for all to see. So as a consequence, more activity in the treasury market, more treasury issuance and which feeds volumes. So, overall, very healthy volumes, and we have a high-margin scaled business, which the platform was able to benefit from that increased level of activity. Also, I think as we did last year, we continue to innovate for clients in the domestic market. And as we said on our January call, the international business is also a key growth opportunity for us and our teams are innovating and developing new products and solutions for our clients internationally. And so I think it's a combination of all the factors that we've talked about on previous calls, kind of showed up as a nice tailwind for us this quarter. And for Clearance and Collateral Management, I think I do expect that trend to continue in the near term."
},
{
"speaker": "Glenn Schorr",
"content": "Thanks, Dermot. You piqued my interest. In the opening remarks, you all talked about T+1 coming in into the market and that helping -- you helping -- help clients. I'm curious now that it's built, now that it's in the run rate, just a couple of quickies of, is there a cost runoff now or is that not big enough? Does T+1 come with lower spread for you, but does it free up capital with more frequent settlement? I'm just curious what the net impact of it all is."
},
{
"speaker": "Dermot McDonogh",
"content": "Hey, Glenn, I would describe it in terms of like the raw P&L impact, which is sort of the second part of your question, is really pretty de minimis. We spent a bunch of time preparing for this over the course of the past couple of years. So it wasn't like there was some big hump in the cost curve in order to really do it. We sort of worked the process over time. But for us, I think the biggest opportunity associated with T+1 is whenever there's a market inflection like this, and this was one of the most significant ones, but we're looking ahead to treasury clearing is another good example of something like that, it gives us the opportunity get closer to our clients. It creates uncertainty for our clients. How is it going to work and they need help navigating it. And so the combination of uncertainty and a need for assistance is really the macro opportunity for us. And we've leant into that. We'll continue leaning into those types of market changes, again, with treasury clearing being another good example. And I would say overall, these types of changes create things that create more efficiency in the market, things that can reduce risk in the market, things that improve efficiency. Sure, they do sometimes call on more of our products and solutions, which, of course, is great, but it's also just a good thing for the market to improve the effectiveness and efficiency of market operation. And I think over time, we're also a beneficiary of that."
},
{
"speaker": "Glenn Schorr",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Ebrahim Poonawala with Bank of America. Please go ahead."
},
{
"speaker": "Ebrahim Poonawala",
"content": "[Technical Difficulty]"
},
{
"speaker": "Robin Vince",
"content": "Good morning, Ebrahim."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Maybe just one follow-up, Dermot, for you on NII. I guess in response to Ken's question, you talked about Fed policy and that having an impact. Remind us the positioning of the balance sheet if the Fed does decide to cut rates come September and we get 100, 150 bps of cuts? Remind us how the balance sheet will behave, how we should think about NII in that backdrop?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, thanks for the question. So I will kind of give a couple of different perspectives on that is, one, cumulative betas are roughly unchanged quarter-over-quarter, which feels like I really believe our book to be fairly priced. As you will remember, our book is largely institutional. We pass on the rates and so cumulative betas are in good shape. So for the dollar portfolio, roughly low 80s, 80 range. And then for euros and sterling we’re in the high 50s, low 60s. And so we kind of do a range of scenarios and at the beginning of the year, we're positioned roughly -- we're roughly flat. So if Chairman Powell cuts in September and then cuts again, I guess, which is the general view of the market, we're kind of basically NII, okay, it doesn't really impact the book that much. So for small moves, we're well positioned in terms of expectation."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Understood. And separately, I guess, maybe Robin, for you just in terms of the fee revenue momentum that you talked about at Pershing and elsewhere, just give us a sense around what the drivers we should be thinking as we think about sort of the medium-term outlook on fee revenue outside of just pure markets activity that could drive fees in a world where NII might be stable to lower as we think about sort of momentum on the positive outlook."
},
{
"speaker": "Robin Vince",
"content": "Sure. Revenue growth in any given year is somewhat market-dependent because, of course, interest rates, equity fixed income markets, volumes volatility, that stuff all moves around, but our strategy has been, of course, to fuel the organic growth of the company, but also to try to position our businesses to be able to respond as well as they can to growth tailwinds that exist just in markets. And so in answer to Ken -- the question earlier on around the treasury market, we've positioned that business to be able to benefit from what we think is a secular growth in activity in the US treasury market. So that's a place where we're benefiting, yes, from the market, we’re also benefiting from the investments that Dermot detailed. And as we go through what's next for our fee growth, we talked a lot about our ONE BNY campaign quarters ago. And we talked last quarter and in January about the fact that we're sort of operationalizing more and more what started off as a movement of ONE BNY into referrals, into new targets, into our commercial model and our Chief Commercial Officer joining and really then getting into the client coverage, the practices, the integrated solutions, which we talked about in our prepared remarks, the fact that we can now bundle individual products into true solutions for clients. So there are a lot of levers on the fee growth, and we've been working very methodically through our plan to build momentum in that space, but also to position the business to be able to take advantage of macro things going on in the market."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Got it. Thank you."
},
{
"speaker": "Robin Vince",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Steven Chubak with Wolfe Research. Please go ahead."
},
{
"speaker": "Steven Chubak",
"content": "Hi. Good morning, Robin and good morning, Dermot."
},
{
"speaker": "Robin Vince",
"content": "Good morning, Steven."
},
{
"speaker": "Steven Chubak",
"content": "So I guess I wanted to build on that earlier line of questioning, but really focusing more on repo activity. It's been a big area of investor focus. You've certainly benefited from recent strength on the repo side. And I was hoping you could potentially quantify the benefit year-on-year from elevated repo activity and just longer term, like, how you're thinking about the durability of the recent repo strength? And what are some of the factors supporting that view?"
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks for the question, Steven. So I would say in terms of year-on-year activity, it's not a kind of a -- cleared repo is not a game changer for us in terms of the overall year-on-year NII story. It's about -- overall in its totality, it makes up about 5% of our NII today. I think I would just echo our follow-on from Robin's answer to the last question in terms of it's a product. Clients want us we're meeting them where they want to be, we're innovating. This come under the $1.4 trillion liquidity ecosystem. Laide runs that business, does a terrific job for us in the clear repo business specifically, we're a top three provider. And so we have a large installed client base who are looking for products and we can meet them with our cleared repo product. And so it's just another tool in our toolbox. And I would say, again, we're positioned, we're investing, we're a scale player and we can provide automated solutions for our clients. So I do expect that business to continue to grow, but in terms of the year-over-year to your specific question, it's not a material driver of the year-over-year change."
},
{
"speaker": "Robin Vince",
"content": "Steven, I would add one thing to it, which is just remember that in the context of our business, we're really the only global solution provider in the space because we're scaled in Asia, we're scaled in Europe, we’re scaled in the United States. And in a world where folks are looking at repo as a collateral tool and an investment tool, the opportunity to be able to help clients navigate the whole world in this product, provide the seamless connectivity between repo and margin and collateral management the connectivity to other things that we do, there's a real appeal, to use Dermot's phrase again about meeting clients where they are. There's a real appeal here for clients in terms of the breadth of what we can offer, but also the innovation that he referred to earlier on in the call where we're creating these new solutions. And so this is another example, along with the US treasury market, but there are so many others in our business of saying there's a macro evolution going on, and we have the opportunity to participate in that as long as we're front-footed with clients and as long as we're innovating."
},
{
"speaker": "Steven Chubak",
"content": "Thanks for all that color. And just for my follow-up on the Pershing business. I know that the core underlying strength has been obscure to some degree by some large client departures. I was hoping you can give some perspective on what some of the core organic growth trends look like in that business? What the pipeline looks like in that business given some of the recent excitement of our Wove platform and the offering? And have we lapped those headwinds at this point, or is there still some remaining pressure on the come?"
},
{
"speaker": "Dermot McDonogh",
"content": "Okay. So I would say nobody is happier to see the ongoing deconversion of the clients to come to an end. So we expect that to be fully out of the portfolio by Q3. As I've said on previous calls, we believe in our ability to earn our way through that deconversion. It happens in life. And so I think the team has been very resilient in terms of earning their way through it and growing. In my prepared remarks, I talked about the re-sign of Osaic on a several year contract. So we're very pleased about that. You take a step back and you look at where we were 12 months ago, we just came off the INSITE conference in Florida where we announced Wove, 12 months later we've announced a new suite of products to support the Wove. We have signed 21 clients so far this year for Wove. The momentum is building, the clients like us. We -- I kind of reiterated my guidance on prepared remarks about the $30 million to $40 million of revenue for this year. And then just I'll remind you that we're a $3 trillion player in the wealth tech space, number one with broker-dealers, top three with RIAs. And in previous quarters, I've kind of guided mid-single-digits of underlying core growth through the cycle. We continue to believe that, notwithstanding on any given quarter, it may be slower or better. But we believe we're in good shape, and there is good momentum in what is a very, very large market, and in which we're a very big player."
},
{
"speaker": "Steven Chubak",
"content": "Very helpful color. Thanks so much for taking my questions."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Steve."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Brennan Hawken with UBS. Your line is open. Please go ahead."
},
{
"speaker": "Brennan Hawken",
"content": "Good morning Robin and Dermot. Thanks for taking my questions. So we saw the ECB cut rates this quarter. And while I know euro is in a huge exposure for you in terms of your deposit base, curious about what impact you saw that on your deposit costs in that currency. And maybe how does that experience and the market reaction inform your expectations for beta and customer behavior around rate cuts in other currencies? Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "So I would say, overall, euros is roughly 10% of the total portfolio. To -- in answer to the earlier question, I think where we feel very well positioned for the range of outcomes that the forward curve is implying in euros, sterling and dollars, we prepare for it. We talk about it a lot. And so I kind of feel like the way the CIO book is currently set up, where we still have a reasonable amount of securities rolling off into higher-yielding assets. So I just feel like the combination of where our deposit book is in terms of our betas to reiterate again for dollars, low 80s sterling and euros high 60s. And the CIO book kind of still room to grow. And so on rate cuts in terms of how we kind of position the book, we're broadly symmetric in terms of -- on the rate cut side. So I think Chairman Powell has done a job of telegraphing to the market how he wants to do it. So I don't think it's going to be a volatile move in rates when it happens. So he's allowed us time to position and manage and get into the right place. So I think overall, I feel very good about where we're at."
},
{
"speaker": "Brennan Hawken",
"content": "Yeah. But what I was asking -- I appreciate that. What I was trying to understand was the actual experience with -- in the actual marketplace beyond like the expectation. Did the 50% to 60% beta, I think you said in euros, did that hold when the cut went through? And did you actually experience that?"
},
{
"speaker": "Dermot McDonogh",
"content": "So specifically, yes, we did experience that, and it held up. It behaved as expected."
},
{
"speaker": "Brennan Hawken",
"content": "Excellent. Thank you for that, Dermot. I appreciate that. Issuer Services very solid. You flagged some CLO trustee gains on the back of a market that's seen solid volume. Could you help us understand maybe how much of the strength and the growth that you saw in that line was attributed to that, which I assume would be in the in the Corporate Trust business and then maybe how to think about the Depositary Receipt fees, just so we're thinking about the right way to baseline and move forward with our models?"
},
{
"speaker": "Dermot McDonogh",
"content": "For sure. Look, Corporate Trust, I think, is, for us, a good opportunity, a very good opportunity. I actually talked about it at some length at the RBC Conference in March when I was chatting with Gerard Cassidy. And I think over the last number of years, Corporate Trust for BNY is a business that's been underinvested in both technology and leadership. And in both Robin and I’s prepared remarks, we did emphasize leadership has been a continuous change for us. And we've made a very -- couple of very important hires over the last 12 months in Corporate Trust, and we have new leadership overseeing the business. And it's that investment and in technology, products, leadership that is showing up. And specifically, we've doubled our activity in CLOs over the last 12 months. We've improved our market share. And as Robin said, a couple -- in an answer to another question, we really want to position Corporate Trust as a business that really can take the advantage of scale, a lot of manual processes, a lot of room for AI, a lot of room for digitization and we can improve the operating leverage of that business. We can improve how we show up for clients, client service. So we feel like in Corporate Trust specifically, we have a lot to play for. Depositary Receipts, we have good market share. We punch above us and we expect that to continue."
},
{
"speaker": "Brennan Hawken",
"content": "Thank you for taking my questions."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Brennan."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Betsy Graseck with Morgan Stanley. Please go ahead."
},
{
"speaker": "Betsy Graseck",
"content": "Hi, good morning."
},
{
"speaker": "Robin Vince",
"content": "Morning, Betsy."
},
{
"speaker": "Betsy Graseck",
"content": "Two quick questions. One, just to wrap up a little bit on the T+1 discussion earlier. Could you give us a sense of how much did T+1 drive sequential revenue growth this quarter? And can you give us a sense as to if there's enough revenue growth you're expecting from this to impact the expense ratio since you've already made the investment? And then I have a follow-up on Wove. Thanks."
},
{
"speaker": "Dermot McDonogh",
"content": "Hi, Betsy, it's Dermot. So the point I would make about T+1 is not so much a revenue or expense topic. It really is -- it speaks to resilience as a commercial attribute kind of point that we make on behalf of BNY in terms of it's been a large-scale infrastructure change that's been coming to the markets over the last couple of years. And as we are a key player in the financial market infrastructure, it's very important that we execute that to an A+ standard. And what I would say is BNY has shown up for clients and delivering an A+ execution of a very big project. It's not really about revenue or expenses, it’s really about delivering a complicated change project for our clients and the ecosystem at large. That's really, I think, the point we're trying to make on T+1."
},
{
"speaker": "Betsy Graseck",
"content": "Okay. Yeah, I just think if you're in a better spot than others, you could pick up some incremental share on the back of that, but that's maybe a couple of conference calls from here. All right. Then separately on Wove, I know you mentioned that you added new clients to Wove. I just wanted to understand, is this new clients of the firm or this is clients who had been yours for a while and they moved to Wove?"
},
{
"speaker": "Dermot McDonogh",
"content": "So I would say it's both. And so I guess the questions that we've had on previous calls, Betsy, are we cannibalizing existing clients? And the answer to that is most definitely no. And I think it speaks to the point of us innovating. Wove is a very big investment for us in terms of technology over multiple years. Existing clients like the fact that we're willing to put money to work for them and give them better solutions and as a consequence of that, we had over 1,500 people show up to Wove in Florida last year, in Nashville this year. And for those that are there, there's real excitement. And as Robin said in his prepared remarks, it's winning awards. So there's a flywheel effect of, BNY is showing up in the wealth tech space and delivering new solutions for us, we want to see what they have to do. So the network effect of that shouldn't be underestimated."
},
{
"speaker": "Robin Vince",
"content": "Betsy, let me double-click on it for one second as well because when we started on the Wove journey, and we announced it, as Dermot said, last year, it was initially really focused on that singular KPI of making advisors' lives easier. And so it was a technology front end that went from wealth planning and help clients with wealth planning all the way through to portfolio construction and then getting into market. Now what's evolved since then and what we talked a lot about this year, one year later in the Wove journey was the fact that now we have the opportunity to link all of these other BNY capabilities to be able to deliver to our Pershing and Wove clients. So you can be a clearing and custody client of Pershing, you can be an adviser taking advantage of that initial set of tooling from Wove, but what you can now also do is you can have that ability to manage and aggregate data, including across multiple custodians. We can connect you to models in the investment management space. By the way, we can fulfill those models because we've got active equity and indexing and all these capabilities that come from BNY investments. And so Wove is becoming a bit more of a delivery vehicle for the various capabilities of the firm and it's also opening the aperture of how clients of Pershing think about us in terms of our ability to solve other problems for them, banking-as-a-service which is a Treasury Services business. But we stimulate the conversation for that because people see us as being more than what we used to be in Pershing. We also, to your question, are attracting people who don't necessarily need the clearing and custody service, but who want to take advantage of these other components, which is why Dermot said both because it's both and delivering the breadth of ONE BNY."
},
{
"speaker": "Betsy Graseck",
"content": "Thanks, Robin."
},
{
"speaker": "Robin Vince",
"content": "Thank you, Betsy."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Mike Mayo with Wells Fargo Securities. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. Could you put a little more meat on the bones for the ONE BNY initiative in terms of products for customers where you're talking about more bundled solutions. Thematically, I understand it. And I guess you're having higher core servicing fees, but connecting from the higher core servicing fees from the high level, let's bundle, let's have everyone work together. I'm just trying to connect the dots a little more."
},
{
"speaker": "Robin Vince",
"content": "Understood, Mike. And you'd asked me a question, it’s probably about more than a year ago now, where you had essentially challenged the fact that in order for something like ONE BNY to be successful, it can't just be hearts and minds, it's got to be deeply operationalized. And we talked at that time about some of our future ambitions for how to really bring it home. So the way that I would now answer your question is, we are rallying around the three strategic pillars that Dermot and I both have talked about a bunch, and this is about being more for our clients. And that's not just words anymore. It's not just a movement. It's just appealing to our people to be able to do -- to be client-obsessed. It's about elevating the effectiveness of our sales organization and the process driving client service differently than we used to. It's about the innovative new products, as we were just talking about Wove, that's a good example. We are being more for clients in that example. And we are also delivering the whole of the company. So it is a great ONE BNY example. Pershing, which used to be somewhat off to the side in the company a few years back, now very much at the heart and benefiting from that integration with all of the other capabilities that we have. And then you hit on a critical word, which is solutions, because that next journey to use the term that Dermot used earlier on of meeting our clients where they are, it's not just about us selling a bunch of great products and client platforms to our clients, it's about the fact that when we look at the challenges that our clients have, they actually need things that cut across multiple parts of our company. And rather than going in disconnected and showing them individually and trying to have them piece it all together, we can now show up and we can actually show them these solutions which bring all the componentry together to solve their needs. And both Dermot and I talked a bit about that in our prepared remarks, and that's the next level of the maturity of that ONE BNY work that we're really doing. That's [involving] (ph) from an initiative and hearts and minds to making everything that we're doing in our commercial organization, the sales practices, the sales targets, the way that we're bringing people together, the account management process, the client service, the digital delivery of tooling and the way that we're thinking about everything that equips our salespeople to be effective across training, we're bringing all of those things together and maturing our commercial model. And over time, we think there's a lot of value both in the process and in what we're actually delivering to clients."
},
{
"speaker": "Mike Mayo",
"content": "And so when you wrap it all up, I mean, what wallet share do you have per customer today? Where was it a few years ago? Where do you hope that to go just in terms of a ZIP code of expectations?"
},
{
"speaker": "Robin Vince",
"content": "Got it. I think some of those metrics as we think about ways in which to show you that story more over time, some of those metrics will be in our future. Right now, I'm going to point you to two things. There are a whole bunch of inputs. I described a bunch of them. And I think over the course of the past couple of years, we've been trying to really show the key inputs, which we think are the leading indicators for performance. And then you have to actually look at the fee growth result, and you saw that in the first quarter. You've seen that in the second quarter, and that's some of the output. But the story that Dermot and I are trying to describe is a story of a maturing of a process, but with still a distance to go and opportunity ahead."
},
{
"speaker": "Dermot McDonogh",
"content": "Mike, just to put a metric on us, it's just to give an indication because we need to mature the metrics as we proceduralize all the strategic comments that Robin has just outlined. Year-over-year, the amount of business that we've won that touches more than one line of business has increased by a third of albeit a very low base. So I wouldn't draw too much into the metric, but just the fact that we are showing up in a different way and clients are buying products and services from more than one line of business because we can deliver integrated solutions. And that's the key that over time, we'll be able to track that and communicate that in a more objective way as that strategy takes root."
},
{
"speaker": "Mike Mayo",
"content": "Understood. So when all said and done, core servicing fees over time, whether it's aspiration or a specific target, where should core servicing fee growth be?"
},
{
"speaker": "Robin Vince",
"content": "My answer to that, which I recognize is a little bit unsatisfying, is we're going to keep pointing you back to the positive operating leverage, which is really how we're focusing for our own growth. We think that each quarter, each year has a different composition to it, but higher fee growth over time is a very important part of that combination of solutions. But any individual quarter or a year is going to have a different composition. We're controlling the things that we can control, albeit we're stoking the engine for growth of organic fees over time."
},
{
"speaker": "Mike Mayo",
"content": "Got it. Thank you."
},
{
"speaker": "Robin Vince",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Alex Blostein with Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Blostein",
"content": "Hi, good morning. Thanks for squeezing me in on this. I wanted to touch on expenses and operating leverage. So, expenses up a little bit year-to-date year-over-year. It sounds like you guys are still targeting flat expenses for the year despite the fact that revenues are obviously shaking out a little bit better than you hoped. So maybe kind of walk us through where you see the flex in the expense base to keep it kind of at that flattish run rate. But I guess more importantly, you guys had a target for pre-tax margin to be at 33% plus recently. You're doing 33% this quarter and obviously you don't want to get too carried away with a single quarter, but it feels like you have an ability to reset the bar. So maybe talk a little bit about what that plus within the 33% could look like a couple of years out?"
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks, Alex. So I guess I would start with the margin part of this. We need to consistently do it. And so one quarter doesn't a medium-term target make. So I'm very pleased that we've done this, but now I want to see it next quarter, the following quarter, the following quarter. So, execution is key. And just showing up in a very disciplined way every day is really important to delivering out that. We don't want to be known as a one-hit wonder. So while I'm pleased that we've managed to do it, I want to see it repeated on a consistent basis. So that's what I would say on margin. On expenses, you and I talked in Madrid a few weeks back at your conference. And I kind of said a little bit like we're in the ZIP code of flat for the year. It's all about running the company better. It's very important that we have 53,000 people wrapped around the same aspiration that we as a leadership team have and everybody is focused on doing it. So there is a real momentum on running the company better, which is the input to how we show up with expenses were being where they are as opposed to a top-down approach. So very different cultural experience within the firm in terms of how we're doing it. And the reason why we're a little bit above trend in the first couple of quarters this year is what I said to you at the conference is revenue-related expenses. And so I kind of anchor that in overall where we are for positive operating leverage in the year. And in my remarks, I kind of said I feel optimistic about delivering positive operating leverage for the year, which in a down 10% NII environment, BNY hasn't really executed to that level before. And so -- and also, Q2 is a seasonally strong quarter for us, which would feed the margin of 33%. So I feel good about expenses. I feel good about flat, notwithstanding there's pressure to that from a revenue-related expense part, but we're very determined to deliver positive operating leverage to our shareholders this year."
},
{
"speaker": "Alex Blostein",
"content": "Excellent. Great. Well, my second quick question around the balance sheet. There's a lot of discussion around deposits, but I wanted to zone in on the asset side of the balance sheet for a second. We've seen pretty nice growth from you guys in both the securities portfolio and loans sequentially. So could you just spend a minute on sort of the sources where you're investing and then your outlook in maybe deploying some of the liquidity that seems to be perhaps a bit more sticky into both loan growth and securities?"
},
{
"speaker": "Dermot McDonogh",
"content": "So yeah, look, very -- feel very proud of the CIO book team, what they've accomplished over the last couple of years, which is really from Q3 of '22. It really has been just a terrific collaboration with inside the firm. And we're deploying where we think we can see opportunity. Our CIO likes to use the word nibbling, and so we're kind of seeing where the next leg is, and we're deploying where we think we can see opportunity to continue to grow NII. So it's opportunistic at the moment, but we feel overall very good about that aspect of us. We're still rolling off the book into higher-yielding securities. We're picking up to 200 basis points, and so that's feeding NII. And then on loan growth, I think the GLS team is doing a really good job of getting very liquidity-friendly deposits, which allows us to extend credit to our clients. And I think we're showing up in a different way to our clients who are important to us and extending our balance sheet to them as they look to buy products in more than one line of business. So where we need the balance sheet to support business activities, that's what we're doing. And it's a kind of a -- it's a strategic tool in our kit for doing that."
},
{
"speaker": "Alex Blostein",
"content": "Awesome. Thanks very much."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Gerard Cassidy with RBC. Please go ahead."
},
{
"speaker": "Gerard Cassidy",
"content": "Good morning, Dermot. Good morning, Robin."
},
{
"speaker": "Robin Vince",
"content": "Morning, Gerard."
},
{
"speaker": "Gerard Cassidy",
"content": "Dermot, can you share with us, now that we're entering into a phase with monetary policy of quantitative tightening easing up a bit, you guys obviously have been through QE, you've seen the initial stages of QT, do you have any thoughts on how this could affect your balance sheet over the next 12 to 18 months? Have you guys done any type of modeling to see what kind of effect the QT as it shrinks could have on your balance sheet?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, we do a lot of work on that, Gerard. And look, CCAR forces us to do that work as well. And so rates up, rates down, quantitative tightening, quantitative easening. We look at it every which way to Sunday. But the thing that I would kind of remind you and everybody who's listening in is our balance sheet is one of our strengths. In -- this time last year, in Q1 of last year, we kind of -- we called our balance sheet a port in a storm for our clients and you see that fly to quality. So we're kind of very proud of our balance sheet. It's vanilla, it's liquid, it stands stress tests and it allows us to be there for our clients. So it's kind of -- it's short in duration. We repositioned it going into the higher-for-longer rate environment. As you will remember in Q4 of '22, we repositioned it. And so we've taken a lot of proactive steps to make our balance sheet durable and liquid and to withstand a wide range of scenarios."
},
{
"speaker": "Robin Vince",
"content": "And, Gerard, I'm just going to add that it's easy to think that just because at this very moment in time, we're looking out, there seems to be some greater consensus than we've had for a little while around what might happen with the Fed in the fall across September and the balance of the year. It's easy to think somehow that the range of risks has somehow narrowed as a result of that. But there's still a lot of uncertainty in the world. We've got all bunch of other types of geopolitical risks out in the world. We're sort of continuing to grind through elections that we've talked about through the course of the year. There are all sorts of other things happening. We've still got wars going on. And so our approach to all of these questions, and Dermot really made the point, is to be prepared for all the different types of outcomes that are possible. And so you can see us, we run conservative on liquidity, we run conservative on capital. You can see it in our ratios that we talked about and that Dermot outlined in his prepared remarks. And that's a very important anchor point for us so that we can be agile according to however things play out because the one thing we can be absolutely sure of is they won't play out exactly the way anybody expects."
},
{
"speaker": "Gerard Cassidy",
"content": "Very good. And then just as a follow-up, Robin, you talked about the new business wins in the quarter, and you talked about ONE BNY as well. It appears that you're having success in chipping down or breaking down some of the silos that many organizations always struggle with. Can you share with us some of the tools you're using to break those silos? And how -- I would assume you're not 100% complete breaking them all down, but how far along are you in actually breaking them down?"
},
{
"speaker": "Robin Vince",
"content": "Well, the company’s been around for 240 years, and we've acquired a lot of different businesses and companies over time. And so these things do build up over a period of time. But the short answer to your question is, we passionately believe as a whole leadership team that the answer to the question is culture. And so I've said before in a slightly pithy way and quoting other people or sort of paraphrasing them, if you will, that culture eats strategy for breakfast, as it was once famously said by Peter Drucker. And we add to that, execution eats strategy for lunch. That's just a long way of saying that the power our culture pillar, which is one of our three pillars, is the thing that's enabling us to run our company better. And that, in turn, is allowing us to be more for our clients. And so the trick to this for us has been investing in our people. It's been creating the benefits, the experiences, the employee experience, the pride, association with the company, the feedback loop that shows that when we do these things, we get better outcomes for our clients, and that translates into better outcomes in the bottom line. And so there's a flywheel effect here that actually builds on itself. And the spring in the step of our employees is now powering that forward, and that's what gives us confidence that we've really turned the corner on it. People want to throw in with the whole because they see that it's not only better for the company, it's actually better for their business because joining their products with other products around the company is allowing us to be more for clients. And it actually feels good to see the benefits in the ultimate results. So that's, for us, the North Star of how we're doing it. And while we've certainly got a distance to go, the early results have been pretty encouraging."
},
{
"speaker": "Gerard Cassidy",
"content": "Very good. Thank you."
},
{
"speaker": "Robin Vince",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is coming from Brian Bedell with Deutsche Bank. Please go ahead."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks. Good morning, guys. Great. Maybe if I could just come back to the -- sticking with the NII guide of down 10%. I'm having trouble getting there. The -- just to confirm, it sounds, Dermot, like what you're saying is it's really almost totally a deposit-driven guide on a seasonal basis. And I just wanted to sort of confirm that given how you've outlined the balance sheet sensitivity to different rate scenarios is pretty strong. And of course, you have the benefit of securities portfolio reinvestment. So is it really simply just the seasonal deposit dynamic? And then if you can just talk about how NIB is factored into that seasonal deposit dynamic. And then, of course, as you move into next year, in 1Q seasonally, of course, that we should be back positive again. I just want to confirm that."
},
{
"speaker": "Dermot McDonogh",
"content": "So, I guess, Brian, in the way you've asked the question, in some ways you've answered the question to yourself. So I will kind of confirm, a, how you're thinking about it in terms of the seasonal decline and it's a deposit story. And I would just kind of reference last year as the guide in terms of, in January of last year, we guided 20% for the year. And then we started out the gates well. And, you as a collective, put pressure on me to change the guidance, which I didn't do. And we ended the year at 24%. And so last year, we used the word skewed to the upside but humble about the fact of what lies in front of us. And I would say the percentages are different this year, the environment is different, but the sentiment is the same. I'm humble about what the outcome could be and uncertainty is -- can be -- is there because, as Robin said, for sure, what we think is going to happen is not going to happen. But I would say we're cautiously optimistic and your point is it is a deposit story. And within the deposit story, it really is the mix between NIBs and IBs."
},
{
"speaker": "Brian Bedell",
"content": "Right. Okay. Yeah. Fair enough there. And then maybe just back to the operating leverage dynamic, and this can be for both Dermot and Robin. Obviously, you're starting off really well with, like, 100 basis points plus of positive operating leverage as we move into the second half, notwithstanding market movements, that would obviously influence the fee revenue dynamic. But given the traction that you're showing sequentially in your core business growth and core business sales and, I guess, the fact that you've made these investments already, so I just wanted to get a sense of whether you feel like you're able to scale those investments in the second half. And obviously, with your flat operating expense guidance, it would seem that's the case. If the revenue does turn out to be better than expected from an organic growth perspective, would we see the expense base creep up a little bit notwithstanding, of course, you'd still generate positive leverage?"
},
{
"speaker": "Dermot McDonogh",
"content": "Okay. A lot of questions in that second question. So, I would say, like, when I talk to the teams, right, and this is quite -- you're kind of hitting on a very important point in that I really focus on running the company better, and then we kind of focus on the operating leverage, not expense as a means to an end. And if revenue-related expenses creep up, that we starve businesses of investments to solve for a flat number because that's what we said we were going to do. I think that's quite important. And it's important to get the balance right that investment and running the company better, it kind of is the same thing. And so that's a cultural transformation that's underway with all of our people. And so we really are focused on getting value for money. We spend a lot of money. We spend over $12.5 billion every year. And so we want to get the best value we can for that, and we do that in a number of different ways. So some of the investments that we've made over the last couple of years, we're beginning to see the scale impact in that. And you can see that in our most profitable segment, Market and Wealth Services. It's a mid-40s margin. We continue to invest at the margin, which is what you want to see from us. And we continue to digitize, we continue to automate, we continue to reduce manual process which ultimately will feed into headcount and better quality jobs for our folks and better careers. So, I think over time, if organic growth plays out, it will feed into a better outcome in operating leverage, not us just growing expenses because revenues are better."
},
{
"speaker": "Robin Vince",
"content": "And I just want to draw out one additional thing that Dermot said as well, Brian, which is we have a lot of work to do. There's no question about it. He used the term skew and slightly optimistic, but staying humble when it related to NII. This one is just about a lot of hard work and really focusing on this point about running the company better. But as a double-click into the way that we're thinking about it, if you look at the second quarter, I mean, we've talked a lot about the fact that it's been a seasonally strong quarter. But if you double-click into it, and the Market and Wealth Services point that Dermot just mentioned, that's an investment story because, as we've said, we're in a good spot on the pre-tax margin of that segment. So we just want more that's growth. We don't want to dilute the margin, but we're not trying to save expense dollars there. But in Securities Services and in Investment and Wealth, where we said there is, in fact, a margin journey that we have ahead of us, that's where you can actually see negative expenses in both of those segments for the quarter, which is a sign of the fact that we're both investing but we're doing even more discipline in those businesses. And so that's how the whole thing comes together for the company."
},
{
"speaker": "Brian Bedell",
"content": "Great. That’s great color. Thank you so much."
},
{
"speaker": "Operator",
"content": "And our final question is coming from Rajiv Bhatia with Morningstar. Please go ahead."
},
{
"speaker": "Rajiv Bhatia",
"content": "Yeah. There was some progress on the Investment and Wealth Management margin in the quarter. I guess my quick question is, are your margins different on the asset management side of the business versus the wealth management side? And do you have a timeline for getting back to that 25%-plus margin?"
},
{
"speaker": "Dermot McDonogh",
"content": "So I don't think we kind of get into the detail of the split between the two. And so the segment overall, I guess, we've said over the last several quarters, we believe we can go back to the 25% margin over a period of a few years. And, like, just to follow on from Robin's answer to the last question, we've shown, I think, good expense discipline over the last 12 months in terms of, okay, revenues have been a little bit challenged in the segment due to a variety of reasons, and we've taken tough decisions. And so that's allowed us to grow the margin by 200 basis points over the last year, which really is kind of the financial discipline [about it] (ph). And we do believe where we are now with distribution as a platform, very, very strong performance in fixed income and LDI and Insight, that the momentum is there within the segment to grow. And as Robin said, the addition of Jose to the leadership team joining in September, giving his fresh perspective, gives us confidence about what we can do in the future."
},
{
"speaker": "Rajiv Bhatia",
"content": "Got it. Thanks."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Rajiv."
},
{
"speaker": "Operator",
"content": "This concludes today's question-and-answer session. At this time, I will turn the conference back to Robin for additional or closing remarks."
},
{
"speaker": "Robin Vince",
"content": "Thank you, operator, and thanks, everyone, for your time today. We certainly appreciate your interest in BNY. If you have any follow-up questions, please reach out to Marius and the IR team. Be well and enjoy the balance of the summer."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today's conference call and webcast. A replay of this conference call and webcast will be available on the BNY Investor Relations website at 2:00 p.m. Eastern Standard Time today. Have a great day."
}
] |
bk | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to the 2024 First Quarter Earnings Conference Call hosted by BNY Mellon. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference call and webcast will be recorded and will consist of copyrighted material. You may not record or re-broadcast these materials without BNY Mellon's consent. I will now turn the call over to Marius Merz, BNY Mellon’s, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Marius Merz",
"content": "Thank you, operator. Good morning everyone, and thanks for joining us. I'm here with Robin Vince, President and Chief Executive Officer, and Dermot McDonogh, our Chief Financial Officer. As always, we will reference our financial highlights presentation, which can be found on the Investor Relations page of our website at bnymellon.com. And I'll note that our remarks will contain forward-looking statements and non-GAAP measures. Actual results may differ materially from those projected in the forward-looking statements. Information about these statements and non-GAAP measures are available in the earnings press release, financial supplement and financial highlights presentation, all available on the investor relations page of our website. Forward-looking statements made on this call speak only as of today, April 16, 2024, and will not be updated. With that, I will turn it over to Robin."
},
{
"speaker": "Robin Vince",
"content": "Thanks Marius, and thank you everyone for joining us this morning. Dermot will talk you through the financials in a moment, but in summary, BNY Mellon is off to an encouraging start for the year. The firm delivered solid financial performance, while we continued to take important steps in the deliberate transformation of our company. And we're seeing early signs of progress that give us confidence, as we work toward the opportunity ahead. Looking beyond BNY Mellon, the first three months of the year provided a mostly constructive operating environment with global markets signaling expectations for continued growth. Equity and credit markets rallied, even as rate cut expectations partially unwound and bond yields rose. Foreign exchange markets, on the other hand, saw a continuation of the relatively low volumes and muted volatility that we've now seen for the past several quarters. And of course, there are many tail risks, including a variety of different market scenarios, the possibility of escalation in one of the ongoing geopolitical conflicts or an unexpected result in the many elections taking place worldwide this year. As I've said many times before, being resilient matters and this represents a commercial strength for our business. We are constantly preparing and positioning for a wide range of potential scenarios to support our clients and deliver compelling outcomes for our shareholders. Now referring to page two of the financial highlights’ presentation. BNY Mellon delivered double-digit EPS growth as well as pre-tax margin and ROTCE expansion on the back of positive operating leverage in the first quarter. We reported earnings per share of $1.25 up 11% year-over-year, and excluding notable items, earnings per share of $1.29 were up 14%. Total revenue of $4.5 billion was up 3% year-over-year. That included 8% growth in investment services fees, led by strength in asset servicing, issuer services, and clearance and collateral management, which more than offset revenue headwinds from muted volatility in FX markets and lower net interest income. Expenses of $3.2 billion were up 2% year-over-year and up 1% excluding notable items. Consistent with our goal to generate at least some operating leverage this year, in the first quarter, we did deliver positive operating leverage, both on a reported basis and excluding notable items. Our reported pre-tax margin was 29% or 30% excluding notable items, and we generated a 21% return on tangible common equity. Our balance sheet remains strong with capital and liquidity ratios in-line with our management targets and deposit balances were up both year-over-year and sequentially. Year-to-date, we returned close to 140% of earnings to common shareholders through dividends and buybacks, and our Board of Directors has authorized a new $6 billion share repurchase program. On our last earnings call in January, we communicated medium-term financial targets and presented our plan to improve BNY Mellon's financial performance. We framed this work for our people through three strategic pillars. Be more for our clients, run our company better, and power our culture. Throughout the first quarter, we've made progress to be more for our clients, including both product innovation and greater intensity around better delivering our platforms to the market so we can truly help clients achieve their ambitions. As a global financial services company, our unique portfolio of market-leading and complementary businesses presents a tremendous additional value for our clients and shareholders. As you know, we are maturing our ONE BNY Mellon initiative by implementing this mentality into the nuts and bolts processes across the company. For example, we recently announced that Ashton Thomas Securities, an independent broker dealer and registered investment advisor, will use clearing and custody services from Pershing and BNY Mellon precision direct indexing capabilities from investment management. This is a great example of multiple lines of business working together to provide holistic solutions for clients. As we continue to grow our client roster, we also know that delivering more to our existing clients represents a significant opportunity. As another example, last month we expanded on a long-standing relationship with CIFC, an alternative credit specialist and existing client of ours in asset servicing and corporate trust to bring their US direct lending strategy onto our global distribution platform. This also speaks to the incremental value that asset servicing can bring to our asset manager clients, by allowing them to tap into BNY Mellon's global distribution platform to extend the reach of their capabilities. Consistent with our previously communicated intention to grow the revenue contribution of our market and wealth services segment, we're starting to see our investments to accelerate revenue growth in this high margin segment begin to bear fruit. For example, we continue to be encouraged by the level of interest from both new and existing clients in our Wove, Wealth Advisory Platform. We have several clients live on the platform today. We closed a number of deals in the first quarter, and the sales pipeline continues to be strong. Across market and wealth services, we also continue to bring new solutions to the market. For example, Treasury Services successfully launched virtual account-based solutions, a set of cash management solutions to meet our clients' demands for more flexibility and transparency into their payment flows. Next, we are taking important steps to run our company better by simplifying processes, powering our platforms, and embracing new technologies. Over the past several months, we've been working to realign several similar products and services across our lines of business. The largest of these changes was moving institutional solutions from Pershing to our Clearance and Collateral Management business. This is also part of making progress toward adopting a platform's operating model. By uniting related capabilities, we can do things in one place, do them well, and elevate overall execution to better serve our clients and drive growth. Last month, we went live with the first step on the transition into our new model. While it has taken and will continue to take a lot of hard work as we transform our operating model over time. We are confident this new way of working will create better outcomes for our clients and it will also create more efficiency and enhanced risk management. Around 15% of our people around the world are now working in our new operating model, allowing them to feel more connected to what we're doing and empowered to make change. I'd like to thank our teams who are part of this exciting change for pushing us forward as we mark this important milestone. We also see meaningful opportunity over the coming years from continued digitization and re-engineering initiatives, as well as from embracing new technologies. To support this effort, we are making deliberate investments, enabling us to scale AI technologies across the organization through our enterprise AI hub. Last month, Nvidia announced that BNY Mellon became the first major bank to deploy a DGX SuperPOD, which will accelerate our processing capacity to innovate, reduce risk, and launch AI-enabled capabilities. Our people have identified hundreds of use cases across BNY Mellon, and we already have several in production today. Across the company, it's our people who continue to power our culture. If you were to walk the halls of BNY Mellon, you'd feel the energy and sense of purpose our leadership team feels when we visit our teams around the world. To that end, we're investing in our people. Over the past several months, we launched new learning and feedback platforms powered by AI, expanded employee benefits, launched a new well-being support program, improved and accelerated our year-end feedback and compensation processes, and more. And we're delighted to welcome Shannon Hobbs, who will join us as our new Chief People Officer in June. As we continue to power our culture forward, we adopted the following five core principles to guide how our teams work and collaborate as we drive our success as a company. The client obsessed, spark progress, own it, stay curious and thrive together. To wrap up, our performance in the first quarter provides a glimpse of BNY Mellon's potential. Running our company better, inclusive of our focus on platforms, is enabling us to improve profitability and invest in our future. While we are pleased to see early signs of progress, we remain focused on the significant work ahead of us, as we become more for our clients and deliver higher performance for our shareholders. As I have said before, the transformation of our company is a multi-year endeavor but we've started 2024, the year of our 240th anniversary, with a sense of excitement and determination around what's possible. Now over to you, Dermot."
},
{
"speaker": "Dermot McDonogh",
"content": "Thank you, Robin, and good morning everyone. Referring to Page 3 of the presentation, I'll start with our consolidated financial results for the quarter. Total revenue of $4.5 billion was up 3% year-over-year. Fee revenue was up 5%. This reflects 8% growth in investment services fees on the back of higher market values, increased client activity and net new business, partially offset by a 14% decline in foreign exchange revenue, as a result of lower market volatility. Firm-wide assets under custody and our administration of $48.8 trillion were up 5% year-over-year, and assets under management of $2 trillion were up 6% year-over-year, both largely reflecting higher market values. Investment and other revenue was $182 million in the quarter. Effective January 1, we adopted new accounting guidance for our investments in renewable energy projects resulting in an approximately $50 million increase to investment and other revenue. We have restated prior periods in our earnings materials to provide you with like-for-like, year-over-year and sequential comparisons. The adoption of this new accounting guidance is largely neutral to net income and earnings per share, as the increase in provision for income taxes roughly equals the increase in investment and other revenue. Net interest income decreased by 8% year-over-year, primarily reflecting changes in the composition of deposits, partially offset by the impact of higher interest rates. Expenses were up 2% year-over-year on a reported basis and up 1% excluding notable items, primarily severance expense. Growth was from incremental investments and employee merit increases offset by efficiency savings. Provision for credit losses was $27 million in the quarter, primarily driven by reserve increases related to commercial real estate exposure. As Robin mentioned earlier, we reported earnings per share of a $1.25 up 11% year-over-year, a pre-tax margin of 29% and a return on tangible common equity of 20.7%. Excluding notable items, earnings per share were $1.29, up 14% year-over-year. Pre-tax margin was 30%, and our return on tangible common equity was 21.3%. Turning to capital and liquidity on Page 4. Our tier 1 leverage ratio for the quarter was 5.9%. Average assets increased by 1% sequentially, as deposit balances grew. And tier 1 capital decreased by 1% sequentially, primarily reflecting capital return to common shareholders partially offset by capital generated through earnings. Our CET1 ratio at the end of the quarter was 10.8%. The quarter-over-quarter decline reflects a temporary increase in risk-weighted assets at the end of the quarter, which was driven by discrete overdrafts in our custody and securities clearing businesses, as well as strong demand for our agency securities lending program. Consistent with tier 1 capital, CET1 capital decreased by 1% sequentially. Over the course of the quarter, we returned $1.3 billion of capital to our shareholders, representing a total payout ratio of 138%. Turning to liquidity. Our regulatory ratios remained strong. The consolidated liquidity coverage ratio was 117% flat sequentially. And our consolidated net stable funding ratio was 136% up 1 percentage point sequentially. Moving on to net interest income and the underlying balance sheet trends on Page 5. Net interest income of over $1 billion was down 8% year-over-year and down 6% quarter-over-quarter. The sequential decrease was primarily driven by changes in the composition of deposits, partially offset by the benefit of reinvesting maturing fixed rate securities [and] (ph) higher yielding alternatives. Against typical seasonal patterns, average deposit balances increased by 2% sequentially. Solid 4% growth in interest bearing deposits was partially offset by a 5% decline in non-interest bearing deposits which was in-line with our expectations. Average interest earning assets were up 1% quarter-over-quarter. We reduced our cash and reverse repo balances by 2% and increased our investment securities portfolio by 5%. Average loan balances remained flat. Turning to our business segments starting on Page 6, please remember that in the first quarter we made certain realignments of similar products and services across our lines of business, consistent with our work to operate as a more unified company. As Robin mentioned earlier, the largest change was the movement of institutional solutions from Pershing to Clearance and Collateral Management both in the Market and Wealth Services segment. And we made other smaller changes across our business segments. We have restated prior periods for consistency. Please refer to the revised financial supplement that we filed on March 26th for detailed reconciliations to previous disclosures. Now, starting with Security Services on Page 6. Security services reported total revenue of $2.1 billion, up 1% year-over-year. Investment services fees were up 8% year-over-year. In asset servicing, investment services fees were up 8%, driven by higher market values, net new business and higher client activity. We've remained focused on deal margins, and as a result the year-over-year impact of repricing on fee growth was de-minimis. Consistent with past quarters, we continue to see particular success with our ETF offering. ETF assets under custody and/or administration surpassed $2 trillion this quarter up over 40% year-over-year on the back of higher market values, net new business and client flows, and the number of funds serviced was up 16% year-over-year. While the pace of alternative fund launches was slower than in the prior year quarter, investment services fees for alternatives were up over 10% on a year-over-year basis. Throughout the quarter, we saw broad-based strength across client segments, products and regions. In issuer services, investment services fees were up 11% reflecting net new business across both depository receipts and corporate trust, as well as higher cancellation fees in depository receipts. Foreign exchange revenue was down 11% year-over-year and net interest income was down 12%. Expenses of $1.5 billion were flat year-over-year, reflecting incremental investments, as well as the impact of employee merit increases offset by efficiency savings. Pre-tax income was $591 million, a 4% increase year-over-year, and pre-tax margin expanded to 28%. Next, Market and Wealth Services on Page 7. Market and Wealth Services reported total revenue of $1.5 billion, up 3% year-over-year. Total investment services fees were up 7% year-over-year. In Pershing, investment services fees were up 3%, reflecting higher market values and client activity, partially offset by the impact of business lost in the prior year. Net new assets were negative $2 billion for the quarter, reflecting the ongoing deconversion of the before-mentioned lost business. Client demand for our Wealth Advisor platform, Wove, continues to be strong. In the first quarter, we signed nine additional client agreements, including our first direct indexing clients, and we onboarded four clients onto the platform. In treasury services, investment services fees increased by 5%, driven by net new business. We continue to invest in our sales and service teams, new products and technology. And so we are pleased with this solid growth and momentum continues to build. Last but not least, strength in clearance and collateral management continued with investment services fees of 13% on the back of broad-based growth both in the US and internationally. Net interest income for the segment overall was down 7% year-over-year. Expenses of $834 million were up 7% year-over-year, reflecting incremental investments, revenue-related expenses, and employee merit increases, partially offset by efficiency savings. Pre-tax income was down 2% year-over-year at $678 million, representing a 45% pre-tax margin. Moving on to Investment and Wealth Management on Page 8. Investment and Wealth Management reported total revenue of $846 million, up 2% year-over-year. In Investment Management, revenue was up 2% driven by higher market values partially offset by the mix of AUM flows and lower performance fees. In our wealth management business, revenue also increased by 2%, driven by higher market values, partially offset by changes in product mix and lower net interest income. Expenses of $740 million were flat year-over-year, primarily reflecting the impact of incremental investments and employee merit increases, which was offset by efficiency savings. Pre-tax income was $107 million, up 15% year-over-year, representing a pre-tax margin of 13%. As I mentioned earlier, assets under management of $2 trillion increased by 6% year-over-year. In the quarter, we saw $16 billion of net inflows into our long-term active strategies with strength in LDI and fixed income. And we saw $15 billion of net outflows from index strategies. Strength in our short-term cash strategies continued with $16 billion of net inflows on the back of differentiated investment performance in our [drivers] (ph) money market fund complex. Wealth management client assets of $309 billion increased by 11% year-over-year, reflecting higher equity market values and cumulative net inflows. Page 9 shows the results of the other segments. I will close by reiterating our existing outlook for the full year 2024. As I've said before, we have positioned our balance sheet for a range of interest rate scenarios and we're managing both sides of it proactively. And so, despite the repricing of the curve since the beginning of the year, we continue to expect net interest income for the full year to be down 10% year-over-year, assuming current market implied interest rates for the remainder of 2024. Similarly, on expenses, our goal continues to be for full year 2024 expenses excluding notable items to be flat year-over-year. We are off to a good start, but we have more work ahead of us to realize further efficiency savings and drive year-over-year expense growth rates lower over the coming quarters, while we continue to make room for additional investments across our businesses. Overall, we remain determined to deliver some positive operating leverage this year. While we don't manage the firm to operating leverage on a quarterly basis, our performance in the first quarter with positive operating leverage on both a reported and an operating basis gives us confidence that we're on track. In light of the adoption of the new accounting guidance for our investments in renewable energy projects, which, as I discussed earlier, increases both our investment and other revenue, and the provision for income taxes. I'll note that we expect our effective tax rate for the full year 2024 to be between 23% and 24%. And finally, we continue to expect returning 100% or more of 2024 earnings to our shareholders through dividends and buybacks over the course of the year. As always, we will manage share repurchases cognizant of the macroeconomic environment, balance sheet size and many other factors. And so for the foreseeable future, we will calibrate the pace of buybacks to maintain our tier 1 leverage ratio close to the top end of our 5.5% to 6% medium-term target range. To wrap up, over the past three months, we've made good progress towards achieving our target for 2024. And we're encouraged by the drive we're seeing in all corners of the firm, as our people embrace being more for our clients, running our company better and powering our culture. With that operator, can you please open the line for Q&A?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Alex Blostein with Goldman Sachs. Please go ahead."
},
{
"speaker": "Alex Blostein",
"content": "Hi, good morning. Thanks for the question. So Robin, really nice progress I guess on organic growth initiatives across a handful of businesses underneath BNY Mellon, as some of the things you talked about are starting to kind of take hold. Can you maybe frame what the firm's organic growth rate aspirations are for the next couple of years? How are you thinking about that for 2024 as well? And then as a side question I guess to that, we've seen quite significant amount of activity in sort of Clearance and Collateral Management. Can -- you maybe help size what is sort of transitory versus more of a recurrent baseline to think about from here. Thanks."
},
{
"speaker": "Robin Vince",
"content": "Sure, Alex. Good morning. So, let me start with the growth question. As you point out, we are quite -- feeling quite good about the early momentum that we have in growth. As you know, we set it out last year to really get our house in order, generate positive operating leverage and really think about the various different investments to drive sort of shorter, medium and longer-term growth. And that's really what we've been focused on and we're pleased that we've got a good start to the year on it. Clearly, we're trying to control the things that we can control. As I mentioned in my prepared remarks and as Dermot touched on as well, our focus here has really been wrapped around being more for our clients, our commercial model. We hired our first Chief Commercial Officer. We're operationalizing One BNY Mellon, as I called it, the nuts and bolts, kind of getting into building that into our client coverage organization, our coverage practice, starting to deliver integrated solutions. I gave a couple of examples of those in my prepared remarks. And we've got a whole bunch more things that really cut across all of the different segments that are related to that. So look, it's early in the journey. I would have said maybe last year we were working the problem. I think now I would say we're working the opportunity. Could you just remind me the second part of your question?"
},
{
"speaker": "Alex Blostein",
"content": "Yeah, sure. Really nice results out of Clearance to Collateral Management for the firm and it's been a pretty active market in Q1, related to treasury issuance and activity there broadly. I'm just trying to get a sense for a better baseline to think about from here. Was there anything kind of transitory in the first quarter that helped the numbers or this is a good baseline to think about going forward."
},
{
"speaker": "Robin Vince",
"content": "Look, I would say in terms of transitory, not really, but let me just go through a few of the drivers. So remember that it's a business that like several of the businesses we have, respond to volumes and it was an active quarter when it comes to trading volumes in the US Treasury market. Now for better or for worse, US Treasuries is kind of a growth business and so that's probably a bit more of a secular tailwind, as opposed to something cyclical. And then remember under the hood in Clearance and Collateral Management, we've also been investing in the operating model of that business as we talked about in our prepared remarks and took something that was very, very adjacent to our Clearing business from Pershing institutional clearing and aligned it with the rest of our clearing -- bigger clearing business in Clearance and Collateral Management. And what we're finding now in those conversations with customers, it's a much cleaner conversation because we've got the ability to deliver all the solutions in our clearing business whether it's US Treasuries, whether it's international, whether it's the different models of clearing that we offer we're able to deliver that in one conversation with a client, and clients are responding to that. So I would call that secular as well."
},
{
"speaker": "Alex Blostein",
"content": "Great. Thanks so much. I'll hop back in the queue."
},
{
"speaker": "Robin Vince",
"content": "Thanks Alex."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Steven Chubak from Wolfe Research. Please go ahead."
},
{
"speaker": "Steven Chubak",
"content": "Hi. Good morning, Robin. Good morning, Dermot."
},
{
"speaker": "Robin Vince",
"content": "Good morning, Steven."
},
{
"speaker": "Steven Chubak",
"content": "So I want to start with a question on capital, a bit of a two-parter, if you will. I was hoping you could just speak to the drivers of RWA growth in 1Q, which was fairly robust, where you're seeing attractive opportunities to deploy that excess capital. And just -- how we should be thinking about the cadence of the buyback. You alluded to this somewhat, Dermot, but I was hoping we could drill down into -- you noted the 6% target or that upper bound on tier 1 leverage is, how should we be thinking about the cadence of buyback in light of planned balance sheet actions and growth potential."
},
{
"speaker": "Dermot McDonogh",
"content": "Okay, I'll take that one. Steven, good morning. So some of the capital increase, there are two parts to the RWA increase, one was a kind of temporary increase around quarter end, as it relates to discrete overdrafts in custody and securities clearing businesses. So that kind of come and gone. And then there was also -- there was strong demand for our agency securities lending program throughout the quarter and particularly leading up to quarter end and that's continued into this quarter. So I would say, half of it was that and half of it was temporary. As it relates to the buyback, I guess there's a little bit of a Groundhog Day here in terms of how we thought about a Q1 of last year versus how we're thinking about a Q1 of this year. Both quarters, we got off to a strong start. But look at there -- there's a lot of rate volatility out there in the market. You've seen the backup in rates last week with the hot inflation report. Last year it was the war in Ukraine, this year it's the geopolitics in the Middle East. And so we kind of gave a guidance in January where we said we were going to be 100% more of earnings throughout the year. We don't give quarter-by-quarter guidance. I would reiterate the guidance of 100% or more, notwithstanding the fact Q1 was very good at 138%. I wouldn't expect that pace to continue, but we'll take it quarter-by-quarter."
},
{
"speaker": "Steven Chubak",
"content": "Understood. And for my follow-up, maybe just drilling down into the investment and wealth margins, in particular, since across the other segments, we're seeing continued progress towards the longer-term targets. That's admittedly the segment with the biggest shortfall. I know in the prepared remarks, Dermot, you noted that you're making investments in the business and just wanted to better understand, one where are those dollars getting deployed? And maybe if you could just speak to the primary drivers underpinning that glide path to 25%. How much is contingent on revenue growth versus expense optimization?"
},
{
"speaker": "Dermot McDonogh",
"content": "Okay, so the first point would be pre-tax margin for the Q1 there was around 13%. If you normalize that for typical seasonal volatility in terms of retirement eligible stock and such, like, if you back that out and adjust it, the margin would have been somewhere in the 16% zip code. So we feel pretty good about that. Still a ton of work to do. And I would say, it's not one thing over the other, it depends on which part of the business you're talking about. In some of our asset managers, we're investing, we're launching new products. Clients, in some places, continue to de-risk and move from more risk on equity to passive fixed income. But in other cases, we see clients coming in and AUM growing. We saw -- we were very pleased with the performance of our drive with cash management business in Q1, where we saw strong inflows and the performance of the business in terms of returns was -- first quarter, so we feel very good about that. So we are investing the business to give our clients good products to invest in. The flip side is, we still believe as it relates to running the company better and desiloing the firm and connecting asset management to the broader enterprise, there's a lot of opportunity there. And at the same time as the opportunity, it allows us to take costs out and become a lot more efficient. So I would say we're working both sides of us. We see more opportunity on the revenue side, and we're working the problem on the efficiency side."
},
{
"speaker": "Steven Chubak",
"content": "Very helpful, color. Thanks so much for taking my questions."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Betsy Graseck with Morgan Stanley. Please go ahead."
},
{
"speaker": "Betsy Graseck",
"content": "Hi. I had two questions. One was just on the AI commentary that you were leading with in the prepared remarks and I wanted to understand how you're thinking about the benefits to the expense ratio and the time frame with which this is going to flow through? Because there's clearly revenue enhancing opportunities and expense reducing or flattening. And how much of this AI investment is, how important is it to your 2024 expense outlook. And yeah, if you could give us the medium-term outlook, that'd be helpful, thanks."
},
{
"speaker": "Robin Vince",
"content": "Sure, hi Betsy. First of all, it's great to have you on the call. Really glad to have you back and to know that you're doing well."
},
{
"speaker": "Betsy Graseck",
"content": "Thanks so much."
},
{
"speaker": "Robin Vince",
"content": "So on the AI, I'll start with the sort of the latter part of your question, which is I really don't think this is a 2024 story. Of course, we're doing things in 2024. But if you ask me to try to put a pin in where the real benefits and sort of tailwinds kick in, I'm actually going to say it's not even necessarily a 2025 story, although maybe we'll see a little bit in ‘25. I think this is a ‘26 and on out benefit on the expense line. But let me go back to the sort of the premise of your question and just sort of briefly mention how we're embracing it, so I'll put it actually through the three pillars that we've laid out in terms of -- the guiding so much of what we're doing in the company. So first, being more for our clients, we think there are solutions out there for clients that are going to help them make better decisions, see risks, be able to be more efficient themselves. We've got software in market today doing that with predictive trade analytics around fails and settlements, allowing clients to be able to look out and to see and take evasive action essentially on potential fails. And by the way, some of those actions involve using other parts of the BNY Mellon platforms in order to be able to improve their businesses. And so that's an interesting example and there are going to be a lot more of those. Under the heading of running our company better this is going to be about streamlining business processes, productivity, figuring out and seeing anomalies that we can see, code assistant, as so many people talk about for our developers. I was walking around one of our buildings the other day, talking to one of our developers. They've been out of school for a year and change and already they think that 25% more productive as a developer and that's in the very early days of using GitHub Copilot. So that's going to be -- there's going to be more there -- and that ultimately is going to create efficiencies for us. And then under the culture heading, which is very important, we want AI to empower our people to be able to go out and be able to be more efficient in terms of what they're doing. And there are any number of different examples of things over time that we think AI is going to be able to help with us. Now importantly in this -- is the way in which we're doing it. Both Dermot and I talked about platforms and another concept in our platform strategy is to create these hubs, these centers of excellence. And in AI that's particularly important. We do not want to repeat the problems we've had in the past of having everyone go off in their own direction. And actually in AI, it's particularly important because problem statements that sound different can in fact have very common root causes. So you might want to be able to respond to an RFP. You might want to generate summaries of documents. You might want to be able to get a head start on a research report. But actually, when you look under the heading, those three things sound different. But the AI that's actually powering them, some of the -- sort of mini platforms that are required are very, very similar. So we're using our AI hub to collect these different use cases and then be able to sort of deliver solutions and many AI platforms that can then be used in multiple places around the company. So we're excited about this. We think it's going to be very significant over time, but it's not a 2024 story."
},
{
"speaker": "Betsy Graseck",
"content": "Okay, got it. That's super helpful with the color. Appreciate that. And then just a follow up on the tax rate guidance. This is part of the accounting change, I believe, is that right? And can you tell us where in the [PPOP] (ph) the offsets are, thanks?"
},
{
"speaker": "Robin Vince",
"content": "Sorry, I missed the last part of it, Betsy. Where are the --."
},
{
"speaker": "Betsy Graseck",
"content": "Offsets -- there's the offsets, right, to the tax -- the taxes impacted by the accounting change, is that right?"
},
{
"speaker": "Robin Vince",
"content": "Yeah, so it's economically it's net neutral for the firm. It's just a gross up in revenue which will show up in the interest and other revenue line and then the offset to that is in the tax line. And we filed an 8-K, a couple of weeks ago where we restated all the prior periods for comparison so that people will see it on a consistent basis going forward."
},
{
"speaker": "Betsy Graseck",
"content": "Sure, I just wanted to highlight that your tax rate guide has the offsets in the revenue. So I appreciate that. Thank you."
},
{
"speaker": "Robin Vince",
"content": "Yeah."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Ebrahim Poonawala with Bank of America Securities. Please go ahead."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Thank you good morning."
},
{
"speaker": "Robin Vince",
"content": "Good morning Ebrahim."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Yes, I guess, not sure Dermot if this was addressed here but in terms of your outlook on deposits, I think the period ends, so a pretty big uptick to $309 billion. Just give us a sense of, within your NII guidance, one what are you assuming in terms of deposit balances? And secondly, if the forward curve holds, is the next inflection on NII and margin higher or lower? Yeah, thank you."
},
{
"speaker": "Dermot McDonogh",
"content": "So, as at the quarter end, Ebrahim, I think the spot number was around $310 billion of deposits. And that was largely, you may recall that quarter end this year fell on a good Friday where markets were closed. So we got a lot of clients putting cash in, so that they could make certain payments. And so we saw a kind of surge in deposits over the last few days of the quarter. And they've largely left the system now. We've returned to more normal levels, which is in the kind of high [270 range] (ph). So that's kind of really the explanation for the spot deposit balance versus the average trend. So sequentially, we're down 6% in the deposits, or NII, an 8% year-over-year. And we saw a 2% growth in the deposit balance, generally speaking. Our guide at the beginning of the year was down 10% and given the rate volatility and what's going on with the inflation report last week and the back-up in rates et cetera, et cetera, we don't see, you know, there's nothing that's causing us to think that we should change our guidance between now and the balance of the year. We're very neutrally positioned, as to whether rates go up a little bit from here or down a little bit from here. And we feel very good about the overall guidance that we gave in January, which was approximately down 10%."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Got it. And I guess one just follow up in terms of some of the actions you took in moving businesses in Pershing. As we think about the strategic review, I guess Robin, maybe it began a year ago or longer than that, give us a sense of in terms of the franchise positioning, how the businesses are talking to each other and if they are in the right place within the enterprise. Is all of that done? How close are you to getting the franchise synced up in terms of what is coming along with regards to what you want to achieve in terms of client synergies? Thank you."
},
{
"speaker": "Robin Vince",
"content": "So the punch line is we're making good progress, but you're essentially asking a cultural question and we're not done on that. So when we did, to go back to your point, when we did our original strategy reviews, which is 18 months or so ago now, and took us a few months to go through, we were really focused on answering the questions of what are we doing, are we doing the right things, how are we doing them, are we doing them in the right way, do we have the right people doing them, and so we looked at that and we certainly found bits of the company that were just in the wrong place and so we've lifted those bits up and we put them in what we now think of the right place so that's what both Dermot and I talked about in our prepared remarks and that was what some of the restatement of prior periods so that you could make the easier comparisons there was about. That was basic blocking and tackling but the bigger opportunity for sure is how the businesses work together, not only to be more for clients by saying, hey, that client over there is a client, but they're not my client in my business, can we work together to basically make them a client of both businesses? That's very significant. That's where we talk about maturing One BNY Mellon into the real heart of a new commercial coverage model and that's being driven by our Chief Commercial Officer. Another part of this is saying, there are things that we used to think of as standalone capabilities, some might call them products, we think about them as client platforms. And in fact, what the client is asking for, and we really heard this when we did our voice of client survey, they don't want these individual products, they want us to take them and weave them together to create solutions for them that are on point to their needs. And so we've also started to do that, and I mentioned some examples of that, and that's a very powerful thing because that takes the breadth of our company, and rather than it being siloed, which is getting in the way of solutions, it's now actually ending up being the opportunity for us to deliver from the breadth of our platforms to our clients with solutions that frankly some other people aren't going to be able to do. So that's we think very exciting and in those journeys, we're still relatively early and that is cultural and we've been doing a lot of things internally in the firm to make sure that our people are lined up behind that. It's early days, but we're quite excited about the direction of travel."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Got it. Thank you both."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Brennan Hawken with UBS. Please go ahead."
},
{
"speaker": "Brennan Hawken",
"content": "Good morning. Thanks for taking my questions. I'd like to start, Dermot, when you were walking through Pershing, I believe you talked about the offboarding and the impact of how that was weighing on the net new assets. Could you give us a update on how far we are along in that off-boarding process and how much we should continue to expect for the rest of the year? And then also LPL recently announced the acquisition of Atria, which I understand was a Pershing client, and they're planning to consolidate those operations in 2025. So is that going to extend maybe some of the headwinds that we're seeing from some of these idiosyncratic off-boardings?"
},
{
"speaker": "Dermot McDonogh",
"content": "Okay, thanks for the question. So the first thing I would say about Pershing in the context of the overall kind of the segment. With respect to Pershing, we continue to invest in Pershing. Pershing continues to grow. As we said since the deconversion was announced, we're going to earn our way out of this situation. That's what's happening. So -- we still as a business feel very good about Pershing and our ability -- it's a market that's growing in mid-single digits on an annual basis and we're a big player in that market. So we're going to win our shares. So while the deconversion was unfortunate, we continue to march on and we learn our way out. Specifically, I would say, we'll be largely done with the deconversion by Q3 of this year. And as it relates to the second part, I would say look we're in a competitive market, people are going to do things the LPL Atria thing it's not a particular headwind, it's not been highlighted to me, it's not hit my radar in terms of oh my gosh, we need to worry about that. And so I think we're winning more than we're losing and we're investing and that's really going well. And when you take it in the context of what's going on with Wove, we're building a strong pipeline there. The backlog is looking good. We've added nine clients to the platform in Q1 of this year, and we made a commitment to the market that we would kind of add $30 million to $40 million of revenue this year, and we still feel very good about that guidance and that commitment that we made to you back in January."
},
{
"speaker": "Robin Vince",
"content": "And Brennan, I just add on the business front to that, which is remember that when we look at a deconversion, for sure those happen, and the one that you're referring to, the original one was a larger one. But we're also growing with our clients. Our clients are growing with us and we also are on the receiving end of roll-ups as well. Our clients are quite acquisitive and we have a couple of clients who've been doing acquisitions and we have some of our largest clients who are growing very significantly and very healthily. So it's always unfortunate when there's a roll-up that goes against us, but when there are roll-ups that go with our clients, those things balance out to some extent which is why Dermot makes the point about overall, we still feel quite enthusiastic about the net new assets growth over time."
},
{
"speaker": "Brennan Hawken",
"content": "Great thanks for that color And then when we think about the deposits, I'm trying to think about really, Dermot, the fact that here we are one quarter in. I get it -- you maybe don't want to update expectations. But it seems like, based on what we've seen so far, deposit trends seem to be doing better than expected. We saw a pick-up in the deposit balances at year-end. They sustained, which is a little unusual. And even though they've come down from [EOP at 331] (ph), they're still in a similar ballpark to where you were on the average. Are you guys -- is there something specific that's driving the expectation for deposit decline or is it just a component of conservatism?"
},
{
"speaker": "Dermot McDonogh",
"content": "If I'm honest with you, I would say it's a little bit of both, but I would expect, like everybody expected deposits to decline this year, and it hasn't necessarily happened yet, And I kind of think -- I make that statement in the context of QT. And so if you look at the [RRP] (ph) in Q1, the drain largely came from there. And if QT continues and rates stay higher for longer, on balance I would expect deposits to decline from here. And so I don't see anything that tells me that I should update the guidance from down 10% NII year-over-year. And then underneath the hood, in terms of the composition of the deposits themselves, you have the mix between interest bearing and non-interest bearing. And as rates stay higher for longer, I would expect NIBs to grind a little bit lower. So the overall balance may be higher, but you have to mix underneath, which will kind of feed into that overall NII guidance. So it's not just the absolute level, it's also the composition of it."
},
{
"speaker": "Brennan Hawken",
"content": "Yeah, yeah, that's great. Thanks for the candor and the embracing the uncertainty."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Mayo with Wells Fargo Securities. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi."
},
{
"speaker": "Robin Vince",
"content": "Hi, Mike."
},
{
"speaker": "Mike Mayo",
"content": "Can you hear me? Yeah. So I guess non-interest bearing deposits inched down again, and I'm just wondering where that floor is. I guess it's 18% versus 19% last quarter and 26% year-over-year. And so on the other hand, your servicing fees were up 8% year-over-year. So I'm not sure if I should draw a link or not. Maybe what you're not getting in non-interest bearing deposits, you're getting in servicing fees. So I guess the question is, how are you getting such strong servicing fee growth year-over-year of 8%, how much of that is due to markets, how much of that is sustainable, and is any of that simply a substitution effect from the non-interest bearing deposits to servicing fees?"
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks for the question, Mike. So let's go with the fee component first. Q1 is kind of one of those quarters where we came into the year I guess both in deposits and in pipeline and sales activity in very good shape. As it relates to kind of asset servicing in particular, the pipeline was strong, we felt good coming into the year, markets rallied nicely. And so clients were in risk on mode, doing more with us. Flows were stronger. Balances are higher. And we're winning our share of mandates. Little factoids for like, of all the deals that we competed for in Q1, we won north of 50%. So we're competitive, we're pricing well, we're very focused on client profitability and deal margin and it goes back to the point that we made in several quarters prior to this where we're very focused on the cost to serve. And so by improving margin, focusing on cost to serve, being more for clients, we can be more competitive in the pricing point. And I made that remark, I made the point in my prepared remarks that we saw repricing being de-minimis. So it was a good quarter all around and we feel very good about the backlog and the pipeline going forward. As it relates to the mix between fees and deposits, you know, we don't lead with deposits as an institution. Clients do multiple things with us across the enterprise and as a consequence of that they leave deposits with us. You know, it's an important point but two-thirds of our deposits are operational in nature and therefore very sticky. But with a higher for longer rate environment, it's only natural to expect that people with NIBs are going to over time move out of that and look for a higher yield. It's inevitable and it's a fact of life and we're ready to deal with that but I'm very proud of what our global liquidity solutions team is doing in terms of winning their share of the business in terms of the deposits and how we price them and so sequentially, we've seen the balances go up because of that competitive pricing. So all-in-all, when you take the ecosystem together we feel very good about where we're at."
},
{
"speaker": "Robin Vince",
"content": "And Mike there was nothing idiosyncratic about trade-offs to the other part of your question. I don't see the quarter built around that at all."
},
{
"speaker": "Mike Mayo",
"content": "Okay. And so for -- a separate question, for all the growth and servicing fees, asset management, what can you do to reverse the trend for sustainable growth? I mean, would it ever be an option to consider selling that? The synergies, when you think about One BNY Mellon, I kind of get the rest of the firm being all one cohesive unit over time, but how does asset management fit into that?"
},
{
"speaker": "Robin Vince",
"content": "Sure, so this is a question that we talked a little bit about last year and I said at the time that we think, and I'll underline the word think, that the business really can complement the strategy of the firm, but we had more work to do and that -- that was a thesis and we needed to put in place the various different steps to really be able to operationalize and make the most of that. And that's what we've been working on over the course of the past few months. The basic thesis is we think there's a strong industrial logic to have $2 trillion worth of manufacturing platform aligned to BNY Mellon's $3 trillion worth of retail distribution capacity, if you look across wealth and Pershing together. Pershing alone having [$2.5 trillion] (ph) plus of client assets on the platform. And so if you only operated in a silo in investment management where it was manufacturing and only its own distribution, there's a legitimate question there about whether or not it would have the scale and the capacity to be able to truly compete but when you put it together with the rest of the company we think there's a pretty compelling thesis there. And so we don't think we've properly capitalized on those benefits in the past and so our strategy is let's -- let investment management stretch its legs in that new approach. And we see some early signs of progress on that. We've been joining some dots. I mentioned a couple of things in my prepared remarks, both in terms of us having a broader distribution platform that actually can attract other investment managers who maybe don't have the benefit of our distribution and they want to come join our platform rounding out our offerings and essentially making our distribution platform more complete but also being attractive to them, so they don't have to build their own. If you will, they're building their business on one of our platforms. And so we've given you our targets. We want to be able to expand the pre-tax margin in the business to over 25%. It's not for nothing that we didn't grow expenses in that segment or in security services for that matter because we're really focused on the margin in those businesses and we have had some growth. And so this is about really working that set of opportunities and we'll see over the coming quarters how we do. But this quarter was one where we felt, we took an important step forward."
},
{
"speaker": "Mike Mayo",
"content": "All right. Thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Glenn Schorr with Evercore ISI. Please go ahead."
},
{
"speaker": "Glenn Schorr",
"content": "Hi, thanks very much. [Robin] (ph) mentioned it, so maybe it wasn't that big of a deal, but T+1 starts at the end of May. I'm curious if it was a big expense lift that we get some relief on going forward? And then related to that, are there any headwinds on NII and any benefits on capital that we have to think about as a result of moving towards a more T+1 world? Thank you."
},
{
"speaker": "Robin Vince",
"content": "So T+1 , sure we had to for sure spend money in different parts of the company in order to be able to ready ourselves for this. We view that as frankly ordinary course of business. There's always some market structure change going on in the world that we have to respond to. So while they may be individually lumpy, there's always something. So we just think about that as part of the expense of running the company and not something that will yield a particular benefit when we happen to have finished the work. Now, I do think that T+1 overall provides benefits to the financial system, improvements in efficiency, some risk reduction. I would say to the second part of your question that more of that probably accrues to our clients because we're not as big a principal player there. It can improve liquidity and capital requirements in the fullness of time. The industry's come a long way. You know, it wasn't that long ago that we're at T+5, T+3 sort of moving down the curve. And I will also say from an opportunity point of view, not only do clients look to us to help them navigate these types of things because they're complicated and detailed, and they want us to essentially help them in executing this type of change, and that's exactly what we've been doing. But we also think that there are just opportunities associated with these sorts of inflections, because clients look at us and it does sometimes cause the question to be raised of another big change in the post-trade landscape life's too short I'm an investment manager or I'm broker dealer or I want to go about the core of my business, I don't have to worry about that stuff as much as I currently do. BNY Mellon, can you help us? Can you help us and maybe there's a platform sale opportunity there for a little bit more outsourcing? Because if the world makes these changes, speeds up, gets more complicated, more change management, we of course have the benefit of scale, we get to change once and we get to take some of those problems off their hands. So I'd call that out when it comes to real-time payments, I'd call it out in T plus 1, I'd call it out in clearing. Each time these things happen, we look at it through a lens of opportunity as well as a lens of client service but overall also just good for the market nothing good happens between trading and settlement as is often said."
},
{
"speaker": "Dermot McDonogh",
"content": "And Glenn on this specific point about headwinds as it relates to NII, I kind of look at the last two quarters together in terms of the strength of what we've done on NII and I feel overall we're in a good place. The balance sheet is very clean. Our CIO book is well positioned and kind of short duration and the CIO is doing a really good job at optimizing yield. And so when you see our securities that are maturing at the moment, they're rolling off at a 2% to 3% rate and then are being deployed at current market yields. So based on what I see today with the back-up in rates that happened last week as a result of the hot inflation report, we feel pretty good about where things are for the balance of the year just using that forward curve. As I said earlier, rates up a little, down a little, don't materially impact us. And so we feel like our base case is, we feel pretty good about it."
},
{
"speaker": "Glenn Schorr",
"content": "Thank you all."
},
{
"speaker": "Operator",
"content": "Our next question is come from Gerard Cassidy with RBC. Please go ahead."
},
{
"speaker": "Gerard Cassidy",
"content": "Hi, Robin. Hi, Dermot."
},
{
"speaker": "Robin Vince",
"content": "Hey, Gerard."
},
{
"speaker": "Gerard Cassidy",
"content": "Dermot, can you give us some color? I noticed you said in your prepared remarks the average loan balances were essentially flat in Q1 versus Q4. But I noticed the spot number, the year-end -- quarter-end number for loans was actually quite a bit higher, you know, around $73 billion versus the spot number in the fourth quarter. Was it something at the end of the quarter that caused that to increase?"
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks, Gerard. Again, it was a little bit of what I call the Good Friday effect, where clients use our overdraft facility mechanisms going into that weekend. And so that really caused the spot balances to go up and that's kind of largely cleaned out so has reverted more to the average numbers that you're familiar with."
},
{
"speaker": "Gerard Cassidy",
"content": "Okay, good. And I know this is not a big area for you guys, so maybe you could give us better insights since it's not as big as it is for a traditional bank. But can you maybe give us some color on the commercial real estate? I know you pointed out you've built up the allowances there. What are you guys seeing? Is it similar to what we're reading about and hearing from others or is it something different?"
},
{
"speaker": "Dermot McDonogh",
"content": "So I would say, look, we're prudently marked in the commercial real estate portfolio. Overall, our CRE portfolio in the context of our overall balance sheet is quite small. 3% of total loans, $2 billion. And the reserve builds that we took in Q1 was really just kind of being prudent on a couple of specific situations that are coming up for restructuring. But I would let you know that they're all still paying and everything is working, and their class A office buildings. And we feel good about the occupancy. So I would say overall very, very clean and nothing that really has me unduly concerned. And look, there has been a lot of chatter in the market, in the press over the last quarter about what's going to happen. I'm sure the back-up in rates, hasn't really helped that chatter but like surveying other banks results so far this quarter I haven't really noticed any specific CRE bills on the back of what's been going on over the last couple of quarters, so it does feel like as a sentiment matter to be quite muted at the moment on the back of others earnings release, at least what I've observed."
},
{
"speaker": "Robin Vince",
"content": "and Gerard I just add to that for the more general view which is I think the answer to what happens in corporate real estate, clearly it depends which markets you're involved in. There are some markets around the country that are more distressed than others. It continues to be focused on office, as you know, although there are certainly some questions on multi-family, but the fact that we're sort of still short housing in the US, as a general matter is probably, ultimately going to be helpful to that story. The most single most important driver of it, as we sit here today, is where are longer-term rates? And so there's so much chatter about what's going to happen in fed funds. Is the fed going to cut? Are they going to stay? Are they going to hike a little bit? But what really matters is where's the curve from five years to 10 years? And as that backs up to the extent that we cross 5%, you get very different outcomes on commercial real estate than you do at 10 years or at 4%. And if they ended up, for some reason, not our base case, but it's possible, you've got to plan for it. If they end up at 6%, then for some folks in the market, that's going to be a much more painful outcome. So I think you watch -- so goes the [10 year] to some extent, so goes the commercial real estate market. Because this is a ‘24 a little bit, but really ‘25 refinancing story."
},
{
"speaker": "Gerard Cassidy",
"content": "Thank you. Appreciate those insights. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of David Smith with Autonomous Research. Please go ahead."
},
{
"speaker": "David Smith",
"content": "Good afternoon. Could you please help us think a little bit more about how far along you are in the efficiency opportunity journey? I know, it's really never ending in some ways, but can you help us think about when the pace of improvement might start to decline, as you get through more of the low-hanging fruit?"
},
{
"speaker": "Dermot McDonogh",
"content": "So, thanks for the question. I was wondering when it was going to come. It's a multi-year journey, and look let's go back to last year and kind of go through it. And last year, we kind of ended up at 2.7% versus a guide of 4% versus a previous year of 8%. And this year, we've guided flat. And we started Q1 on an operating basis of 1%. You'll see that our head count -- we've largely, you know, give or take a few hundred people, it's largely flat and so the headcount is flat, we feel like we have our arms wrapped around that. There's a lot going under the hood in terms of bringing in -- like growing our analyst class, high-value location growth, et cetera, et cetera. So we see a lot of opportunity to continue to improve the efficiency story. Also, as we both said in our prepared remarks, the migration to a new way of working, the platform operating model over the next couple of years, we feel will not only help us grow top-line, but it will also just help us run the company better. And I think, it's quite important culturally that we don't really talk about efficiency internally. We talk about running our company better, which is very important strategically and also culturally. So I think you're going to see quarter-by-quarter proof points on how we're able to run the company better, which will result in efficiency, which will then in turn result in improved margin. So we feel very optimistic about what's coming."
},
{
"speaker": "David Smith",
"content": "Thank you. And lastly, just to confirm, you know, $1 billion or so of buyback in 1Q, does that come out of the $6 billion new re-purchase authorization or is the $6 billion incremental to what you did in 1Q?"
},
{
"speaker": "Dermot McDonogh",
"content": "So we did an authorization last year which was $5 billion. We have a little bit left in that. And so -- it's just more of an administration thing that we decided to get another authorization this year for $6 billion. That's largely open-ended. So I wouldn't really dwell on the size of the authorization that much. It's just more of what we commit to you doing on an annual basis. And the key thing for you to take away is we're committing to north of 100% this year."
},
{
"speaker": "David Smith",
"content": "Got it. Thank you."
},
{
"speaker": "Dermot McDonogh",
"content": "Thanks David."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Brian Bedell with Deutsche Bank. Please go ahead."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks for taking my questions. Maybe most of them have been asked and answered, but maybe just a couple of follow-ups. One, a little bit on that prior question, Dermot, I guess this could be for Robin as well. I think Robin you mentioned, earlier in the call about 15% of staff are in the new operating model. Maybe if you could just talk about your migration plan over time and going back to what you just answered, Dermot, about the efficiency improvement, should we be thinking of this over the long-term as maybe roughly even between expenses and revenue or still more geared towards expenses?"
},
{
"speaker": "Robin Vince",
"content": "Okay. Let me just start with the platforms operating model. So ultimately, if you just go back to why are we doing -- what it is that we're doing, we've been pretty siloed as a company as we've talked about before. We think that's a bad artifact, at least it's a bad artifact for a company like us, which is inherently a scale platforms provider. It's kind of the nature of our business, diversified many different platforms but largely at scale. And so to have the separation of all of these pieces that are in support of that and in some cases, duplication, it just -- in our opinion wasn't the right way to run the company. So what is platform’s Operating Model going to do? It's going to simplify how we work, it's going to improve the client experience, and it's going to create more empowerment for our employees. It's an opportunity to do things in one place, do them well and elevate the quality of overall execution. And so with that said, it sort of hits on the expense line, as a benefit and it hits on the revenue line as well. And we've done, remember we did a bunch of studies for this before we embarked on it because pretty significant change. We also did some pilots and to some extent we've even built new businesses using this operating rhythm because we built Wove in that way and that wasn't entirely by accident. So we've had some experience associated with all of that and we feel pretty good therefore that we are going to get expense savings and revenue opportunities associated with it. We also think that from a cultural point of view, it's just an opportunity for our people because we think our people, and this is certainly what the data so far has shown, they just feel more empowered working in the model. They can see a problem, they can get on it more quickly, they're more empowered to pull the levers to create change, and they no longer feel that maybe that they're part of a long chain of a bureaucracy to make change. On the efficiency opportunity thing, the thing I would add in answer to your question from what Dermot said earlier on, is just to reinforce that there are short, medium and long-term opportunities for efficiencies and we've talked about it this way for a while now. As Dermot said, we had to bend the cost curve last year. We thought it was very important, so we took a bunch of slightly tactical but nonetheless important and decisive changes. We also laid the groundwork for some medium-term saves. We talked about project catalysts, 1500 ideas, sourced from our employees, essentially delivering savings in ’23, in ‘24, and ‘25. And then we've got things that are longer-term, like the platform's operating model, which are fundamentally changing the ways that people actually work. That's a longer term opportunity. Probably get a little bit of benefit from that from ‘24, but ‘25 and ‘26 are places where we'll probably see a bit more of that. And then in answer to Betsy's question from earlier on, we've been investing in AI. Now that's definitely not a ‘24 story for benefits, maybe not even ‘25, but a ‘26 and beyond story. So we're layering in these different opportunities, recognizing that we wanted to take swift action, but then we also feel that we're laying the seeds for future efficiencies over time."
},
{
"speaker": "Dermot McDonogh",
"content": "And I would just, Brian, just to add on, I would just anchor you in a number. Like last year, when we grew expenses by 2.7%, we invested $0.5 billion in new initiatives within that 2.7%. And we're replicating that again this year. And so as somebody who's very close to the platform operating model strategy, the cultural point is when you walk the corridors of BNY Mellon now, you feel an energy and enthusiasm for our people, as Robin said, from embracing the model that hasn't been seen before. And it is a very, very exciting strategy that's going on at the firm."
},
{
"speaker": "Brian Bedell",
"content": "That's fantastic, color. And maybe just one -- last one on the speaking of initiatives, the buy side trading solutions initiative. I know we've had a lot of other initiatives to talk about, so just maybe to get an update on how that's tracking."
},
{
"speaker": "Robin Vince",
"content": "Yeah, this was, I'll take this one. This was always going to be a medium-term thing. As we've told you, we sort of have this capability in-house. It's a great example of platform thinking. It was captive in one bit of the company, only looking internally. We essentially made it fit for external use as well. We onboarded, as we told you last quarter, a large client onto that platform, and that's been going very well. I have a lot of conversations with clients about how they could consider part of their trading desks to be outsourced. Sometimes it's all of it. Sometimes it's a region or a product that somebody wants to essentially say, hey, I'm not at scale. You're at scale. You're executing a $1 trillion worth of volumes. Can I rent that capability from you, essentially? We think there's a large addressable market here, but it's going to be, this is a longer sell process. The sale cycle of this takes longer. It's definitely a C-suite conversation, but we continue to be cautiously optimistic about this over time."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks for all the color. Thanks so much."
},
{
"speaker": "Robin Vince",
"content": "Thanks, Brian."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Ken Usdin with Jefferies. Please go ahead."
},
{
"speaker": "Ken Usdin",
"content": "Thanks. I know we're getting on here. I'll try to ask just a couple quick cleanups. First of all, this is the first quarter that the securities book has actually grown in absolute terms, And I'm just wondering, is part of that an increased confidence in just where you do expect deposits to land, or was it more just opportunity cost of what your options were in the market?"
},
{
"speaker": "Robin Vince",
"content": "Thanks, Ken. I would say very much the latter. And when you look at the overall portfolio, you think of cash and securities together. And it was really the CIO team just optimizing yield and deploying cash where they see the opportunities."
},
{
"speaker": "Ken Usdin",
"content": "Yeah, okay. And then I know you said a little bit of this before, but I was wondering if you could tighten up. You know, last quarter you said, to Glenn's question, you talked about reinvesting at market rates. So last quarter you put that together and said that you would expect that this year's reinvestments to be 150 basis points to 200 basis points on your roll-on, roll-off. And with higher rates, I'm just wondering if you've kind of put that together for us. Like, what do you think that net benefit is now versus that 150 basis points to 200 basis points?"
},
{
"speaker": "Dermot McDonogh",
"content": "I think it's in the 200 zip code."
},
{
"speaker": "Ken Usdin",
"content": "Okay, and then last one, just duration of the portfolio. Can you just give us an update on where that stands?"
},
{
"speaker": "Dermot McDonogh",
"content": "Roughly, two years, give or take, yeah, but yeah, two years is the best number to give you on that one."
},
{
"speaker": "Ken Usdin",
"content": "Okay, so to your point, like still keeping really short and opportunistic."
},
{
"speaker": "Dermot McDonogh",
"content": "Correct, yeah."
},
{
"speaker": "Ken Usdin",
"content": "All right, great, thanks a lot."
},
{
"speaker": "Operator",
"content": "And our final question comes from the line of Mike Mayo with Wells Fargo Securities. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. When you mentioned your comments about commercial real estate, I was just wondering, I don't think you have much exposure, but you highlighted that commercial real estate, I guess, to the industry or are you talking office? You said it's really a 2025 refinancing story and ASCO the 10-year, ASCO commercial real estate. It's just – if you could provide any color. Why did you highlight that and why do you have that sort of conclusion?"
},
{
"speaker": "Robin Vince",
"content": "Well, the question, Mike, was more general in nature. It wasn't really applying to us. Dermot talked a little bit about us in particular on commercial real estate, but I think the question that was being asked was just using our vantage point, I think it was from Gerard, just using our vantage point in the world because we're not particularly invested in the space. What do we see in the world, maybe as a slightly less conflicted observer? And so I was just giving my perspective on it."
},
{
"speaker": "Mike Mayo",
"content": "Yes, your perspective, what's -- I'm just curious, interested. ASCO to 10 year, it's a 2025 refinancing story. Any color behind that?"
},
{
"speaker": "Robin Vince",
"content": "Sure, so at the end of the day, as you look at the various different owners of commercial real estate who have refinancings and they're looking at their own occupancy level, they're looking at their own maturity of their own debt stack, and they need to go out and they need to find refinancing, of course, as you know better than anybody, when their debt stack starts to come due. That isn't a Fed funds type of refinancing because they're not for funding of very short dates. And most of them, for understandable reasons, like to lock in funding as well. So they're looking further out the curve, it's not precisely at the 10 year point but my point really is the risk to refinancing in the commercial real estate space is very correlated to the shape of the treasury curve overall. Clearly credit spreads matter as well, but it's a different proposition when you have the longer, call it 10 years, but it's probably a little inside of that, part of the curve at 4% versus 5% versus 6%. That was the purpose of my observation."
},
{
"speaker": "Mike Mayo",
"content": "All right. That's helpful. Thank you."
},
{
"speaker": "Robin Vince",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "And with that, that does conclude our question and answer session for today. I would now like to hand the call back over to Robin with any additional or closing remarks."
},
{
"speaker": "Robin Vince",
"content": "Thank you, operator. I'd just like to wrap up by thanking our employees for their hard work to unlock the tremendous opportunity inside of BNY Mellon. We started the year with great momentum, delivered very solid results in the first quarter, and the pace of change continues to pick up. And I want to thank our investors for their continued support. We appreciate your interest in BNY Mellon and thank you for your time today. If you have any follow-up questions, please reach out to Marius and the IR team. Be well."
},
{
"speaker": "Operator",
"content": "Thank you. And that does conclude today's conference and webcast. A replay of this conference call and webcast will be available on the BNY Mellon Investor Relations website at 2 Eastern Standard Time today. Have a great day."
}
] |
bkng | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Welcome to Booking Holdings' Fourth Quarter 2024 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Legislation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied or forecasted in any forward-looking statements. Expressions of future goals or expectations and similar expressions reflected something other than historical facts are intended to identify forward-looking statements. For a list of factors that could cause Booking Holdings' actual results to differ materially from those described in the forward-looking statements, please refer to the safe harbor statements in Booking Holdings' earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligations to update publicly or any forward-looking statements whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release is available in the For Investors section of Booking Holdings' website, www.bookingholdings.com. And now I would like to introduce Booking Holdings' speakers for this afternoon, Glenn Fogel and Ewout Steenbergen. Go ahead, gentlemen."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you. Welcome to Booking Holdings Holdings' fourth quarter conference call. I'm joined this afternoon by our CFO, Ewout Steenbergen. I am pleased to report we had a strong finish to 2024, closing out another successful year. I'm even more pleased to report the progress we are making on our long term strategic plan. In a few days, I will mark my 25th year at this company, quarter of a century. And I am more excited than ever about our potential. It's an incredible time to be in the travel industry with a transformative force of AI, particularly generative AI, redefining how people will experience the world. Adapting to and leveraging new technologies has been in our DNA from the start and generative AI is pushing the pace of technology innovation faster than ever. In this dynamic environment, I am confident that we are well positioned to deploy this technology to further benefit our travelers and partners given our legacy of innovation, resources, proprietary data, the global nature of our business and years of experience with AI. I'll speak more about the AI opportunity shortly. But first, I will briefly cover our financial highlights from the last quarter and the full year. Our fourth quarter room nights exceeded the high end of our prior expectations and grew 13% year-over-year. The improvement in room night growth was seen across all our major regions, each of which grew by double digits in the quarter. The stronger than expected room night growth helped drive fourth quarter gross bookings growth of 17% and revenue growth of 14%, both above the high end of our prior guidance ranges. Adjusted EBITDA of $1.8 billion was 26% higher than the fourth quarter of 2023 and 12% above the high end of our prior guidance range, driven by revenue outperformance and lower than expected adjusted fixed OpEx. Finally, adjusted earnings per share in the quarter grew 30% year-over-year. Looking back at the full year of 2024, I am proud of our achievements, including advancing our connected trip vision, further innovating our AI capabilities, expanding our merchant offerings, growing alternative accommodations and enhancing and expanding our Genius loyalty program. Our achievements in these areas allowed us to deliver even more value to our travelers and supplier partners while all helping to drive our strong financial results for the year. For the full year, gross bookings of $166 billion increased 10% versus 2023 and revenue of $24 billion grew 11% year-over-year. We achieved these strong top line results while growing our bottom line even faster with adjusted EBITDA of over $8 billion, increasing 17% year-over-year. Finally, adjusted earnings per share was up 23% year-over-year, helped by the 7% reduction in our full year average share count versus last year. I would note that on a constant currency basis, our full year gross bookings, revenue, adjusted EBITDA and adjusted EPS all grew about 1 percentage point faster than the reported growth rates I just mentioned. Our long term ambition in a normalized travel environment continues to be to grow our annual constant currency gross bookings by at least 8%, to grow our constant currency revenue by at least 8% and to grow our constant currency adjusted earnings per share by at least 15%. I'm proud to say that we exceeded these growth targets in 2024. At the start of 2025, we continued to see healthy demand for leisure travel globally. Assuming another year of normalized growth for the travel industry, we are targeting full year constant currency growth rates that would again deliver on our long term growth ambition for gross bookings, revenue and adjusted EPS. Given the importance of travel to consumers and the aspirations of people to experience the world, we remain confident in the long term outlook for the travel industry and believe that we are well positioned to deliver attractive growth across our key metrics in the coming years. Ewout will provide further details on our fourth quarter results, our expectations for 2025 and our approach to capital returns in his remarks. At Booking Holdings, we have always been driven by innovation from the early days of the Internet and online travel to be one of the first employers of large scale A/B testing, to the advent of the smartphone and consumer adoption of mobile apps, to using sophisticated machine learning models early in our business, we have consistently evolved to meet the needs of travelers and partners. We believe that compelling AI powered offerings like a travel vertical specific agent will play a central role in delivering even more seamless and personalized connected trip experience to travelers. We see the development and use of AI agents and those agents working with other AI agents as a potential way to more quickly bring together the different elements of travel into a truly connected offering on our platform. We are highly focused on the many opportunities with AI and we'll continue the sophisticated work already happening across our company to integrate generative AI into our offerings, which includes Booking.com's AI trip planner and Priceline's AI powered travel assistant called Penny. In addition, we're pleased to see the work being done at OpenTable with its use of Salesforce's agent force platform, while Agoda and KAYAK are making their own generative AI advances. As we continue to incorporate this technology, we are confident that it will enhance our ability to attract and satisfy our travelers as well as our partners who have long relied on our technology advancements to help attract customers and grow their businesses. In addition, we believe generative AI has the potential to drive improvements and operational efficiency, which would contribute to a further deceleration of our fixed expense growth in 2025. Whether customer service, partner service, developer productivity or other areas where we are finding more efficient ways of working, we are already seeing some early benefits and we plan to continue to build on this. We are also excited to be working with leading generative AI organizations on their agentic developments. These collaborations reflect our commitment to staying at the forefront of this rapidly developing field and are consistent with our long-standing approach to work with different sources of new customer traffic. And with our track record in this area, I am confident in our ability to create value for all participants in this new evolving economic landscape. We expect that agentic models will change the way some bookers discover and use our platforms. And we believe that working with these models will be another attractive way for us to deliver unique value to our travelers and partners through competitive pricing, loyalty benefits and rewards offering of other travel products, high quality customer service and an easy and trusted payment process. Given the complexity, expense and importance of travel to customers, it is critical to deliver value and to continue to be a trusted platform in order to have customers choose to make bookings with us. I'm encouraged to see that we continue to build trust with travelers as evidenced by our growing mix of direct bookings, which was in the mid-60s percentage of our B2C room nights in 2024. We will continue to learn how customers want to interact with all forms of GenAI, and I like how we are positioned. I'm excited about the changes and benefits that this technology is bringing to us now and we expect will do even more so in the future. Now focusing a bit more on our connected trip vision. We are making steady progress towards simplifying the planning, booking and travel experience, making more personalized, seamless and enjoyable while delivering better value to our travelers and supplier partners. We saw connected trip transaction growth accelerate to over 45% year-over-year in the fourth quarter and these connected transactions represented a high single digit percentage of Booking.com's total transactions. Flights are an important component in many of the connected trips that our travelers book. For the full year, our travelers booked almost 50 million airline tickets across our platforms, which increased 38% year-over-year and had a gross bookings value of $13.1 billion. We continue to see this vertical bring new customers to our platforms while delivering a more complete offering to our existing customers, making travel planning and booking easier for them and creating opportunities for us to provide more value to them. And we believe that GenAI, coupled with our data and machine learning capabilities, will enable us to improve our supplier partners' businesses, particularly the small and medium sized businesses who do not have easy access to these sophisticated technologies. Another foundational component of the connected trip vision is our expanding merchant offering at Booking.com. Merchant capabilities offer more flexibility for our travelers and partners while also unlocking the ability to merchandise across verticals. The mix of merchant gross bookings reached 59% of total gross bookings at Booking.com in 2024, an increase of about 9 percentage points year-over-year, which is higher than our expectations at the start of 2024. We are pleased to see that processing transactions through Booking.com's merchant offering generated incremental contribution margin dollars in 2024, though this was still a small percentage of our total adjusted EBITDA. We believe that we are still very early in our fintech journey and expect over the upcoming years to reduce the cost of transactions for our travelers and supplier partners while also contributing to our bottom line. We believe our Genius loyalty program at Booking.com also helps to connect more elements of travel as we extend this program beyond accommodations into other travel verticals. We believe the value this program delivers will promote customer loyalty, frequency and direct booking behavior. We are encouraged to see more of our travelers moving into our higher genius tiers of Levels 2 and 3, which represent over 30% of our active travelers. And these travelers booked a mid-50s percentage of Booking.com's room nights in 2024. These Genius Level 2 and 3 travelers having meaningfully higher direct booking rate and a higher booking frequency than the rest of our travelers. We continue to drive more Genius benefits to our travelers in 2024 and we have seen steady growth in the share of connected trip transactions that receive Genius benefits. We believe that all of the connected trip elements provide value to our customers, leading them to choose to book more frequently and directly with us. We are encouraged to see that the direct booking channel continues to grow faster than room rights acquired through paid marketing channels. Providing great supply choices for our travelers is another way we deliver a comprehensive planning and booking experience. And in one area, we are actively expanding our supply is alternative accommodations. For alternative combinations at Booking.com, we continue to see year-over-year growth with listings at the end of Q4 reaching 7.9 million, up about 8% from last year. More listings means more accommodation choices for our travelers, which we believe contributed to strong alternative accommodations room night growth of 19% in the fourth quarter, which was an acceleration of 14% growth in the third quarter. We were pleased to see alternative combination room night growth accelerate in the quarter across all of our regions. We remain committed to being a trusted and valuable partner to all the accommodation properties on our platforms by delivering incremental travel demand and developing products and features designed to support the success of these businesses, a majority of which are small independents. Now I want to briefly discuss our transformation program, and Ewout will provide further details in his commentary. In November 2024, we announced our intention to implement certain organizational changes, including modernizing processes and systems, initiating an expected workforce reduction, optimizing procurement and seeking real estate savings. We are in the process of reviewing some of these potential workforce reductions with works councils, employee representatives and other organizations. While workforce reductions in some areas, along with investing in other areas, involve very difficult decisions, we believe that these steps are critical to improve organizational agility and drive greater operating efficiencies. Reallocating resources across our strategic initiatives in a disciplined manner is a key requirement to maintain global competitiveness. Ultimately, we believe this will help drive stronger and more durable top line and earnings growth over the long term. In conclusion, as I look back over 2024, I am proud of all of the hard work and excellent execution by our teams as they continued to advance our strategic initiatives while delivering strong financial results. These are exciting times for our industry and I am confident in our company's position and ability to leverage generative AI technology to deliver an even better offering for our travelers and partners. I will now turn the call over to our CFO, Ewout Steenbergen."
},
{
"speaker": "Ewout Steenbergen",
"content": "Thank you, Glenn. And good afternoon. I will now review our results for the fourth quarter and the full year of 2024 and provide our thoughts for the first quarter and full year of 2025. All growth rates are on a year-over-year basis. Information regarding reconciliation of non-GAAP results to GAAP results can be found in our earnings release. We will be posting a summary earnings presentation as well as our prepared remarks to the Booking Holdings Investor Relations Web site after the conclusion of the earnings call. Now let's move to our fourth quarter and full year results. Our room nights in the fourth quarter grew 13%, which exceeded the high end of our guidance by 5 percentage points. The higher than expected room night growth was driven by stronger than expected performance across all our regions with the largest impact coming from Europe. Looking at our room nights growth by region. In the fourth quarter, Europe was up low double digits, Asia was up mid-teens, rest of world was up about 20% and the US was up about 10%. We are encouraged by the progress we are making in enhancing the experience for our travelers and partners as we continue to advance our strategic initiatives and build towards our connected trip vision. This includes strengthening our offering through alternative accommodations growth, increasing the direct and mobile app mix of our bookings, expanding our Genius loyalty program and growing our other travel verticals. For our alternative accommodations at Booking.com, our fourth quarter room night growth accelerated to 19% and continue to outpace the overall business. The global mix of alternative accommodation room nights at Booking.com was 33%, which was up 1 percentage point from the fourth quarter of 2023. We continue to strengthen our direct relationships with our travelers and increase loyalty on our platforms. For the full year, the mix of our total room nights coming to us through the direct channel was in the mid-50% range and increased year-over-year. When we exclude our B2B business, our full year B2C direct mix was in the mid-60% range, which is an improvement from the low 60% range in 2023. The mobile [epics] of our total fourth quarter room nights was in the mid-50% range, which was up from the low 50% range in 2023. We continue to see that the significant majority of bookings received from our mobile apps come through the direct channel. For our Genius loyalty program, the mix of Booking.com room nights booked by travelers in the higher Genius tiers of Levels 2 and 3 was in the mid-50% range in 2024 and this mix increased year-over-year. In our other travel verticals, about 14 million airline tickets were booked across our platforms in the fourth quarter. Airline ticket growth in the fourth quarter was 52%, driven by the continued growth of our flight offerings at Booking.com and Agoda and accelerated from the 39% growth in the third quarter. Fourth quarter gross bookings increased 17% year-over-year and increased about 18% on a constant currency basis, which was approximately 5 percentage points higher than the 13% room night growth due to a few percentage points from higher flight bookings growth and an increase in constant currency accommodation ADRs of about 2%. The year-over-year ADR increase was impacted by a higher mix of room nights from Asia. Excluding regional mix, constant currency ADRs were up about 3% versus the fourth quarter of 2023. The increase in gross bookings exceeded the high end of our guidance by 8 percentage points due to stronger than expected room night growth as well as stronger than expected constant currency accommodation ADRs and flight ticket growth, partially offset by about 1 percentage point of impact from changes in FX. Fourth quarter revenue of $5.5 billion grew 14% year-over-year, which exceeded the high end of our guidance by 5 percentage points. Constant currency revenue growth was about 15%. Revenue as a percentage of gross bookings of 14.7% was lower than expected due to impacts from timing and a higher mix of flight bookings. The timing impact was driven by the acceleration in bookings in the fourth quarter as well as a booking window that was more extended in the quarter than expected. Revenue as a percentage of gross bookings was also lower than the fourth quarter of 2023 due to impacts from timing and an increased mix of flight bookings, partially offset by increased revenues associated with payments. We expect the impact from timing in the fourth quarter will benefit our revenue in 2025. Marketing expense, which is a highly variable expense line increased 10% year-over-year. Marketing expense as a percentage of gross bookings was 4.2%, about 30 basis points better than the fourth quarter of 2023 due to lower brand marketing expense and higher direct mix, partially offset by higher spend in social media channels at attractive incremental ROIs. Fourth quarter sales and other expenses as a percentage of gross bookings was 2.0% in line with last year despite a higher merchant mix as higher payment expenses were offset by efficiencies in customer service. Adjusted fixed operating expenses were up 9% year-over-year, which was better than expected due primarily to lower IT and G&A expenses. Throughout this year, we have been very focused on carefully managing the growth of our fixed expenses. Adjusted EBITDA of $1.8 billion grew 26% year-over-year and was 12% above the high end of our guidance range, largely driven by the higher revenue and also by the better than expected adjusted fixed operating expenses. Adjusted EBITDA margin of 33.8% in the fourth quarter was up versus last year by about 320 basis points due primarily to leverage from adjusted fixed operating expenses and marketing expenses. EPS of $41.55 per share was up 30% and benefited from a 5% lower average share count than the fourth quarter of 2023. On a GAAP basis, net income was $1.1 billion in the fourth quarter and was impacted by a mark-to-market adjustment to the conversion option premium of our convertible note due May 2025. This was mostly offset by FX remeasurement gains on our euro bonds. Both items were excluded from our adjusted results. When looking at the full year, we are pleased to report that our 2024 room nights grew 9% year-over-year. On a regional basis, we saw full year room night growth from Europe up high single digits, Asia was up mid-teens, Rest of World was up high single digits, and the US was up mid-single digits. European bookers represented about half of the room nights booked in 2024. Asian bookers were about a quarter and US bookers were a low double digits percentage. The growth in room nights helped drive increases in gross bookings, revenue and adjusted EPS that were above our long term annual growth ambition. Our full year gross bookings and revenue increased 10% and 11%, respectively, and both growth rates were about 1 percentage point higher on a constant currency basis. Revenue as a percentage of gross bookings was 14.3% in 2024, which was up slightly versus 14.2% in 2023 due to a positive impact from increased revenues associated with payments, mostly offset by an increased mix of flights. Our underlying accommodation take rates continue to be stable year-over-year. Marketing as a percentage of gross bookings in 2024 was 4.4%, down slightly from 4.5% in 2023, driven by higher direct mix, lower Brent marketing expenses and higher performance marketing ROIs, partially offset by higher spend in social media, which became a more significant channel for us in 2024. Our full year adjusted fixed operating expenses were up 8% versus 2023, which was better than our expectation for low to mid-teens growth at the start of 2024 and was a source of leverage due to many management actions taken throughout the year. Our full year adjusted EBITDA was more than $8 billion, which was up 17% year-over-year and up about 18% on a constant currency basis. We're proud to have generated $1.2 billion more adjusted EBITDA than in 2023, delivering profitable growth and expanding margins while investing in strategic initiatives. Adjusted EBITDA margin was 35%, which was 170 basis points higher than our adjusted EBITDA margin in 2023 and ahead of our expectations at the start of the year. Our adjusted EBITDA margins, along with every other profit metric that we report, includes the impact of stock based compensation expense as this is a very real cost of doing business. Our full year adjusted EPS was over $187 per share, which was up 23% year-over-year and up about 24% on a constant currency basis. Our full year average share count was 7% lower than in 2023 due to the impact of our share repurchase program. Now on to our cash and liquidity position. Our fourth quarter ending cash and investments balance of $16.7 billion was up versus our third quarter ending balance of $16.3 billion due to about $1.9 billion of debt raised in November and about $650 million in free cash flow generated in the quarter, partially offset by about $1.4 billion of capital return, including share repurchases and dividends. Free cash flow in the fourth quarter was pressured by about $825 million from changes in working capital, driven primarily by the seasonal reduction in our deferred merchant bookings balance. For the full year, we repurchased about $6 billion of stock and paid out $1.2 billion in quarterly cash dividends. Since restarting our repurchase program in early 2022, we have repurchased almost $23 billion of stock or 21% of our shares standing at the start of 2022. We ended 2024 with about $7.7 billion remaining under our existing share repurchase authorization. As we look ahead, we remain focused on strategically investing in our business and returning capital to shareholders while maintaining our strong investment grade credit ratings. We are pleased to announce today that our Board of Directors approved a new $20 billion share repurchase authorization, along with a 10% increase to our quarterly cash dividend per share. These actions reflect our confidence in our earnings power, strong free cash flow generation and our ability to consistently return capital to shareholders through both share repurchases and dividends. Moving to our thoughts for the first quarter. We expect the comparison to the extra day in February 2024 to be about 1 percentage point headwind to our first quarter growth rates. Also, we expect a calendar shift of Easter from March in 2024 to April in 2025 to be a small tailwind to room nights and growth bookings growth and a larger headwind to revenue and profitability growth in the first quarter. We expect first quarter room night growth to be between 5% and 7%, which includes a slight benefit from the calendar shift of Easter into April. We expect first quarter gross bookings to increase between 5% and 7%, which includes about 4 percentage points of impact from changes in FX, offset by about 2 percentage points of positive impact from higher flight ticket growth, about 1% higher constant currency accommodation ADRs and a slight benefit from the calendar shift of Easter. We expect first quarter revenue growth to be between 2% and 4%, which includes a headwind of about 3 percentage points from changes in FX and about 3 percentage points from the calendar shift of Easter into April. We expect first quarter adjusted EBITDA to be between about $800 million and $850 million, down 5% year-over-year at the high end, which includes about 14 percentage points of year-over-year impact from the Easter shift and about 2 percentage points of impact from changes in FX. Note that historically, the first quarter is our seasonally lowest EBITDA quarter for the year. Normalizing for the impacts of Easter timing, changes in FX and the leap year, our expectation for our fourth quarter gross bookings, revenue and adjusted EBITDA is for low double digits growth at the high end of each of those ranges. Turning to the full year 2025. We're targeting full year constant currency growth rates that would reach our long term growth ambition of at least 8% growth for gross bookings and revenue and 15% growth for adjusted earnings per share. We believe we are well positioned to achieve these levels of growth, given the investments we have made to build a stronger foundation for our business and a better product offering for our travelers and partners. At recent FX rates, we expect changes in FX will impact our reported growth rates by about 3 percentage points for gross bookings and revenue and by about 3.5 percentage points for adjusted EBITDA and adjusted EPS. As a result, we expect full year reported gross bookings and revenue to increase mid-single digits and on a constant currency basis to both increase high single digits. We expect to drive leverage in our marketing expenses. Additionally, we expect revenue to grow faster than adjusted fixed operating expenses in line with our prior commitment for 2025, which we communicated at the start of last year. As a result, we expect adjusted EBITDA to grow a couple of percentage points faster than revenue and on a constant currency basis to increase low double digits. We expect to continue to expand our adjusted EBITDA margins in 2025 and deliver margin growth slightly below 100 basis points. We expect our full year adjusted EPS to grow low double digits and on a constant currency basis to grow mid-teens. Finally, we remain focused on managing our capital expenditures and we expect that CapEx will be about 2% of revenue similar to 2024. Turning to our new transformation program, which we announced in November. Our intention is to implement certain organizational changes to reduce complexity and increase agility, which we estimate will ultimately produce annual run rate cost reductions of approximately $400 million to $450 million versus our 2024 expense base and we expect the majority of these savings to be realized after 2025. By the end of 2024, we have already actioned over $35 million in run rate savings. We estimate the aggregate transformation cost that we will incur over the coming two to three years to be similar to the expected annual run rate savings. In order to provide transparency, we will report these costs separately in a transformation cost expense line and we expect that certain of these costs will be excluded from our adjusted results. Embedded in our full year 2025 guidance is about $150 million in cost savings related to the transformation program, the majority of which we expect to be in variable cost. Beyond the transformation program, we expect to drive additional efficiencies in our ongoing operations. With the capacity created by these savings and efficiencies, we are reinvesting about $170 million above our baseline investments in 2025 to support our strategic priorities for long term value creation while still expanding our adjusted EBITDA margins for the year. These investments will be in areas, such as progressing our GenAI capabilities, advancing our connected trip vision and expanding our fintech offering. We see the potential for these investments to contribute incremental revenue growth in future years and deliver attractive returns. In conclusion, we are pleased with our fourth quarter results and our outlook for the first quarter and the full year of 2025. We're excited about our long term vision for the connected trip and enhancing our offering through technological advancements such as generative AI. Thank you to all of my colleagues across the company for their amazing work and dedication to drive new product offerings, tech innovation, speed and agility and deliver value to our shareholders, travelers and partners. With that, we will now take your questions. Operator, will you please open the lines?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question is from the line of Lee Horowitz with Deutsche Bank."
},
{
"speaker": "Lee Horowitz",
"content": "Maybe starting with Glenn, and thanks for the details on all the products you guys have rolling out there. But I guess, how do you contextualize the risks associated with perhaps greater competition from agentic platforms? We have massive pockets of investment aimed at building functional AI agents that could circumvent listings on booking and go direct to hotels. Any more thoughts there would be helpful. And then one follow-up, if I could."
},
{
"speaker": "Glenn Fogel",
"content": "I'm not surprised by it. I've been here now, as I mentioned in my prepared remarks, I've been here almost 25 years. And it's been a rare time that somebody hasn't brought to me to the fact that we were going to be disintermediated if someone else is going to take away our business. And at first, it was the hotels. We're going to build our web sites and we will go direct there. And then it was Google that was going to get rid of us, et cetera, et cetera, et cetera. So it does not surprise me that new technology comes out and people are asking an appropriate question. How is that going to impact your business? And are you still going to be able to achieve what you've been able to achieve for quarter of a century? And I would say one of the great things about this company is our ability to evolve, adapt, use all of our resources, our technological knowledge, the tremendous ability of our people, our capital, in terms of agenic AI, one of the important things is data. It's something that I think about a lot as to many, many people in the management team of how can we change so we make sure that we are the winner of these new technologies. One of the things we mentioned about was coming up with a travel vertical specific agent, having a model that domain specific, there a lot of different ties we're working on. I'm not going to spell out all of the playbook and how we will make sure that we maintain this leading the industry. But I recognize the question and I say that we will be able to do it, not only by ourselves but we also, as I mentioned, and we've talked about this in the past, that we're working with all of the major players in the Valley and elsewhere, that we are working together to do things that would be better as togetherness instead of trying to do separately. And I believe that past is a good example of being able to adapt and continue to go forward and create something that is even better than it was from the past. I'm incredibly excited about this new world of AI -- generative AI, agentic AI models. All of these things are incredible opportunities for someone like us that has the ability to actually turn it into something that is better than it was before. So I hear you Lee, I hear that question. It's not new but I believe we will be a winner in this. Ewout?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Let me build on the answer that Glenn gave with one other perspective. As we all know, these developers of large language models are spending an incredible amount of capital expenditures, and they have choices. One choice could be, are they trying to figure out the complexity of travel themselves or what is probably more likely is partnering with us as they are already doing today because we are able to give them very clear monetization opportunities, which, of course, is going to be very important in order to prove that there will be very sound returns on these very large CapEx numbers. So really, the economic argument on top of all the arguments that Glenn has mentioned is very important from our perspective as well."
},
{
"speaker": "Lee Horowitz",
"content": "And maybe just a follow-up on alternative accommodations. I guess it's fairly clear you guys are a share gainers point. I wonder if you could maybe unpack a bit more on a regional basis where are you seeing the biggest contributions to your sort of consistent teens growth rate in our alternative accommodations business in '24 or regions do you perhaps expect to invest most behind in '25? And what do you think is resonating so strongly with the consumer that allows you guys to really outpace the competitors at this point?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Lee, I think a brief answer to your question, the first part is we see higher growth in alternative accommodations in all the regions in the world compared to the traditional accommodations. And the second part of your question is why are we growing so fast? I think that has to do with the total proposition that we offer, really great supply, expansion of the proposition in terms of accommodations that we can offer to travelers. And most importantly, that we have traditional accommodations and alternative accommodations together on the platform and travelers can compare and ultimately pick the best option in their particular situation. And what we're hearing back is that its absolutely something that travelers like that we have that all combined on our platform. So those are a couple of the reasons why we are growing faster, really the quality of our platform and our product."
},
{
"speaker": "Glenn Fogel",
"content": "That's a good opportunity to do a shout out to the team who has done such wonderful work for so long now. I mean, to 14 out of the last 15 quarters to be the leader in the space and it's not because we're small. I mean our homes area in terms of a room night number and you compare it to the leader we're more than two thirds, potentially a lot more than two thirds, you don't really know because the number one puts their experiences and their room nights together. So -- but it's at least two thirds. So it's not like we're tiny. So it's really just wonderful. The incredible ability of us to come from but was something that a lot of people didn't think we'd be able to do and achieve something that is now a competitive product."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Mark Mahaney with Evercore ISI."
},
{
"speaker": "Mark Mahaney",
"content": "I'd like to ask about airlines and then operator. On the airline that growth you had, you talked about it a little bit on the call, but that's the I think the fastest growth you've had in, I don't know, a year and half or something like that. So maybe just talk about the growth going forward, like how much higher you think the attach rate could be or how many more markets is the -- do you still have the airline offering to roll out in? Like just give us a sense of what inning we are in terms of the growth of airline as a product in the booking portfolio? And then could you talk a little bit about the operator experience you have, anything you'd disclose on the economics, how did that partnership come together and what do you expect to get out of that going forward?"
},
{
"speaker": "Glenn Fogel",
"content": "Yes, very excited about those slight numbers. I think 52% growth and it was an acceleration from the previous quarter at 39%. I look back, it was even an acceleration from the quarter before. So I think it's really nice to see that trend. I do not think anybody should be projecting in a linear way, that's just going to continue to increase and accelerate, accelerate, accelerate that obviously is not going to happen. But I do believe that we will continue to maintain a strong growth in our flight business and it's not just by adding more markets. I don't think there's a lot to be done in that are, it's going to do a lot. What it is, is providing a better service to the traveler, so the traveler wants to use us versus all the other ways they can do a flight and that includes bringing it together part of our connected trip, given all the other types of value that we can provide. And it's not just giving them a hotel, it's not just giving them perhaps a discount in terms of a ground transportation in the airport or insurance or to actually -- it's creating something that really is different, something that provides value that the traveler has always wanted and that is that travel agent in your pocket and that travel agent in your pocket lives in the phone. And the idea is that this connected trip which many people when they start their travel planning starts with a flight. So we want to get them in. But once they're in, give them a lot more value. And then, of course, they're telling other people that this is something new and actually a much better way to do it. That's the idea and that's how we maintain a strong growth rate in all of our verticals, not just flights and that's what we're going to do. Now in terms of operator, very, very early. I don't think we're going to disclose any economics, and I'll be perfectly honest with you as you may not be surprised. I don't think there'll be much to talk about in that area right now. This is an area, though, that has just started and just learning how it works. What is the purpose of it? It's working with a very respected partner who knows a lot about AI. We know a lot about the travel industry. How can we do things together that'd be mutually beneficial to both of us, and we'll learn. Look, you go way back and again, going back in the past, I look at our site from 1999 and 2000. My God, it was horrible. It's amazing anybody bought anything back then. And now this thing, too, it's not the easiest I've used it. It's a little quanky but it will get better and we'll improve and build upon it. Got to start somewhere but we already started."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Brian Nowak with Morgan Stanley."
},
{
"speaker": "Brian Nowak",
"content": "Glenn, I have one for -- on gen tech for you. Just want to ask a question. So when you think about partnering with some of these other players like operator or maybe Gemini or any of the emerging potential next generation travel players, you give them access to your differentiated supply. How do you sort of think about managing the long term risk that a larger percentage of people and travelers could start using those products the next three, five, 10 years as opposed to going direct to you and it potentially has a negative impact on your overall mix between paid and direct traffic?"
},
{
"speaker": "Glenn Fogel",
"content": "Well, that is obviously something that people think about when you're putting together an agreement of any type with anyone in terms of what you're going to maintain proprietary to yourself, what you're going to be able to share with someone else to use, how the economic powers between the parties is going to work, lots of things to still work out that is something that's going to be a negotiation with a lot of the different parties involved in this and we'll see how it plays out. I will say the obvious that we are aware of the issues that you bring up. I do believe there are going to be different ways to come together so that different parties in this new world of agentic AI in that ecosystem, there'll be ways for a lot of players to do well. And I'm just pleased to be in the position with all the data we have, with the resource we have, the people we have, the worldwide network of consumers who trust us, which is also a very big deal. People when they're putting together travel for a lot of people, it's a lot of money to them and they don't do it often enough that they're just willing to just throw it at anybody, they want to do it with somebody they trust. So we have the advantage of having a brand that is trusted. All those things together help us in terms of discussions with other players who have other expertise to bring. And I am positive that we are in a very, very good position for this going forward. And Ewout, you may have some more."
},
{
"speaker": "Ewout Steenbergen",
"content": "And Brian, one other perspective to think of is the following. So with multiple agents that are going to be developed, and we will see many, many agents by developers over time, horizontal agents, vertical agents, very task specific agents. For us, that actually, from an economics perspective, will create an advantage because think about the cost of acquisition. If there are many parties and many providers working together with them will give us some advantage in terms of cost of acquisition that will come down from where we are today. So actually, with all the partnerships that we're building, all the relationships plus our own travel specific vertical agent that we are developing over time, we believe that actually this could help us very much from an overall economic perspective for the company."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Kevin Kopelman with TD Cowen."
},
{
"speaker": "Kevin Kopelman",
"content": "Could you give us your updated thoughts on your interest or lack of interest in larger M&A deals given recent activity in the space?"
},
{
"speaker": "Glenn Fogel",
"content": "Well, as you know, we don't discuss about M&A, except when we have a transaction to discuss then we'll just keep it the way. I said every single of the conference calls, this is the same one, same answers, we don't comment on M&A."
},
{
"speaker": "Kevin Kopelman",
"content": "Can I ask about ad costs, you mentioned that you're expecting leverage this year. Could you give us more color there on the trends you're seeing? Is it safe to assume that direct traffic you expect to continue to go up? And if you could touch on what you're doing with your brand spend, you mentioned it was down and also merchandising?"
},
{
"speaker": "Ewout Steenbergen",
"content": "So we expect marketing leverage to continue for the full year 2025, driven by the same trends that you have seen in the more recent past. More direct traffic is clearly a benefit overall. Higher performance marketing ROIs that we are able to achieve based on all the optimization algorithms that we are running and where the company has built so much expertise over time. And then I would very much like to call out also how excited we are about the development of social media channels. This is a big area of investment for us. We have invested a lot of our technology in this space and expertise working together with some of the large social media channels, particularly Meta where we have built a very close relationship. I don't want to say too much about that from a competitive perspective. But this is very much a bespoke model where both teams from both companies have built very effective way how we can monetize their leads and our leads, because this is really based on both remarketing and prospecting that come from both sides, as well as very personalized creative content in terms of feed. So incremental ROIs that we can measure with respect to social media channels is something that is new but we have been able to find out, figure out how to do that. So therefore, we are very confident that this is not ultimately a traveler that would have booked anyhow with us but it's really an incremental traveler that comes to us. And therefore, we're spending much more at attractive incremental ROI. So the combination of all of that means that we are very positive and enthusiastic about the outlook with respect to continued marketing leverage for the company."
},
{
"speaker": "Operator",
"content": "Your next question is from the line of Stephen Ju with UBS."
},
{
"speaker": "Stephen Ju",
"content": "So Glenn, I wanted to dig in a little bit more on your thoughts on AI. I think I heard in your prepared remarks about products that can help drive more revenue. And on the other side, other products that can help in cost avoidance. So as we talk to other companies, it seems like the cost avoidance part seems easier to deliver and things that might help revenue may take some more efforts. So where do you see yourself positioned in terms of when we can start seeing, I guess, noticeable impact to either the top or bottom line?"
},
{
"speaker": "Glenn Fogel",
"content": "That's a very good question, and I'm going to talk a little bit. I'm going to let Ewout what he wants to disclose there what we're already seeing in terms of some of the benefits. But let's start with the cost avoidance part. Last call, we talked a little bit about what we were seeing in benefits in customer service, clearly an area where there's great opportunity for anybody who has a large customer service operation to achieve significant savings, even something as simple as a CS agent that has to do a summarization at the end of the call. We're right away you have something that can do it automatically, thereby making the amount of time the agent is spending, not talking to a customer but summarizing goes away. Simple example but there's so many about that. And then think not just in terms of the cost there but this is an important one is there are a few things that are as frustrating is having to wait on hold to get in touch with a customer service agent. The wonderful thing as we develop AI capabilities and customer service is we won't be waiting for somebody to answer the phone. The agent will be answering the phone. In fact, one of the things that we mentioned in the call it's not a big thing for our income statement. I like saying it is an open table and the interactions they're doing with sales agent -- sales force in their agent wear and coming up with some things that are very helpful in that area. So that's just one area. Of course, you have the coding efficiencies that everybody talks about. You get hopefully some significant benefits down the road as our developers are able to do a lot more work in the same amount of time, and they're all different areas. So I'm not sure what Ewout is going to want to talk in terms of numbers for that but I'll let him say how much he want to disclose or not. On the revenue side, yes, it is going to be a little slower and showing up in terms of increases but it's great to see what we're already doing. And again, it's the benefit of having the knowledge, the expertise and the resources to do this. I mean one of the things when you're not involved in the industry is you're not as knowledgeable about the complexity of travel. It's not just simply a press a button and you get a booking. I mean, even things as simple as the regulatory world that you have to deal with to make sure if you're using AI, it's not like the travel rules you have to worry about, you kind of worry about the legal things with AI. For example, in Europe, there's the EU AI act. So you've got to make sure anything you're building is going to fit that. And then there's obviously is the context, awareness and kind of knowledge of travel. The great thing is having the incredible amount of data we have really understanding what works, what doesn't work and being able to put that into a database that can then be used by a generative AI model that's an advantage. I go on and on I won't use it all the time. But I just say yes, it's going to be a little slower perhaps than the cost savings but that revenue opportunity is huge. And Ewout, I don't know what you want to disclose."
},
{
"speaker": "Ewout Steenbergen",
"content": "Stephen, I would like actually more to point out actual numbers then to speak about some percentage of savings that sometimes is being mentioned. But then, of course, the question is where does it actually show up in the results. So let me first point you to our sales and other expenses for the fourth quarter. What you see here is that those were flat as a percentage of gross bookings around 2% of gross bookings compared to the fourth quarter of 2023. And beneath what is happening there is with the growth of our deferred -- of our merchant bookings, we had higher payment related expenses but that is offset by efficiencies in our customer service. So the fact that we have basically flat S&O expenses as a percentage of gross bookings despite the growing merchant business is a clear point in our results that has already seen the advantage of generative AI in terms of actual efficiencies. The other example that I can give is that in terms of the transformation program savings in year 2025 of $150 million, a meaningful part of that is already coming from efficiencies that we will be able to achieve with regenerative AI in multiple parts of the company. So it is already clearly showing up in our numbers in the fourth quarter as well as the savings target that we have for 2025."
},
{
"speaker": "Operator",
"content": "Our final question today will come from the line of Justin Post with Bank of America."
},
{
"speaker": "Justin Post",
"content": "Glenn, I'd like to comment a little bit more on the merchant mix shift. Obviously way faster growth for merchant bookings. Can you talk a little bit about how that might translate to higher margins or better loyalty, better repeat rates? And just how that's kind of transforming your business over time? And then I'd love to ask about room nights. Obviously, some decel in Q1 but you seem very confident on the year. So were some of those nights borrowed in Q4? And then maybe talk about summer booking pacings, if you can."
},
{
"speaker": "Glenn Fogel",
"content": "I'll take the first, and then I'll let Ewout take the second. On the first one, when we first started the merchant program Booking.com, there's lot of questions of why are we getting out of an agency model that seems so simple, so clean and why you're doing that. And one of the key things, right, from the get go was to achieve the connected trip vision, you need to have that foundational platform in payments, very, very important. We have that now and obviously it's the numbers you just mentioned, they continue to increase in terms of the share of the total amount of our bookings. That's very important in terms of being able to give benefits to our customers. It's also very important for giving them the way they want to pay, some of them want to pay in one way, some want to pay it another way. A lot of people who aren't international don't understand that a lot of people don't use Visa. They don't use Mastercard. They had their own way to pay. And the traveler on the other side -- the supplier on the other side doesn't really want to take the payment the way the traveler wants to give it. So for example, the easy example is out of China, somebody is using Alipay, the small hotel in France doesn't take Alipay. Fortunately, we, as that person in the middle, with that merchant pay we can do that. So it makes us a win-win for everybody, and it could be less expensive given the FX charges, the interchange charges, et cetera, there's money to be made for all of us. It's cheaper for the traveler, it's cheaper for the supplier and we can make money in the middle. That's one example. But then you come up with new products, new things that we talked about. And Ewout mentioned the pay your own currency type thing, there are a lot of different things. Here's the thing. So we said we did $166 billion of total transaction value in 2024. Now not all of that was done on payment, so it was agency, but it's continued to grow up as our total volume continues to increase. The question is, what percentage of that, how many basis points, what should we be able to get out of that as profit? And I'll let everybody else make their own guesses and estimates on that. But there's a lot of way, there's a lot of way to make some very good returns, at the same time, providing better services to both sides of the marketplace. And Ewout, you can forward on his room nights question."
},
{
"speaker": "Ewout Steenbergen",
"content": "Justin, let me first zoom out a little bit for our guidance with respect to the first quarter and then I will give you a more specific answer with respect to room night. So first, let me point out for the first quarter, normalized and that means normalized for the impacts of Easter, FX and leap year, we are having guidance that shows low double digit growth with respect to gross bookings, revenue and EBITDA, low double digits growth. So specifically on room nights, there's a few elements why it's 5% to 7%. Looking first back to the fourth quarter of 2024. The comps were a little bit easier in the fourth quarter, particularly due to the effect of the October 7th attacks in 2023. So that drove a little bit of the higher growth and also the expansion of the booking window. And then we have, for the first quarter of this year, a little bit of headwind from the impact of the leap year compared to a year ago. So those are couple of specific elements why we are guiding to 5% to 7%. But as I said, normalized, we think it's going to be a really good quarter. And again, for the full year guidance, what you see is on a constant currency basis, we're hitting our long term algorithm for the company. So coming out of a, I think, fantastic quarter for the company with a lot of momentum, we're very encouraged about the outlook for the year and we see a lot of underlying healthy trends for the company."
},
{
"speaker": "Operator",
"content": "I will now hand today's call back to..."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you. So I just want to say I thank our partners, our customers, our dedicated employees and our stockholders, we are truly grateful for everyone's support as we work towards realizing our company's long term vision. Thank you very much, and good night."
},
{
"speaker": "Operator",
"content": "This concludes today's call. Thank you for joining. You may now disconnect your lines."
}
] |
bkng | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Welcome to Booking Holdings Third Quarter 2024 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guaranteed of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from these expressed, implied or forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical facts are intended to identify forward-looking statements. For a list of factors that could cause Booking Holdings actual results to differ materially from those described in the forward-looking statements, please refer to the Safe Harbor statements at the end of Booking Holdings earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release together with an accompanying financial and statistical supplement is available in the For Investors section of Booking Holdings website, www.bookingholdings.com And now I'd like to introduce Booking Holdings speakers for this afternoon, Glenn Fogel and Ewout Steenbergen. Go ahead, gentlemen."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you, and welcome to Booking Holdings third quarter conference call. I'm joined this afternoon by our CFO, Ewout Steenbergenn. I am pleased to report an improvement in topline trends in the third quarter, particularly in Europe that resulted in room nights, gross bookings and revenue all exceeding the high-end of our prior expectations. The revenue outperformance combined with disciplined marketing spend and lower-than-expected fixed OpEx growth helped drive adjusted EBITDA that was 9% above the high-end of our prior guidance range. We continue to be encouraged by the strength of our underlying business, the health of the travel industry and the attractiveness of our products. In the third quarter, our travelers booked just under 300 million room nights across our platforms, an increase of 8% year-over-year. Revenue of $8 billion grew 9% year-over-year and adjusted EBITDA of $3.7 billion increased 12% year-over-year. Finally, adjusted earnings per share grew 16% year-over-year, helped by our strong capital return program, which reduced our average share count by 6% year-over-year. From a regional perspective, we observed an improvement in our room night growth in Europe in the third quarter, which was the primary driver of the sequential increase in our global room night growth. In Asia, we continue to perform well with another quarter of double-digit growth and we remain optimistic in our outlook for this region, which I'll discuss in more detail later on the call. In the U.S., we see relatively stable levels of growth in our business so far this year, which we think continues to outpace the broader U.S. accommodation industry. As we look ahead to the fourth quarter, we expect to continue to see healthy levels of room night growth as demand for travel remains resilient. Ewout will provide further details on our third quarter results and our thoughts about the fourth quarter. I remain confident in the attractive growth profile of the travel industry, our competitive position and our long-term growth and earnings model. We continue to see progress across several important initiatives, which include growing alternative accommodations, advancing our connected trip vision, continuing to develop our AI capabilities and continuing our progress in Asia. These initiatives contribute to our ongoing effort to deliver a better planning, booking and travel experience for our travelers, while also benefiting our supplier partners. We remain focused on being a trusted and valuable partner to all of the accommodation properties on our platforms by delivering incremental travel demand and developing products and features to help support these businesses, the majority of which are small independents. For alternative combination of booking.com, we continue to see more properties connect to our platform with listings at the end of Q3 reaching $7.9 million, up about 10% from last year. The growing number of listings provide more combination choices for our travelers, which we believe contributed to strong alternative accommodations room night growth of 14% in Q3. We believe that we have a differentiated offering, because we make all property types, hotels and alternative accommodations available on our booking.com platform. We see benefits to this approach. For example, our data shows that a portion of our bookers landing on our platform with an interest in a hotel will instead end up booking an alternative accommodation and vice-versa. We believe that this shows, in many cases, travelers are open to comparing hotel and alternative accommodation options when determining the best place to stay for their trip. Our objective is to make sure we continue to provide great choices for our travelers across all property types. On the connected trip, we continue to take steps towards our long-term vision to make the planning, booking and travel experience easier, more personal and more enjoyable while delivering better value to our travelers and supplier partners. We believe the connected trip is strengthened by our growing merchant capabilities, which help bring the different elements of travel together in a more seamless booking experience. In addition, our Genius loyalty program at booking.com has been expanding outside of accommodations and into our other travel verticals, which helps to deliver more value to our travelers as they book more components of their trips with us and to our partners as they receive incremental bookings. We continue to see growth in Connected Trip transactions, which means a trip that includes booking more than one travel vertical. These connected transactions increased by over 40% year-over-year in the third quarter and represented a high single-digit percentage of booking.com's total transactions. We believe by making it easier to plan and book multiple elements of a trip on our platform, we are providing a better overall booking experience for our travelers and we have seen in past experiments that customers who choose to book a connected trip book more frequently with us and have a higher likelihood of booking directly with us in the future. Turning to flights. They're an important component for many of the connected trips that our travelers are booking. In the third quarter, air tickets booked on our platforms increased 39% year-over-year, which was an acceleration from Q2 growth of 28% and was driven primarily by the growth of booking.com flight offering, but we also benefited from strong growth in our flight business. We continue to see a healthy number of new customers coming to booking.com through the flight vertical and are encouraged by the number of these customers and returning customers that also see the value of the other services we offer on our platform. To achieve the easier and more personalized experience of the Connected Trip, we've always intended for AI technology to be at the center of this vision. At each of our brands, our teams of AI experts continue to draw on their valuable experience as they incorporate AI technology into our platforms. We believe that our proprietary data, along with our resources and scale, position us well to build compelling and personalized AI-powered offerings for our travelers and partners. This technology will also enable us to drive further efficiency in our own operations. We have significant activity in this area across the company, and I'll briefly discuss just a few of the encouraging efforts that are underway across our brands. Last summer, Booking.com launched its AI trip planner. And since the launch, Booking.com has gained valuable insights from its millions of interactions with bookers, as well as from the use of the Gen AI technology alongside our existing machine-learning models. The learnings from the AI trip planner are leading to new applications of Gen AI technology, including a recent launch of our smart filter, which makes over 200 potential search filters findable through a free text interface. These innovations also extend to the partner-facing side of the business at Booking.com. Gen AI is being leveraged to help properties write responses to traveler queries, and this tool has led to an increase in response rates to traveler messengers. This improves the experience for our travelers and partners. Booking.com is also testing a Gen AI-powered partner Chatbot to help with questions during the onboarding process and accelerate sign-ups, starting with a focus on alternative accommodation properties. Booking.com is also working to incorporate Gen AI into its customer service function to drive increased efficiency and a better experience for travelers. Initial testing shows meaningful improvements in topic detection in Booking.com's customer help center as well as customer service agent case summarization. Booking.com is still early in this journey and sees meaningful opportunities in improving customer service and driving greater efficiency by leveraging AI in the future. At Priceline, travelers have now had over 3 million interactions with its generative AI travel assistant called Penny. This was launched last summer. While Penny was originally positioned at the end of the funnel on the checkout page, it's now available across the full booking experience and can address many types of traveler questions, including destination discovery, hotel search and trip support. In October, Priceline launched Penny Voice, which enables Penny to engage in verbal conversations with travelers and to assist them with planning trips, searching for hotels and servicing bookings. As Priceline continues to enhance this offering, we envision that Penny will be able to anticipate needs based on preferences and past interaction, and then respond in a real-time voice. While there has been great progress in the development of Penny over the last year, Priceline is focused on further enhancing Penny over time by leveraging their valuable learnings so far. In Agoda, over 120 use cases for GenAI have been implemented across customer service, software development, content generation, product, finance and HR. Agoda is highly focused on leveraging Gen AI to automate product development using both externally and internally developed tools. This is leading to an increase in the share of code written by AI as well as measurable improvements in productivity per developer and development time. In March, Kayak launched its Ask Kayak travel Planning tool, which improves and personalizes the search experience by allowing travelers to use free-form text entries to search and refine the results. At the same time, Kayak, also launched PriceCheck, a price comparison tool that allows travelers to upload a screenshot of a flight intinerary, which Kayak can then check against many different sites in order to determine if there is a better price available for the traveler. At OpenTable, an AI voice bot has been recently integrated into its offering to help participating restaurants answer their phones. Diners can call these restaurants and perform tasks like making a reservation, altering their reservation, asking questions and noting dietary restrictions, which are then automatically updated into OpenTable software. OpenTable has also partnered with Salesforce Agent Force platform. This helps its customer service agents better serve its restaurants and diners. This platform is now handling restaurant web queries, which is helping agents focus on delivering great service in more complex situations. It's exciting to see the work happening across our company to integrate Gen AI into our platforms and the knowledge hearing that is ongoing between all of our brands. We know we are still in the very early days of Gen AI and we have much more to learn about consumers, how they ultimately want to interact with this new technology, but I remain confident in our company's ability to benefit from AI development and to improve our products for our customers given our many years of experience in AI, our travel-related data, connections to our supply partners and our human and financial capital. Over time, as we further incorporate this technology, we expect to see benefits in traveler and partner acquisition, retention and satisfaction. In addition, we expect it to improve operational efficiency, which will contribute to a deceleration of our fixed expense growth in the future. Finally, as I mentioned at the start of the call, we continue to be optimistic about our long-term outlook for Asia. We see Asia as strategically important due to its size, growth potential and our positioning in the region. We estimate that the travel industry growth in Asia will be in the high single-digits over the next five years, which is the highest market growth rate of our major regions. Our ambition is to continue to grow faster than the overall travel industry in Asia as we have done through the pandemic recovery. Over the last 12 months, about 24% of our global room nights were booked by bookers in the Asia region, which is a slightly higher mix than it was prior to the pandemic. Our business in Asia is diversified across the countries in the region with no single country representing more than a low single-digit percentage of our global room nights. The success we have seen in Asia and our solid positioning in the region has been driven by operating two complementary brands, Agoda and Booking.com. Our approach is to utilize both of these brands across the region with an eye on profitable growth for Booking Holdings over the long run. In conclusion, I'm encouraged by our strong third quarter results and the continued resilience of leisure travel demand. Our teams continue to execute well against our key strategic priorities, which helps position our business well for the long term. We remain confident in the long-term growth of travel and in the many opportunities ahead for our company. I will now turn the call over to our CFO, Ewout Steenbergen."
},
{
"speaker": "Ewout Steenbergen",
"content": "Thank you, Glenn, and good afternoon. I will now review our results for the third quarter and provide our thoughts for the fourth quarter and the full year. All growth rates are on a year-over-year basis. Information regarding reconciliation of non-GAAP results to GAAP results can be found in our earnings release. We will be posting a summary earnings presentation as well as our prepared remarks to the Booking Holdings Investor Relations website after the conclusion of the earnings call. Now let's move to our third quarter results. Our room nights in the third quarter grew 8%, which exceeded the high end of our guidance by 3 percentage points. The stronger-than-expected room night growth was driven by an improvement in trends in Europe starting in August and benefited from the booking window expanding year-over-year in the third quarter versus our expectation for it to be more similar to 2023. Looking at our room night growth by region in the third quarter, Europe was up high single-digits, Asia was up low double-digits, rest of higher world was up mid-single-digits and the US was up low-single digits. As Glenn noted, we continue to make progress against our strategic priorities, including growing alternative accommodations, increasing the mix of our bookings to the direct channel and our mobile apps, enhancing our Genius offering and driving growth in our other travel verticals as part of our Connected Trip fishing. For our alternative accommodations at Booking.com, our third quarter room night growth was 14%, which continued to outpace the overall business. The global mix of alternative accommodation room nights at Booking.com was 35%, which was up 2 percentage points from the third quarter of 2023. We continue to strengthen our direct relationships with our travelers and increase loyalty on our platforms. Over the last four quarters, the mix of our total room nights coming to us through the direct channel was in the mid 50 % range. And when we exclude our B2B business was in the low 60% range. We've seen both of these mixes continue to increase year-over-year. Mobile app mix of our total third quarter room nights was in the mid 50% range, which was up from the low 50% range in 2023. We continue to see that a significant majority of bookings received from our mobile apps come through the direct channel. For our Genius loyalty program, the mix of Booking.com room nights booked by travelers in the higher genius stairs of levels two and three was in the mid-50% range over the last four quarters and this mix continued to increase year-over-year. In our other travel verticals, we saw airline tickets booked on our platforms in the third quarter increased 39%, driven by the continued growth of flight offerings by Booking.com and Agoda. We also saw rental car days booked on our platforms increased 16% in the third quarter, driven by strong growth at Booking.com. The growth rates for airline tickets and rental car days were both better than our expectation and both accelerated from the second quarter. Third quarter gross bookings increased 9%, which was approximately one percentage point higher than the 8% room night growth due to about two percentage points from higher flight bookings growth, partially offset by a decrease in constant currency accommodation ADRs of less than 1%. The year-over-year ADR decline was negatively impacted by a higher mix of the room nights from Asia. Excluding regional mix, constant currency ADRs were up less than 1% versus 2023. The increase in gross bookings exceeded the high end of our guidance by five percentage points due to stronger room night growth plus less pressure from changes in FX and stronger flight ticket growth. Third quarter revenue of $8 billion grew 9% year-over-year, which also exceeded the high-end of our guidance by five percentage points. Revenue as a percentage of gross bookings was in line with our expectations at 18.4% and was also in line with the prior year as increased revenues associated with payments were offset by a higher mix of flight bookings. The increased revenues from payments were driven by an increase in our merchant mix, which reached 65% of our total gross bookings, up from 56% in the third quarter of 2023. Marketing expense, which is a highly variable expense line, increased 6% year-over-year. Marketing expense as a percentage of gross bookings was 5.0%, about 15 basis points lower than the third quarter of 2023 due to a higher direct mix and higher-performance marketing ROIs, partially offset by increased spend in social media channels. Third quarter sales and other expenses as a percentage of gross bookings was 2.0% in line with last year. Our fixed expenses on an adjusted basis were up 7% year-over-year and were below our expectation due primarily to lower IT expenses, some of which we expect to shift into the fourth quarter, as well as lower G&A expenses. We continue to be very focused on carefully managing the growth of our fixed expenses. We believe it is important to drive greater operating leverage in our fixed expenses as this creates capacity for disciplined investment across our strategic initiatives, which we believe will help drive stronger top line and earnings growth in the future. Adjusted EBITDA of $3.7 billion grew 12% year-over-year and was above our expectation, largely driven by the higher revenue and also by the lower-than-expected fixed expenses. Adjusted EBITDA margin of 45.8% in the third quarter was up versus last year by a bit more than one percentage point due to marketing and fixed expense leverage. Adjusted net income of over $2.8 billion was up 9%. Adjusted EPS of $83.89 per share was up 16% and benefited from a 6% lower average share count than the third quarter of 2023. On a GAAP basis, net income was $2.5 billion in the third quarter and was negatively impacted by a $365 million accrual in G&A expenses related to a potential settlement of certain Italian indirect tax matters, partially offset by a $250 million reduction to our US repatriation tax liability, which lowered income tax expense. Now on to our cash and liquidity position. Our third quarter ending cash and investments balance of $16.3 billion was down versus our second quarter ending balance of $16.8 billion due to about $2 billion of capital return, including share repurchases and dividends and a paydown of about $1.1 billion for debt that matured in September, partially offset by about $2.3 billion in free cash flow generated in the quarter. Moving to our thoughts for the fourth quarter, we expect fourth quarter, room night growth to be between 6% and 8%, continuing our positive trend from the third quarter. We expect fourth quarter gross bookings to grow between 7% and 9%, a point ahead of room night growth due to expected higher flight ticket growth. We expect constant currency accommodation ADRs to be approximately flat year-over-year. We expect fourth quarter revenue growth to be between 7% and 9%. We expect fourth quarter, adjusted EBITDA to be between about $1.6 billion and $1.65 billion, representing growth between 9% and 13%. We expect adjusted EBITDA to grow faster than revenue due primarily to marketing leverage as a result of increasing direct mix. We're increasing our outlook for the full-year, driven primarily by the stronger than expected third quarter, which is our seasonally largest revenue and profit quarter. We expect full-year gross bookings to increase about 8%, an improvement from our prior expectation of faster than 6%. We expect full-year revenue growth of just below 10%, which is better than our prior expectation of faster than 7%. We expect a slightly negative impact from changes in FX on our full-year top-line growth rates, which compares to our prior expectation for about one percentage point of negative impact. We expect fixed OpEx on an adjusted basis to grow around 10%, lower than our prior expectation. We expect adjusted EBITDA to grow between 13% and 14%, which is better than our prior expectation due to the increased revenue growth and lower fixed OpEx growth. We expect adjusted EBITDA margins to expand year-over-year by a bit more than one percentage point. And finally, we expect our full-year adjusted EPS to grow in the high-teens. In conclusion, we are pleased with our third quarter results and our outlook for the fourth quarter, and the full year. Thank you to all my colleagues across the company for their hard work, determination, innovation and teamwork. With that, we'll now take your questions. Operator, will you please open the lines?"
},
{
"speaker": "Operator",
"content": "Thank you, sir. [Operator Instructions] We'll take the first question today from Justin Post, Bank of America."
},
{
"speaker": "Justin Post",
"content": "Thanks. I guess since you talked a lot about AI in your prepared remarks, maybe you could talk about how you expect that to translate to financials. Do you think AI can bring more direct traffic because of all your tools, better attach rates when people come to your site, maybe lower expenses? Just how we see that translate to financials. And then one on bookings. It looks like, you know, could you talk about some of the factors in Q4 that could affect bookings, either the hurricanes or the you know maybe the Middle East comps, how you're thinking about some of the 4Q factors? Thank you."
},
{
"speaker": "Glenn Fogel",
"content": "Hi, Justin. It's Glenn speaking. I'll take the first question about AI and then I'll let Ewout talk a little bit about your question regarding fourth quarter. So we did give a number of examples about some of the things we're working on at the company on AI because I know there's a lot of curiosity about where are we, what's happening and it is one of the most exciting times I've -- this company ever. And it's something I've talked about before, maybe you've heard me talk in some conferences, et-cetera, that this type of technology is really transformational and it's going to make it so much better for all people in the travel industry, particularly for the traveler. It's also going to enable us to be able to provide a better service to our partners, enabling them to get more incremental, more targeted customers, help their business better. You, of course, you'd like to know how does that translate into dollars and cents. That is difficult at this time. It's still very, very early. We see some of the efficiencies already coming in some places. And we've mentioned and I mentioned in the prepared remarks about some of the numbers in terms of number of people using it, which is actually a relatively small number compared to the total number of interactions we have with customers. Sounds like a big number, 3 million, where that's a big number, but it's small compared to the size of this company. So I know what you'd like to know, but we're not going to project those kind of numbers right now. But what I will say is, it's incredibly important the companies that are successful in AI are going to be the long-term winners because it is going to, as I say, be transformational. I'm very pleased that we've made progress so far and we have some certain advantages. We've got capital. We've got people who have been working with AI now for many, many years. Sure, it wasn't Gen AI. They're working on machine learning model, et cetera, but we've got a lot of people who are very, very skilled in the areas of technology. In addition, having more data, which is so important to be able to combine with other people's large language models, other people's systems and come up with really unique ways to provide a better service. It's something that I'm just so thrilled to see what we're doing, what we're building. And I urge anybody who's curious about this, test out some of the things we have out there. It's out in the market. It's live, it's real. See what you think of it. I've done it a lot myself and sometimes I'm really pleased, sometimes a little disappointed, but I know we're making great progress. And in the future, we'll be able to better quantify for you what you'd like to know. Ewout I'll let you go into fourth quarter."
},
{
"speaker": "Ewout Steenbergen",
"content": "Justin, with respect to the outlook for bookings in the fourth quarter, I think the headline is we're looking at the fourth quarter as a very robust and positive quarter where we see a continuation of the trends we have seen over the last few months. But let me dive a little bit deeper into that. First, the comps get a little easier in the fourth quarter because we are lapping the period last year where we had an impact, particularly with respect to the start of the conflict in the Middle East. The second point is, you are referring to events. Events from our perspective doesn't really impact our results. It might have a really short-term impact, but in the end, it always will average out. So you will never hear us really pointing to events as an impact on our outlook or actual performance. The third is what we have seen so far is continuation of the strength of August and September, also in October. The fourth is, I think it's important to take into consideration that we expect the booking window to be less expanded in the fourth quarter than we have seen in the third quarter. In other words, there might have been some pull forward of bookings that otherwise would have been in the fourth quarter into the third quarter. And the last is, we absolutely also have reflected uncertainties and risks with respect to the global geopolitical environment. We all know there are a lot of things out there that are happening and we also have taken that into consider -- in our consideration with respect to our fourth quarter outlook and guidance."
},
{
"speaker": "Justin Post",
"content": "Great. Thank you. Appreciate it."
},
{
"speaker": "Operator",
"content": "The next question comes from Mark Mahaney, Evercore. Two questions, please."
},
{
"speaker": "Mark Mahaney",
"content": "On the Asia callout, Glenn, was this the first time that Asia, I think as a percentage of your mix was higher than it was pre-COVID? I assume so. That's why you called it out, but anything in particular in the region that you've done? Or is that just the region you know finally recovering back to kind of full outbound travel mode? So you know how much of that sort of success for you was what you did versus just the market there finally recovering? And then AA in the mix, this I think 35% number. The question I have for you is trying to figure out where that mix is you know long term. In markets where you have kind of full sufficient inventory, both traditional and AA, is the usual mix in those markets around that average of 35% or is it materially higher? Therefore, we could expect the overall mix to go up because you still have a lot of regions where you don't have enough AA inventory? Thanks a lot."
},
{
"speaker": "Glenn Fogel",
"content": "Hi, Mark. I'm not sure if you're right actually on that thing about calling out Asia. I think we had some things where Asia has done better, but regardless of that, let's just talk a little bit about how pleased we are with the growth we're seeing in Asia. And yes, we're obviously getting a bit of a benefit because Asia overall as a market is growing fast. There were certain areas of Asia that were a little slower coming out of the pandemic and such. But this is an opportunity for me to really put out a thanks to our Agoda team. That team has been just doing really well in coming up with ways to provide a better service to the Asia customers. It's a little bit different in some parts. Now I say Asia, obviously, Asia is a very big place, a lot of different countries, a lot of different ways people buy what people are looking for. And the Agoda team has done a good job of localization of coming up with ways that the customer in different parts of Asia, the way they want to buy, matching up with different types of payment methods, for example, to be able to -- that the local person who wants to pay in a certain way can use our service and feel comfortable doing that. In addition, making sure we're getting great inventory. Again, can be a little different in Asia than other parts where there's a lot of small independence or different ways to get great pricing, make sure it's showing up on our site. So great team effort by everybody there in Agoda and that's helping great deal of booking, also doing Asia efforts. So overall, we're really, really pleased with what's happening there. Now your second question about alternative accommodations, we are pleased, again, with the growth rate there, 14%, like it, increasing the listings to 7.9 million, 10% increase in list like that one too. You know last time in the call, I said how we had beaten our biggest homes competitor 11 of the last 12 times and we came out of that time ahead of them in terms of the earnings announcement, I didn't know if we're going to beat them again and we did. So I'm wondering this time will we do it again, maybe at 13 quarters out of 14 and it's not a small business. It's a big business because as we mentioned a couple of times, the total amount of room nights for alternative accommodation is running roughly a little bit two-thirds of the biggest homes player in this market. So it's a big business. So it's great to be able to growing at this size and it's great to be doing in sort of the leading in terms of growth. Your question is, at what stage do we end up and feel sort of that sort of the max or so? I don't know because one of the key things to our business is making sure that we just get as much of the inventory that the customer wants on the site and they choose. And I mentioned it in the remarks about how customers come to our site and from what they've chosen to start with, we know what they were thinking of and then they go and they buy something else. So a key thing to our business is making sure we provide whatever the customer wants and not try and steer them. So I don't know what the ultimate share is going to be. I do know though what's important is to continue to work on getting great inventory. And as long as we're talking about it, we're nowhere near in certain regions sort of getting it. It's a lot of ramp left in front of us. US in particular, I keep repeating myself quarter-after-quarter. Sure, we're growing that business nicely in the U.S., but there's so much more to be done. And I was just looking today, literally today because seeing what was available for us in the Hamptons, I'm a New Yorker. I look into the summer, it's like not enough inventory there yet. So some people can say that's a negative. I say that's you know an opportunity for us and I'm really looking forward to continue to build out the business."
},
{
"speaker": "Mark Mahaney",
"content": "Thank you, Glenn."
},
{
"speaker": "Operator",
"content": "And your next question comes from Doug Anmuth with JP Morgan. One moment…"
},
{
"speaker": "Dae Lee",
"content": "First one --"
},
{
"speaker": "Operator",
"content": "I apologize, just one moment. Okay, go ahead, Doug. I'm sorry."
},
{
"speaker": "Dae Lee",
"content": "Okay. Hey, this is Dae on for Doug. Thanks for taking the questions. I have two. So the first one, could you double-click on what you're seeing in Europe? Last quarter, you talked about mild moderation in growth in Europe, but the region drove outperformance this quarter. So what changed there into end of summer and fall? And do you have any macro views to share around the U.S. as a region?"
},
{
"speaker": "Ewout Steenbergen",
"content": "First, with respect to Europe, we have clearly seen first, with respect to Europe, we have clearly seen a reacceleration of growth starting in August. We believe that perhaps in July, there was a bit of impact of some of the events. But again, we always look at that as purely timing and that is averaging out. But then we also believe there is a general underlying improvement what we are seeing in Europe in terms of the general demand for our products and services. It's partially market, but it's partially also our proposition. Of course, as Glen already explained, having such a great platform with so many options, so many verticals where you can purchase in so many different ways. And in Europe, many people use us on the app and it's really very much a mainstream app that people are using if they want to travel very easy. You have your credit card there, easy to book, easy to adjust. So that is definitely in Europe, a big winner and therefore, we have been so much really the standard in Europe with respect to our proposition. I also need to point at the expansion of the booking window that happened in the third quarter. So that definitely also helped with the acceleration of growth at the same time."
},
{
"speaker": "Dae Lee",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "And the next question comes from Kevin Kopelman, TD Cowen."
},
{
"speaker": "Kevin Kopelman",
"content": "Great. Thanks so much. I had a question on marketing. Could you give us an update on kind of you know what you're seeing? You mentioned higher ROIs in the third quarter. How much of that is underlying improvement in ROIs versus Europe being stronger? And can you update us on how you expect the full year now to look in terms of marketing and merchandising as a percentage of GBP? Thanks."
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes, Kevin. Overall, how you should look at marketing and higher ROIs I think this is really where the company has such a specialized expertise, has such great algorithms that are continuously optimizing our incremental spend to make sure that the incremental ROIs are really the highest that are possible and doing that across all the different options we have how to allocate our dollars. So this could be the different forms of performance marketing channels, it could be with respect to merchandising, but it could also be with the social media channels where we are expanding our marketing spend as well. So clearly, the opportunity was there through our continuous optimization to ultimately achieve higher growth with higher ROIs at the same time. With respect to your question on the outlook, merchandising as a percentage of growth bookings, we expect it to be more or less flat compared to last year for each of the quarters of 2024 and for the full year. With respect to marketing, we expect marketing leverage to continue in the fourth quarter as a result of the continued growth of our direct channels."
},
{
"speaker": "Kevin Kopelman",
"content": "Great. Thanks so much."
},
{
"speaker": "Operator",
"content": "Next up, we'll hear from Eric Sheridan, Goldman Sachs."
},
{
"speaker": "Eric Sheridan",
"content": "Thanks so much for taking the question. I want to come back to the theme on fixed investments. You know, first, looking backwards, you know, maybe highlight some of where you've made investments around fixed costs and what you're most proud of in turning a return profile in those fixed investments that you're seeing an impact on the business today? And not about 2025, but just longer term, how do you think about coming out of that fixed investment cycle and how to think about the return profile or incremental margin that could be produced in the business as fixed investments start to grow slower than revenue over the longer term? Thank you."
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes, Eric, I really love that question because it's something I'm extremely personally passionate about. The way we look at this is actually in two different ways. One is where do we see opportunities for efficiencies and achieving operating leverage and then a completely separate decision mechanism around where can we reinvest those dollars in the most optimal way that we will achieve the highest growth potential at attractive business case returns in the future. So let me start with the first part. In terms of operating leverage, we believe there are many opportunities we have as a company because we have been building up skill in the organization and now, we should have an opportunity to run much more volume over the existing scale over the next period. So let me point you to a couple of areas. First, we have tremendously slowed down hiring. So if you look now, our year-over-year headcount is up approximately 3%. If you go back a year ago in the third quarter of 2023, headcount was up 13%. So clearly, we are being more efficient and we are very careful with hiring. We already touched on our AI, artificial intelligence as a clear opportunity to find efficiencies in the future across many different areas. In the interest of time, I will not elaborate on that, but that's a clear opportunity. We're also looking at procurement, real estate, operating model optimizations, looking at spends, layers to really make the organization more agile in many of those areas. And we believe we really have an opportunity to expand on that in the future, But then I think your question is also where are we proud about in terms of investments? Well, if you think about the number of new areas where we're growing as a company, it's super impressive from my perspective. A few years ago, we were not really in flags. Look at the growth we are reporting, 39%, look at all the other verticals. Looking at what we're doing with respect to payments and fintech, looking at what we're doing from a geographical perspective. Glenn was touching on the very impressive growth in Asia, the investments we're making in the U.S. and we believe we are growing still faster than the market in the U.S. and we'll continue to aim to do that in the future as well and many other areas. So we are very much focused on in a very disciplined way, looking at our scarce resources, making sure that we're using that in the most optimal way and in the end, invest in the most attractive growth opportunities for the company over the next period."
},
{
"speaker": "Glenn Fogel",
"content": "And I'll just add, I think what Ewout said really hit a lot of the key things that have made us successful. And looking back, there have been a lot of times that people have questioned what are we investing in and why we're spending the money there, et cetera. And we're now finally beginning to see a little bit of the benefit to this. So there was a point where, as you know, Booking.com was totally an agency business, totally an agency business, no payments at all. Now we talk about our merchant mix is now 65% and we talk about how important it was to have that as a foundational pillar for our connected trip, which is another area where people question, why are you getting out of hotels? Why are you getting into these other verticals? The end of the day is long term success of a company is being able to make change, to make things different as the world changes, you have to change with it. If we just stayed as an agency-only hotel and not had invested in other areas, we will not be where we are today. Now going forward, we can't stop. We continue to do that. So as Ewout said, we've got to be very careful, where are we spending our money. We've got to not put money into things that are not going to be productive and move resources into place that is -- of something is no longer necessary, we just have to have the will to stop that and do something else. So I'm really proud that we've been able to -- I've been here now almost 25 years. It will be 25 years in February. And throughout this, we have changed tremendously, but the one thing that we really concentrate on is making sure we are careful with our shareholders' money."
},
{
"speaker": "Eric Sheridan",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And from Deutsche Bank, Lee Horowitz has the next question."
},
{
"speaker": "Lee Horowitz",
"content": "Great, thanks. Maybe Glenn, another one on alternative accommodations. You gave a lot of color on the booking patterns you're seeing on the platform as it relates to cross-shopping hotels and alternative accommodations. But can you comment at all what you're seeing in terms of incrementality of this volume? Do you think your growing presence here is bringing in new cohorts of travelers who are coming to booking for this vertical specifically or is a large piece of this volume coming from consumers that would have likely booked a hotel on your platform otherwise?"
},
{
"speaker": "Glenn Fogel",
"content": "That's a very interesting question because I haven't noticed any surveying or trying to understand. Obviously, we can see if we look at it, a customer has come who we've never seen before, we started with an alternative accommodation because they knew that we had alternate accommodations and that would be completely incremental because we have alternate location accommodations. I don't have the data on that, but I can say, I believe without actual data proof, I believe that we have brought in people who would not have come otherwise, would have gone to another site, but came to us because we did offer them an alternative accommodation. And I would say specifically in Europe, I'm almost certain of that because the awareness of our alternative accommodations business in Europe is very high unlike in other parts of the world. So when somebody thinks that I want to have a nice villa in Nice and France, they will think booking.com and that is the incrementality that you're asking about. But again, what's more important is to offering all aspects of travel that goes back to the whole connected trip vision because if somebody does get that nice villa, they have to get there somehow. So if they're going to fly, it's good to be able to combine that. And then they'll have to get from the airport to the villa. So it's nice to have the ground transportation, maybe they need insurance. And as I always say, nobody goes on a holiday, so they can sit in the room, whether it be a villa, even this really nice one or a hotel room, they want to do stuff and that's why attractions is important. I can go on and on and on. And tying that all together in that connected trip vision using science, using data, using our Gen AI capabilities to make sure we're offering the optimal things for that traveler in addition given the opportunities for our suppliers to offer up different types of service at different price points so that they too can enjoy the benefits of this connected vision in terms of more customers, more profitability. That's the thing we're building. That's the real true incrementality and that is getting people whoever they're traveling right now some other way that they come to us because we offer them a better service."
},
{
"speaker": "Lee Horowitz",
"content": "Great. Thanks. And then maybe just one follow-up on sort of fixed OpEx. So given a lot of conversation around your passion for driving fixed OpEx going forward. I guess, given where you guys are in your investment cycle, the -- your motivation to free up resources to invest in a lot of your growth drivers and a lot of the conversation on the potential for Gen AI to help the P&L? Do you think that, you know, the business is in a place where it can drive fixed OpEx leverage, not just next year, but for many years out into the future and it should be part of the way we think about you guys going forward?"
},
{
"speaker": "Glenn Fogel",
"content": "I would say absolutely, Lee, there is a big opportunity to do that. But there's always the flip side of how much opportunity do we have to reinvest in the business. So again, coming to the two sides of the coin that I was talking about before, do we have opportunities to find more opportunities for operating leverage, not only in 2025, but also in 2026, absolutely. And of course, some of the initiatives that are being worked on or under development or have been recently implemented, the run rate effects, you will see that coming in then over time in the future. But as I said as well is, I think this company -- the uniqueness of this company is it's doing well, it's growing fast, it's delivering very strong results. We have a lot of free cash flow generation, but we also can reinvest in so many initiatives in order to grow even faster, grow even faster in all those different areas. So how that on a net basis will play out, that's a little bit hard to say. But on the growth basis, in the sense of how much can we really find in terms of efficiencies, I think there's still a long way to go."
},
{
"speaker": "Operator",
"content": "Next up, we'll take a question from Tom White, D.A. Davidson."
},
{
"speaker": "Tom White",
"content": "Oh, great. Thanks for taking my question. Just one, if I could, on social. It seems like in recent months, you know, we've heard you guys mention having better success kind of accessing travel demand in social media channels, which I guess for a long time didn't really seem to be the case. There's obviously a ton of engagement there, but it didn't seem like it was necessarily efficient demand source for you. Can you maybe talk a bit about why that's changing or it seems to be changing? And curious like how big a vector of growth social maybe could be for you guys over the next several years? And how do you think about the incrementality, I guess, of that channel? Thanks."
},
{
"speaker": "Glenn Fogel",
"content": "So, this is Glenn speaking, I'll let Ewout talk a little bit if he wants about anything that I don't mention. But we are pleased that we are seeing good results from putting money to work in social platforms. And as you know, over many years, we had mentioned that we were experimenting, but it wasn't really working for us yet. And now finally, we are beginning to see it work. That being said, it's a relatively small amount of money compared to our overall marketing expenses, but we're glad. And the thing is, it always comes out that we're agnostic. As long as we get the right ROI, that's what we really -- you, know our goal is, that's what we care about and it's working now more than in the past because I think cooperation with people in the social platform areas that we're working with people there and coming up with creative ways together to achieve our mutual goals. And we want to continue to do that and we'll continue to invest so long as we keep getting the ROIs that we want, that's as simple as it is. How big could it be? I don't know. It really will depend on how much further ahead we keep the ROIs. In the past, in the past, we had seen some interesting things that worked a little bit, but then when you try to scale it, the ROIs fell off. Now we're not really seeing that in the things we're trying now. But I can't promise that, you know, as we grow bigger and bigger, you start getting to large numbers, real large numbers like when our number -- our total amount we spend on marketing, who knows, but I am encouraged by the progress we have made so far and I am really glad to be able to diversify that pay performance type spend. And, Ewout, you want to say anything on it?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes, maybe two quick things to add. First, coming back to AI, actually, AI is an important tool to help with the additional advertisement effectiveness. So that the targeting is better and therefore, we can achieve those higher incremental ROIs. And maybe one other point with respect to the financials. Glenn is right, in absolute terms, the spend on the social media marketing channels is still relatively small. But I'm actually encouraged because if you look at the marketing increase spend year-over-year, actually meaningful part of the delta increase is actually going to those social channels."
},
{
"speaker": "Operator",
"content": "Next question is Jed Kelly, Oppenheimer."
},
{
"speaker": "Jed Kelly",
"content": "Hey, great. Thanks for taking my question. Just going back to the U.S., you're getting some nice branding here with the baseball playoffs having, you know, record ratings. You called out room nights maybe growing low-single-digits. So can you talk about where you think your brand is in the U.S.? And then just on the single units in the U.S., you know, talking to some property managers, they still think you're a little more complex to work with versus some of the other platforms. Can you talk about where you are in terms of maybe simplifying it for them? Thank you."
},
{
"speaker": "Glenn Fogel",
"content": "So you're right on your second point about it's not as easy yet as some of our competitors. I know that's true and that's one of the things we're working on. I'll be sure to say that's opportunity for us. That's great. We're doing so well right now and we still haven't perfected that. So that's all upside for us. In terms of awareness, we're still not where we'd like to be, but we continue to improve. I continue to see those numbers going up. When I look at the reports, marketing comes back -- market report comes back to me, reports our marketing department comes back to me. I am pleased with the progress we're making. But again, that's more opportunity for us. Ewout anything specific on that?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes, just a small technicality just to point out is it looks like where we said last quarter, we are growing in the U.S. mid-single digits and now it's low-single-digits. I would still characterize this more stable growth over these periods because we're really at the cusp in both quarters in terms of which of those buckets it's falling. So I wouldn't read too much in it as an investor, but overall, I would call this more stable growth over the last two quarters in the U.S."
},
{
"speaker": "Jed Kelly",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question is from Naved Khan, B. Riley Securities."
},
{
"speaker": "Naved Khan",
"content": "Yes, hi. Thanks a lot. A couple of questions. Glenn, it's great to hear the updates on Gen AI. Maybe give us your thoughts on if you think Gen AI can drive more shift in bookings that can happen through online marketplaces like booking.com versus those that happen directly on a hotel website? And then with respect to Connected Trip, I remember you guys had a partnership with some super apps in Asia like Grab, which is a ride-hailing app. Any updates you can share on those partnerships would be great. Thanks."
},
{
"speaker": "Glenn Fogel",
"content": "Sure. So two separate questions. Let me talk first a little bit about AI in general and the ability for us versus others. This stuff is not easy. It's complicated. Gen AI is hard stuff and it's really good to be in a position where you have resources, people, capital, data to be able to drive forward experiments to see what works, what doesn't work, see how well, how quickly it works. And there's no doubt this is an advantage. So if you're a hotel, even an extremely large hotel, you don't have -- you do not have the resources that we have, I believe. Now, of course, you can partner with others. In fact, we're doing that ourselves. An example, we have, you know, go to OpenTable example, they're not building so much themself. They're partnering with us; they did a good agreement with Salesforce to work with their new AI service that's great there. But I believe it's really important to be able to combine your own data in the hotels accommodations area and come up with things that are truly differentiating and personalization. So I am confident that we have, I'd say, the pole position in the growth of this area, and I'm very excited about it. The other thing you mentioned about our partnerships in Asia with some other players, it's a very small amount of business. Look, we're pleased with where our relationships are with them, et cetera. But that is not something that is -- should be seen as anything that was influencing our Asia numbers at all."
},
{
"speaker": "Naved Khan",
"content": "Thank you, Glenn."
},
{
"speaker": "Operator",
"content": "We'll go next to John Colantuoni, Jefferies."
},
{
"speaker": "John Colantuoni",
"content": "Great. Thanks for taking my questions. A quick one on booking window. Maybe you could just help us size the benefit to the third quarter in terms of room nights from both relative to your expectations and on a year-on-year growth rate perspective? And then second, on North America, your business there seems to be maybe the one region that's tracking more consistent with the broader market. Talk about what investments and capabilities you're making to start driving market-share gains once again in North America? Thanks."
},
{
"speaker": "Ewout Steenbergen",
"content": "John, I will take the first question. We're not really breaking out how much the booking window had an impact on accelerated growth in the third quarter. It is a bit of benefit, but I wouldn't overestimate the impact period-over-period. So I would say slight benefit in the third quarter, but we're not really quantifying that. In terms of your second question, we are doing in North America relative to the market based on external data sources that we are looking at, we believe in the third quarter actually we were growing a bit faster than the market overall. And that's of course the result of a lot of investments we're making. Glenn has touched on many of those already, the number of listings, the focus on alternative accommodations, the investments in the brand we're making. For example, with respect to the World Series and the baseball playoffs in general, what we're doing in terms of becoming more -- creating more familiarity with the brand in the U.S. and many other features and product enhancements we're making to really further improve our market position in the U.S. We're a challenger in this market and actually we think that's a good position to be in because it is an opportunity to grow and ultimately be able to get to our natural position in terms of overall market impact in the U.S."
},
{
"speaker": "John Colantuoni",
"content": "Thanks so much."
},
{
"speaker": "Operator",
"content": "And Everyone, that does conclude our question-and-answer session. I'd like to hand the call back to Mr. Glenn Fogel for any additional or closing remarks."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you. I want to thank our partners, our customers, our dedicated employees and our stockholders. We greatly appreciate everyone's support as we continue to build on the long-term vision for our company. Thank you and good night."
},
{
"speaker": "Operator",
"content": "Once again, everyone, that does conclude our conference for today. We would like to thank you all for your participation. You may now disconnect."
}
] |
bkng | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Welcome to Booking Holdings' Second Quarter 2024 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical facts are intended to identify forward-looking statements. For a list of factors that could cause Booking Holdings' actual results to differ materially from those described in the forward-looking statements, please refer to the Safe Harbor statements at the end of Booking Holdings' earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release, together with an accompanying financial and statistical supplement, is available in the For Investors section of Booking Holdings' website, www.bookingholdings.com. And now I'd like to introduce Booking Holdings' speakers for this afternoon, Glenn Fogel and Ewout Steenbergen. Go ahead, gentlemen."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you and welcome to Booking Holdings' second quarter conference call. I'm joined this afternoon by our CFO, Ewout Steenbergen. I am proud to report second quarter results that exceeded the high end of our expectations for room nights and revenue. The upside on revenue, combined with lower-than-expected fixed OpEx growth, helped drive adjusted EBITDA above the high end of our prior guidance range. As expected, the travel market has continued to normalize and we are pleased with the strength of our underlying business. Moving to our key metrics in the second quarter. Our travelers booked 287 million room nights across our platforms, an increase of 7% year-over-year. Revenue of $5.9 billion and adjusted EBITDA of $1.9 billion, both increased 7% year-over-year. Finally, adjusted earnings per share grew 11% year-over-year, helped by our strong capital return program which reduced our average share count by 7% year-over-year. In line with our expectations, we saw that the booking window expanded less in the second quarter relative to the first quarter which negatively impacted room night growth compared to Q1. From a regional perspective, we observed a mild moderation of travel market growth in Europe. However, we believe we're continuing to perform well relative to the market in Europe. Looking at our other regions, we continue to see high growth levels in Asia and a slight improvement in growth in the U.S. As we look ahead to the third quarter, we believe room night growth will be impacted by a booking window that expands less than it did in Q2 as well as by the more moderate market growth we have seen in Europe, where our growth has remained stable from May through July. We expect that this will result in some deceleration in room night growth compared to Q2. Ewout will provide further details on our second quarter results and our thoughts about the third quarter. I remain confident in the attractive long-term growth profile of the travel industry, our competitive position over the long term and our long-term growth and earnings model. We remain focused on what is important for the business for the long term which means continuing to execute against our strategic initiatives while simultaneously taking actions to drive more cost efficiency in the business. We continue to see progress across several important initiatives which include advancing our connected trip addition, expanding our merchant offering at Booking.com, continuing to develop our AI capabilities, growing alternative accommodations and enhancing our Genius loyalty program. These initiatives all fit together in our ongoing effort to deliver a better planning, booking and travel experience for our travelers while also benefiting our supplier partners. We believe that continuing to drive benefits to our supplier partners is critical to successfully operating a growing 2-sided marketplace. We are encouraged to see healthy second quarter year-over-year growth in a number of supply partners working with us at Booking.com. We are focused on being a trusted and valuable partner by delivering incremental travel demand and developing products and features to help support these accommodation properties, the majority of which are small and independent businesses. We believe that improving the competitiveness and profitability of our smaller partners and supporting those partners across macroeconomic cycles contributes to the long-term economic health of our sector. Our alternative accommodation offering at Booking.com continues to benefit from having more listings available for travelers to choose from. At the end of Q2, our global alternative accommodation listings were about 7.8 million which is about 11% higher than Q2 last year. We believe this greater selection of listings is contributing to the increasing mix of alternative accommodation room nights booked on our platform. We continue to make incremental enhancements to our alternative accommodation offering for both our travelers and supply partners. For our travelers, we are focused on successfully delivering a better planning, booking and travel experience over time which we believe will lead travelers to choose to book directly and more frequently with us. At Booking.com, we are continuing to grow the number of total active travelers with repeat travelers growing at an even faster rate. In terms of direct booking behavior, we are pleased to see that the direct booking channel continues to grow faster than room nights acquired through paid marketing channels. As I've stated before, we think it's important for us to remain proactive in paid marketing channels in order to bring new travelers to our platforms so long as we're able to do this at attractive ROIs. In addition, I'm encouraged by the work our team at Booking.com is doing to increase our spend on social media in a disciplined manner which is an effort that helps to further diversify the channels we utilize while reaching our travelers on platforms they are actively using. Our Genius loyalty program at Booking.com plays an important role in helping to drive more travelers to choose to book directly with us over time. We see a meaningfully higher direct booking mix for Genius users versus other users. And that direct mix percentage steps up at each higher level of Genius status. So we are encouraged to see continued success and more of our travelers moving into the higher Genius tiers of levels 2 and 3 which now represent nearly 30% of our active travelers. In addition to a higher direct booking rate, we also see higher booking frequency from our Genius Level 2 and 3 travelers when compared to our overall business. In Q2, we drove more Genius benefits to our travelers with a 15% year-over-year increase in benefits. This is primarily driven by accommodation bookings. However, we are seeing growth in benefits and the other elements of travel as well with triple-digit growth in Genius discounts for car rental off of a small base last year and continued testing of Genius benefits for flights. In addition to these benefits, bookings in travel verticals outside of combinations contribute to a traveler's Genius level tier. We will continue to explore opportunities to enhance our Genius loyalty program and deliver more benefits to our travelers. And we know that Genius is a win-win with our supplier partners, enabling them to get incremental demand when they want it which is one reason more of our supplier partners are electing to participate. On the connected trip, we continue to take steps towards our long-term vision to make the planning, booking and travel experience easier, more personal and more enjoyable, while delivering better value to our travelers and supplier partners. In order to achieve the easier, more personalized experience of the connected trip, we have always envisioned AI technology at the center of this vision. Our teams of AI experts continue to draw on their valuable experience from using AI extensively for many years as they work to further incorporate this technology into our platforms. We believe our proprietary data, along with our resource and scale, position us well to build compelling AI-powered offerings over time. Another foundational element of the connected trip is the merchant offering that we continue to expand at Booking.com. Merchant capabilities will help bring different elements of travel together in a seamless booking experience while also unlocking the ability to merchandise across verticals. The mix of merchant gross bookings reached 58% of total gross bookings at Booking.com in the second quarter which is an increase of 10 percentage points year-over-year and is higher than our prior expectations. We are pleased to see that processing transaction through Booking.com's merchant offering generated incremental contribution margin dollars in the quarter, though this was still a small percentage of our total adjusted EBITDA. We continue to see growth in transactions that are connected to another booking from a different vertical in a trip. These connected transactions increased by about 45% year-over-year in the second quarter and can change or represent a high single-digit percentage of Booking.com's total transactions. We believe by providing a better overall booking experience, travelers may choose to book more trips with us with a higher likelihood of booking directly in the future. Flights are an important component for many of the connected trips that our travelers are booking. In the second quarter, air tickets booked on our platform increased 28% year-over-year, driven primarily by the growth of Booking.com's flight offering as well as strong growth in Agoda's flight business. We continue to see a healthy number of new customers coming to Booking.com through the flight vertical and are encouraged by the rate that these customers and returning customers see the value of the other services offered on our platform. In conclusion, we continue our work to deliver a better offering experience for our supply partners and our travelers. We remain confident in our long-term outlook for the travel industry, we are positive about our future and we believe we are well positioned to deliver attractive growth across our key metrics in the coming years. I will now turn the call over to our CFO, Ewout Steenbergen."
},
{
"speaker": "Ewout Steenbergen",
"content": "Thank you, Glenn and good afternoon. I will now review our results for the second quarter and provide our thoughts for the third quarter and the full year. All growth rates are on a year-over-year basis. Information regarding reconciliation of non-GAAP results to GAAP results can be found in our earnings release. Now let's move to our second quarter results. Our room nights in the second quarter grew 7% which exceeded the high end of our guidance by 1 percentage point. As expected, we saw room nights growth moderate from the first quarter as we saw less year-over-year expansion of the booking window in the second quarter. Looking at our room night growth by region, in the second quarter, Europe was up mid-single digits. Asia was up mid-teens, rest of world was up high single digits and the U.S. was up mid-single digits. We continue to grow our alternative accommodations business faster than our overall business. For our alternative accommodations at Booking.com, our second quarter room night growth was 12% and the global mix of room nights was 36% which was up 2 percentage points from the second quarter of 2023. We continue to see encouraging progress in strengthening direct relationships with our travelers and increasing loyalty on our platforms. Over the last 4 quarters, the mix of our total room nights coming to us through the direct channel was in the mid-50% range and when we exclude our B2B business was in the low 60% range. We've seen both of these mixes continue to increase year-over-year. Mobile ad mix of our total room night was about 53% which was up 6 percentage points from the second quarter of 2023. We continue to see that the significant majority of bookings received from our mobile apps come through the direct channel. For our Genius loyalty program at Booking.com, we continue to see a year-over-year increase in the mix of room nights booked by travelers in the higher Genius tiers of levels 2 and 3. These members booked more than half of the room nights over the past 4 quarters. Outside of accommodations, we saw airline tickets booked on our platforms in the second quarter increased 28%, about in line with our expectations, driven by the continued growth of flight offerings of Booking.com and Agoda. Second quarter growth in bookings increased 4% which was approximately 3 percentage points lower than the 7% room night growth due to about 2 percentage points of negative impact from changes in FX and about 1% lower constant currency accommodation ADRs. The year-over-year ADR decline was negatively impacted by a higher mix of room nights from Asia. Excluding regional mix, constant currency ADRs were about flat versus 2023. While room night growth was above the high end of our guidance range, gross bookings growth came in at the midpoint of our range due to about 2% lower constant currency accommodation ADRs versus our expectation. In addition, our gross bookings were negatively impacted by lower flight ticket prices in line with the recent trends we have heard from many airlines. Second quarter revenue of $5.9 billion grew 7% year-over-year which exceeded the high end of our guidance by 1 percentage point. Revenue growth was negatively impacted by about 2 percentage points from the change in Easter timing and 2 percentage points from changes in FX. Adjusting for these two items, revenue would have grown about 11%. Revenue as a percentage of gross bookings was 14.1% which was slightly higher than expected due to a timing benefit as we saw gross bookings growth decelerate in the quarter and a less expanded booking window than expected. Additionally, revenue associated with payments was higher than expected. Marketing expense which is a highly variable expense line increased 8% year-over-year. Marketing expense as a percentage of gross bookings was 4.7%, about 15 basis points higher than the second quarter of 2023, due primarily to the timing of brand marketing spend as well as increased spend in social media channels. Second quarter adjusted sales and other expenses as a percentage of gross bookings was 1.9%, about 15 basis points higher than last year due to a higher merchant mix and higher transaction taxes. Our more fixed expenses on an adjusted basis were up 5% and were below our expectation across all three line items: personnel, G&A and IT. We're very focused on carefully managing the growth of our more fixed expenses and are taking actions to help improve our operating leverage in future quarters. Adjusted EBITDA of $1.9 billion was above our expectations, largely driven by higher revenue and lower-than-expected fixed expenses. Adjusted EBITDA grew 7%, despite approximately 5 percentage points of pressure from Easter timing and 2 percentage points from changes in FX. Adjusting for these two items, adjusted EBITDA would have grown about 14%. When looking at our adjusted EBITDA margins, for the first half of 2024 which neutralizes the impact of the Easter timing shift, we're pleased to see 160 basis points of margin expansion versus the first half of 2023. Adjusted net income of over $1.4 billion was up 3%, slower than the growth in adjusted EBITDA, due primarily to higher income tax expenses which was impacted by some discrete items. Adjusted EPS of $41.90 per share was up 11% and benefited from a 7% lower average share count than the second quarter of 2023. On a GAAP basis, net income was over $1.5 billion in the second quarter. Now on to our cash and liquidity position. Our second quarter ending cash and investments balance of $16.8 billion was up versus our first quarter ending balance of $16.4 billion due to about $2.4 billion of free cash flow generated in the quarter, partially offset by about $1.9 billion of capital return, including share repurchases and dividends. Moving to our thoughts for the third quarter. We expect third quarter room night growth to be between 3% and 5%, a sequential deceleration as we expect the third quarter to benefit less from a year-over-year expansion of the booking window than we saw in the second quarter. For the third quarter, we expect the booking window to be more similar to last year. Additionally, we have seen a mild moderation in the market growth in Europe over the last couple of months, though our growth in Europe has remained stable from May through July and we believe we continue to perform well relative to the market. We expect third quarter gross bookings growth to be between 2% and 4%, slightly below room night growth due to about 1 percentage point of negative impact from changes in FX. We expect constant currency ADRs to be down slightly year-over-year and for this to be offset by a slight benefit on flight bookings growth. While we continue to expect growth in flight bookings, we believe this will be less than previously expected due to lower flight ticket prices. We expect third quarter revenue growth to be between 2% and 4%. We expect third quarter adjusted EBITDA to be between about $3.25 billion and $3.35 billion, about flat year-over-year at the midpoint of the range. We expect adjusted EBITDA to grow slower than revenues due to deleverage from sales and other expenses and from growth in IT expenses related to higher software license fees and increased cloud cost. We expect third quarter revenue and adjusted EBITDA growth to also be negatively impacted by 1 percentage point from changes in FX. In terms of our outlook for the full year, we're adjusting our gross bookings growth expectation to faster than 6% which is a bit lower than our prior expectation due to less growth in flight growth bookings as a result of the lower flight ticket prices I previously mentioned. While flight prices have come down, we still expect strong growth in flight tickets for the year as we continue to expand the flight offerings at Booking.com and Agoda. We expect accommodation ADRs will be about flat to down slightly on a constant currency basis. For revenue, we now expect revenue growth of more than 7% which is a bit higher than our prior guidance, based on the outperformance in the first half of the year and our expectation for higher revenue associated with payments. Revenue is impacted to a much lesser extent than gross bookings from the decline in flight ticket prices. We continue to expect about 1 percentage point of negative impact from changes in FX on our topline growth rates while reducing our fixed OpEx growth expectation to low double digits as we continue to focus on bringing this growth rate down over time. We expect adjusted EBITDA to grow in the high single digits which is slightly faster growth than our prior expectation, given our outlook for increased revenue growth and lower fixed OpEx growth. We continue to expect adjusted EBITDA margins to expand year-over-year by a bit less than 8 percentage point. Finally, we're increasing our adjusted EPS growth expectation to above 15%. In conclusion, we continue to expect 2024 to be a strong year for the company. We remain focused on executing against our strategic initiatives while taking actions to drive greater operating leverage. We're excited about our long-term vision for the connected trip and enhancing our offering through technology innovation like generative AI. And with that, we will now take your questions. Operator, will you please open the lines?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Mark Mahaney with Evercore."
},
{
"speaker": "Mark Mahaney",
"content": "I was just asking about the European travel conditions, Glenn and Ewout. It sounded like that market may be slowing a little bit but if I'm capturing it right, your performance there seems to have been pretty steady, that sort of indicates market share shifts, market share gains. Any more color on that? Why you would be -- why your performance would be relatively unchanged, I guess, in a slowing European travel market environment?"
},
{
"speaker": "Glenn Fogel",
"content": "Mark, it's Glenn. I agree with what you say. I'm very pleased with where we're sitting right now. We've talked in the past about normalization and we're happy with the numbers that we're seeing so far. Your question sort of assumed a softening of the travel business overall. Let's talk about how much and to what extent. Our goal always is to gain share. Whether the market goes up or the market goes down, I can't control demand. I can't control economies. What I can control is how well we can provide value to the travelers and to the suppliers. And as long as we continue to do that, as long as we continue to provide a reason that people should come to us as a traveler or use us as a way to distribute somebody's travel suppliers, we'll continue to gain. And we've seen this in the long run here and I expect to continue to see it in the long run going forward. I can't really give more than that right now."
},
{
"speaker": "Ewout Steenbergen",
"content": "And Mark, if I may quickly build on the answer that Glenn just gave, it's also important to point out that actually our growth in Europe has been quite steady and stable in the period from May through July. So yes, we are seeing some mild moderation but it has been relatively stable over the last couple of months."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Kevin Kopelman with TD Cowen."
},
{
"speaker": "Kevin Kopelman",
"content": "Great. Could you maybe give a little bit more color on some of the moderation you're seeing, like other indicators, like length of stay or any trading down activity that you might be seeing? And given that things have started to slow, how do you gain confidence that they're not going to continue to slow both in room nights and rates?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Kevin, if you look at the overall conditions of the market, we're not really seeing a trade down on a global basis. So both in terms of the star ratings as well as in the length of stay, it's relatively stable to what we have seen in previous periods. Maybe with one exception is a really mild indication of some trade down in the U.S. but otherwise, globally, we see a very steady picture."
},
{
"speaker": "Kevin Kopelman",
"content": "And a quick follow-up on ad spend dynamics with the deleveraging expected in the third quarter. Is that more of the same in terms of brand and social spend?"
},
{
"speaker": "Ewout Steenbergen",
"content": "If you look at deleverage in the third quarter, that mostly relates to SNO and fixed OpEx. Marketing, actually, we expect leverage -- to see leverage in the second half of this year and also from a longer-term perspective because we expect to continue to see some benefit from the expansion in the direct mix. I also would like to point out and we think it's a really positive message for this call, that we are spending more on social media channels. That's a very attractive channel for us where we are expanding now and where we're investing more and we can do that at very attractive incremental ROI. So really an important point to really highlight with respect to our marketing leverage and the success we're gaining there."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Justin Post with Bank of America."
},
{
"speaker": "Justin Post",
"content": "Great. Glenn, I'd love to hear your perspective on the travel market, bookings growing 3% to 5%. We know Europe has a really tough comp against reopening last year. Is that kind of how you're thinking about longer-term market growth? Or do you think it's kind of depressed right now on really difficult comps? And then love to hear about alternative accommodations, really, really strong growth there, an increasing percentage. Are you featuring that more on your website? And do you really like the economics of accommodations? How do you feel about those economics versus hotel?"
},
{
"speaker": "Glenn Fogel",
"content": "Justin, so two separate questions. One, just going back to the general sense of the travel market. And we talk about this a lot over many, many, many calls about how much we believe that the travel market is best influenced by GDP and that in the long run, GDP goes up, more people travel, more people couldn't travel, get wealthy enough that they can travel, that's a tailwind for us. And we talk about other things. You mentioned the 3% to 5%. I mean, lots of people can come up with whatever way you want in terms of global, what's global GDP? What's it going to do to travel? Numbers aren't that different or some are probably in that neighborhood, then how much additional can we get out of increasing share because we provide a good service. And then, of course, there are the other tailwinds of the off-line to the online, another one that's a point in our favor. All these things together blew the -- the growth algorithm that we've talked about in the past is totally intact. There's going to be volatility, there's going to be variations, there's going to be events are going to happen globally, macro events that happen that can influence a quarter or a week or a day. But in the long run, we just continue to build what we've been trying to build for a long time which is a better service and that's how we do it. And one of the things we've been building and we've been working hard on and I've talked about it for a number of years, how important it is for us to build an alternative accommodations business that will rival anybody's. And we admitted that it was taking us time to build it. We started from behind. Another company may have had a bigger head start on us and building it bigger. We think we've done a really good job of catching up. I love the last call we did a few months ago when we came out and we talked about it, our homes business, our homes business, more than 2/3 of the biggest player in the industry. In that last quarter, we said how we had grown faster, 11 of the last 12 quarters. Now, I don't know if our 12% is going to win or not this time, I don't know. I'm pleased with that growth rate, given the size of the business. And how are we doing it? We're doing it by doing what we do with all things is provide a reason, I said this just to Mark earlier, is that continue to build out a product that gives a person a reason to come and use it. Now I don't really care whether the customer uses a home, or a hotel, or a villa or an igloo. I don't care. I care they get what they want. That's the important thing. And then come back. In terms of the profitability of one versus the other, we can go into that and talk about it but it's not really relevant. Because what's relevant is making sure that they use what they want. We don't try and steer them. We're trying to just make sure they have the best tools to choose what they need in the long run. That's the way we'll win and create a great business."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Doug Anmuth with JPMorgan."
},
{
"speaker": "Doug Anmuth",
"content": "Glenn, just curious, first, how you're interpreting the relative tightening of the booking window and what does that tell you about the state of the traveler into the back half? And then just curious, in your outlook, how much are you contemplating? Any impact from the tech issues that we've seen over the last couple of weeks and their impact to airlines as well?"
},
{
"speaker": "Glenn Fogel",
"content": "Right. Sure. So the booking window is an interesting thing and we saw it expanding, expanding, expanding and at some point it has to stop, right? I mean, eventually, you can't keep getting bigger and bigger. One of the things I was wondering was why. Why was it expanding? Was it expanding because of inflation and people trying to book early to get that price locked up, afraid that was going to be more expensive down the road. And then now maybe they're thinking well, maybe rates aren't going to keep on increasing, so I can wait. Maybe I'll get a lower price later. I don't know and I haven't done any data to analyze and come up with what the reason is. The fact is, window gets bigger and the window gets smaller. That, of course, influences any particular quarter but in the long run, it all averages out. So I'm not going to worry too much about that. What we do make sure though is make sure that we're spending the right amount of marketing money to try and get the right conversion, do it the right ROI and that's what we continue to do and we're very careful with that. But again, another thing, just like the economies, I can't control what people are going to decide when they want to book. In regard to the tech thing, the tech issues, if you assume you're talking about the horrific events that disrupted travel throughout the world but particularly hit some of our supplier partners significantly. Delta, horrific event and I saw the CEO's interview on Squawk Box and read about what they're planning to do. It's a problem when you have critical infrastructure breaks down and then disrupts millions and millions of people's lives. That's really unfortunate. And hopefully, it won't happen again. Hopefully, people test their products before they put them out into the market. And hopefully, there are backups. Things happen but in travel, we know happens a lot. Certainly, weather happens an awful lot. This is something though that wasn't weather which you can't control, this was making sure that your infrastructure works and will be interesting how that lawsuit turns out. I will point out, it didn't affect us very much though. So we're very pleased about that."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Eric Sheridan with Goldman Sachs."
},
{
"speaker": "Eric Sheridan",
"content": "Maybe two questions, if I could. First, following up on sort of the demand environment. When you think about the shift from goods to services that has played out in the economy more broadly in the last couple of years, do you think elements of stability or maybe re-acceleration in terms of demand, it might be down to price? Or do you think it's just time and duration that might have to sort of find a new footing for demand and maybe elements of a potential to return to growth? So will this come down to sort of suppliers and pricing or elements of a new normal and finding a new level. I'm just curious for your perspective there, Glenn. And then in terms of the broader marketing messages, you've been on this journey to sort of rejigger the way you're approaching marketing funnel and driving more direct traffic. What do you see as the key investment priorities built on some of the learnings in the last 12 months that you want to share in terms of how the marketing focus for the company might continue to evolve beyond just 2024?"
},
{
"speaker": "Glenn Fogel",
"content": "So the first more generic question about goods versus services and I think your question, I'm trying to narrow it down to, I think what we're really talking about is we saw a change in people's behavior where they seem to value services significantly more than good which, of course, helps someone like us. And I think the question is, is this a permanent change or appears to go back to a balance that they had a few years ago, maybe pre-pandemic. And I think that in the end, again, this is one of those things that I believe but I don't have proof of is that as people get wealthier, you end up spending more money on services. And it ends up a lot because people generally have one home, you got one couch. You don't keep buying more and more but as your wealth increases, you want to do things, you want to enjoy things. And we see that happening. There's also -- there could be something of the Instagram effect where -- and this is a human nature that you want to show off to your friend, to your friends, all the great things you're doing, I think that definitely has some impact because we certainly -- certain parts of the world that people never used to travel to, now they are being overrun and I think that is the Instagram effect there. So that's all good for our business. I don't know how much further it will go, though, because you need to buy homes and you need to buy couches, et cetera. And I don't see that as a big swing but I'm not concerned that it's going to flip back and we're going to end up with lower; that's one. In terms of the marketing, let's talk a couple of these. I just want to repeat this point I made earlier about. One of the things that we -- I'm happy to see is seeing us making some progress in using social. We have a long problem getting that to work for us for many, many years, just didn't seem to work. But now we're seeing, okay, starting to work, getting some good ROIs. Putting more money into it like that and I think they will continue doing that. Another thing we saw that we don't talk a lot about it, I won't get too specific but we saw ourselves using money that we thought was producing a good ROI and we turned out, it really wasn't. And we shut some of these things down. I won't go into exactly what they were. And we said, that's really not hurting us. We said, \"Well, that's great.\" And that's something that over last year or so that we saw some of the benefit in terms of our marketing leverage is coming from that. So, two good things and I'll let Ewout anything else to say about marketing there."
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes, Eric, maybe to give you another perspective. So I'm now 4.5 months with the company. A lot of joy, a lot of pleasure to be here and a great honor. But I'm also, of course, looking at some of the perceptions of the company. I think it's still very much an outdated perception out there that we are largely dependent in terms of sales in our business on the paid channels. Actually, we're emphasizing a lot as you have heard in our calls around the direct mix and being now in the low 60% level for B2C which is really a game changer from my perspective for the company. Also we're very much diversifying our paid channels which is very important because this is a very dynamic world. The paid channels are changing all the time. They are changing their algorithms. But I'm really impressed about the science that the company has behind its paid channels, the algorithms that we are adjusting to optimizing all the time, the way how we spend our paid marketing dollars and how we're investing that. And so it's -- there is not a silver bullet. It's all the time really the details about the optimization, how to get to the highest number of new customers coming to us through the paid channels in the most optimal way with the most attractive ROIs and super impressed how the company is doing that. And I think that gives us really an edge in terms of how we can deal with paid channels also in the future. Operator, I think you are ready for the next question."
},
{
"speaker": "Operator",
"content": "And our next question is from James Lee with Mizuho."
},
{
"speaker": "James Lee",
"content": "Two here. First, on loyalty program. It seems like one of your major peers is having mixed success with their loyalty program. And maybe, Glenn, you can once again talk about how your program is differentiated and that would allow you to have very high rate of repeat bookings? And secondly, on advertising, I noticed that your ad revenue seem to be under monetized at only 0.7% of gross booking. Is that a source of opportunity as you're looking to give -- to take advantage of scale or your reach? And if so, maybe help us understand what areas are you looking to expand?"
},
{
"speaker": "Glenn Fogel",
"content": "Yes. Sorry about that. Thinking of the answer. I'm going to let Ewout handle the ad opportunity. I'll talk about our loyalty program, Genius which is the Booking.com program which we talked a little bit about in our prepared remarks. We really haven't talked about it much in terms of numbers in the past but I was just really pleased to be able to talk about our Level 2 and Level 3 players. 30% of our active users -- active travelers are Level 2 or Level 3. And we talked about that gives us more than half of the Booking.com business which is really great. That -- and we talk about how they come back more frequently and they come back more direct. That's the point that it works. And one of the great things about it is, for the most part, we're not paying for it. Our partners are supplying almost all the benefit right now but we talk about we are also putting some benefits at a time. We're going to experiment putting more in ourselves. But it's a great thing. You think why do the suppliers do it? They do it because it gets them incremental demand. It gets them demand when they need it, when they want it. It's very flexible. We work together with them, with these partners, so they can get the demand and the reason they get the demand is because our high Genius level people, our high-spending people and they are going to come and they're going to use those services. It's really a win-win-win. Win for our travelers, win for our partners and win for us. There aren't a lot of people who are doing a program like that. So we think it does differentiate. And I'm really happy to see car rental now doing a lot more of it and we're experimenting with flights. And part of the whole vision of the connected trip the Genius program fitting right into that comes with all different types of permutations of ways to provide better benefits to travelers and use it in a way, a scientific way, a data-driven way. A way using all of our AI capabilities, all the data we have so that we can come up with the best solutions for both sides of the marketplace. That is where -- that's what we're driving to. And I see it happening now in some of the numbers we said, I think gives a little indication. And then, of course, there will be the other thing which is really [ph] advertising opportunities are great. And I'll let Ewout talk a little bit about that."
},
{
"speaker": "Ewout Steenbergen",
"content": "James, thank you for pointing out the advertising revenues because it is indeed a very attractive potential line that gives us an opportunity in terms of growing our revenues in the future. Today, this line is mostly coming from KAYAK and OpenTable but there are opportunities, of course, to think about more advertising income from particularly the apps and the active app use that we're having mostly with Agoda and Booking.com. But as everyone knows, this is a very fine line because if you get too many advertisement as a traveler on an app, where you're interested in something else that can ultimately also become quite annoying. So finding there the optimal point is really important. But overall, you're right, that is an opportunity to help to drive further growth with the company in the future, next to many other opportunities we have because I think that's actually -- the exciting part for us as a business, are not just growing with the market. We have so many opportunities to grow faster if it is alternative accommodations we discussed or the multiple verticals around the connected trip we discussed or growing geographically in Asia, in the U.S. around payments, around generative AI and many other opportunities. So definitely, I would put this on the same list as well."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Stephen Ju with UBS."
},
{
"speaker": "Stephen Ju",
"content": "All right. Great. So Glenn, I think I heard you talk in the prepared remarks about connected trips bookings up, I think it was 45% and accounting for a high single-digit percentage of the mix. At this point, is there anything you can share about how the basket size of a particular trip could be moving around and presumably it's up a lot because people are attaching more things. And I guess what the impact to your customer acquisition strategy may be as a result as customer lifetime values go up?"
},
{
"speaker": "Glenn Fogel",
"content": "Sure. Well, I won't give specifics but I'll confirm what you say is true, is that somebody buys two things. It's definitely going to be bigger than one thing. And also because they bought more things, as we use the science, as we use our data, as we use all the capabilities we have to come up with, what is the value for that customer? Well, how much should we spend to attract that person is going to change, obviously. And it's also the question is in terms of loyalty. We found and it does make sense, a more satisfied customer is going to come back more often. And people in the connected trip, people who use the connected trip, we do see a higher repeat rate for a connected trip person. And we see them coming direct. And the great thing about the connected trip too is that in the past, with just one vertical which was the hotel business, we were missing on customers who wanted to start with flights and now with flights, people are starting at flights and they come and they buy something else too. And also, it's the convenience factor and that goes into the whole reason why the connected trip. I've heard from people say, \"Well, what makes you different?\" And the truth is right now, we're semi-different because we don't have the full connected trip done yet, the way I want it to be. But at the end of the day, we all know how frustrating travel is. And we know how much easy it would be if there was just one place, one person who would handle everything for you, put it all together in the way that was the optimal way with all the different things you have to decide upon. And then if anything went wrong, that it would all get fixed. And now with the benefits of GenAI coming out and the progress I see being made with it, I talked to our people in customer service and what we're putting together there, I believe we will create something that truly is differentiating and that will create a reason that people will want to come to us. The more people who come to us, more opportunities we have to work with our partners to provide them opportunities to help build their businesses. Again, I'll get to use it again, I could say win-win-win again, because that's really what we're trying to achieve here."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Lee Horowitz with Deutsche Bank."
},
{
"speaker": "Lee Horowitz",
"content": "So the modestly softer travel environment that the industry seems to be expecting in the second half of the year seems to be working through models by way of pricing pressures. I guess, Ewout, can you comment some on how you think about flexing your cost structure going forward to the extent that, say, hotel ADR has become a bigger headwind for the industry and by extension, your adjusted EBITDA margins?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Lee, thank you so much for asking the question because we are, at this point in time, really putting much more emphasis on this particular area and looking for more operating leverage for the company in the future. And we should particularly be well positioned to do that because we have the scale. So we should be able to run much more volume over the same fixed infrastructure that we have as a company in the future and take advantage of that. And take advantage of that in the way that we can reinvest in new growth initiatives as well as, of course, also benefiting EBITDA margins and return of capital to our shareholders. So let me give you a couple of examples what we are doing at this moment. We have already done a couple of reorganizations in some of our businesses. We have been looking very carefully at head count, in some places, put a head count pause in place. We are looking at some expense benchmarking in some other brands and businesses, looking at procurement in real estate and many other areas. So more to come on that over the next couple of quarters that I can give you more details. But definitely, this has become a really big focus area. And we are pleased that, therefore, we can also say to you that for the full year guidance, we are now reducing the outlook with respect to fixed OpEx from low to mid-teens to now low double digits. As well as we continue to focus on growing our fixed OpEx at a lower level than the topline growth in 2025."
},
{
"speaker": "Lee Horowitz",
"content": "Really helpful. And then, Glenn, maybe on alternative accommodations, you continue to deliver very healthy supply growth here. Do you feel like you are reaching a point of supply parity relative to your peers in the U.S. specifically, where you can perhaps lean in more aggressively investing against marketing and discounting within this vertical to sort of accelerate share gains?"
},
{
"speaker": "Glenn Fogel",
"content": "I have to admit, I don't believe we are at that level at all right now. But that, to me, is an incredible opportunity. The fact that we are performing as well as we are in terms of our overall number but we still do not have anywhere near the number or the type of home accommodations in the U.S. to be fully competitive is, well, it's a disappointment to me that is not done yet. It's an opportunity where we have all this upside still to come. And we won't be spending huge amounts of money on a subpar product. So not to fear. We're not going to do that. What we're going to do instead to spend the money that we're spending now to make sure we get the properties we need, get the things up and running the way we want the product, the way we want it to be. So nobody ever comes to our site and feels disappointed because it wasn't as good as X. That's what we're working on right now. Clearly, the numbers show that we're doing a good job in many parts of the world but the U.S. is, to me, something that is great opportunity. And for people who live in the New York area, you know if you were looking for -- I use this example all the time because I live in the New York area. If you are looking for a rental, you wanted a home in the Hamptons this summer, you came to our site. You probably said, \"Jesus, there's not a lot here compared to some other people.\" I don't want that to be. I want us to have as many, if not more and I want it to be easier for them to come. I want the trust that coming to Booking is a better way to get that summer rental. And we're going to work on that and that's good for us, an opportunity for us. But your answer is correct. We're not there yet."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of John Colantuoni with Jefferies."
},
{
"speaker": "John Colantuoni",
"content": "You mentioned direct bookings were mid-50% of total and low 60%, excluding B2B which I think implies your B2B mix decreased from last year, if I'm doing the math correctly. In general -- but in general, B2B is a smaller offering relative to your biggest competitor. And I imagine this was a strategic decision but I'm curious why you're less excited about the opportunity in the B2B relative to some of the other players in the space?"
},
{
"speaker": "Ewout Steenbergen",
"content": "John, we are not really recognizing that math. And actually, we are really encouraged by the growth of our B2B business as well. You're right that overall, it's a smaller business than some other players in our industry but we have a couple of propositions that are really strong and all of our brands are actually active in the space. Booking.com is active in this space. Priceline with Getaroom, Agoda with Rocket Travel and many other propositions that we have in the market. So it is an important part of our commercial strategy but it is definitely something that is a bit smaller than other players."
},
{
"speaker": "John Colantuoni",
"content": "Great. And maybe a second one on alternative accommodations. I think just broadly speaking, marketing intensity in the alternative space appears to have escalated a bit year-to-date. Talk about Booking's offering and positioning in the vertical and how that positions you to sort of continue delivering impressive growth if the competitive environment continues to ramp over time?"
},
{
"speaker": "Ewout Steenbergen",
"content": "John, I think actually, our proposition is unique with respect to alternative accommodations because we are putting both traditional and alternative accommodations on our same platform. So we have the benefit of all our brand marketing spend, all our paid market spend coming together on the same platform and giving the traveler an opportunity to pick and select their best option. Maybe they're coming in and looking for 2 hotel rooms for their family and ending up by booking an apartment with 2 bedrooms and they're very happy with that outcome. As Glenn said earlier, we are actually agnostic about which direction this is taking customers because it is important that they are finding the best option for them, ultimately, how to travel. We're agnostic from an economics perspective about this. And it is all about making sure we have the most attractive proposition in the market. But this is, from our perspective, a differentiator because we are able to bring all of those supply opportunities together on our platforms as a company."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Naved Khan with B. Riley Securities."
},
{
"speaker": "Naved Khan",
"content": "Maybe just on this commentary on booking window kind of not expanding as much. Can you maybe just talk about if you're seeing any mix in your cross-border versus domestic bookings and if that might have anything to do with it. And the second question I have is on the U.S. online growth. It seems like it picked up a little bit versus the last quarter. I'm wondering if it was driven by alternative lodging or if that is not the case?"
},
{
"speaker": "Glenn Fogel",
"content": "Ewout, why don't you take that first one and then I'll talk a little bit about the U.S. and the increase we saw in the second quarter versus the first quarter."
},
{
"speaker": "Ewout Steenbergen",
"content": "Naved, the way how we look at booking window is, as Glenn actually commented on a couple of minutes ago, to some extent, it doesn't matter for us. It doesn't matter when a traveler actually books because they will travel at a certain point in time. When they travel, they have the experience. And at that point, we will recognize the revenues and the economics to the company. So if you look at the performance of the business over multiple quarters, this is averaging out. If bookers booked earlier or later, ultimately for the same trip and that can really depend on many factors. It can depend on assumptions what will pricing do over time or locking in certain flights or locking in certain accommodations or other factors why bookers might come to us earlier or later for the same trip. But it is important if any investor looks at us from a medium- and long-term perspective, it doesn't matter because over time, it's averaging out and we will deliver the same results for our shareholders and continue to build our business over time with all the opportunities we have."
},
{
"speaker": "Glenn Fogel",
"content": "In regards to the U.S. and trying to distinguish, is it because we did better in homes or we did better hotels or -- I really try and stay away from that a little bit. We're trying to provide a traveler with what they need and provide all the different opportunities, whenever. But I'm very happy in the second quarter, accelerated versus the first quarter for our U.S. business. That's very good, I'm pleased by doing better over the long run. But I'm not going to say it's because we did X, Y or Z. In the end, we have to do well in every single part of this business. That means we've got to provide the homes. Absolutely, I talked about that. We got to be a good partner to the hotels and provide them with the incremental demand they need, when they need it. In addition, the connected trip, we got to make sure we're getting all the inventory we can in terms of flights, to making sure we have that ground transportation. And as I always say, nobody goes on a holiday to hang out in the accommodation. They want to do stuff. So we got to make sure we get our attraction things working well and that we're putting up the right offers to the person that they want, when they want at the right time. And of course, there's all the other things, provide the insurance and tying it all together in our merchant platform which we put in our prepared remarks some of the numbers, very pleased about the increase in that. Glad to see it continuing to go up. Glad because it provides a great convenience. It makes it easier to do a lot of things in the connected trip. All working together to provide the ultimate thing which is having a better experience for the traveler and providing more opportunities for our supplier partners. Glad that we're seeing that we did better in America, I'd like to do even better in the long run. I think America, the U.S. is a great opportunity. We continue to under index there which means for me, that's a place that we can do better."
},
{
"speaker": "Operator",
"content": "This concludes the Q&A session. Yes. That was our last question. Thank you so much. And with that, I will hand the call back over to you, Mr. Fogel for closing remarks."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you. So I want to thank our partners, our customers, our dedicated employees, our shareholders. We greatly appreciate everyone's support as we continue to build on the long-term vision for our company. Thank you very much and good night."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect."
}
] |
bkng | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Welcome to the Booking Holdings First Quarter 2024 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied and forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical fact are intended to identify forward-looking statements."
},
{
"speaker": "",
"content": "For a list of factors that could cause Booking Holdings' actual results to differ materially from those described in the forward-looking statements, please refer to the safe harbor statements at the end of the Booking Holdings' earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release, together with an accompanying financial and statistical supplement, is available in the For Investors section of Booking Holdings' website, www.bookingholdings.com."
},
{
"speaker": "",
"content": "And now I'd like to introduce Booking Holdings speakers for this afternoon, Glenn Fogel and Ewout Steenbergen. Go ahead, gentlemen."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you, and welcome to Booking Holdings' First Quarter Conference Call. I'm joined this afternoon by our CFO, Ewout Steenbergen. I am pleased to report a strong start to 2024. Our travelers booked nearly 300 million room nights across our platforms in the first quarter, which exceeded our expectations and grew 9% year-over-year. First quarter revenue of $4.4 billion grew 17% year-over-year, and adjusted EBITDA of about $900 million increased 53% year-over-year. Both revenue and adjusted EBITDA were ahead of our first quarter expectations. Finally, adjusted earnings per share in the first quarter grew 76% year-over-year, helped by improved profit levels as well as our strong capital return program, which reduced our average share count by 9% versus the first quarter last year."
},
{
"speaker": "",
"content": "We continue to see resiliency in global leisure travel demand, including healthy growth for travel on the books that's scheduled to take place during our peak summer travel season, although a high percentage of these bookings are cancelable, and what is on the books today represents a modest percentage of the expected total summer bookings."
},
{
"speaker": "",
"content": "As we look ahead to the second quarter, room night growth compared to last year will benefit from the shift in Easter timing. However, we expect that this will be offset by a less expansion of the booking window and an increased impact from the geopolitical situation in the Middle East. We believe this will result in some deceleration in room night growth versus Q1. Ewout will provide further details on our first quarter results and our thoughts about the second quarter."
},
{
"speaker": "",
"content": "Over the last few years, we have talked quite a bit about our key strategic priorities, which include building towards our connected trip vision, expanding our merchant offering at Booking.com, developing our AI capabilities and enhancing our genius loyalty program. These initiatives may seem to be distinct efforts, but I'd like to emphasize, they actually all fit together in our ongoing effort to deliver a much better planning, booking and traveling experience for our travelers while also benefiting our supplier partners."
},
{
"speaker": "",
"content": "By creating a much better experience for our travelers and solving more of the challenges they face when planning, booking and experiencing a trip, we believe travelers will choose to book directly and more frequently with us, resulting in increased loyalty over time. We see encouraging early proof points at Booking.com as we have grown the number of total active travelers while experiencing higher growth in repeat travelers, which speaks to the progress we are making in encouraging customers to book again with us. In addition, we are seeing increases in the average number of trips booked per traveler as well as an increasing mix of our room nights that are booked directly with us."
},
{
"speaker": "",
"content": "On direct mix, we are pleased to see the direct booking channel continues to grow faster than room nights acquired through paid marketing channels. While we see paid marketing channels becoming a gradually smaller proportion of our business over time, we think it's important for us to remain proactive in these channels in order to bring new travelers to our platforms, so long as we're able to do so at attractive ROIs."
},
{
"speaker": "",
"content": "We believe continuing to improve the experience for our travelers by advancing towards our connected trip vision will help to further drive these positive proof points around loyalty, frequency and direct booking behavior. I'm encouraged to see strong growth in transactions that are connected to another booking from a different travel vertical in a trip. These connected transactions increased by just over 50% year-over-year in the first quarter, though it's important to note that this growth is off of last year's small base."
},
{
"speaker": "",
"content": "Connected transactions represented a high single-digit percentage of Booking.com's total transactions in Q1. It's great to see more of our travelers choosing to book connected transactions. And we believe by providing more value and a better overall experience to those travelers, they may choose to book more trips with us and have a higher likelihood of booking directly with us in the future."
},
{
"speaker": "",
"content": "Flights is the most frequently booked vertical in a connected transaction outside of accommodations. And it is an important component of many of the trips our travelers are booking. In the first quarter, air tickets booked on our platforms increased 33% year-over-year, driven primarily by the growth of Booking.com's flight offering. We continue to see a healthy number of new customers to Booking.com through the flight vertical and are encouraged by the rate that these customers and returning customers see the value of the other services on our platform."
},
{
"speaker": "",
"content": "Winning a traveler's business is never easy because of the high level of competition in our industry. But we are pleased to see that by providing a better way to do it, less friction, better value, a broader selection and great customer service, we are building a customer base that is more likely to choose us."
},
{
"speaker": "",
"content": "Outside of flights and accommodations, we are seeing strong growth from rental cars and attraction bookings that are part of a connected transaction. We believe continuing to enhance and expand the attractions vertical has the ability to increase traveler engagement with the app while travelers are in destination and looking for something to do. And we believe that over time, travelers who experience the value we provide for in-destination services like attractions will choose to use us more in the future."
},
{
"speaker": "",
"content": "Bringing all of these elements of travel together in a seamless booking experience and unlocking the ability of merchandise across verticals is a capability we have been building at Booking.com over the last several years. In addition to being a foundational element to our connected trip vision, our merchant offering brings many other benefits to our travelers and partners. For travelers, we provide the ability to pay in many different methods. And we can offer discounts, incentives and other merchandising opportunities. For our supplier partners, our merchant offering enables us to take fraud liability from our partners as part of the services we provide, reduces cancellation rates versus the agency model. And over time, we believe we can help to lower payment costs for our partners."
},
{
"speaker": "",
"content": "In order to achieve the easier and more personalized experience with the connected trip, we have always envisioned AI technology playing a central role. We believe we are well positioned to leverage this technology given we have built strong teams of AI experts and gained valuable experience from using AI extensively for many years. In addition, we have proprietary data that can be used to train specific use case models or fine-tune large AI models and have the resources and scale required to help build AI-powered offerings."
},
{
"speaker": "",
"content": "As we have discussed before, our teams continue to work hard to integrate generative AI into our offerings in innovative ways, including Booking.com's AI Trip Planner, Priceline's generative AI travel assistant named Penny and Kayak's recent release of generative AI-powered features and tools. We will continue to learn from traveler interactions with these tools and enhance our offerings over time."
},
{
"speaker": "",
"content": "In addition, customer service, which is a critical function that we provide to both our travelers and partners, is an area we believe will be meaningfully enhanced by AI advancements. At each of our OTA brands, our teams are actively exploring ways to leverage generative AI technology to improve self-service tools, which we believe will reduce live agent contact rates and enable us to answer traveler questions faster. When customers still need to speak with a live agent, we believe that this technology will improve our live agent efficiency by making it easier to access information and document the conversations. In sum, we believe gen AI will lower our customer service cost per transaction over time and improve the customer experience."
},
{
"speaker": "",
"content": "Our Genius loyalty program at Booking.com also plays an increasingly important role in the multiple elements of travel that we offer as we expect our travelers will be able to experience the benefits of Genius in each of our travel verticals over time. In addition, bookings in travel verticals outside of accommodations will contribute to a traveler's Genius level tier. We have seen an encouraging number of our rental car supplier partners choosing to adopt the Genius program, and we have just begun to test the program in flights and attractions."
},
{
"speaker": "",
"content": "We are seeing success in moving more of our travelers into the higher Genius tiers of Level 2 and Level 3, which require 5 and 15 bookings in a 2-year period, respectively. We see encouraging behavior from our Genius Level 2 and 3 travelers, including higher frequency and a higher rate of direct booking than what we see for our overall business. We will continue to explore opportunities to enhance our Genius loyalty program and deliver more benefits to our travelers with more of our supplier partners electing to participate."
},
{
"speaker": "",
"content": "While we have mostly been discussing about our traveler customers, we operate a 2-sided marketplace, and our supplier partners are equally important to us. The success of our business is built on a mutually beneficial and balanced partnership with our millions of hotels, alternative accommodations and other supplier partners around the world."
},
{
"speaker": "",
"content": "We strive to be a trusted and valuable partner for all accommodation types on our platform, the majority of which are small independent businesses. We believe that improving the competitiveness and profitability of our smaller partners contributes to the long-term economic health of our sector. And we continue to onboard more small independent businesses through our alternative accommodation offering at Booking.com, and we are benefiting from having more listings available on our platform for travelers to choose from."
},
{
"speaker": "",
"content": "At the end of Q1, our global alternative accommodation listings were about 7.4 million, which is about 11% higher than Q1 last year. We are focused on continuing to build on this progress by further improving the product for our supply partners and travelers, particularly in the U.S."
},
{
"speaker": "",
"content": "In conclusion, I am encouraged by the strong first quarter results and the continued long-term resilience of leisure travel demand. We continue our work to deliver a better offering and experience for our supply partners and our travelers. We remain confident in our long-term outlook for the travel industry. We are positive about our future, and we believe we are well positioned to deliver attractive growth across our key metrics in the coming years."
},
{
"speaker": "",
"content": "I will now turn the call over to our CFO, Ewout Steenbergen."
},
{
"speaker": "Ewout Steenbergen",
"content": "Thank you, Glenn, and good afternoon. I'm very excited to join the Booking Holdings team. I look forward to continuing to work with you and David in his new role and the rest of the leadership team to help drive continued future success for our investors, employees, traveler customers and supplier partners."
},
{
"speaker": "",
"content": "I will now review our results for the first quarter and provide our thoughts for the second quarter. All growth rates are on a year-over-year basis. Information regarding reconciliation of non-GAAP results to GAAP results can be found on our earnings release. We'll post our prepared remarks to the Booking Holdings Investor Relations website after the conclusion of the earnings call."
},
{
"speaker": "",
"content": "Now let's move to the first quarter results. Our room nights in the first quarter grew 9%, which exceeded the high end of our guidance by about 3 percentage points. The higher-than-expected room night growth was driven by a continued expansion of the booking window as well as healthy underlying demand with better-than-expected performance in Europe and less of a negative impact from the war in the Middle East than expected."
},
{
"speaker": "",
"content": "Looking at our room night growth by region. In the first quarter, Asia was up mid-teens. Europe and the rest of the world were up high single digits. And U.S. was up low single digits."
},
{
"speaker": "",
"content": "We are encouraged by the continued progress we are making in strengthening the direct relationships with our travelers. Over the last 4 quarters, the mix of our total room nights coming to us through the direct channel was in the mid-50% range, and when we exclude our B2B business, was in the low 60% range. We have seen both these mixes increase year-over-year in each of those 4 quarters."
},
{
"speaker": "",
"content": "We're focused on continuing to increase our direct mix going forward, which we believe will benefit from our efforts to improve the experience for our travelers, including building towards our connected trip vision. Increasing our direct mix benefits our P&L by driving higher efficiency of our marketing spend as a percentage of gross bookings while reducing the mix of bookings we source through paid marketing channels."
},
{
"speaker": "",
"content": "In our mobile apps, the significant majority of bookings we receive are direct. And we continue to see favorable repeat direct booking behavior from consumers in our mobile apps when compared to direct bookings on desktop or mobile web. The mobile apps also allow us more opportunities to engage directly with consumers. In the first quarter, mobile app mix of about 51% was 5 percentage points higher than the first quarter of 2023."
},
{
"speaker": "",
"content": "We continue to offer our travelers a broad selection of places to stay and are seeing an increasing mix of our room nights being booked in alternative accommodation properties. For our alternative accommodations at Booking.com, our first quarter room night growth was 13%. And the global mix of alternative accommodation room nights was 36%, which was up versus 33% in the first quarter of 2023."
},
{
"speaker": "",
"content": "Outside of accommodations, we saw airline tickets booked on our platforms in the first quarter increased 33%, driven by the continued growth of Booking.com's flight offering. First quarter gross bookings increased 10%, which exceeded our expectations. The 10% increase in gross bookings was approximately 2 percentage points higher than the 9% room night growth on an unrounded basis due to about a 1% higher accommodation ADRs plus about 1 point of positive impact from flight bookings. There was an immaterial impact from changes in FX on our gross bookings growth rate."
},
{
"speaker": "",
"content": "Our ADR growth was negatively impacted by regional mix due to a higher mix of room nights from Asia. Excluding regional mix, ADRs were up about 2 percentage points. Similar to comments we have made in the past, we have not seen a change in the mix of hotel star rating levels being booked or changes in the length of stay that could indicate that consumers are trading down. We continue to watch these dynamics closely."
},
{
"speaker": "",
"content": "Revenue for the first quarter of $4.4 billion also exceeded our expectations, increasing 17% year-over-year. Revenue as a percentage of gross bookings was 10.1% and improved versus the first quarter of 2023 due mostly to the Easter timing shift as well as the easier year-on-year take rate compare due to changes in the booking window last year, as mentioned on our first quarter 2023 earnings call."
},
{
"speaker": "",
"content": "Marketing expense, which is a highly variable expense line, increased 6% year-over-year. Marketing expense as a percentage of gross bookings was 3.7%, about 15 basis points lower than the first quarter of 2023 due to higher ROIs in our paid channels and a higher mix of direct business. Performance marketing ROIs increased year-over-year, helped by our ongoing efforts to improve the efficiency of our marketing spend."
},
{
"speaker": "",
"content": "First quarter sales and other expenses as a percentage of gross bookings was 1.6%, about 20 basis points higher than last year due in large part to a higher merchant mix. Our more fixed expenses on an adjusted basis were up 11%, which was below our expectation due primarily to lower G&A expense. We recognize that this fixed expense growth is elevated as we invest in the business but are fully focused on driving operating leverage from our more fixed expenses and targeting a much lower OpEx growth level in 2025."
},
{
"speaker": "",
"content": "Adjusted EBITDA of approximately $900 million was above our expectations, largely driven by stronger-than-expected bookings as well as better-than-expected marketing efficiency. Adjusted EBITDA was up 53%, including about 20 percentage points of benefit from the shift in Easter timing. Note that we expect the first quarter will be our seasonally lowest EBITDA quarter for the year."
},
{
"speaker": "",
"content": "Adjusted net income of over $700 million resulted in adjusted EPS of $20.39 per share, which was up 76%. Our average share count in the first quarter was 9% below the first quarter of 2023. On a GAAP basis, we had net income of $776 million in the quarter."
},
{
"speaker": "",
"content": "Now on to our cash and liquidity position. Our first quarter ending cash and investments balance of $16.4 billion was up versus our fourth quarter ending balance of $13.1 billion due to the $3 billion debt issuance in the first quarter and $2.6 billion in free cash flow generated in the first quarter. This was partially offset by the $1.9 billion in capital return, including share repurchases and the dividend we initiated in the quarter as well as $315 million in additional share repurchases to satisfy employee withholding tax obligations."
},
{
"speaker": "",
"content": "Now on to our thoughts for the second quarter. We expect second quarter room night growth to be between 4% and 6%, a deceleration from the first quarter as the first quarter benefited more from the year-over-year expansion of the booking window. We expect the booking window to be closer to the prior year in the second quarter. Additionally, the impact from the ongoing war in the Middle East was less negative than we expected in the first quarter. However, we expect a more negative impact in the second quarter given the geopolitical situation in April."
},
{
"speaker": "",
"content": "April room night growth rate was above the high end of that range and benefited by a couple of points from Easter being in March this year versus April last year. Adjusting for Easter, April room night growth was about in line with the high end of that range."
},
{
"speaker": "",
"content": "We expect second quarter gross bookings growth to be between 3% and 5%, slightly below room night growth due to about 3 points of negative impact from changes in FX, offset by about 1% higher constant currency accommodation ADRs plus about 1 point of positive impact from flight bookings."
},
{
"speaker": "",
"content": "We expect second quarter revenue growth to be between 4% and 6% and for revenue growth to be impacted by about 2 points of negative impact from changes in FX. Adjusted for the changes in FX, we expect second quarter revenue growth to be in line with second quarter gross bookings growth as the negative impact from the shift in Easter timing is offset by increasing revenues associated with payments."
},
{
"speaker": "",
"content": "We expect marketing to be a source of slight deleverage in the quarter. But if you adjust for Easter timing, we expect marketing as a percentage of revenue to be neutral year-over-year. We expect our sales and other expenses to grow faster than revenue in the second quarter, driven by a higher merchant mix. We expect our more fixed OpEx to grow faster than revenue in the second quarter due primarily to faster IT expense growth as we have been investing in new tech platforms and in line with the full year guidance we provided last quarter."
},
{
"speaker": "",
"content": "We expect second quarter adjusted EBITDA to be between about $1.7 billion and $1.75 billion, down low single digits year-over-year due to about 7 points of pressure from the shift in Easter timing and about 2 points of negative impact on growth from changes in FX. Normalizing for Easter timing and changes in FX, our expectation for second quarter adjusted EBITDA would be for mid- to high single-digit growth."
},
{
"speaker": "",
"content": "In closing, we are pleased with our first quarter results and the healthy leisure demand environment we are seeing. In terms of our outlook for the full year, we're not updating our previous full year commentary at this time. We want to see how the next few months develop before considering any updated commentary. We continue to expect 2024 to be a strong year for the company."
},
{
"speaker": "",
"content": "Lastly, I would like to thank all my new colleagues across the company for their hard work and dedication to make these strong first quarter results possible. And thank you for your continued commitment towards our shared vision of making it easier for everyone to experience the world."
},
{
"speaker": "",
"content": "We'll now move to Q&A. And Kathleen, will you please open the lines?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question comes from the line of Kevin Kopelman of TD Cowen."
},
{
"speaker": "Kevin Kopelman",
"content": "So a quick one on the guidance. Can you talk about what changed in terms of the shape of the year that you're seeing versus what you expected on the February call? And walk us through this kind of changing booking window trends that you're seeing. And then if you could comment on whether it's giving you any concern about the back half or you see it as more of a neutral change."
},
{
"speaker": "Ewout Steenbergen",
"content": "Kevin, this is Ewout. If you think about the second quarter guidance that we have provided to you, I think a couple of elements that you have to take in consideration. One is we are expecting a less expanded booking window in the second quarter than we have seen in the first quarter. So there has been a little bit of a pull forward of room nights from the second quarter into our first quarter results. We are expecting more of an impact from the Middle East from what we have seen so far. But in the opposite direction is that Easter is a slight benefit for the second quarter."
},
{
"speaker": "",
"content": "There is a little bit of noise, so to say, in the results quarter-by-quarter, particularly from Easter and the booking window. But if you look at the combined first half year results that we are expecting, so the actuals in the first quarter and the guidance for the second quarter, we believe that the results are really strong and very consistent to full year guidance that we have provided."
},
{
"speaker": "",
"content": "In terms of the comps that you are referring, actually, first quarter and second quarter comps are a bit tougher for us. And the second half of the year, the comps will become easier. So that is actually going to be a benefit during the course of 2024."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Mark Mahaney of Evercore."
},
{
"speaker": "Mark Stephen Mahaney",
"content": "Can I try 2 questions, please? First, why do you think the ROI is higher in paid marketing channels? Is that just efficiencies you found or you find that overall performance marketing channels, platforms that are out there are just providing a better return on ad spend to their customers in general? And then secondly, could you quantify at all what percentage of total transactions now are connected?"
},
{
"speaker": "Glenn Fogel",
"content": "So why don't I say the first part, Mark, and I'll let Ewout talk a little bit about -- I think we gave away that -- a very generic term. I'll let him repeat it. So look, we are pleased with what we're doing with our marketing programs all around everything. And you know, Mark, we've talked about this for many, many years. We view this all holistically. And we're always looking for what is the best use of the money, what's the best way to put it to work. And when we find things that work, we put more into it. When we find things that actually are not incremental and are actually duplicative, we pull it out and say, well, let's not spend the money there."
},
{
"speaker": "",
"content": "And that's really what we've been doing. And I'm not going to get into specific things because, obviously, it's competitively -- a competitive advantage to have these things are better. But I definitely, definitely love the fact that we are producing some very nice ROIs on our marketing programs. It's really a lot of hard work by a lot of people. So I'm going to going to shout out to them because I know they've done some really good work. And Ewout, do you want to give a -- repeat what we've already said once? But go ahead."
},
{
"speaker": "Ewout Steenbergen",
"content": "Sure. Mark, so the percentage of connected trip as a mix of total transactions at this moment is high single digits, and that is growing very rapidly. I think the way we look at it is really in combination with multiple other elements. We're seeing that we're delivering more value for our customers. Therefore, we see higher loyalty customers moving up to higher levels of Genius, more repeat customers coming to us. We can provide them more benefits over time. They're buying more from multiple verticals, and therefore, the connected trip is growing as well."
},
{
"speaker": "",
"content": "So this is really a flying wheel that we're having here. And we're seeing all of these metrics moving in the right direction, and they are all interrelated. So we're actually really encouraged by the total pattern of what we're seeing in terms of the added value we deliver to the customer and how it is being recognized by those travelers."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Justin Post from Bank of America."
},
{
"speaker": "Justin Post",
"content": "I was wondering if you can give us the update of your regional mix. We get that question all the time and just how it's changed, any regions growing faster than others at this point and how it's changed maybe since pre-pandemic. And then second, the Digital Service Act in Europe has taken hold. And just wondering if you're seeing any changes in performance marketing channels around that or any disruptions or any opportunities."
},
{
"speaker": "Glenn Fogel",
"content": "Thanks, Justin. I kind of missed the second part. Let me start with the first part, and then let Ewout pick it up on the other. So regional mix. And one of the things that we've been talking about for some years because of the pandemic. The issue has been depending on when the pandemic was in its worst parts and then people coming out of it, definitely impacted how we're doing different regional ways. So as we talked in the last year's calls -- calls last year, we talked about how Asia had been behind in coming out, but of course, we're getting a good comp because they were farther behind. And now we're still benefiting from some of that. The U.S., if you recall, came out first. So of course, we had a harder comp, so to speak, when we're looking last year."
},
{
"speaker": "",
"content": "But one of the things I've said, though, in terms of regional mix and one of the things, as you know, we are very strong in Europe. You also know that I have prioritized that we should be better in the U.S. And that is something we have been spending money, time, energy. And I'm really pleased, I've mentioned a couple of times in our previous calls, how well we have performed in the U.S. going back to pre-pandemic numbers. And it's just wonderful to see that the effort that we've put to work is actually producing results. We are going to continue to put priority in the U.S. I said that."
},
{
"speaker": "",
"content": "And one of the areas where I think we've done extremely well, in our alternative accommodations. As you know, we have a very strong alternative accommodation on a global basis, but I've also talked in the past about us being a little bit further behind in the U.S. in alternative accommodations, particularly in types of properties that I think will be helpful in the U.S. And we are making good progress, and we're improving the product. And it's giving you the reason that people have supply, the people who own the homes are willing to come now and put them onto our platform, too."
},
{
"speaker": "",
"content": "And you've seen some of our marketing, where we've been mentioning more about the alternative accommodations. All those things together are things the reason I believe we have a great opportunity to continue to increase our share in the U.S. and so I'm looking forward to. Ewout, I'll let you pick the rest because I didn't catch the second part."
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes. And quickly to give a couple of numbers around the regional mix. Europe, high single-digit growth in the first quarter, that was above our expectations. Very important that we see even Europe continue to do better than our own internal expectations. Asia, mid-teens growth, particularly very strong, China, Japan, Korea, India and Indonesia. And then U.S. at low single-digit growth, as Glenn already mentioned, but we believe that we have done better than the market in the first quarter with our U.S. growth and are on great trajectory and have many additional opportunities to grow faster in the future in the U.S."
},
{
"speaker": "",
"content": "With respect to your second question regarding the DMA changes, actually, if we look at the higher ROIs for our paid channels and the marketing leverage that we're seeing in the first quarter, that is all coming from our own actions, from the improvements we're making, the continuous optimization of our paid marketing approach as well as the growth of direct channels. We don't see really an impact from the Google DMA changes. And I would say that is more neutral for us as a total effect."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Doug Anmuth of JPMorgan."
},
{
"speaker": "Douglas Anmuth",
"content": "Glenn, just hoping you could perhaps quantify anything on Genius frequency or bookings versus nonmembers? And maybe you can just help us understand what you see in the path of customers as they move into upper Genius loyalty tiers. And then Ewout, just a follow-up on your U.S. comments from a few minutes ago, the low single-digit room night growth above market. Is there anything to point to in that region in particular relative to the faster growth you've seen elsewhere?"
},
{
"speaker": "Glenn Fogel",
"content": "Doug, we don't give away numbers in our Genius membership. We don't talk about how many are in different tiers. I can say, though, how pleased I am and how the whole program continues to grow. And that's why we're continuing to expand, as I mentioned in my prepared remarks about we are now testing additional verticals, flights, attractions. The idea is that to give more value to the traveler, but it also provides a great opportunity for our supplier partners to get incremental demand when they need it. It's really a symbiotic relationship here. We're working together with our partners to both increase the value of our business but also increase the value of their business."
},
{
"speaker": "",
"content": "Genius is not something somebody has to do. A partner decides to participate and decides how they want to participate because they believe they are actually getting true value out of that. And we're going to continue to experiment with it in terms of different ways, and sometimes we'll even put value in ourselves to make sure that we are providing the best alternative for any traveler. They should come to us and then they start to come back."
},
{
"speaker": "",
"content": "And we talked about that in my prepared remarks about -- Ewout just mentioned it, too. As people get more value, as they get a benefit, they see the reason to come back. And then they come back not only again and again more frequently, but it's the coming back to rep. And that's the great thing. And I see this as another reason. I love Ewout using the term. I think he said flywheeling. I use flywheel. It's the same thing. It's the idea that giving more value will get people to come back more often, and that is something I see great opportunity for us. And I'll let Ewout talk a little bit about the low single digit for the U.S., any more comments he wanted to make on that."
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes, Doug, a couple of additional insights around the U.S. So what we like particularly is the sequential improvement from the fourth quarter in terms of our growth. Particularly within the growth, we saw the highest growth for alternative accommodations, which is really encouraging. If you look at U.S. bookers, more international growth than domestic growth. And then again, we really very much believe that U.S. is for us a growth market opportunity. It's fantastic with the scale that we have already today, with all the strategic expansions we're doing in multiple verticals and going more direct to connected trip, generative AI and many of the other strategic initiatives that we're having that we're actually having an opportunity to expand our position over the next few years in the U.S."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of James Lee from Mizuho Securities. Sorry, your next question comes from the line of Brian Nowak from Morgan Stanley."
},
{
"speaker": "Brian Nowak",
"content": "Maybe to come back to the last discussion you are having about the U.S. Over the last sort of 10 years or so, you've had a lot of strategies in the U.S. between branded spending, paid search spending, the merchant product and now AI. I guess maybe for either of you, as you sort of think about the next couple of years, what do you sort of think the largest unlock will be to differentiate yourself to drive continued outsized growth within the online travel category in the U.S.?"
},
{
"speaker": "Glenn Fogel",
"content": "Brian, a couple of interesting things about that question. And it's interesting when you said online, you kind of limited to online. I just had the benefit of looking at a research report by -- an industry report that talked about how much business there is that's not online yet and seeing that, saying, wow, this is still a tremendous opportunity for us. I'm speaking specifically about U.S."
},
{
"speaker": "",
"content": "But directly to your question, so you're right. We've been doing a lot of things, and I would say they all have worked out fairly well given the numbers, the share that we have increased over the time, again, going to pre-pandemic. And I love the way we're doing, the way it keeps going. And we're going to continue to grind it out. And I've talked about it. I've used that word a number of types in previous calls, about we're grinding it out, just doing incremental changes that are getting us a little bit more. And it continues to grow on itself."
},
{
"speaker": "",
"content": "But I think your question more is, is there going to be something down the road that is going to be transformational instead of just incremental? And I believe that is possible. I believe the things that we are doing with AI, the things that we can do with technology, the way we can do it, so it really is different. And I think I hear your question a little bit of is there enough differentiation between us and our competitors. And I believe over time, we will be doing that. And I believe the things that we can build will make it different. And I talk about how -- the frustration that travelers have nowadays."
},
{
"speaker": "",
"content": "So even though it's become so much better than it used to be, it's still not good enough. And I believe the use of AI, particularly gen AI, and what I'm seeing through, I'm seeing testing and things that are being done, I believe that over the next few years, it will become much better because of these technological advancements. Our job is to make sure we get it out fast, and we are able to provide it to both sides of the marketplace, to our supplier partners and our travelers, such that they see the value and they continue to come back. And then we begin. I love it. I'm going to be using flywheeling from now on."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of James Lee of Mizuho Securities."
},
{
"speaker": "James Lee",
"content": "Two over here. Can you guys comment about ADR by region and kind of what you're seeing among different markets that you're operating? And also, can you update us on ADR expectations for 2024? Maybe any changes from your prior expectation. I guess lastly, any trends that you see in terms of summer travel season, I guess, especially in Europe? How does that compare to last year?"
},
{
"speaker": "Glenn Fogel",
"content": "ADR by regions, James, in the first quarter, what we have seen is ADRs were up in Europe and were flat in North America and in Asia. So therefore, on a constant currency basis, 1% overall growth in ADRs as we have reported today."
},
{
"speaker": "Ewout Steenbergen",
"content": "And in terms of summer, as I said earlier, I said that we have a healthy growth for travel on the books that's scheduled to take place during the peak summer. And that's where we're feeling that -- why I'm feeling pleased about the summer. I'm not going to quantify it though."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Stephen Ju of UBS."
},
{
"speaker": "Stephen Ju",
"content": "So I was wondering if there is anything you can share about how the folks who have access to Trip Planner might be behaving. It seems like there's a lot of potential application here because if they're doing research, then there's top-of-funnel implications. And then you could theoretically recommend other pieces of the trip as well. So this could theoretically drive greater connected trip activity. So just wondering. This has been out for a little less than a year. So I'm just wondering what you guys are seeing so far."
},
{
"speaker": "Glenn Fogel",
"content": "Yes. So it's low numbers of people who are using in such, and we're continuing to develop and learn all the time the interactions to see how people are using it. So it's a very small number of people compared to the number of people who use our services, but we are continuing to advance it."
},
{
"speaker": "",
"content": "And I agree with you. This has tremendous potential down the road. And I think a lot of people believe that, too. In fact, it's very hard to read any article about generative AI and not have in the first paragraph the use case of travel. It's always right there because we all see how complex the number of permutations, trying to understand what is the best way to do it. And using gen AI to simplify it, it's really something that I believe will make a huge difference, albeit it's going to take time. You're not going to see tremendous changes over the next couple of quarters."
},
{
"speaker": "",
"content": "But I do believe, over time, this will create a much better way for people to do their planning, their booking, executing and helping them when they are in destination, which is a really important thing because nobody goes on travel so they can sit it in the hotel. They want to do stuff. And we want to be able to provide that, too, and bring, as I said, about all the elements we've talked about, all the initiatives into one holistic system that enable it to be a better experience for our traveler customers. I believe that just has tremendous opportunity for us."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Lee Horowitz of Deutsche Bank."
},
{
"speaker": "Lee Horowitz",
"content": "Great. Two if I could. Ewout, there remains sort of a robust debate on sort of what the structural growth algorithm is for online travel at this point. I guess in your early experience of booking, what strikes you as perhaps the most compelling area that you could put $1 of investment to work in order to drive faster revenue growth for longer that maybe comes in above the investor expectations? And then maybe one on fixed OpEx. Obviously, your fixed OpEx base is up materially relative to '19, particularly when you compare it to bookings growth relative to '19. So I guess maybe what has shifted in the business that is perhaps maybe a bit more capital intensive at this point or necessitating sort of greater headcount to sort of accomplish the goals that you guys want?"
},
{
"speaker": "Ewout Steenbergen",
"content": "Yes. Thanks, Lee. So first, your question about structural growth. So I am really super positive about the outlook for the company. Why? This is, of course, a phenomenal company, super high quality, very successful. And I very much believe that we will be able to grow in the future faster than GDP. Shift of offline to online bookings. I think overall, also consumers that will spend more on experiences than on material goods."
},
{
"speaker": "",
"content": "And then a number of areas that I believe actually, in my view, now being 6 weeks here in the position that are really underestimated for the company. So first, let me talk about direct. I think this is a company now that is -- completely has a complete game changer with respect to the share of direct. We're not only dependent on pay channels anymore. And that is now in the low 60% range for the B2C business. It's really important, and we are keeping those customers with us, and we have talked about it now before previous questions of really adding more value and more of those travelers coming back to the app, booking direct to us and the benefit we are having with that."
},
{
"speaker": "",
"content": "The other is the opportunity we have with respect to alternative accommodations. I think, again, this is completely not well understood and underestimated. We are actually, in terms of size, 2/3 of the largest player in this space, and we are growing faster in most of the last 8 quarters. And we still have a lot of opportunity to further develop our offering. But the fact that we are combining traditional accommodations and alternative accommodations on a platform and having travelers really being able to go from one to the other -- sometimes they go in and want to book one type of accommodation, and they end up booking a completely different type of accommodation."
},
{
"speaker": "",
"content": "And the last is gen AI. Glenn was just commenting on this. I have to say, I think the strategic benefit we have in terms of our capital investments we can make as well as the quality of the data because in generative AI, it's not so much about the language models. The data that go into the language models is strategically probably the biggest differentiator. And we have really advantage with respect to the data because of all the different ways that we touch travelers and partners and other stakeholders in the travel industry. So therefore, I'm really very positive and optimistic about the structural growth opportunities for the company over the next couple of years."
},
{
"speaker": "",
"content": "Quickly about fixed OpEx. I think that has to do with a couple of strategic expansions that the company has done, multiple verticals, moving in payments. But that is actually linked to your previous question. That will help drive future growth for the company. So that's actually a good thing. But as we have said, we are targeting to lower the growth of fixed OpEx from 2025 onwards. And you will see more operating leverage from that over the next few years. So this year, we'll still have some end finalization of some of the investments, for example, about some of the tech platforms. But then for next year, you will see more operating leverage coming in from all of those investments we have been making."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of John Colantuoni from Jefferies."
},
{
"speaker": "John Colantuoni",
"content": "Just wanted to ask about underlying room night trends. just talk about in the first quarter, the size of some of the transitory impacts that you called out like Easter shift, geopolitical disruption and the booking window and sort of how that shakes out to how you think about underlying trends in the business."
},
{
"speaker": "",
"content": "And second, on the attractions offering, can you talk about the investments that you've made so far and how your supply is today versus where you need it to be over time to sort of open up the full potential of that opportunity? And our understanding is that attractions are often booked closer to the trip date, which requires getting the traveler back to the app. Talk about how you're sort of looking to drive a solution to that dynamic and how the connected trip offering could help drive that behavior over time."
},
{
"speaker": "Ewout Steenbergen",
"content": "With respect to your first question, room nights dynamics in the first quarter. So positives here compared to our original guidance for the first quarter were the fact that the booking window was expanding and that we're able to pull some room night bookings from the second quarter into the first quarter, healthy demand in Europe, and Europe was stronger than we anticipated, as we mentioned before, and less of an impact from the Middle East. And you saw excluding the Middle East impact, actually, the result was exactly the same. So there was no material impact from the Middle East. Easter was a negative, a small negative. But that was, of course, anticipated in the guidance that we provided before."
},
{
"speaker": "Glenn Fogel",
"content": "So on attractions -- and it's a good question to ask because we haven't talked about it a lot in the past. Attractions is mostly supplied through third parties. So we have arrangements with companies like Viator, or a Klook or Musement. And we get the supply that way. In addition -- and we don't talk about this much at all either. We also have FareHarbor, which if you may recall, we acquired that. Think of it as the OpenTable for small- and medium-sized attractions because it's a good loop into those attractions."
},
{
"speaker": "",
"content": "We have priorities though. We can be anything, but we can't be everything, and we definitely can't be everything all at once. So the priorities have been to get the flight stuff up, get that one. It's the biggest thing, get that going well first. And then we have making sure that we have the ground transportation to make sure all that stuff is -- now our people have attraction. They also want to have a lot of emphasis, too, and they are doing a great job building that, and we've talked a little bit about that."
},
{
"speaker": "",
"content": "And that's going to come in as part of the overall connected trip because as you point out, people don't generally book their attractions far, far in advance. In fact, a lot of them want to book it when they're actually in destination, and that's why I love the fact of the increased amount of use of our app because that's like having your travel agent in your pocket and be able to -- we're able to send them great offers, great ideas where they go right to it, checks on the app and can they get something better."
},
{
"speaker": "",
"content": "And that's why we're bringing that into our Genius program for people to have an attraction business and want to get that incremental demand. We can push something to a customer who's in destination and give us on -- bring them to that particular supplier. All over, it's a tremendous opportunity down the road. We have yet to even really scratch the possibilities with that, and that's just another reason why I see just tremendous opportunity for us as we continue to roll on."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Ron Josey from Citi."
},
{
"speaker": "Ronald Josey",
"content": "I want to ask maybe a follow-up on alternative accommodations here just given how much faster overall room nights are growing. And Ewout, you talked a little bit about this as well as Glenn, but I wanted to hear more about the supply side, the 7.4 million properties on the site. Are these higher quality than maybe what you've seen in the past? Are they differentiated from other platforms given -- that are available out there? And Ewout, you made a good mention earlier just that with Booking offering both alternative accommodations and traditional, that's an advantage. I'd love to hear your thoughts on what you're seeing from a consumer perspective, those that book both and then the mix between that going forward between those 2 bookings."
},
{
"speaker": "Ewout Steenbergen",
"content": "So let me first take the second part of the question in terms of alternative and traditional accommodations. We're actually not so much separating in our thinking one versus the other because we believe that our unique proposition is that we're putting both in the same way on our platforms because it is an artificial separation as we are seeing many consumers are looking for both. They want to alternate -- look at different alternatives. They want to compare. And often, if they start to look for a traditional hotel, they maybe end up with an apartment they want to rent as an alternative accommodation or the other way around. So actually, the way we look at it is we think it's actually really strong to bring all of these propositions together and have a really a combined offering to our traveler customers."
},
{
"speaker": "Glenn Fogel",
"content": "In terms of quality -- and I'd like to think that the inventory we have is high quality, obviously comes at different price points. It's a complete range. And you may not be surprised that lower-priced things may not be as luxurious the higher-priced things. And I think we cover the gamut, but we don't have enough of certain types in certain areas. And I've talked about this before. We're entering close to the summer, and I look at -- I live in the New York metropolitan area. And I'm looking, do we have enough of these high-end homes in the Hamptons? And I don't think we do. If I look at some of our competitors, I see more."
},
{
"speaker": "",
"content": "I look at that as opportunity for us, though, because we're doing so well. Yes, we don't have all the different types of accommodations and the quantity that I want to have in that. It's great that we are as big as we are, but I absolutely see no reason we shouldn't be significantly bigger throughout every geographical area. Look, our base was Europe. So we are very, very competitive. We have great inventory, all types there. But I've talked about the U.S., and that's an area we continue to do more work. And I mentioned earlier, I see us making great progress there."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Jed Kelly of Oppenheimer."
},
{
"speaker": "Jed Kelly",
"content": "Great. Just following up on that last point, Glenn. How do you think about getting more of that single unit inventory? Is it connecting more with property managers, the PMS systems? And then my second question is, just how should we view the big events in Europe this year, this summer in travel, particularly around the Olympics impacting demand or how people would travel?"
},
{
"speaker": "Glenn Fogel",
"content": "Sure. So yes, and we definitely have -- you're not surprised of the fact that it's easier to get more inventory when you go to some of the managers who have significant number of the inventory you're looking for. And those multi-property managers are the place where we definitely assume more business. And we have not, until very recently, really spent a lot of time trying to do it in the low -- trying to go for individuals and trying to bring them in, too."
},
{
"speaker": "",
"content": "There's no doubt, though, over time, we have to make sure to make an effort to everybody. And that means being sure that we are providing a platform that a supplier really likes to use. And I saw something recent. Just to give you an example, turns out that until fairly recently, it was hard for some of our big managers to be able to reconcile the payments with individual properties. And we improved that significantly recently. And that's the reason, it was, okay, now I'll do that. And I can go through a whole bunch of different individual things that, well, by themselves may not be so big. As a whole, they end up saying, yes, I will now be more than happy to get incremental demand from Booking.com because I find it easy and helpful."
},
{
"speaker": "",
"content": "If somebody is going to make business to make money, you definitely never want to have your property empty. That's 0 revenue. You're never going to get back. That inventory expires. So that's why people are always looking to try and get more demand. As long as we provide them with demand and we provide them with a platform that they find easy and helpful, they will come to us."
},
{
"speaker": "",
"content": "In regards to the summer and things like Paris and the Olympics, stuff like that, it's always a mystery what's going to happen with the Olympics. So I've been here now 24 years. So I've been through a whole bunch of Olympics and thought it was going to be -- this is what's going to happen and then something else happens. Here's the big point. Let's not concentrate too much on one individual event to last for a couple of weeks."
},
{
"speaker": "",
"content": "I continue to say the important way to view value in this company in the long run. What have we done? What have we done over the last 24 years here? Continue to increase the value, bring in more customers and more suppliers and continue to produce more cash flow for our investors. That's the way we've done in the past and what we did in the past. And as far as how the Paris Olympics go, I really -- I can guess, but my guess is as good as yours. And I don't think that's something that I'd spend a lot of time worrying about."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Tom White from D.A. Davidson."
},
{
"speaker": "Thomas White",
"content": "Just one. I wanted to follow up on some of the prior questions on the U.S. market. I was hoping you could kind of comment on maybe the relative unit economics of your U.S. accommodations business today versus in Europe. Obviously, the Booking.com brand here is well known but less well known than in Europe. And so maybe there's like a heavier kind of marketing load per room night here. But the ADRs here are nice and high. But then again, maybe the take rates are lower. So I'm just kind of curious directionally how accommodation kind of unit economics in the U.S. stack up versus Europe at the moment and maybe where you kind of see that going over the next few years."
},
{
"speaker": "Glenn Fogel",
"content": "We don't disclose much more and giving you these regional growth rates. We don't go any further than that in terms of detail. And I don't think we'll be starting that right now. I understand your reason for asking, but for reason of competitiveness and such, we're not going to break this down any further than that."
},
{
"speaker": "Operator",
"content": "That concludes our Q&A session. I will now turn the conference back over to Glenn Fogel for closing remarks."
},
{
"speaker": "Glenn Fogel",
"content": "Thank you. I want to thank our partners, our customers, our dedicated employees, our shareholders, and I especially want to thank Ewout for joining the team. Ewout, thank you very much. We greatly appreciate everyone's support as we continue to build on the long-term vision for our company. Thank you, and good night."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect. Goodbye."
}
] |
bkr | 2,024 | 4 | [
{
"speaker": "Chase Mulvehill - VP, IR",
"content": ""
},
{
"speaker": "Lorenzo Simonelli - Chairman & CEO",
"content": ""
},
{
"speaker": "Nancy Buese - CFO",
"content": ""
},
{
"speaker": "Arun Jayaram - JPMorgan Securities",
"content": ""
},
{
"speaker": "David Anderson - Barclays",
"content": ""
},
{
"speaker": "Saurabh Pant - Bank of America",
"content": ""
},
{
"speaker": "Stephen Gengaro - Stifel",
"content": ""
},
{
"speaker": "Neil Mehta - Goldman Sachs & Co.",
"content": ""
},
{
"speaker": "Scott Gruber - Citigroup",
"content": ""
},
{
"speaker": "Kurt Hallead - Benchmark",
"content": ""
},
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Baker Hughes Company Fourth Quarter 2024 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 is being recorded. I would now like to introduce your host for today's conference, Mr. Chase Mulvehill, Vice President, Investor Relations. You may begin."
},
{
"speaker": "Chase Mulvehill",
"content": "Thank you. Good morning, everyone, and welcome to Baker Hughes fourth quarter and full-year earnings conference call. Here with me are our Chairman and CEO, Lorenzo Simonelli, and our CFO, Nancy Buese. The earnings release we issued yesterday evening can be found on our website at bakerhughes.com. We will also be using a presentation with our prepared remarks during this webcast, which can be found on our investor website. As a reminder, during this conference call, we will provide forward-looking statements. These statements are not guarantees of future performance and involve a number of risk and assumptions. Please review our SEC filings and website for the factors that could cause actual results to differ materially. Reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release. With that, I will turn the call over to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Chase. Good morning, everyone, and thanks for joining us. Starting on Slide 4, we're very pleased with our strong fourth quarter results, exceeding the midpoint of our EBITDA guidance for the eighth consecutive quarter and setting new quarterly and annual records for revenue, free cash flow, and our adjusted measures of EPS, EBITDA, and EBITDA margin. Our adjusted earnings per share remains on an impressive growth trajectory, increasing 37% from the fourth quarter of 2023 and up 47% for the full year. For the fourth quarter, company adjusted EBITDA margins increased by 1.8 percentage points year-on-year to a record of 17.8%. Significant margin expansion across both segments drove this exceptional performance. Industrial and energy technology orders remained at strong levels during 2024, including $3.8 billion in the fourth quarter that drove the annual total above the midpoint of our guidance range. This order performance highlights the end market diversity and versatility of our technologies, led by strength in gas infrastructure and FPSOs. Accordingly, Gas Tech Equipment's non-LNG orders more than doubled, totaling $3.6 billion. We achieved another important milestone in booking new energy orders of $1.3 billion. This represents approximately 70% year-over-year growth for the new energy awards and the third consecutive year, we have exceeded the high end of our original guidance range. We generated strong free cash flow of $894 million during the quarter, resulting in record annual free cash flow of $2.3 billion. This represents a free cash flow conversion rate of 49% near the high end of our 45% to 50% target range. These record results clearly demonstrate that we are the leading energy and industrial technology company. Turning to Slide 5, we want to highlight recent awards and technology developments. As I mentioned, 2024 was another strong year for IET orders, booking several large-scale GTE awards that span across gas infrastructure, FPSOs, and LNG. This is the third consecutive year that GTE has booked more than $5 billion of orders. In the fourth quarter, we secured orders for multiple LNG projects, bringing total LNG equipment bookings to almost $2.1 billion for 2024. We received an order from Venture Global to provide modularized LNG systems and a power island. Additionally, we received an award from Bechtel for the first phase of Woodside Energy's Louisiana LNG project. This phase will include two Baker Hughes liquefaction compression trains with a capacity of 11 MTPA. The gas infrastructure buildout in the Kingdom of Saudi Arabia continues to gather pace, following our Master Gas System Free Award in early 2024. During the fourth quarter, we booked an award for gas compression equipment for the third expansion phase of the Jafurah gas field. We will supply a total of 12 electric motor-driven compression trains and auxiliary treatment equipment in this unconventional gas field. In total, we have now been awarded 24 electric motor-driven compressors and an additional 14 compressors for this strategically important gas field. In gas technology services, we secured over $1 billion of long-term service agreements for the second consecutive year. In the fourth quarter, we signed a long-term service frame agreement with Venture Global to support Phase 1 and 2 of their Plaquemines LNG facility in Louisiana. Additionally, GTS was awarded a 25-year services agreement to support next decade's Rio Grande LNG facility in Texas. We were also awarded a contract to provide plant maintenance at a major LNG facility in Asia Pacific, which will leverage IET's iCenter. In addition to booking several meaningful long-term service awards, GTS recorded the strongest quarter of equipment upgrades since 2020. This included a key project to upgrade the Monsanto Compression Station for Snam, one of Europe's leading midstream companies. During the quarter, IET's Climate Technology Solutions secured multiple awards targeting flare reduction. As announced at COP29, CTS will provide SOCAR with an integrated gas recovery and hydrogen sulfide removal system to significantly reduce downstream flaring at the Heydar Aliyev Oil Refinery. Separately, in the Middle East, CTS will supply electric-driven centrifugal compressors for one of the largest gas processing and flare gas recovery projects globally. In Oilfield Services & Equipment, we continue to experience strong auto momentum in Brazil, particularly for our differentiated flexible pipe technology. During the quarter, we received a significant award from Petrobras for 48 miles of flexibles to be delivered across four fields. This follows the third quarter award for 43 miles of flexible for the Santos Basin and takes our total year orders for flexible pipe to $1.4 billion, a record year for this business. In mature asset solutions, we received a multi-year contract from ENI to unlock bypass reserves in one of Europe's largest developments. Baker Hughes will provide its auto-track exact rotary steerable drilling system, which will be deployed to help ENI lower risk and execution costs. We continue to see solid order momentum in the Middle East, receiving multiple awards across the region for coil tubing services as well as drilling and completion fluids. We also booked an award from a major operator to provide artificial lift services in Iraq, which includes advanced permanent magnet motors for improved electric submersible pump efficiency. In Abu Dhabi, we signed an agreement with AIQ, ADNOC, and CORVA to launch the AI Rate of Penetration Optimization project. This innovation, which utilizes the latest AI digital technology, enhances drilling efficiency in real time by providing insights and recommendations for optimizing weight on bit, rotations per minute, and other critical parameters. Driving innovation and expanding our manufacturing footprint in key growth markets are critical to the long-term success of our company. During the quarter, we expanded our footprint in Namibia and Oman. We also had the grand opening of our recently relocated surface pressure control headquarters in Abu Dhabi, ensuring that we are close to key customers in a major demand region. Turning to the next slide, as we enter 2025, we believe Baker Hughes is very well positioned to thrive in the back half of the decade, with a number of positive tailwinds that will continue to drive demand for our technology and solutions. On the macro front, the U.S. economy has remained resilient in the face of higher interest rate environment, while the European and Chinese economies have struggled to stimulate growth. Looking at 2025, the global economy will be navigating a number of economic and geopolitical uncertainties, which could result in another year of uneven global economic growth. Against this economic backdrop, we have seen increasingly positive trends for power consumption. Boosted by this encouraging development, we believe that natural gas and LNG demand will demonstrate accelerated growth, which will drive increasing demand for our gas levered products and solutions in both OFSE and IET. According to Wood Mackenzie, demand for U.S. natural gas is set to increase by approximately 20 BCF per day, or 18% by 2030, led by a continued increase in gas requirements for new LNG facilities and data centers. For LNG, we still expect 100 MTPA of FIDs between 2024 and 2026, a level that would increase global capacity to our longstanding forecast of 800 MTPA by 2030. Last year, there were 17 MTPA of project FIDs. Accordingly, we anticipate more than 80 MTPA of FIDs in ‘25 and 2026. Our strong FID outlook is supported by a record year of offtake contracting last year, which totaled 92 MTPA and exceeded the prior record of 84 MTPA set in 2022. We also expect demand to remain robust for gas infrastructure projects. This follows a very strong 2024 when we booked MGS3 and Jafurah in Saudi Arabia, Hassi R'Mel in Algeria, and the Margham Gas Storage Facility in Dubai. While we may not see the same level of large-scale projects in 2025, we are in active conversations on several pipeline expansion projects across the Middle East, Africa, North America, and Latin America. Turning to our new energy outlook, we see energy efficiency and decarbonization technologies playing an increasing role in achieving net zero goals. Looking forward, we are targeting $1.4 billion to $1.6 billions of new energy orders in 2025. While some near-term policy uncertainty across several clean technology areas exist in the United States, we remain confident in achieving our 2030 orders target of $6 billion to $7 billion. Our pipeline of project opportunities, both domestically and internationally, continues to grow. Further, we are very excited about the potential of new technologies under development, like net power and our direct air capture solution Mosaic. These technologies will help and enable a sustainable energy development plan that provides affordable, more secure, low-emissive energy in the future. Turning to oil markets, there are several factors that could drive further volatility in oil prices. On the supply side, we see production slightly increasing in North America, adding to significant growth in offshore volumes. The demand outlook has an element of uncertainty given the potential for U.S. tariffs, which would likely dampen growth in key oil-consuming countries like China, where persistent structural imbalances still weigh on the economy. Ultimately, the oil price path will be highly dependent on the pace and magnitude at which OPEC+ production cuts are reversed in 2025. In line with this backdrop and changing activity trends by major EMP operators, we expect global upstream spending to be down slightly in 2025. In North America, we anticipate spending to decrease year-on-year in the mid-single-digit range, as many operators remain focused on capital discipline and look to optimize their newly consolidated acreage. Given our production-weighted portfolio mix in North America, we expect to outperform the market. In international markets, we expect spending to be flat to down year-on-year. The prospect of an oversupplied oil market, uncertainty in Mexico and Saudi Arabia, and shifting focus to gas are all leading to reduced activity levels in some of the key international markets. This will be somewhat offset by bright spots of activity in Brazil, the Middle East outside of Saudi Arabia, and Sub-Sahara in Africa, but ultimately not enough to drive growth from 2024 levels. In offshore, we continue to see a consistent stream of development projects for the next several years, translating in a steady outlook for subsea trees and FPSOs. In 2025, we expect SSPS orders to be up materially, led by strong subsea tree order flow, as several projects for key customers are anticipated to reach FID. Turning to Slide 7, we want to continue the discussion around our lifecycle business in gas technology. A key value-creating attribute of our IET segment that is consistent with high-quality industrial businesses. Over the past three years, we have booked more than $19 billion of equipment orders that will drive a 20% increase in our serviceable installed base by 2030. We expect Gas Tech Services revenue to outpace this installed base growth due to pricing, mix, upgrades, and digital enhancements. We see strong demand across the gas turbine market. Market forecasts suggest the pace of gas turbine installations could double to around 100 gigawatts per year out beyond the end of the decade. The major driver of this growth will be the rapid expansion of data center capacity required to meet increasing generative AI workloads. When combined with an already tight supply chain and material cost inflation, this environment provides a tailwind for pricing. We also expect our serviceable LNG installed base to increase by over 50% through 2030, outpacing the overall 20% growth rate. This mix shift towards LNG installed units is important as these projects have the highest attachment rates across all of our aftermarket services. Another benefit of our large and growing installed base is the opportunity to provide performance enhancement through upgrades as equipment ages. In recent years, customers focused on maximizing equipment uptime as markets manage through the energy crisis. However, as we move into a more stable energy environment and gas gains fervor acceptance as a destination fuel, we expect upgrades to demonstrate strong growth over the coming years. We have a range of upgrade technology solutions that can drive lower emissions, lower energy consumption, increase power output, and produce higher throughput yield. In addition, we are excited about new upgrade technologies that we are introducing into the market, a direct result of our R&D investment and innovation pipeline. We believe new upgrade technologies that enhance aging equipment have the potential to generate hundreds of millions of dollars of orders at accretive margins by 2030. In addition to equipment upgrades, we are enhancing our customers' plant performance and emissions abatement through the development of advanced service solutions. We are leveraging our 24/7 eye center monitoring capabilities, more than 20 years of monitoring and diagnostic data, the latest in generative AI capabilities, and our Cordant platform to create digital solutions that help our customers optimize their total cost of equipment ownership. On the back of increasing customer acceptance and enhanced digital product offerings, GTS digital orders increased by approximately 60% this year, with over 1,800 units connected at the end of 2024. Looking forward, we expect GTS digital orders to double by 2026 and continue this strong growth trajectory thereafter. In summary, we have four discreet and tangible revenue growth accelerators that will benefit Gas Tech Services. Alongside an increasing installed base, this gives us confidence that we can structurally grow our high margin GTS business for the next decade and beyond. Before turning the call over to Nancy, I would like to again emphasize the strength of our 2024 results. We face some near-term market headwinds with the maximum sustainable capacity MSC reduction in Saudi Arabia and the LNG moratorium in the United States, yet we still exceeded the midpoint for orders and the high end of our EBITDA compared to our original guidance ranges. Our company is clearly delivering results, evidenced by another record year. We expect this momentum to continue, with EBITDA to demonstrate another year of strong growth in 2025. And as we embark on our continued journey, we are excited about the opportunities to further expand the versatility and breadth of our technology portfolio, as well as drive segment margins beyond our 20% target. With that, I will turn the call over to Nancy."
},
{
"speaker": "Nancy Buese",
"content": "Thanks, Lorenzo. I will begin on Slide 9, with an overview of our consolidated results and then speak to segment details before summarizing our first quarter and full year outlook. We demonstrated another year of strong progress during 2024. For the full year, orders totaled $28.2 billion, including $13 billion of IET orders that marks the second highest order total for the segment. Technology versatility and differentiation of IET's portfolio continued to support a strong order book and near record levels of RPO. We generated total adjusted EBITDA of $4.6 billion, increasing over 20% and setting a record for the second consecutive year. Adjusted EBITDA margins increased 1.7 percentage points to 16.5%, marking the fourth consecutive year of margin expansion for the company. Adjusted diluted EPS for the year increased by 47% to $2.35. In addition to our strong operating results, EPS benefited from our effective tax rate declining by approximately 5 percentage points to 28%, adding $0.17 to EPS for the year. Free cash flow totaled $2.3 billion, which represented a free cash flow conversion of a 49% near the high end of our targeted range. Turning to our fourth quarter results. As Lorenzo mentioned, we delivered a very strong quarter for orders with total company orders of $7.5 billion, including $3.8 billion from IET. Adjusted EBITDA increased by 20% year on year to $1.31 billion, driven by continued strong IET revenue growth and exceptional margin performance across both segments. We are delivering on our commitments and we remain focused on meeting our margin targets. GAAP operating income was $665 million. Adjusted operating income was $1.02 billion. GAAP diluted earnings per share were $1.18. Excluding adjusting items, earnings per share were $0.70, an increase of 37% when compared to the same quarter last year. Excluded from adjusted diluted earnings per share was a net benefit of $0.48 related to unrealized gains on certain equity investments and the release of valuation allowances for certain deferred tax assets, partially offset by restructuring and other charges. The valuation allowance release reflects our growing pattern of profitability over recent years, alongside our confidence for continued profit growth into the future. Restructuring charges primarily relate to streamlining of our OFSE operating model and right-sizing our workforce to match forecasted activity levels. We generated free cash flow of $894 million for the quarter, supported by a strong quarter of collections. Turning to capital allocation on Slide 10. Our balance sheet remains strong, ending the fourth quarter with cash of $3.4 billion, net debt to EBITDA ratio of 0.6 times and liquidity of $6.4 billion. In 2024, we have returned $1.3 billion in dividends and share repurchases, amounting to approximately 60% of free cash flow. We remain committed to returning 60% to 80% of free cash flow to shareholders. Turning to the next slide, I want to highlight our steadily growing dividend, strong earnings growth and improving return on invested capital. We have demonstrated robust growth and earnings per share over the past three years, increasing by a 37% compound annual growth rate over this period. Moving to our dividend, we announced a 10% increase yesterday. This marks the fourth consecutive year that we've raised our dividend, increasing by 28% since the third quarter of 2022. This consistent dividend growth demonstrates our confidence and the durability and momentum of the company's earnings and free cash flow, a quality we share with our industrial peers. Looking forward, I believe we're uniquely positioned to continue increasing the dividend, consistently buyback shares, and retain the financial flexibility to pursue opportunities that will enhance our growth capabilities. We are demonstrating solid progress in enhancing the company's returns profile, driven by our capital efficient growth and significant margin expansion achieved over the last two years. For 2024, IET ROIC of 25% exceeded our 20% target one year early. In OFSC, ROIC continues to make steady progress towards our 15% target, increasing to 13% for 2024. We expect both segment returns to further increase in 2025 and beyond as our focus remains on capital efficient, profitable growth. Now I will highlight the results for both segments, starting with industrial and energy technology on Slide 12. During the quarter, we booked strong IET orders of $3.8 billion, primarily driven by LNG awards and further gas infrastructure order momentum. For the full year, IET secured $13 billion of orders with a book-to-bill of 1.1 times, resulting in near record RPO levels of $30.1 billion at year end. Our fourth quarter results reflect a strong increase in IET EBITDA, up 38% year-over-year due to another strong quarter of revenue growth in Gas Technology for both Equipment and Services and significant margin expansion. For the full year, IET EBITDA approached $2.1 billion, setting a record for the second consecutive year as revenue reached a new high and margin reclaim prior peak levels. This was mostly driven by significant margin improvements in both Industrial Solutions and Gas Tech Equipment, with the latter benefiting from operational enhancements and conversion of higher price backlog. Turning to Oilfield Services & Equipment on Slide 13. We booked strong orders and flexibles during the quarter, which drove SSPS orders of $802 million and resulted in full year orders of $3.1 billion. OFSE EBITDA margin continues to outperform the segment's revenue performance, supporting solid fourth quarter EBITDA of $755 million. Full year EBITDA increased by 11% to approximately $2.9 billion, driven by margin that expanded 1.5 percentage points to 18.4%. Turning to Slide 14. I want to provide additional highlights on the significant progress we are making in driving structural margin improvement. We are executing several projects to streamline activities, remove duplication and modernize management systems. This is improving clarity, transparency and the pace of decision-making, enable our teams to work smarter and drive costs structurally lower. We continue to enhance our supply chain across the enterprise. Our best value country spend increased 15% year-on-year in 2024. Typically, we see over 20% cost savings when we move volumes from higher-cost regions to best value countries. Going forward, we're focused on sourcing a larger volume of materials from these countries. In IET, we are seeing the benefits of lean strategies being adopted across our operations. The team has initiated over 120 large problem-solving kaizen projects this year alone, involving over 1,300 employees across all functions. Our GTE team has been applying lean to its execution model, focusing on improving throughput efficiency. Through multiple kaizens, the team has driven a 40% increase in GTE volumes within our existing manufacturing footprint to support growing demand. This has enabled us to gain share in key markets due to our speed to deliver on customers' needs. In Industrial Tech, we have levered kaizens to improve lead times on Cordant's flagship product, Orbit 60. Lean adoption and manufacturing processes helped develop a new layout of the assembly line, reducing lead times by 50% and more than doubling effective capacity. In OFSE, a great example of the progress we have made is the improved performance of SSPS. EBITDA margins have increased significantly over the last two years with SSPS margins more than doubling into the mid-teens last year. This has been driven by refocusing our commercial model, rightsizing our capacity and improving our execution. For the overall OFSE segment, we continue to transform the business. In 2024, the focus was centralizing the business operations, leading to a significant reduction in duplication across our regions and product and service lines. The focus now is to drive consistency and operational excellence across the new business structure. These activities are centered on enhancing commercial intensity and optimizing operational efficiency. In line with this, we are matching our structure to anticipated activity levels. These actions, along with the implementation of our streamlined operating model will be key drivers to achieve our OFSE margin target. We are making significant progress on our transformation journey, yet have additional opportunities to enhance efficiency, productivity and ultimately, margins. Our strategy is clear, and we are taking further action in 2025. We have cultivated an organizational culture focused on continued margin improvement, and we see 20% margin targets as milestones on our journey towards best-in-class margins. Next, I would like to update you on our outlook. The details of first quarter and full year 2025 guidance can be found on Slide 15. The ranges for revenue, EBITDA and D&A are shown on this slide, and I will focus on the midpoint of our guidance. Starting with the full year, we expect total company revenue of approximately $27.75 billion and EBITDA of $4.95 billion. We are also targeting free cash flow conversion of 45% to 50% relative to our annual EBITDA. We expect an effective tax rate in the range of 25% to 30%, with a strategic plan in place to further optimize our tax rate beyond 2025. We expect IET orders to remain at robust levels this year with LNG momentum returning to the market, while gas infrastructure and energy production order strength continues. Given the strong environment, we expect IET orders of $12.5 billion to $14.5 billion. At the midpoint, this would mark the third consecutive year of at least $13 billion of IET orders. This not only provides strong backlog support for our equipment business into 2027, but will provide years, if not decades, of growth for our high-margin aftermarket service businesses. As a result of this continued momentum and strong orders performance over the last two years, we expect full year IET revenue of $12.75 billion and EBITDA of $2.3 billion. For OFSE, we forecast full year revenue of $15 billion, down slightly year-on-year as a result of softening oilfield service market in North America and lower SSPS revenues. Importantly, we still expect EBITDA to increase to $3 billion. We have been proactively positioning our OFSE portfolio to remain resilient in a maturing upstream spending cycle. Now turning to first quarter guidance. We expect revenues of $6.5 billion and total EBITDA of approximately $1.02 billion. For IET, we expect first quarter results to demonstrate strong year-over-year EBITDA growth led by GTE. Overall, we expect IET EBITDA of $460 million. The major factors driving this range will be the pace of backlog conversion in GTE, the impact of any aero derivative supply chain tightness and gas technology, operational execution in industrial technology and CTS and material changes in foreign exchange. For OFSE, we expect first quarter results to reflect a more pronounced seasonal decline for international OFS and SSPS. Accordingly, we expect EBITDA of $645 million. Factors driving the range include the SSPS backlog conversion, activity levels in Saudi Arabia and Mexico and winter weather in the Northern Hemisphere. In summary, we are extremely pleased with the operational performance of the company during 2024. The fourth quarter marks the third consecutive quarter of record EBITDA and the second consecutive quarter of record EBITDA margin. These are clear indicators that our transformation is working. The entire organization is committed to structurally improving margins and capitalizing on market opportunities with our differentiated portfolio of solutions. Both are key drivers in our journey to further increase shareholder value. We are proud of the progress the company is making, and we are excited about the future of Baker Hughes. I'll turn the call back to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Nancy. As you can see from our strong 2024 results and the exceptional margin improvement illustrated on Slide 17, we have evolved into a much more profitable energy and industrial technology company. At the midpoint of our 2025 guidance, Baker Hughes' EBITDA margin will have increased by more than 6 percentage points over the past five years. Additionally, EBITDA has more than doubled over this same period. Looking at 2025 and beyond. Our balance sheet remains strong. Our strategy is clear, and we see a differentiated growth opportunity for Baker Hughes. Markets are evolving, and this aligns with our vision of the energy technology ecosystem. The need for more energy with fewer emissions is critical and the increased use of natural gas will be fundamental to achieving this objective. Our strong market positioning across natural gas, LNG and gas infrastructure, new energy and mature fields provides multiple growth vectors across our portfolio. This will be accompanied by emerging opportunities for distributed power solutions and new industrial markets. We have a unique broad technology portfolio that will drive growth through the remainder of the decade, irrespective of the pace of the energy transition. Given this balanced portfolio untapped market opportunities, significant recurring IET service revenue and our more efficient cost structure, Baker Hughes is becoming less cyclical in nature and will generate more durable earnings and free cash flow across cycles. To conclude, I'd like to thank the Baker Hughes team for yet again delivering outstanding results. As we continue our journey to propel Baker Hughes forward, we remain committed to our customers, shareholders and employees. With that, I'll turn the call back over to Chase."
},
{
"speaker": "Chase Mulvehill",
"content": "Operator, we can open up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Arun Jayaram with JPMorgan Securities. Your line is open, please go ahead."
},
{
"speaker": "Arun Jayaram",
"content": "Yes, good morning. Lorenzo, I wanted to dig a little bit deeper on your 2025 IET order outlook. You guided to $13.5 billion of inbound orders at the midpoint. Can you discuss some of the puts and takes as well as the overall macro picture for orders between some of the sub-segments, LNG, OOP, gas infrastructure? And do you think you can reach that $5 billion threshold for Gas Tech orders that you've been running at for several years now?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, hi Arun. Thanks. And yes, clearly, we've had a before past few years. And when you look at the amount of bookings, we've actually booked $40 billion of IET orders over the past three years, which obviously, is a history exceeding the past. And in 2024, we booked $13 billion, the second highest order year in the company's history. And I think it's important to recognize that, that was even with the U.S. LNG permitting moratorium. And in 2024, we had a 65% decline in our LNG orders versus 2023. And we do see this continued strength continuing in 2025. And I think as we look at gas infrastructure, we're going to have continued strong demand in gas pipelines, gas processing 2025, we're going to see LNG come back. And obviously, LNG orders increasing over 2024. And when we booked 2.1, we've got about 80 MTPA that's going to be FID-ed over the next couple of years. You look at FPSOs, continued demand strength, and we see 7 to 9 FPSOs per year. And also increasingly, NovaLT. We're seeing an increased interest in the NovaLT turbines with orders possibly doubling versus last year in 2025 with behind the meter solutions for both data centers and oil and gas. And then on the CTS side, again, we continue to see strong order growth led by CTOS emissions management and also the opportunity of clean power. And as we look at 2025 robust pipeline, that supports our $1.4 billion to $1.6 billion of new energy orders for this year. As you look at industrial tech and also the strength in the market continues to recover, and we see overall continued strength across the IET market environment. So feel good about where the midpoint is of $13.5 billion. It would mark the third consecutive year of being ahead of the $13 billion orders. And again, on the GTE side, the $5 billion well in reach. So as we look out to 2030, we've got an addressable market of $150 billion with 70% of that being outside of LNG. So we feel good about the long-term trend within, again, the industrial energy technology order book in 2025, looking for another strong year."
},
{
"speaker": "Arun Jayaram",
"content": "Great. Thanks, Lorenzo. A follow-up. You had an interesting commentary in your deck around the gas turbine market, anticipating the market to more than double by 2030. Lorenzo, your strengths in gas turbines for LNG and oil and gas largely unmatched. But I was wondering if you could highlight what type of inroads are you making in the turbine market outside of oil and gas, thinking about applications in industrial settings as well as power, et cetera."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, Arun, again, we've got a full portfolio of Gas Turbine technology and multi-fuel drivers, which can be used in multiple applications. As you look at the aspect of our NovaLTs and you look at below the 150 megawatts, we've got the opportunity to continue going into the data center, marketplace and providing distributed power solutions behind the meter and also off-grid solutions. And this is an increasing space that we see as an opportunity and we're continuing to enhance our industrial gas turbine lineup and the portfolio that we have. So as you look at in particular, the data center market continuing to grow, we see opportunities going forward in that place. But also, as you look at the aspect of gas processing and pipelines, we continue to need compression as well as also the aspect of power to be able to propel the molecule. So across the board, good opportunities."
},
{
"speaker": "Arun Jayaram",
"content": "Great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of David Anderson with Barclays. Your line is open, please go ahead."
},
{
"speaker": "David Anderson",
"content": "Thank you. How are you doing today, Lorenzo?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Good, Dave."
},
{
"speaker": "David Anderson",
"content": "So a lot of the focus today is going to be on your IET business and the question is the IET business we fully so. But I just want to ask you a question about the OFSE side, specifically around how you see the various components playing out in '25. Overall, you're seeing spending down a bit this year. I would expect the later cycle businesses, including -- you mentioned mature asset solutions, production chemicals to grow alongside with the flexibles. However, the midpoint you guide this year is for OFSE to be down -- on top line down by 4%. So question is really on the mix of the business in OFSE and kind of how it plays out during the year and maybe what some of the puts and takes could be around that guide for the year? Thank you."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, sure. And OFSE is an important part of our business, and we're very pleased with the way in which the margin has progressed and definitely don't want to take away from OFSE by talking about IET all the time. So I think as you look at our prepared remarks, definitely, we do see 2025 slightly lower when compared to 2024. I think you know historically, we've taken a more conservative approach which has proved to us well last year. As you look at North America, we do anticipate spending this year to decrease year-on-year in the mid-single-digit range. A number of operators continue to be focused on capital discipline and they're looking to optimize the newly consolidated acreage that they've got in place. We do expect to outperform the market in this area just because our portfolio is production weighted greater than 50% of what we have is related to the production side. On the international markets, again, we're seeing a flat to down year-on-year. There's the potential overhang of the OPEC+ spec oil capacity some of the changing regimes and also the focus on gas, leading to some reduced activity. Looking at Mexico, Saudi and North Sea expected to remain soft this year, partially offset by Brazil and outside of Saudi Arabia and the Middle East and some sub-Sahara and Africa. But again, as we look at it, we do expect on the international side, flat to down year-on-year. And from an offshore perspective, as we mentioned, we do see that continuing to be positive. And as we go past this 2025, we still feel good about the mature asset solutions in the latter part of the decade and again, continuing to increase our focus on the brownfields and the opportunity to maximize production from existing assets."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of Saurabh Pant with Bank of America. Your line is open, please go ahead."
},
{
"speaker": "Saurabh Pant",
"content": "Hi, thank you. Good morning, Lorenzo and Nancy. Lorenzo, like you discussed, I want to touch on the life cycle aspect of the Gas Tech business. And I know you discussed how Gas Tech Services is outpacing installed capacity growth, which is obviously really impressive, right? And then if I go back to your slide, I think Slide 7 in your deck, Lorenzo, you talked about the four revenue growth accelerators, pricing mix upgrades, digital. If we just think about the next two to three years, Lorenzo, which one of these four should we think would be the most meaningful for Gas Tech Services growth?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, definitely. And again, as we've highlighted, our installed base is expected to grow by at least 20% between now and 2030. And from a revenue standpoint, again, we expect GTS revenue to outpace this growth rate. And it's really on the back of the drivers that you mentioned that we shared on the page. And mix is going to be the biggest driver. It's improving mix as we continue to see an increase in the LNG aspect. And as you look at our installed base for service for LNG, it's going to increase by over 50% through 2030, which is outpacing the overall 20% growth rate. So that mix on the LNG side, as it has high attachment rates is definitely beneficial, and it generates more service revenue over the life of the equipment. Also, the other aspects, pricing, upgrades in digital. We continue to see those having an important factor as well. But mix is the one that is going to be important. And as we go forward, also upgrades is something that we think is poised for increasing. As you saw in the second half of 2024, we had an uptick of 10% year-over-year. And in the fourth quarter, we saw the highest order intake since 2020. So looking favorable there as well."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Stephen Gengaro with Stifel. Your line is open, please go ahead."
},
{
"speaker": "Stephen Gengaro",
"content": "Thanks and good afternoon. I guess, over there. So you guys have been obviously very successful on the margin front the last few years. I was curious if you could walk us through the moving pieces to get to the 20% target for OFS this year and on the IET side for 2026?"
},
{
"speaker": "Nancy Buese",
"content": "Sure. Good morning. I'll take that one. We are pleased with the progress the teams have made in driving our business transformation. And I would say that self-help initiatives and broader transformation will absolutely continue to be a major driver of the margin improvement as we think about 2025 and even beyond. And in OFSE in particular, as we demonstrated in 2024, we're driving really significant initiatives, just not necessarily related to activity levels. So there's that piece as well, and that's all going to drive margin expansion in coming years. And in 2024, the OFSE margin increased by 1.5 percentage points, and that was really outpacing the revenue growth. And that's what you saw, we generated incremental margins over 100%. So a lot of good work there. I think good evidence that we've been proactively positioning the OFSE portfolio to really remain resilient in what we see as a truly maturing upstream spending cycle, and we continue to be focused on driving consistency, operational excellence and service delivery across that sort of streamlined operating structure that we worked on in 2024. We're also, in addition to that, now rightsizing our structure to match expected activity levels. So when you think about the portfolio plus this work, we really play at the high end of technology, and we're not as much in the highly commoditized range. And as Lorenzo mentioned, our production weighted portfolio provides quite a bit of resiliency in a softer environment. So when our customers think about they're optimizing production from their existing assets, we see more OpEx revenue for ourselves at highly accretive margins. So all of that to say that we are very highly confident in achieving our 20% margin even in the softer upstream spending environment. And the team side OFSE have been doing fantastic work on rightsizing the business and focusing on all the operational excellence components. So all of these structural enhancements will fuel that margin expansion even beyond 2025 as we continue to focus on closing the gap with our peers in OFSE. And then turning to IET, the margin expansion there has been really solid and gaining a lot of momentum. So in 2024, we demonstrated almost 2 percentage points of margin expansion. We will continue to see expansion in 2025 towards that 20% goal, and the guidance implies 18% segment margin working towards 20% in 2026. And so we'll continue to progress. We are on track and a couple of drivers of that is just in GTE. We expect to continue significant volume leverage, coupled with further productivity gains. And we've said previously that our backlog is higher priced than previous. So we will continue to focus in that way, and that will help GTE margins as well. In GTS, we've got new digital offerings and enhanced services solutions, and as Lorenzo mentioned, upgrades and all of that will support margin expansion and we also continue to see better normalization on the aeroderivative supply chain. Another component, as we've talked about in the past, is R&D costs starting to decline, and that's most evident in CTS, but that's going to help drive margin uplift. And then finally, in industrial tech, we are really improving margins there, getting more volume through the factories and better cost absorption. So all of that's contributing to better margins. And we're excited. There's lots of opportunities for expansion, and we remain very confident in our ability to get to the 20% in 2026 and continue to mention that 20% margins are not a final destination. We will continue in both segments to lift our eyes past 2025, past 2026 and improved margins even past the 20% goals."
},
{
"speaker": "Lorenzo Simonelli",
"content": "And Steve, I would just add, I think as you look at 2024 and the progress that's been made on the self-help and we've said a lot of this is down to the execution and also the simplification and the processes that we're working on internally. And on the IET side, considerable amount, about half of it is driven by self-help and on the OFSE side, two-third. So again, focused on the continued process enhancements and positions within the company. And as Nancy mentioned, the 20% is not an end point, it's just a path on the journey."
},
{
"speaker": "Operator",
"content": "And our next question is going to come from the line of Neil Mehta with Goldman Sachs & Co. Your line is open, please go ahead."
},
{
"speaker": "Neil Mehta",
"content": "Yes, good morning, Nancy, Lorenzo, team. A question around capital returns, great to see the dividend bump today. And just your perspective on the right way to return that 60% to 80% back to shareholders here as you think about the dividends versus the buybacks and I think, Lorenzo, Nancy, you definitely talked about leaning into the dividend. So just your latest thoughts there. And then as it relates to capital allocation, maybe you could also touch on M&A. It was a quieter year for M&A activity for Baker Hughes. And what do you think the opportunity set looks like for no transformational M&A but bolt-ons?"
},
{
"speaker": "Nancy Buese",
"content": "Yes. Great questions. And we were really pleased with our free cash flow performance in 2024, and we remain committed to our stated goal of returning 60% to 80% of free cash flow to shareholders that will be completely anchored by the dividend and we increased the dividend to show our commitment to the growing profitability of the company. And since the company was formed in 2017, we've returned over $10 billion of dividends and buybacks. So we will continue to maintain that. And we will also remain opportunistic in terms of share repurchases to fulfill that total commitment, which is exactly what we did in 2024. So we raised the dividend in the past four years in a row, and our shareholder return track record remains strong. And in 2025, we will do the same as with the increased dividend and continue to focus on share buyback. So all of that will work towards our commitment of the 60% to 80%. And then we do want to retain some financial flexibility. We've got a very strong balance sheet, and we want to have the ability to be -- be in that position, strong credit ratings and some flexibility as we need it for the business. And then on the M&A question, our philosophy is to do what's always right for shareholders. So we continue to look at our portfolio think about how we optimize and what the composition of that should be as the company continues to grow. So we will always focus on tuck-in M&A and some small tech bets in the new energy space and anything that really will complement our existing technology leadership. So as we think about horizon 2 and 3 between now and 2030, we will always look at places where we need to fill a gap in the portfolio and opportunities for strategic fits with our existing asset base. So we're always on the lookout. But yes, it was acquired in 2024, and we will always have our eyes open for opportunities in 2025 and beyond."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of Scott Gruber with Citigroup. Your line is open, please go ahead."
},
{
"speaker": "Scott Gruber",
"content": "Yes. Good morning, good afternoon. Another one for Nancy. You've maintained the 45% to 50% free cash conversion target for the year. Can you just update us on the puts and takes on the conversion rate? Your margins are getting better. I know you've had initiatives to improve the cash tax rate, and you've discussed R&D and new tech moderating over time. Are there offsets from a work capital perspective that kind of keeps a lid on the convert rate in '25? So more color would be great."
},
{
"speaker": "Nancy Buese",
"content": "Yes, sure. We're very pleased with our free cash flow performance. That's been a major target area for the entire company in 2024, and we're really pleased with that conversion rate of 49%. So that's right in the range of the 45% to 50%. A lot of that is just thinking about our free cash flow processes, our overall performance day-to-day. We're very confident in achieving that range again in 2025. And when I think about some of the big drivers for that, it's really around working capital efficiency. We see so much work we can still do to tighten up our collections process, our inventory turns, and this is a really high priority area for the people inside Baker Hughes. We've spent a lot of time thinking about how we can make every aspect more tight, more profitable, more efficient. So this has been really fun to watch the organization over the past year, and we have much work to do in 2025. So highly confident in that space. The other piece is tax management. So in 2024, we made some really good improvements in our tax rate. And in 2025, we're working to drive cash tax rate and our rate meaningfully lower and we've given guidance around that, and our book rate will come down as well. So lots of effort in everything around our working capital and free cash flow. And then another driver is really structurally higher margins. And so that margin improvement is going to flow through and you're going to see overall free cash flow continue to move. So we're very confident about -- through our path to consistently achieve 50% of free cash flow conversion as we really think going forward about working capital efficiency and the tax side. So lots of efforts made great progress in 2024, and there's more to come in 2025 for sure."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Kurt Hallead with Benchmark. Your line is open, please go ahead."
},
{
"speaker": "Kurt Hallead",
"content": "Happy Friday, everybody and appreciate making some time for me here. Lorenzo, big picture, kind of question for you, right? You've outlined a very compelling story for obviously the IET growth dynamics, not only through 2030, but it looks like it extends out beyond that, when you start to talk about your increased installed base and aftermarket services. So given the moderating growth rates in Oilfield Services, without putting a hard number around it, you happen to have a feeling here about whether or not the IET business could wind up being at least half, if not more, of your business mix as you get closer to 2030?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Kurt, good to hear from you. And look, as we stated, our strategy is to continue to grow Baker Hughes in totality. And from a percentage standpoint of the two segments over time, IET will grow as the market and the addressable market is considerable, and we've got the opportunity to continue to move into new spaces. And the mix will change. Again, we don't have any final destination in mind, both of the business units are critically important and actually share a lot of the capabilities together and also customers together. And so that's why we think we're in a unique opportunity and like the way in which the portfolio is structured to the point of overall mix, yes, you'll see the element of IET as we continue to grow from a percentage standpoint, be a larger portion of Baker Hughes. Great. I think we're coming to time."
},
{
"speaker": "Operator",
"content": "That was our last question, and I would like to hand the conference back over to Lorenzo Simonelli, Chairman and Chief Executive Officer, for his concluding remarks."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you very much, and thanks to everybody for joining us and taking the time on today's earnings call, and I look forward to speaking again with you all soon. Operator, you may close out the call."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day."
}
] |
bkr | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Baker Hughes Company Third Quarter 2024 Earnings 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. I would now like to introduce your host for today's conference, Mr. Chase Mulvehill, Vice President of Investor Relations. Sir, you may begin."
},
{
"speaker": "Chase Mulvehill",
"content": "Thank you. Good morning, everyone, and welcome to Baker Hughes third quarter earnings conference call. Here with me are our Chairman and CEO, Lorenzo Simonelli; and our CFO, Nancy Buese. The earnings release we issued yesterday evening can be found on our website at bakerhughes.com. We will also be using a presentation with our prepared remarks during this webcast, which can be found on our website. As a reminder, during this conference call, we will provide forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. Please review our SEC filings and website for factors that could cause actual results to differ materially. Reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release. With that, I'll turn the call over to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Chase. Good morning, everyone, and thanks for joining us. Starting on Slide 4, we delivered strong third quarter results, highlighted by another record quarterly EBITDA and the third consecutive quarter of at least 20% year-on-year EBITDA growth. EBITDA margins continue to improve at an accelerated pace, increasing year-over-year by 2.7 percentage points to 17.5%, which marks the highest margin quarter since 2017. This strong performance is driven by significant margin expansion across both segments, with clear progress being made toward our 20% EBITDA margin targets. Total company orders remain at solid levels during the quarter, including $2.9 billion for IET. This marks the 8th consecutive quarter for IET orders at or above that level and highlights the end market diversity and versatility of our technologies. Our free cash flow performance was equally impressive during the quarter, coming in at $754 million. Our business continues to perform well and we remain confident in achieving the midpoint of our full year EBITDA guidance. Baker Hughes is becoming less cyclical and is demonstrating the capability to generate more durable earnings and free cash flow across cycles given our balanced portfolio, significant reoccurring IET service revenue, and improved cost structure, in addition to the company's untapped market opportunities. Turning to Slide 5. We want to highlight recent key awards and technology developments. In Gas Technology Equipment, we secured two additional FPSO orders, increasing the year-to-date total to four. Saipem awarded us a contract to supply BCL and ICL centrifugal compressors for TotalEnergies' all-electric Kaminho FSO project in Angola. Separately, IET was selected to provide electric motor-driven compressors for an FPSO project in a strategic Latin American basin. In Gas Technology Services, we secured a multi-decade agreement for an LNG facility in the Middle East to provide extensive aftermarket services and digital solutions leveraging IET's iCenter. Including this award, Gas Technology Services has booked into RPO over $600 million of contractual service agreements year-to-date, highlighting the value of gas technologies lifecycle offering. In new energy, we continue to see solid order momentum. We booked $287 million during the quarter increasing year-to-date orders to $971 million. We are on pace to exceed the high end of our $800 million to $1 billion order guidance, anticipating to book over $1 billion for the first time. In Climate Technology Solutions, we received the largest award to-date for our zero emissions ICL technology. As part of the UAE's decarbonization strategy, we will supply 10 compressor units to Dubai Petroleum enterprise for the Margham Gas storage facility, highlighting continued strong global demand for gas infrastructure. In OFSE, we continue to experience strong order momentum in Brazil, further strengthening our relationship with Petrobras. During the quarter, we received multiple contracts to supply flexible pipe systems in Brazil's Santos Basin. The contracts also include multi-year service agreements to support maintenance activities through the lifecycle of the project. We are also seeing increased brownfield activity as more customers spending is allocated to optimizing recovery from existing fields, an underlying trend that we expect to last many decades. This creates a strong backdrop for mature asset solutions; our integrated offering that leverages OFSE's full range of innovative technologies to enhance total field recovery. Aligned with this trend, we were awarded a sizable multi-year well intervention and completion contract in the Middle East. We continue to make progress on the digital front. OFSE benefited from increased customer adoption of Leucipa, our intelligent automated field production digital solution, a major global operator expanded the use of Leucipa across multiple wells in the Permian Basin, enabling optimized recovery rates through real time field orchestration to produce lower carbon short cycle barrels. Additionally, we announced earlier this month a new strategic collaboration with Repsol to develop and deploy next-generation AI capabilities for Leucipa across its global upstream portfolio. In addition, at the Gastech Conference last month, we launched CarbonEdge powered by IET's Cordant. This end-to-end risk-based digital solution delivers precise real time data and alerts on CO2 flows across CCUS infrastructure from subsurface to surface. This connectivity enables OFSE and IET customers to mitigate risk, improve decision making, enhance operational efficiency, and simplify regulatory reporting. Turning to the next slide. It is important to reiterate our long held macro view of structurally growing energy demand, which underpins our strategy and remains the nucleus of our long-term growth potential. Between now and 2040, we expect global primary energy demand to grow by 10%, driven by population growth and increasing energy intensity across major developing countries. To put this in perspective, there are roughly 8 billion people in the world today. 1 billion live in OECD countries, with the other 7 billion living in emerging economies. According to the Energy Institute, a person in the developed world consumes on average 3x the energy of a person who lives in emerging countries. Therefore, even a small increase in energy consumption per capita in the emerging world can have a sizable impact on overall energy demand. While we forecast significant growth in renewables, we believe this increase in primary energy demand will need to be met by multiple sources. Ultimately, we expect renewables to fall short of meeting both growing demand and replacing hydrocarbons to decarbonize the existing energy system. It will take an all of the above strategy, focusing on the emissions and not the fuel source, to meet the increase in energy demand. In our view, natural gas is a clear winner. It is abundant, low cost, and has lower emissions. This is the age of gas. By 2040, we expect natural gas demand to grow by almost 20% and global LNG demand to increase at an even faster rate of 75%. This backdrop provides a very constructive environment in which Baker Hughes can flourish. We are experiencing a significant increase in gas infrastructure equipment orders and anticipate this trend will continue as many developing economies look to increase the use of natural gas within power generation and industrial applications. In LNG, we continue to see a requirement for 800 MTPA of liquefaction capacity by 2030 to meet increasing global LNG demand. This year is supported by more than 200 MTPA of LNG capacity under construction today and a positive outlook for additional FIDs. Turning to oil. We anticipate moderating levels of demand growth through the end of the decade. In this environment, we expect OpEx spend to accelerate as the focus shifts from greenfields to brownfield developments. We have positioned our OFSE portfolio for differentiated growth in mature fields, playing a leading role in helping customers optimize oil and gas production through our mature asset solutions. With this energy mix backdrop, the focus must be on lowering emissions. We see energy efficiency and decarbonization technologies playing a critical role in achieving net zero goals. We are focusing our efforts to enhance and develop new technologies in these areas and see this as a fundamental growth theme for our company. On decarbonization, we continue to experience good traction across our new energy portfolio, which focuses on CCUS, hydrogen, geothermal, clean power and emissions abatement. We expect deployment of decarbonization technologies will continue to gain momentum as policy support and technology advances drive improving project economics. With this anticipated strengthening demand backdrop, we remain confident in our ability to achieve our 2030 orders target of $6 billion to $7 billion. Across our industrial and energy installed base, we are also developing solutions to enhance efficiency and reduce emissions from our equipment. This can be in the form of upgrading turbines and compressors, installing electric motors, or adding zero leak valves. Beyond equipment, we are seeing increased levels of digital adoption for Cordant, which improves asset performance, optimizes processes, and reduces energy consumption. Turning to Slide 7. I wanted to spend some time discussing near-term market dynamics, where we see customer spend shifting toward global gas and mature fuels as oil demand fundamentals soften. Oil markets have recently been impacted by both supply and demand factors, including slowing global economic growth, resilient North American production, weakening OPEC+ compliance, and geopolitical uncertainty in the Middle East. Even with the uncertain oil macro backdrop, our global upstream spending outlook for this year remains unchanged. In North America, we continue to anticipate spending to decrease year-over-year in the mid-single-digits range, and we expect to outperform given our production weighted portfolio mix. Across international markets, we maintain our outlook for high-single-digit growth this year. Looking beyond 2024, there are many factors that we are monitoring that could drive further volatility in oil prices. On the supply side, we continue to see production increasing in North America, adding to the growth in deepwater production that is planned for next year. Combining these variables, with planned OPEC+ production increases, projections point to relatively soft oil fundamentals in 2025. However, geopolitical uncertainty across the Middle East could create added volatility for oil prices. We continue to evaluate our 2025 plans for the company and we will communicate guidance in January. Based on the current macro and geopolitical environment, we expect next year's global upstream spending to be similar to 2024 levels. As the upstream cycle matures, we expect our customers to increasingly focus on optimizing production from existing assets, providing significant growth opportunities for our mature asset solutions. This leverages our decades of experience, deep domain knowledge and industry-leading technologies by capitalizing on our expansive capabilities across the OFSE portfolio. By 2030, we estimate that 80% of the world's oil and gas supply will be produced by mature fields. Turning to natural gas. We continue to see strong growth which will drive demand for our gas led products and solutions in both OFSE and IET. For LNG, year-to-date, off-take contracting has totaled 78 MTPA, which is on pace to exceed the record 84 MTPA achieved in 2022. This contracting strength supports our outlook for 100 MTPA of FIDs between 2024 and 2026. We also continue to see strong demand for gas infrastructure projects with significant awards this year for MGS-3 in Saudi Arabia, Hassi R'Mel in Algeria, and Margham Gas storage facility in Dubai. We expect non-LNG gas technology equipment orders this year to more than double levels booked in 2023. On the back of another strong year for new energy, we see several projects progressing toward FID in the U.S. and internationally in 2025, giving us confidence that our new energy orders will continue to grow. To conclude on the market outlook, our production levered OFSE portfolio will benefit from increasing levels of OpEx spending. In addition, our diversified IET portfolio and significant leverage to recurring revenue position us well to drive more earnings and free cash flow stability, which will be supplemented by the structural growth drivers, I outlined in our long-term energy outlook. Turning to Slide 8. I wanted to spend a few minutes discussing the full life cycle aspect of gas technology, where there is a strong linkage between equipment and services. This connectivity and associated recurring service revenue stream are valuable characteristics of our IET business that are more aligned with our high quality industrial peers. Starting from the design phase of the project, we work closely with our customers to select the right equipment to meet the desired operating conditions, while also providing solutions that are safe, reliable, and efficient. This early engagement provides significant visibility into our future equipment orders. After receiving the equipment award, we worked with the customer to design the appropriate maintenance plan to optimize their total cost of ownership. This typically includes preventive maintenance, the provision of spare parts, repairs, and field technical support. Compared to the original equipment sale, these aftermarket service agreements provide recurring revenue streams that can generate 1x to 2x the revenue over the life of the equipment. Commercial value of these long-term agreements is linked to performance, reliability and availability guarantees. This along with the engineering support over the life of the contract drives customer loyalty and in turn higher margins. In many cases, this recurring service revenue is supplemented by upgrade opportunities on our installed equipment. As the original equipment manufacturer with decades of service experience, we have the best knowledge to assess the feasibility of various options. We have successfully executed over 2,000 upgrade projects around the world, optimizing upstream oil and gas production, LNG production, pipeline transport volumes, refinery and petrochemical output, and much more. To meet rising upgrade demand, we are investing in new technology that keeps equipment running beyond its original design life and improve the availability, reliability, emissions, productivity and life cycle costs of our customers installed equipment. Our service capabilities will also continue to evolve and provide additional growth opportunities for our advanced service solutions, leveraging the latest AI capabilities and over 20 years of monitoring and diagnostic data from our machines. Through our iCenter facilities, which specialize in the edge to cloud applications and remote operations, we are able to improve operating performance, increase asset efficiency, and reduce emissions throughout the life of the equipment. At every stage of this life cycle journey, we are closely aligned with our customers to ensure they extract the best value from our equipment. In return, we are rewarded with a recurring higher margin revenue stream that is reflective of the differentiated industrial like aftermarket services provided by gas technology. Looking at Slide 9, our gas technology serviceable equipment base, which spans across LNG, onshore, offshore production, industrial, downstream and gas infrastructure markets, has doubled from 4,400 units in 2000 to about 9,000 units in 2023. Due to the significant growth and the introduction of service business models like contractual service agreements in the early 2000s, our Gas Technology Services revenues demonstrated a notable increase from about $400 million in 2000 to $2.6 billion in 2023. Looking out to 2030, we expect our serviceable installed base to increase by 20%, given our robust level of equipment backlog and positive outlook for orders. This significant installed base growth and the multi-decade lifespan of our equipment gives us confidence that we can structurally grow our Gas Technology Services revenue over the next decade. Anchored by gas technologies life cycle business model, our IET segment is truly differentiated and what sets us apart from our peer group. Before turning the call over to Nancy, I would also like to take a moment to welcome Amerino Gatti to the company, as our new Executive Vice President of OFSE. Amerino has an extensive background in both energy and industrial sectors. He will be pivotal in leading OFSE into the next horizons, building upon the strong foundations laid by Maria Claudia Borras and her team to achieve our 2025 EBITDA margin targets. We are accelerating towards the next phase of our journey. Across our three horizons, we remain focused on executing our strategic pillars, which include transforming the core, driving profitable growth, and delivering for new energy. We are committed to driving margins and returns higher and realizing the full potential of our diversified energy and industrial company. With that, I'll turn the call over to Nancy."
},
{
"speaker": "Nancy Buese",
"content": "Thanks, Lorenzo. I will begin on Slide 11 with an overview of our consolidated results and then speak to segment details before summarizing our outlook. We have again delivered solidly on our third quarter results, setting another record for quarterly EBITDA and generating the highest EBITDA margins for the company since 2017. It is clear that our focus on operational excellence and profitable growth is demonstrating results. OFSE and IET both delivered exceptionally strong margin performance, helping to drive record adjusted EBITDA of approximately $1.21 billion, a 23% year-over-year increase and above our guidance midpoint. We have now met or exceeded the midpoint of our EBITDA guidance for all seven quarters that we've been providing guidance. We are delivering on our commitments and we remain focused on meeting our targets. GAAP operating income was $930 million; there were no adjustments to operating income during the quarter. GAAP diluted earnings per share were $0.77. Excluding adjusting items, earnings per share were $0.67, an increase of 59% when compared to the same quarter last year. Our adjusted tax rate declined to 26% as we continue to execute our tax optimization program. We expect our year-end tax rate to be slightly below the midpoint of our full year guidance range. As Lorenzo mentioned, we delivered another quarter of solid orders with total company orders of $6.7 billion, including $2.9 billion from IET. The diversity of IET's end markets continue to support a healthy order book, strengthened by additional gas infrastructure projects and two FPSO awards. We generated free cash flow of $754 million for the quarter, bringing our year-to-date total to almost $1.4 billion. For the full year, we are targeting free cash flow conversion of 45% to 50%. Our balance sheet remains strong, ending the third quarter with cash of $2.7 billion, net debt-to-EBITDA ratio of 0.8x and liquidity of $5.7 billion. Turning to capital allocation on Slide 12. In the third quarter, we returned $361 million to shareholders. This includes $209 million of dividend and $152 million of shares repurchased during the third quarter. Year-to-date, we have returned $1.1 billion to investors. For the full year, we remain committed to returning 60% to 80% of free cash flow to shareholders. Our primary focus is to continue growing the dividend with increases aligned with the structural growth of the business. We will continue to use share repurchases to reach the target range that we remain opportunistic. Now, I will walk you through the business segment results in more detail, and provide our outlook, starting with Industrial and Energy technology on Slide 13. IET EBITDA outperformed our guidance midpoint entirely attributed to outstanding margin performance. As I will discuss later, the process mindset adopted by the team is driving a culture of improved efficiency and productivity, which is clearly reflected in the segment's margin performance. IET orders remain strong at $2.9 billion, driven by further FPSO and gas infrastructure orders. We are also seeing solid momentum for Cordant solutions, which booked record orders. Year-to-date, we have now booked $9.2 billion of IET orders and we remain on pace to achieve our full year order guidance. The versatility and differentiation of the IET portfolio remain significant advantages for Baker Hughes, allowing us to profitably grow with new customers across both core energy and industrial end markets. IET RPO ended the quarter at $30.2 billion, an increase from prior quarter's record level and up 5% year-on-year. This level of RPO provides exceptional revenue and earnings visibility over the coming years. As we execute our robust equipment backlog, this will significantly increase our installed base, which will then drive structural growth in our aftermarket service business well beyond 2030. IET revenue for the quarter was $2.9 billion, up 9% versus the prior year, led by a 200% increase in Climate Technology Solutions and 9% growth in Gas Technology Services. IET EBITDA was $528 million, up 31% year-over-year. EBITDA margin increased 2.9 percentage points year-over-year to 17.9%. I want to specifically highlight the progress in gas technology equipment margins, which are up significantly due to conversion of higher margin backlog, cost efficiency improvement and strong productivity gains. We also continue to see good margin expansion in a few of our more digital and industrial levered businesses. Turning to Oilfield Services & Equipment on Slide 14. The segment maintained its strong margin trajectory and we are on track to achieve our 20% margin target for next year. This is a testament to the work the OFSE team has done to drive cost efficiencies and maintain commercial discipline as they remain focused on profitable growth and driving towards stronger service delivery to customers. Continued strength in flexibles helped to drive Subsea & Surface Pressure Systems orders of $776 million. We expect offshore activity to remain at solid levels and anticipate increased order contribution from subsea tree awards in 2025. OFSE revenue in the quarter was $4 billion, led by sequential growth in flexible pipe systems, surface pressure control, and artificial lift. International revenue was flat sequentially. Growth continued in Europe and Sub-Saharan Africa, which was offset by lower revenue in the Middle East and Latin America. In North America, revenues declined 5% sequentially, mostly due to the Gulf of Mexico. North America land revenues were flat sequentially, again outperforming rig activity due to our heavy weighting towards production levered businesses. OFSE EBITDA in the quarter was $765 million, up 14% year-over-year. OFSE EBITDA margin rate was 19.3%, increasing 2.3 percentage points year-over-year. This strong margin improvement was led by higher pricing, cost efficiency, and productivity enhancements that we've been executing across the business. We are particularly pleased with the continued improvement in SSPS performance where margins increased to record levels. Turning to Slide 15. I want to take a moment to emphasize the strong progress we are making in driving structural margin improvement. This is clearly evident from our results. An important aspect to highlight is that more than half of this quarter's year-over-year margin improvement is attributed to the transformation actions the team has executed across the company. This will continue to be a large contributor to our margin improvement as we progress through 2025. We are executing several projects to streamline activities, remove duplication, and modernize management systems. This is improving clarity, transparency, and the pace of decision making, enabling our colleagues to work smarter and drive costs structurally lower. We also continue to enhance our supply chain across the enterprise. Specifically, on our procurement strategy, we are focused on sourcing a larger volume of materials from best cost countries by leveraging suppliers in India, Mexico, and Eastern Europe. In IET, we have demonstrated significant progress this year, highlighted by EBITDA margins reaching the high-teens this quarter. We remain on track to achieve our 20% margin target in 2026, an important milestone in our journey towards high quality industrial type margins. The key drivers in achieving our margin target include conversion of higher margin gas technology equipment backlog, cost and supply chain efficiencies, higher industrial technology margins and reduced R&D spending as revenues continue to grow. We are demonstrating tremendous progress in IET. The team has adopted a process mindset that is driving a culture of improved efficiency and productivity, embracing industrial automation and deploying lean strategies across our operations. This is yielding higher throughput, lower manufacturing costs, and reduced lead times for our customers. This year alone, IET has initiated over 100 Kaizen projects. To give you some perspective on targeted improvements from these Kaizen, the team has recently reduced the lead time of one of our X-ray industrial inspection machines by one-third and made significant improvements to product costs on multiple product lines. In OFSE, we delivered an EBITDA margin rate of 19.3% in the quarter, which is approaching our 20% target. SSPS performance this year is a great example of the progress we have made in OFSE. SSPS EBITDA margins have increased significantly over the last two quarters and now are in line with our subsea equipment peers. This has been driven by refocusing our commercial model, rightsizing our capacity, and improving our execution. There are still more opportunities across the broader OFSE portfolio to optimize our supply chain improve service delivery and drive further cost productivity. We are focused on profitable growth over the coming years and remain confident in driving continuous margin improvement beyond our 20% target. Overall, we are making significant progress in changing the way we operate and are excited by the many opportunities still available to drive margins even higher across Baker Hughes. Next, I'd like to update you on our outlook. The details of our fourth quarter and full year 2024 guidance are found on Slide 16. The ranges for revenue, EBITDA, and D&A are shown on this slide and I will focus on the midpoint of our guidance. Overall, we maintain our outlook for the company. IET is benefiting from multiple cycles including LNG, gas infrastructure, offshore, and new energy. Our portfolio is well-suited to capitalize on the positive momentum in each of these areas. Given these tailwinds and our continued operational improvement, we expect fourth quarter total EBITDA of approximately $1.26 billion at the midpoint of our guidance range. For IET, we expect fourth quarter results to benefit from continued productivity enhancements and process improvements, as well as strong revenue conversion of the segment's robust backlog. Overall, we expect fourth quarter IET EBITDA of $590 million at the midpoint of our guidance range. The major factors driving this range will be the pace of backlog conversion in Gas Technology Equipment, the impact of any aero derivatives supply chain tightness in Gas Technology, and operational execution in industrial technology and Climate Technology Solutions. For OFSE, we expect fourth quarter EBITDA of $750 million at the midpoint of our guidance range impacted by activity uncertainty in Saudi Arabia, Mexico, and North America. Factors impacting this range include the SSPS backlog conversion, realization of further cost-out initiatives, broader activity levels, and the amount of year-end product sales. Now, turning to our full year guidance. We have narrowed the guidance range for total company EBITDA and the midpoint remains unchanged. We expect IET orders to remain at robust levels this year, driven by strong momentum across all aspects of the IET portfolio. We maintain our full year guidance range of $11.5 billion to $13.5 billion, with expectations for orders to approach the midpoint. As a result of robust backlog conversion and strong margin performance, we are increasing our full year outlook for IET EBITDA to $2 billion at the midpoint of our guidance range. For OFSE, our updated EBITDA midpoint is $2.87 billion, where margin strength is expected to be offset by lower second half OFS revenues. In summary, we are extremely pleased with the operational performance of the company. The third quarter marks the second consecutive quarter of record EBITDA, the highest EBITDA margin quarter since 2017 and a more than 150% increase for quarterly EPS in just two years. These are clear indicators that our transformation is working. The entire organization is committed to structurally improving margins and capitalizing on market opportunities with our differentiated portfolio of products and services, both of which are key drivers in our journey to further increase shareholder value. We are proud of the progress the company is making and we are excited about the future of Baker Hughes. I'll turn the call back over to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Nancy. Turning to Slide 18, our results are showing clear progress as the company's strategy is delivering success. EBITDA has almost doubled in four years and our margins are expected to be up 5 percentage points compared to 2020. Looking forward, we see a differentiated growth opportunity for Baker Hughes, led by our strong market positioning across natural gas, LNG, new energy, industrial, and mature fields. Recent growth cycles across multiple end markets have resulted in robust order levels that provide significant revenue visibility for IET's equipment and aftermarket service businesses. In addition, we continue our journey of relentless margin improvement. Total EBITDA margins this quarter reached the highest level since 2017, with both segments achieving high-teen margins on a path to our 20% targets. 20% is not a destination. It is only a milestone on our journey toward peer leading margins across both segments. To close, I'd like to thank the Baker Hughes team for yet again delivering very strong results. It's a testament to the strength of our people, the culture we are building, the portfolio we have created and the value of the Baker Hughes enterprise. With that, I'll turn the call over to Chase."
},
{
"speaker": "Chase Mulvehill",
"content": "Thanks, Lorenzo. Operator, let's open the call for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions]. Our first question comes from David Anderson with Barclays."
},
{
"speaker": "David Anderson",
"content": "Great. Thank you. Good morning, Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Hey, Dave."
},
{
"speaker": "David Anderson",
"content": "So, global gas infrastructure being a theme, IET is clearly really well-positioned over the -- as you highlighted through the end of the decade. I thought it was really interesting. You were highlighting kind of interconnectivity between the equipment and the services component. I was wondering if you could just talk about that a little bit and kind of dig into that a little bit more. The services business is clearly an accretive kind of growth angle here. You highlighted kind of how this all changes. So could you talk about kind of how you expect services to change going forward? I'm assuming most of this is LNG now, but then we also have a bit of a mix shift happening as you're seeing kind of the order book this year is more non-LNG. So could you talk about the various components of services and kind of how you see those sort of inflecting over the next several years?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, definitely, Dave. And I think it's an important aspect of our business that sometimes is overlooked, and it's a key differentiator for gas technology because of the life cycle offering that we have with our customers, and we're able to optimize their total cost of ownership. And you can see in the presentation Slide 8, the connectivity that's associated with recurring service revenue stream, and the valuable characteristics, as I've mentioned before, razor, razor blade, and it's really aligned with our high quality industrial peers that have some of the same characteristics across the entire life cycle of the equipment. And this recurring revenue stream spans for a period of 20 years to 30 years, and can generate 1x to 2x the revenue that we get from the equipment originally when sold. And from a margin standpoint, also, it generates higher margins as an aftermarket service business compared to our equipment margin. And as you look at it today, Gas Tech Services already accounts for nearly 50% of IET's total EBITDA. And so when you look at the equipment build cycle that we've had, not just in LNG, but also on offshore, onshore production gas infrastructure, it provides us a lot of visibility to our service revenue over the next 20 years to 30 years that I think is different than some of our traditional peers. And it can be lumpy just because of the timing intervals of maintenance, but it typically takes about 7 years to 10 years from the equipment award to the vast significant service revenue milestone. So accordingly, what we're starting to see the benefits of now is related to the 2014, 2019 LNG cycle, where we booked more than 165 MTPA of LNG projects which were commissioned. And these facilities are now starting to reach their major inspection milestones. What's interesting though, and again important is the 200 MTPA under construction today hasn't yet started to generate material service revenue and won't start to do that until the latter part of this decade, early the next. The important aspect is though that we have the LNG installed capacity already in our backlog today, and that installed capacity is expected to grow by 70% by 2030. The same is true also on onshore and offshore production gas infrastructure. And we have a number of machines, as you know, in service today on FPSOs, pipelines, downstream, and industrial sites, with several under construction. So it gives us a lot of confidence that with the nearly $20 billion of Gas Tech Equipment orders since the start of 2022, along with the positive outlook for further GTE orders will drive a 20% growth in our installed base by 2030 and further upside beyond 2030. So it gives us continuous visibility and that increasing installed base as well as the upgrade opportunities will give us structural growth for the Gas Tech Services revenue over at least the next decade, led by the high service calories of LNG. But as you mentioned, also the increasing mix within FPSO and the gas infrastructure, and it's a very important element of our business that we want to shine a light to and hence the focus on page Slide 8 today."
},
{
"speaker": "David Anderson",
"content": "Lorenzo, a real quick follow-up there, is the LNG calories from services? Are those higher calories than everything else? Is it a noticeable difference or just slightly higher?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "The attachment rate on LNG is definitely higher. And as you know, we have contractual service models that we've implemented over the course of the last decades. And on LNG, there is a higher attachment rate. We do have the same attachment rate also on some of the FPSOs and then also transactional service agreements as well. So all bodes well with regards to Gas Tech Services going forward."
},
{
"speaker": "Operator",
"content": "Our next question comes from Scott Gruber with Citigroup."
},
{
"speaker": "Scott Gruber",
"content": "Well, I could say that you guys have been beating on margins all year, but this is by far the most impressive quarter, so congrats."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thanks."
},
{
"speaker": "Scott Gruber",
"content": "In IET, you mentioned confidence in achieving the 20% margin threshold in 2026. How do you think about the cadence of margin improvement over 2025? And in 2026, how smooth will that expansion be? Or is it more 2026 weighted from here? And as you think about the margin drivers, what are the biggest contributors over the next two years, just given the improvement already realized today?"
},
{
"speaker": "Nancy Buese",
"content": "Yes, Scott. I'll take that one. We are really pleased with the progress we're making on the margin front, and you've noted the significant improvement that we've made. We're continuing to really improve those margins at, I would say an accelerated pace, and that's increased 2.7 percentage points up to 17.5%, which is really the highest margin quarter since the company was formed. And truly, this is driven by really strong progress across both the segments and at corporate. And one way to help frame that up a little bit is just to kind of isolate the drivers, as you've asked is about half, a little over half of the year-over-year margin improvement was attributed to self-help across the company. And I think that's really notable about the work that's been done. So if you think about corporate, for example, we've really driven down our corporate costs. And we're right now on pace to be about $60 million annually, lower than they were just two years ago. And that's part of the work around enhancing the systems and processes, driving some real efficiencies, and removing any duplication between the center and the segments. We found that to be super effective. And then in IET, EBITDA margins have increased to 17.9%, that's up 2.9 percentage points year-over-year, and also a record. And that's due to a lot of really good work being done in the segments that's been going on over the last couple quarters, and you're seeing that play out today. So for example, Gas Tech Equipment margins are up significantly year-over-year, as we've signaled due to conversion of higher margin backlog, cost efficiency improvements, very strong productivity gains, and also some great work being done in supply chain. We've also continued to see really good margin expansion in some of our more industrial levered businesses like Bently Nevada, in valves and in gears. And as I mentioned, the segment has over 100 Kaizen projects going on today, and they're all driving for more improvement. So there is more to go. The progress is really clear. I think it's -- we've restated that we're very confident in achieving our 20% EBITDA target by 2026 in IET. And I would also say just one thing to note is that, that mix question we get between Gas Tech Equipment and Gas Tech Services, that differential is actually more muted than ever before. So that's really not a driver. This is really driven by excellent work being done on the segment. And then on the OFSE side, similarly, EBITDA margins have increased to 19.3%, that's up 2.3 percentage points year-over-year. So it's a really important change for them. The main driver was also around strong progress made in SSPS, which we noted, where EBITDA margins are up more than twice year-over-year, and they're really now in line with peers. So a lot of great work there. They've removed layers of duplication. They've right sized capacity and really narrowed the focus to basins and customers, and focusing more on price than on volume and really around service delivery. And in the rest of OFSE, we've been taking numerous actions to drive the margin rate beyond 20%. And if you recall, earlier this year, we talked about additional actions we were taking to remove duplication, and we're still receiving more benefits from that program, so more work to be done also in OFSC, but some great early signs. I think it's also really important to highlight that there is a lot within our control and we are actively progressing for both segments. We are fundamentally changing the way we work. Another thing to note though is the margin journey we're on is not totally reliant on the external market environment. So there is a lot of self-help. And even with the external markets changing, we are very confident in our ability to drive continuous margin improvement well beyond the 20% targets. So hopefully that gives you a little bit of color on where we're headed."
},
{
"speaker": "Lorenzo Simonelli",
"content": "And Scott, just to note, I mentioned this in the remarks as well. This is not a destination the 20%. It is a milestone along a longer journey. And what you can see is, as Baker Hughes, we have visibility to a longer timeframe. And during that time frame, the goal is to continue to accrete the margin rates and obviously go above the 20% and that's just a milestone for 2025 for OFSE and 2026 for IET, and then it will continue to improve."
},
{
"speaker": "Scott Gruber",
"content": "Got it. Appreciate the color. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Stephen Gengaro with Stifel."
},
{
"speaker": "Stephen Gengaro",
"content": "The -- you have a slide in the presentation on GTS on the installed base. And I was curious, looking at the slide, you've seen, I think about 8.5% CAGR in revenue for the last 20 plus years, but the installed base has grown I think about 3%. So there's been strong outperformance in revenue versus the installed base. And I'm curious, as we look forward and you kind of guided to 20% growth in the installed base through 2030, how we should think about revenue growth relative to the installed base? Should we continue to see outperformance, and maybe if so, what would drive that?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, definitely, Stephen. And you're rightly correct that we do see that the revenue growth should continue to outpace the 20% increase in our installed base as we go out to 2030. And as you look at the history, it's really down to four main factors that will contribute to that revenue growth. Firstly, higher pricing, as you know, some of the services are contractual service agreements, which are indexed pricing factors. And as you look at inflation being driven up, we'll see that come through in the contracts. Likewise for transactional agreements, as we see the pricing environment by market conditions, we're able to see benefit from that. Secondly, as you look at the mix improvement, and in fact as we're going forward, as was highlighted also with Dave's question, we do see a LNG mix being higher and our LNG installed base expected to increase by 70% between now and 2030. So that's a overall outpacing the 20% GTS installed base with higher attachment rates and more revenue per installed unit. Thirdly, advanced service solutions, our capabilities to evolve with digital capabilities and continue to monitoring and diagnostics of data on the machines, which we've been doing for 20 years, and we continue to do more. And finally, upgrades. And typically, customers have been really running their equipment right now and looking to not have upgrades. They've been deemphasized. But as we go forward, we think there's a lot of opportunities for our installed base to actually benefit from the upgrades, especially as we see the focus on emissions and efficiencies. And we've got a good technology basket of capabilities from an upgrade technology that we've been investing in and releasing them to the market. So those four levers are really the ones that give us comfort that the revenue growth is going to outpace the 20% increase in our installed base by 2030."
},
{
"speaker": "Operator",
"content": "Our next question comes from James West with Evercore ISI."
},
{
"speaker": "James West",
"content": "Hey, good morning, Lorenzo, Nancy."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Hey, James."
},
{
"speaker": "James West",
"content": "So I wanted to ask again on IET, given the importance of that business, especially over the next couple of years and for the next decades or so of the business, a few things. One, kind of comfort on the $12.5 billion order number for this year. Obviously, it's late October, so probably pretty high. Two, kind of what are the puts and takes on 2025 orders? And how should we think about that? And then maybe lastly, if I could throw in a third one and break all the operators rules here. If I could talk a third one and ask you, when would you anticipate IET starting to surpass OFSE in terms of income for the company?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Good, James, that's a great way to get three questions into one."
},
{
"speaker": "James West",
"content": "There you go."
},
{
"speaker": "Lorenzo Simonelli",
"content": "So look, with regards to the first question on the aspect of 2024 for IET, feel good about the $12 billion to $12.5 billion. As you know, at the beginning of the year, we gave a guidance of $11.5 billion to $13.5 billion. And if you take that midpoint, again, we feel good about being able to achieve that. And I think what I've been particularly pleased about this year is, we gave that guidance at the beginning of the year before we knew about the LNG moratorium, and we've been able to see very robust levels of order intake even with lighter year-over-year LNG orders. And if you look at $9.2 billion of year-to-date orders, and only $700 million of LNG equipment orders so far in 2024. So significantly lower than last year when for the year, we booked $5.6 billion. So we've been able to see the diversity of our portfolio really come through. And as you look at the significant orders in gas infrastructure, FPSO as well as new energy, which, again, I highlight we're going to top the $1 billion for the first time, relative to new energy. And as you look at the guidance we gave at the beginning of the year, $800 million to $1 billion. So we feel good that even with all the headwinds, we are looking solid for the IET number this year. And as we look to next year, which was really your second question associated with order expectations. We'll come back in the fourth quarter earnings call and give more specific guidance relative to 2025. I'd say though, we feel good about 2025, with most segments similar to 2024, showing slight growth. I think if you start off with the equipment side, we do expect the pace of LNG FIDs to pick up next year, again, assuming a positive resolution of the U.S. LNG moratorium as well as the significant international LNG projects that are accelerating pace. Also, we've got a considerable addressable market outside of LNG that continues to be there. We stated that before for our GTE equipment, $100 billion to $120 billion between 2024 and 2030. Gas Infrastructure, again, we've had a very good year in 2024. That may be slightly softer in 2025, but again, overall, the puts and takes means that we're seeing a solid year in 2025 as well and very similar to 2024. And FPSO markets remain strong. Other market opportunities in micro grid as well as CTS. So positive with regards to IET orders in 2025. And on your last question, look, we feel good about both segments. We feel good about the growth trajectory, both on the margin, getting more accretive. And obviously, the Baker Hughes story is made up of both of them growing."
},
{
"speaker": "Operator",
"content": "Our next question comes from Saurabh Pant with Bank of America."
},
{
"speaker": "Saurabh Pant",
"content": "Lorenzo, Nancy, if you don't mind, I want to continue with the IET discussion, maybe make it a little nearer-term. If we look at the revenue number for the third quarter, it was a little below the range we were expecting. But the fourth quarter guide implies a pretty good rebound. And this is especially on the Gas Tech Equipment side of things. Maybe you can give us a little color on how things were evolving in the third quarter? And what's driving that rebound over the fourth quarter? Maybe it's just timing, right, but a little more color on that, please."
},
{
"speaker": "Nancy Buese",
"content": "Yes. Happy to take that one. This is -- as you remember, this is a long-cycle business, and we certainly can experience some lumpiness from quarter-to-quarter for GTE in particular. And really, in some cases, they're just large projects that can experience some kind of delay due to an external factor. And that's why we give the range that we do. So that exactly happened in Q3, where we just had some supplier delays and some vessel delays. But the IET midpoint, we missed by just over $200 million, and that is all GTE related to timing. And so you will see that revenue coming in the coming quarters, and we'll see some of that in Q4, some of it in Q1. But we do remain super confident in our guidance. And I would say the important point to note is our guidance is still intact. And even with that lumpy revenue, the margin improvement continues and revenue overall is still increasing by 30% this year. So just to give a little context around that, GTE revenue is up 4% year-over-year. And if you look at year-to-date 2024 versus year-to-date 2023, it's actually up 33% and margins are now up to 17.9%. So we remain totally confident in our ability to continue executing on the nearly $12 billion of the GTE backlog. And again, as I said earlier, it's really not about mix, but revenues are up and margins are up. And margins are up 10 points year-over-year, and we are very confident in executing on that backlog. And it's also just good to note, too, that these are really diverse businesses deep down in IET and including Gas Tech, all of them are growing. So we are confident and GTE is -- all the orders are still there, and we are working through the backlog."
},
{
"speaker": "Lorenzo Simonelli",
"content": "I would just add, and again, to go back to what Nancy mentioned at the beginning, and I know maybe it's different than some of our peers. These are long-cycle projects. Having seen these for over a decade, you're going to have some puts and takes over the course of quarters just based on also shipping and logistics as well as some of the deliveries. Again, all timing related. And I think the element here is, we're staying on track with the 20% EBITDA for 2026, the target that's been laid out and feel very good about the continued momentum of the orders coming in and the backlog being converted."
},
{
"speaker": "Operator",
"content": "Our last question comes from Marc Bianchi with TD Cowen."
},
{
"speaker": "Marc Bianchi",
"content": "Hi, thanks. I guess, the first question I had was just on the IET book-to-bill as we think about 2025. So it sounds like maybe the base case for the order level is flattish with where 2024 is. I'm curious how we should be thinking about the backlog conversion."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes. So again, if you look at the early read of 2025, and again, we'll give official guidance during the fourth quarter earnings call in January 2025. We're seeing, again, a robust level of activity. And year-over-year, again, like 2024, with positive momentum and then obviously looking to the LNG moratorium being lifted. And from a conversion perspective, again, the cycle time of these projects continues to be the same. So again, when you think about the RPO continuing to be at record levels as we go forward and continuing to convert at the same pace."
},
{
"speaker": "Operator",
"content": "And thank you. That was our last question. I will hand you back to Mr. Lorenzo Simonelli, Chairman and Chief Executive Officer, to conclude the call."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thanks a lot to everyone for taking the time to join our earnings call today, and I look forward to speaking with you all again soon. Operator, you may now close the call."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day."
}
] |
bkr | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Baker Hughes Company Second Quarter 2024 Earnings 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. I would now like to introduce your host for today's conference, Mr. Chase Mulvehill, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Chase Mulvehill",
"content": "Thank you. Good morning, everyone, and welcome to Baker Hughes second quarter earnings conference call. Here with me are Chairman and CEO, Lorenzo Simonelli; and our CFO, Nancy Buese. The earnings release we issued yesterday evening can be found on our website at bakerhughes.com. We will also be using a presentation with our prepared remarks during this webcast, which can be found on our investor website. As a reminder, during the course of this conference call, we will be provide forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. Please review our SEC filings and website for the factors that could cause actual results to differ materially. Reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release. With that, I'll turn the call over to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Chase. Good morning, everyone, and thanks for joining us. We delivered outstanding second quarter results, highlighted by strong operational performance across the company. Our IET performance benefited from excellent execution of its robust backlog. In OFSE, results were supported by a solid seasonal recovery in the Eastern Hemisphere, portfolio resilience in North America and added success in driving enhanced cost efficiencies across the business. We continue to improve our operational consistency, as this marks the sixth consecutive quarter of meeting or exceeding the midpoint of our quarterly EBITDA guidance. As highlighted on Slide 4, we had another strong quarter for orders. This is particularly evident in IET, where we booked $3.5 billion during the quarter, including a large SONATRACH award for gas boosting in Algeria's Hassi R'Mel gas field. This marks the highest level of non-LNG equipment quarterly bookings in the company's history and again underscores the breadth and versatility of our IET portfolio. We also secured two major offshore topside contracts to provide power generation systems for innovative all-electric FPSO units, which will be installed offshore in Latin America. These awards further build on IET's positive momentum in the offshore market. On the digital front, Baker Hughes secured a multimillion dollar global frame agreement with BP, covering all of their upstream and downstream assets. This provides an enterprise subscription for Cordant Asset Health, enabling BP to deliver reliable, efficient condition monitoring and supporting its digital optimization strategy. We also saw continued traction in our Gas Tech Services business, booking to backlog free multi-year service awards that totaled $500 million. This included a 25 year service agreement to support our customers' offshore operations in Latin America. Our services backlog uniquely differentiates Baker Hughes, adding recurring long term and profitable revenue streams. In the new energy, we continue to see solid order momentum. We booked record new energy orders of $445 million during the quarter, taking year-to-date orders to $684 million sand already approaching the $750 million we booked in 2023. Considering this strong first half performance, we are trending toward the high end of this year's new energy guidance range of $800 million to $1 billion. This is another reflection of our technology differentiation and the versatility of our portfolio to provide new energy customers with innovative solutions. In Asia Pacific, we secured a major Gas Tech and Climate Tech Solutions contract to supply electric-driven compression and power generation to a global energy operator. This will enhance gas operations and power CO2 capture to reduce the carbon intensity at the customer's LNG facility. We also continue to build on our strategic collaboration with Air Products. In the second quarter, CTS was awarded a contract for CO2 and hydrogen compressors as well as pumps for one of Air Products' hydrogen projects in North America. In Germany, CTS also secured an award to provide [Passoni Deutschland] with zero emission integrated compressors, providing increased compression capacity to handle the large volumes of gas entering the network from new LNG regasification terminals. In July, we signed a long-term agreement to be a preferred equipment and service supplier for Wabash Valley Resources' ammonia and carbon sequestration plant in Indiana. The project will capture and sequester 1.6 MTPA of CO2, making it one of the largest carbon sequestration projects in the U.S. Importantly, the EPA issued Wabash Class VI permits in January of this year. Once this project is FID, we have the potential to book a wide range of orders that could span across both OFSE and IET. These include compression, pumps, valves, digital hardware and software, NovaLT turbines in IET, and sequestration analysis, CO2 flexible pipe, well construction, and surface and sub-surface monitoring in OFSE. This is one example of how we realize synergies between IET and OFSE, a theme we believe will become a common thread for new energy projects at Baker Hughes. In OFSE, we received another significant Petrobras award for workover and plug and abandonment services in pre-salt and post-salt fields offshore Brazil. The multi-year project will leverage Baker Hughes' integrated solutions portfolio to optimize performance for Petrobras. Turning to our operational performance. We delivered strong second quarter results, highlighted by 46% year-over-year EPS growth and 25% increase in EBITDA. Importantly, we again exceeded our EBITDA margin guidance, driven by outstanding execution and continued cost productivity improvements across the company. Our efforts to structurally change the way we operate are evident in our margin performance. Overall, EBITDA margins increased almost 150 basis points year-over-year to 15.8%. In OFSC, margins came in above our guidance, driven by strong performance in SSPS and the acceleration of our cost optimization initiatives announced earlier this year. Notably, OFSE's year-over-year incremental margins were approximately 60%, highlighting the team's persistent focus on cost productivity. In IET, margins also exceeded our guidance. Gas Tech Equipment posted another strong quarter with margin significantly increasing from the same period last year, as we convert higher margin backlog. In addition, Industrial Products & Solutions benefited from higher volumes and improved supply chain efficiency with both contributing to IET's better margin performance. Turning to the macro view on Slide 5. On the back of softer global demand and continued economic uncertainty, oil prices experienced some volatility during the second quarter. Yes, Brent prices still averaged $85 per barrel with support from the extension of OPEC+ production cuts, rising geopolitical risk, and firming oil demand in June. The trajectory of global economic activity, the persistence of inflation and geopolitical risk will be key factors in determining the oil price path for the remainder of this year. Next year, the pace of OPEC+ barrels returning to the market will likely be the major determinant of oil prices. Our global upstream spending outlook for the year is revised slightly lower due to North American softness. In North America, we previously expected the market to decline in the low to mid-single-digit range compared to last year. Due to lower-than-expected first half rig activity and tempered second half expectations, we now expect year-over-year declines in North America spending to be down in the mid-single-digits. With our Gulf of Mexico exposure, which is expected to demonstrate another year of solid growth and our portfolio mix that is more tied to production, we believe that our North American revenues will outperform the market. Across international markets, we maintain our expectations for high single-digit growth compared to last year. The market outlook already contemplated the expansion that OPEC+ cuts through the end of the year, as well as any potential timing differences between the transitioning of rigs from oil to gas in Saudi Arabia. Looking out beyond 2024, we expect global upstream growth to be led by Latin America and West Africa offshore markets and the Middle East, albeit at a decelerated pace. As the cycle matures, we expect our customers to increasingly focus on optimizing production from existing assets, providing significant growth opportunities for our mature asset solutions. This leverages our decades of experience, deep-domain knowledge and industry-leading technologies, including Leucipa and coveted franchises in both upstream chemicals and artificial lift. Turning to global natural gas and LNG on Slide 6. We reiterate our positive outlook for global gas markets. Earlier this year, the IEA updated its projections for electricity consumption, noting that, global demand for data centers, driven by crypto currency and AI could double by 2026. This robust data center growth implies its annual electricity consumption could account for 4% of global energy demand. To put this in perspective, this would equal roughly the same amount of electricity, used by the entire country of Japan. We believe natural gas will be essential to meet this growing power demand, which will be additive to the growth required for new energy sources in the future. Therefore, the notable rise in generative AI could provide upside to our current expectations for natural gas demand to increase by almost 20% between now and 2040. We are confident that, strong underlying natural gas demand will lead to robust and sustainable growth in LNG. Through the end of this decade, we maintain our expectations for LNG demand to increase by mid-single-digits annually, requiring an installed nameplate capacity of 800 MTPA by 2030. As we highlight on the slide, year-to-date offtake contracting for LNG is 42% higher than the same period last year. With recent contracting of Middle East capacity from Asian buyers and portfolio players, we expect a record breaking year for contracting offtake volumes. Contracting of offtake capacity is a key factor in many LNG projects reaching FID. Therefore, these recent trends only increase our confidence in the pipeline of potential projects progressing. We continue to expect global LNG FIDs of about 100 MTPA over the next three years, which would result in our installed capacity increasing by 70%. Importantly, our growing installed base of equipment, brings significant aftermarket service opportunities for Baker Hughes across the lifecycle of the equipment. Turning to Slide 7, I want to take a moment to reflect on the strong tailwinds outside of LNG that we are experiencing within IET's Gas Technology Equipment portfolio. The versatility of Gas Tech Equipment uniquely sets Baker Hughes apart from our peers. This enables us to sell our equipment into numerous end markets, outside of LNG, where we often compete and win against a diverse group of industrial companies. In the first half of this year, we have booked $6.4 billion of orders, with about 85% associated with non-LNG equipment and services. This strength has been most notable in Gas Tech Equipment, where we booked almost $1.4 billion of non-LNG orders during the quarter. On the back of a robust fast half, we now expect Gas Tech Equipment orders outside of LNG to exceed $3 billion for the full year, which is almost double last year's level. Looking beyond 2024, we see an opportunity for our GTE business to capture increasing share of the addressable non-LNG market, which we expect to total $100 billion to $120 billion through 2030. This significant opportunity includes a broad set of growing end markets, including gas processing and pipeline infrastructure, onshore and offshore production, downstream, and industrial. This year, we have experienced a notable increase infrastructure orders. In the first quarter, we announced the Master Gas System Free award with Aramco. During the second quarter, we booked the Hassi R'Mel pipeline expansion project in Algeria that will bring gas to Europe. In total, these two projects accounted for more than $1 billion of equipment bookings. Looking over the next few years, we see continued strength in gas infrastructure opportunities across the Middle East, U.S., Latin America, and Sub-Saharan Africa, due to secular growth in global natural gas and LNG demand through at least 2040. This will drive further momentum in gas infrastructure equipment orders well beyond this year and provides opportunities for Gas Tech services, condition monitoring and pipeline inspection. A key strength of our business model is to monetize equipment cycles and leverage our growing installed base for sustainable and profitable revenue growth. Beyond gas infrastructure markets, we also expect continued strength in onshore and offshore production orders, led by the FPSO market. Over the next few years, we anticipate the market awards 7 to 9 FPSOs per year, driven by growth in Brazil and Guyana. Long, X.M recent discoveries in Namibia's Orange Basin provide growing confidence in FPSO orders outside the strong momentum we see over the next couple of years. In onshore production, we are optimistic about associated processing opportunities as global gas production increases, particularly in the Middle East. One example is the Jafurah gas field where we have been previously awarded compression trains, stabilizer compressors, valves and condition monitoring for the strategic gas basin in Saudi Arabia. As this basin is set to significantly increase production, we see opportunity to book additional IET orders in the future. In refining and petrochemicals, we are also experiencing positive momentum. We see growing opportunities for refinery conversion to bio-feedstock as well as growth in ethylene and ammonia markets, driven by rising fuel, fertilizer, and plastics demand. We are seeing increasing power demand led by data center and electric vehicle growth. This dynamic coupled with renewables intermittency and planned reduction in coal-fired generation capacity is expected to result in power shortages across U.S. grid network. For example, ERCOT's Texas power grid operator has forecasted that 2030 peak summer low demand will exceed generation by 33 gigawatts. This is equivalent to the energy needed to power 25 million homes, which amounts to 10x the number of homes in Houston. Due to these grid reliabilities and availability concerns, we are experiencing increased interest in our turbo-machinery technology for behind-the-meter and off-grid solutions across data centers, transportation sectors such as airports and seaports, and oil and gas markets. Our NovaLT turbines, which can run either on natural gas or hydrogen, are the core technology for our micro-grid offering. We will also benefit from increased demand for utility scale power solutions through our partnership with NET Power as well as our steam turbine generators and super-critical CO2 technology that enable power generation through small modular reactor solutions. Lastly, we have experienced solid growth across our BRUSH portfolio, which includes solutions to meet most challenging requirements for power generation, grid stabilization and decarbonization with its electric motors, synchronous generators and condensers. As additional intermittent renewable power capacity and electrification-driven demand are added to the grid, we expect that grid stabilization will be an area of significant growth for IET. In summary, we are very excited by the strong tailwinds that we are seeing across our energy and industrial end markets. We remain confident in our ability to deliver $11.5 billion to $13.5 billion of IET orders this year. Before I turn the call over to Nancy, I wanted to briefly provide some highlights around the progress we are making on our emissions and the success we're having in helping our customers reduce their own emissions intensity. Baker Hughes was one of the first companies in our industry to make a public commitment to a reduction in our operational emissions by 2030 and achieve net zero by 2050. As detailed in our Corporate Sustainability Report published in May, we remain on-track to achieve these goals, and we continue to provide products and services that help our customers reduce their emissions intensity. In IEC, we have sold a number of zero emission integrated compressors or ICLs. Also, customers are increasingly interested in our more efficient turbines highlighted by increasing NovaLT order flow. Our Panametrics' flare.IQ technology is also seeing increased customer adoption. It helps to monitor, reduce and control emissions associated with flaring and covers a wide range of assets, including assisted flares associated with downstream petrochemical, refinery, and upstream operations. In OFSC, our artificial lift product line deploys more efficient permanent magnet motors at well sites, replacing older, more emissive technology. Combining permanent Magnum motor technology with Baker Hughes' electrical, submersible pump capabilities creates differentiated solutions, providing advantages for our customers and producing fewer emissions. Across both segments, we have developed digital and condition monitoring solutions that enable our customers to efficiently monitor their equipment performance, highlighting any inefficiencies that drive emissions up. Our customers are clearly focused on reducing their emissions, and we have a broad suite of products to help them on this journey. With that, I'll turn the call over to Nancy."
},
{
"speaker": "Nancy Buese",
"content": "Thanks, Lorenzo. I will begin on Slide 9 with an overview of our consolidated results and then speak to segment details before summarizing our outlook. We're extremely pleased with our second quarter results. Our operational discipline and rigor are gaining traction, highlighted by our consistent improvement in EBITDA margins and returns. In just two years, our margins are up almost 300 basis points, a credit to our team's dedication and hard work. We're pleased with the strong margin performance in both OFSC and IET, resulting in adjusted EBITDA of $1.13 billion, a 25% year-over-year increase. This was driven by strong backlog conversion in both SSPS and IET, effective management of our aeroderivative supply chain tightness in Gas Tech Services and realization of efficiency gains and productivity improvements across the business. GAAP operating income was $833 million. Adjusted operating income was $847 million. GAAP diluted earnings per share were $0.58. Excluding adjusting items, earnings per share were $0.57 an increase of 46% compared to the same quarter last year. Our continued discipline resulted in corporate costs for the quarter of $83 million, down more than 20% since our transformation effort began in 2022, a testament to our multi-year focus on driving productivity and efficiency gains. Our adjusted tax rate was down slightly year-over-year to approximately 30%, as we continue to execute our tax optimization program. We have line of sight to additional tax rate improvement opportunities and we'll execute on these in the coming quarters. As Lorenzo mentioned, we had another quarter of strong order momentum with total company orders of $7.5 billion including $3.5 billion from IET. The diversity of IET's end markets continue to support a healthy order book, which was led by the Hassi R'Mel gas pipeline boosting project and two FPSO awards booked during the quarter. Alongside a strong order book, IET RPO ended the quarter at $30.2 billion, up 10% year-over-year and setting a new record for the company, as IET RPO is now up 50% over the last 5 years. In OFSC, RPO remained at a healthy $3.3 billion. Free cash flow came in at $106 million for the quarter, bringing our first half total to $608 million. As we previously highlighted, we expect free cash flow to be more weighted towards the back half of the year. For the full year, we continue to target free cash flow conversion of 45% to 50%. Turning to Slide 10. Our balance sheet remains strong, as we ended the second quarter with cash of $2.3 billion, net debt-to-EBITDA ratio of 0.9x and liquidity of $5.3 billion. Let's turn to capital allocation on Slide 11. In the second quarter, we have returned $375 million to shareholders. This included $209 million of dividends and $166 million of shares repurchased during the second quarter. In total, for the first half of the year, we have returned $743 million to investors. For the full year, we remain committed to returning 60% to 80% of free cash flow to shareholders. Our primary focus is to continue growing our dividend with increases aligned with the structural growth in the company's earnings power. We will continue to utilize buybacks to reach the target range and we remain opportunistic. Now I will walk you through the business segment results in more detail and provide our outlook. Starting with Industrial and Energy Technology on Slide 12. For the second consecutive quarter, IET outperformed our EBITDA guidance, mostly attributed to excellent conversion of Gas Tech Equipment backlog that drove revenue and margin upside. IET orders were strong at $3.5 billion with non-LNG Gas Tech Equipment accounting for 97% of the total. Year-to-date, we've now booked $6.4 billion of IET orders and we remain on track to achieve our guidance range $11.5 billion to $13.5 billion. The versatility and differentiation of the IET portfolio across Industrial and Energy segments remains a significant competitive advantage for Baker Hughes, allowing us to profitably grow with new customers and applications. CTS orders were $392 million in the second quarter, led by solid order activity in both carbon capture and hydrogen-related projects. This puts CTS orders for the first half of 2024 at $585 million, supporting robust year-to-date new energy orders of $684 million. IET RPO ended the quarter at $30.2 billion a record level and up 10% year-on-year. This level of backlog provides exceptional revenue and earnings visibility over the coming years. As we execute our robust equipment backlog, this will significantly increase our installed base, which will then drive structural growth in our aftermarket service business well beyond 2030. Turning to Slide 13. IET revenue for the quarter was $3.1 billion, up 28% versus the prior year, led by a 59% increase in Gas Tech Equipment revenues, as we continue to execute our record levels of backlog. We also experienced outstanding performance in Cordant. Gas Tech services revenues expectations, increasing 5% versus the prior year. IET EBITDA was $497 million, up 37% year-over-year. EBITDA margin increased about 100 basis points year-over-year to 15.9%. I want to specifically highlight the progress in Gas Tech Equipment margins, which are up about 500 basis points compared to prior year levels, due to conversion of higher margin backlog, cost efficiency improvement and strong productivity gains. We also continue to see good margin expansion in our Industrial Tech business led by Cordant, where we are benefiting from the improved output due to process enhancements and a return to normalization of our supply chain. Now turning to Oilfield Services and Equipment on Slide 14. The segment maintained its strong margin trajectory, keeping us on track to achieve our 20% margin target for next year. This is a testament to the work the OFSC team has done to drive cost efficiencies and maintain commercial discipline as they remain focused on profitable growth. Continued strength in flexibles helped to drive SSPS orders of $888 million up 40% on a sequential basis. We expect the offshore market to remain strong and anticipate an increased order contribution from subsea-tree awards in the second half of the year. OFSC revenue in the quarter was $4 billion, up 6% quarter-over-quarter. International revenue was up 7% sequentially. We experienced continued growth across all Middle Eastern markets and a strong seasonal recovery in North Sea, where rigs returned from maintenance following the prior quarter's delays. In Latin America, we continue to experience rig reactivation delays in Mexico. In North America, 3% sequential growth was entirely attributed to the Gulf of Mexico, where a sharp increase in project-related activities benefited results. North America land revenues remained relatively stable compared to first quarter, outperforming the decline in rig activity due to our weighting towards production businesses. OFSC EBITDA in the quarter was $716 million, up 13% year-over-year. This was led by solid performance on both revenues and margins. OFSC EBITDA margin rate was 17.8%, increasing 144 basis points year-over-year. This strong margin improvement was led by cost efficiency and productivity enhancements that we've been executing across the business. We are particularly pleased with the continued improvement in SSPS margin performance, which is now approaching low teens. More broadly, we are clearly seeing the benefits of our transformation efforts initiated in late 2022, which are having a positive impact on our financial performance across both segments. Turning to Slide 15. I want to take a moment to provide more details on the actions we're taking to drive sustainable margin improvement across the company. In IET, the team has adopted a process mindset that is driving a culture of improved efficiency and productivity. We are on a journey to create an efficient organization that emphasizes the elimination of waste, continuous improvement and delivers more value to our customers. As highlighted by the strong margin outperformance so far this year, these continued optimization efforts are gaining traction across IET and are a key part of the strategy to reach our 20% margins by 2026. In OFSC, we're focusing on improving our cost competitiveness and enhancing our execution. Supply chain optimization and service delivery improvements are key strategic priorities to achieve our 20% margin targets. Commercially, we remain disciplined, ensuring we are maximizing returns and focusing on profitable growth. Combined with our leading technologies and solutions, we are now demonstrating a sustainable uplift in our OFSC margins. In our corporate functions, we're driving structurally lower corporate costs, as we execute several projects to streamline activities, remove duplication and modernize management systems. This is improving clarity, transparency and the pace of decision making. We are making significant progress in changing the way we operate. What it strikes me the most is what lies ahead. We still have a lot of opportunity to drive margins higher and the market tailwinds for our unique portfolio of technologies and solutions are only strengthening. Next, I'd like to update you on our outlook. The details of our third quarter and full year 2024 guidance are found on Slide 16. The ranges for revenue, EBITDA and G&A are shown on the slide and I'll focus on developments. Overall, we're increasingly bullish on the outlook for the company, in particular, our IET business. As Lorenzo highlighted, this segment is benefiting from strength in multiple cycles including LNG, gas infrastructure, offshore and new energy. Our portfolio is well-suited to capitalize on the positive momentum in each of these areas. Given the tailwinds and our continued operational improvement, we expect third quarter company EBITDA of $1.2 billion at the midpoint of our guidance range. For IET, we expect third quarter results to benefit from continued productivity enhancements and process improvements, as well as strong revenue conversion of the segment's record backlog. Overall, we expect third quarter IET EBITDA of $525 million at the midpoint of our guidance range. The major factors driving this range will be the pace of backlog conversion in Gas Tech Equipment, the impact of any aeroderivative supply chain tightness in Gas Tech and operational execution in Industrial Tech and Climate Tech Solutions. For OFSE, we expect third quarter results to reflect typical seasonal growth in international and flattish activity in North America. We expect third quarter OFSC EBITDA of $760 million at the midpoint of our guidance range. Factors impacting this range include the phasing of 2024 E&P budgets, SSPS backlog conversion, realization of further cost out initiatives and execution on larger international projects. Turning to our full year guidance. We are increasing the midpoint of the EBITDA range by 5%, entirely attributed to strong IET performance as our OFSC EBITDA midpoint remains unchanged. For the full year 2024, we now expect Baker Hughes EBITDA of $4.525 billion at the midpoint of our guidance range. Given the strength in first half new energy orders, we now expect to end the year towards the high-end of our $800 million to $1 billion range. We expect IET orders to remain at robust levels this year and maintain the guidance range between $11.5 billion to $13.5 billion driven by strong momentum across all aspects of the IET portfolio. As a result of robust backlog conversion and strong margin performance, we are increasing our full year outlook for IET EBITDA to $1.965 billion at the midpoint of our guidance range. Compared to our prior guidance, this amounts to a 12% increase. For OFSE, we maintain our EBITDA midpoint at $2.9 billion for our guidance range, as we expect margin upside to offset lower revenue expectations in North America. In summary, for Baker Hughes, we now expect the company to generate at least 20% EBITDA growth for the second consecutive year. We remain focused on execution, driving further operational improvements and capitalizing on market tailwinds with our differentiated portfolio of products and services. Overall, we are very pleased with the progress demonstrated by our second quarter results. The structural changes we are making to the business are increasingly visible in our financial performance and provide a clear path to our upgraded guidance range. We are intensely-focused on driving sustainable margin improvements and remain on track to deliver 20% EBITDA margins in OFSC and IET. We are excited about the continued improvement of our business and about the future of Baker Hughes. I'll turn the call back to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Nancy. Turning to Slide 18. We are exceptionally proud of the progress we have demonstrated on the margin front. EBITDA margins are expected to be in the high teens range during the second half of this year, and 2024 is anticipated to produce Baker Hughes' highest margin rate. Our transformation efforts are clearly driving structural improvement in underlying margins. Our progress is clear and we are confident in our plan to achieve 20% margins for OFSE in 2025 and IET in 2026. The story today of Baker Hughes is more than just improving operational performance. As I highlighted earlier, we have growth tailwinds in IET that span across multiple end markets, including gas infrastructure, LNG, FPSOs, distributed power, and new energy. Orders from these key growth markets have been major drivers of our record equipment backlog. Throughout our transformation, we have taken steps to reinforce our culture as one Baker Hughes. Our people are the driving force behind our success. We put people first and take energy forward. I'd like to conclude by thanking the Baker Hughes team for yet again delivering very strong operating results. It's a testament to the strength of our people, the culture we're building, the portfolio we have created, and the value of the Baker Hughes enterprise. With that, I'll turn the call back over to Chase."
},
{
"speaker": "Chase Mulvehill",
"content": "Thanks, Lorenzo. Operator, let's open the call for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Luke Lemoine with Piper Sandler."
},
{
"speaker": "Luke Lemoine",
"content": "Good morning, Lorenzo, Nancy. You had really strong margins in both segments, which I guess is another step on your journey to 20% for both. You talked about some of what has been done, but could you elaborate on the drivers from here, if it's any cost initiatives, operational enhancements that we should focus on or kind of an IET or backlog conversion or mix?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Definitely, Luke. And I'm really proud of what the team's been able to accomplish. As you said at 2Q, really some great results and it's a testament to the execution that we started also back in the fall of 2022, when we went from four discrete segments into two. We had numerous changes and also we started a restructuring of taking cost out, $150 million in 2023, and really streamlining processes, reducing duplication. As you look at the segments in particular, I mean, IET is really on a process of continuous improvement, adopting lean mindset as they have a great backlog that they're continuing to churn out and we're increasing automation, the efficiencies of supply chain, the customer-centric approach and really delivering more value to our customers with what we have. And that volume is great for the future as well, and we're continuing to do more with it and getting the efficiencies from a margin perspective. On OFSC, again, it's cost competitiveness. It's continuing to drive as you saw in the fall of '23, announcing a restructuring with taking out duplication, announcing execution, service delivery improvements, a focus on best cost country sourcing and really profitable growth as we go forward. It doesn't stop in the segments, also across the company, the structural improvements that you heard, Nancy mentioned beforehand. We're expecting the margin expansion to continue. As you look at '24, we're going to be up about 150 basis points, which is better than what we said previously, and we're fully committed to the 20% in OFSE in 2025 and also the 20% in IET in 2026 and very confident in our ability to achieve those. A lot of things coming together and a lot of hard work by the team."
},
{
"speaker": "Nancy Buese",
"content": "Luke, I would just add to that. As we've indicated, we're doing a lot of fundamental work. We are changing the way we work within the company. We are building sustainable improvement. You will continue to see those margins pick up over time. Just to be clear, this is the hard work from thousands of employees across the globe and every little bit matters. And so, we're really seeing the margin improvements from many, many things. There's key drivers, but it's a great effort and a testament to all the work the teams are doing across the company."
},
{
"speaker": "Luke Lemoine",
"content": "This is somewhat related, Nancy, but you raised your EBITDA guidance by 5% this year, and we saw some of the segment detail in the slide deck. Could you walk through some of the drivers that's pushing this higher? I mean, I know some is probably the margin expansion here, but anything else that's noteworthy?"
},
{
"speaker": "Nancy Buese",
"content": "Yes. From an IET perspective, that was really the driver of the increase to guidance. So we raised the midpoint by about 12%. That's the second consecutive year of significant record EBITDA for the segment. It was really driven by stronger revenue expectations and upgrade in margins. And so, we believe that IET revenues will increase by about 20% this year, which is 8% above our prior guidance. That's really driven by GTE and Industrial Solutions, if those are the drivers of the margin upside. Revenue comes on the back of stronger backlog conversion, Industrial Solutions on the heels of Cordant. Great improvements there. On the margin side, we were expecting 2024 IET margins of 16.2%, which is about 120 basis points ahead of last year and 70 basis points upgrade versus our prior outlook. Really starting to see great margin improvement on the IET side. Those are just outperforming, where we originally thought we'd be. On the GTE side, that's that higher margin backlog that we've spoken about, stronger pull through and then the cost efficiencies really starting to come through. In Industrial Solutions, that's around supply chain optimization and higher volumes as well. I would note that, OFSC has remains unchanged, so still strong from what we had indicated earlier in the year. But overall, we're very happy with where we are today and our technology differentiation, our portfolio versatility is really driving performance and that's what we've indicated. I would also say is that, we're really seeing sustainable improvements that we expect to extend for quite some time. I would also note that, with the backlog that we have and the growth in the equipment base, you're going to see even more Gas Tech Services growth opportunities over the longer-term with these backlog levels. That's really the driver for the guidance increase."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of David Anderson with Barclays."
},
{
"speaker": "David Anderson",
"content": "Hi. Good morning, Lorenzo and Nancy. I want to follow on with Nancy you're just talking about and that was on the services side of Gas Tech. You had another big quarter in orders, IET backlog at another record level, up quite a bit over the last five years. How is that installed base translated to Gas Tech Equipment services side of the business? Given the backlog and installed base, what does this mean for kind of the growth over the next few years? You did 13% sequentially this quarter, bit higher than we were modeling. Are we at a point now where we can start thinking about this as a mid-teens growth annually? Is that a reasonable expectation from here? A lot going on in maintenance and replacement cycle. It's kind of hard for us to model that."
},
{
"speaker": "Lorenzo Simonelli",
"content": "David, as you said, it's an impressive growth rate. Over the course of the last five years, again, a 50% growth in the RPO. I think that's a testament to the portfolio that we have of equipment that goes into critical areas. It's a key differentiator. We're not just in one aspect of an industry or market. We can cut across many. Gas Tech is a full life cycle business. I think you've got to look at it from a standpoint of razor, razor blade. We've said this before, this isn't just an equipment sale, this is the ability to stay close to the customer and be with them for 20 to 30 years. That may come later than the equipment sale, but it's there. And so, we look constantly at our installed base and look at the opportunity for that services revenue stream to come through. You're starting to see it come through and it provides that long-term visibility and confidence in the sustained growth outlook that we see for the company going forward. It's under-appreciated right now, we feel, because, again, it's that aspect of an amazing backlog that's been built over five years, now starting to come out, and we've got the equipment being installed and you'll see that service stream continuing for many years to come and again being on a life cycle basis. Razor, razor blades, that's clearly a model here that we're taking forward."
},
{
"speaker": "David Anderson",
"content": "Maybe if I could just shift over on the OFSE side around Eastern Hemisphere. Latin America has been a bit of a mess this year. It's kind of hard to figure out which way the ball is going there. But, you outperformed overall, internationally, your peers 7% sequentially, Eastern Hemisphere is really strong, particularly in the Middle East. In your guidance for high single-digit growth spending internationally for this year and then as we think into 2025, can you talk about which markets you have kind of really good lines of sight on in which you can outperform? I know Saudi is on the top of the mind. You mentioned West Africa as well. Could you just dig into that a little bit more in terms of, are these big contracts that are starting up? What gives you the confidence on that visibility over the next, let's say, 18 months?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes. Definitely, Dave. And as you said, we continue to see an outlook of high single-digit in the international market and very pleased with also the second quarter performance from a quarter-over-quarter being up 7%. Again, as we look at the marketplaces, there's the significant offshore as you look at Suriname, Namibia, Guyana that continues to be strong, Brazil. Again, you've got, as you mentioned, some of the dynamics that take place in Mexico, which will continue, no doubt. With the international overall, continues to be strong. Middle East is also an area of growth for us as we continue to move forward. There's several good prospects. I would look at it from a standpoint of growth in the future at a slower pace, so positive, but again decelerating as we go forward. We remain very optimistic about the continued aspect of international growth and also the mature assets and the opportunity around mature asset solutions that we can actually provide to the company and the customers we have, and brownfield opportunities that exist, as people continue to look at increasing production. That's a sweet spot for us. As you know, we are more on the production side. We've got the chemicals. We've got the ESPs, and we've got the solutions also from a digital standpoint that we rolled out to the marketplace."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of James West with Evercore."
},
{
"speaker": "James West",
"content": "Thanks. Good morning, Lorenzo and Nancy. Clearly from your prepared remarks and some of the comments made already in the Q&A, you guys are feeling good momentum. That's great to hear. Perhaps the first question for me, Lorenzo, if we think about the really with an unappreciated part of your business is leverage to the behind the meter. You mentioned some of the things, but there's micro grids, obviously the off-grid solutions and of course data centers are an opportunity that we all see going forward. Could you still elaborate on the role you see Baker and your gas technologies playing in these other solutions outside of the big LNG and other projects?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Definitely, James. As you say, I think it's an area that's coming to the forefront and people are better appreciating the portfolio of capability that we have to help in an area where you need continuous power supply, the need for distributed power systems and we know that, that's just going to increase over time. I mean, you look at some of the predictions out there, you highlighted the data centers and the IEA says that by 2026, they're going to consume 800 terawatt hours, and that's basically a doubling of the consumption from 2022. And you need a lot of these micro-grids to help. And we've got gas turbine technology that is beneficial for those, especially on the off-grid. And it's not just the data centers, it's overall, as you look at the instability of the grid and the requirements that are being placed on the grid. A lot of people, customers are looking at off-grid solutions, and that's even evident in the Permian. And where brownouts are a regular occurrence and now we're seeing companies come to us and ask for off-grid solutions, and we've got modular capabilities. And on the small scale, again, we've got the NovaLT turbines. We've got the opportunity of steam cabins. We've got the SMR solutions. And then as we go larger scale and in the future, you've also got net power. And these are -- is a portfolio of capabilities that we can give to oil and gas, airports, shipping, and we see those as all key segments that need additional power going forward. And increasingly, they're going to off-grid solutions. So we're looking at the market, developing proposals, working with partners and ecosystems and see this as a tremendous opportunity going forward."
},
{
"speaker": "James West",
"content": "Great. We certainly agree with that. And maybe, Nancy, for you. We have the new range for the year. Curious about the puts and takes on cash flow, the high end of the range versus the low end of the range. What are the key drivers to either hit the high end or be towards the low end? And I know you've always talked this year about cash flow and free cash flow, especially being back-end loaded, which looks like it's going to be. But I'd love to hear -- maybe some additional color there would be great."
},
{
"speaker": "Nancy Buese",
"content": "Sure. And free cash flow is always lumpy from quarter-to-quarter, and that's really why we don't guide to it by quarter, but we give you the guidance of 45% to 50% free cash flow conversion. And if you look back over the last 5 years, we're very consistent with where we have landed. And remember also that Q1 really outperformed. And so I would say what you've seen for first half of the year is exactly what we would have anticipated, and we're pleased with that. And as you mentioned, second half free cash flow is always stronger, and that's what we're anticipating again this year. It's always impacted by a few things, certainly in this quarter by timing of collections with some key customers. We always have down payments that we're not always sure when those are going to come in. And I would just reiterate our confidence in the 45% to 50% conversion for the year and our longer-term target remains 50% plus. And right alongside that, we would also remind, James, just the returns to shareholders. So in the first half of the year, we returned almost -- sorry, almost $750 million, which is up 50% year-over-year, and that's focused on the dividend growth and the share buyback. So we will always continue to focus on those things being an alignment, but strong conviction in our ability to get there on the free cash flow conversion."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of Arun Jayaram with JPMorgan Securities."
},
{
"speaker": "Arun Jayaram",
"content": "Lorenzo, LNG has obviously been a big part of the Baker story over the last couple of years, but we're seeing now a step change in your non-LNG orders in Gas Tech. Can you talk about some of the underlying drivers of this non-LNG growth? Do you expect it to continue and perhaps your thoughts on the setup of the IET order book as we think about the back half of the year and into 2025?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, definitely, Arun. As you say, LNG has not gone away, and we anticipate it's going to be coming back and again, we've seen the pause in the U.S. But our orders continue to be strong across IET and in particular, as you look at the onshore/offshore production, as you look at gas infrastructure, and all of this plays into the ecosystem that's required around gas. And that's where we play strongly from a compression standpoint. We play strongly with the turbines that we provide. And so as you look at the first half, $6.4 billion booked, and we see that even the second half going to be strong again. And we're affirming, as you heard from Nancy, the range. And as I look at the year, we should be around $12 billion to $12.5 billion from orders perspective. As we go forward, we'll start to see LNG come back. So this isn't an aspect of the backlog or also the industry shifting and going away. We're going to continue to see robust orders as we continue also into 2025. And it's the breadth of the portfolio that we have and the capability of having the right equipment to be installed at the right time. So we feel very good about the way in which the differentiation of the technology comes through here."
},
{
"speaker": "Arun Jayaram",
"content": "Great. And just a follow-up, Lorenzo, you and the team have booked a couple of large orders on the gas infrastructure side, in Algeria this quarter and in Saudi in 1Q. Thoughts on how this could progress, again, over the same time table over the balance of the year and into next year?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, Arun, we've often said it's the age of gas, and this is the time for natural gas. It's a plentiful resource. We know it's merits again, from an emissions perspective being lower than coal. And we think that gas has a lot of growth potential going forward. And we're seeing that also from the developments of gas infrastructure around the world as energy demand continues to be there and also people are looking for lower carbon intensity and gas is the solution. So as we go forward, we're seeing that gas production being a positive for Baker Hughes. You mentioned and highlighted the Master gas system free that was booked earlier this year. Again, there are going to be other Master gas systems required. You mentioned also Algeria Hassi R’Mel. There's going to be other countries that need that same gas infrastructure. As I talk to customers, as I go around the world, there's a common theme around gas infrastructure being needed, and we're going to have that opportunity to leverage our portfolio into that marketplace."
},
{
"speaker": "Operator",
"content": "Our next question is going to come from the line of Stephen Gengaro with Stifel."
},
{
"speaker": "Stephen Gengaro",
"content": "You've given us a lot of good detail around 2024. And I was curious, as we look into next year, given the IET backlog at record levels and what appears to be international oilfield service strength continuing. Can you give us some thoughts on sort of the pluses and minuses we should be thinking about heading into '25?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, I'd say, Stephen, it's a little early to provide full detail. And obviously, it's something that we continue to monitor. As we think about it at a macro level, more of the same. And as you think about Baker Hughes, continuing to grow positively and also focus on the margin trajectory that we've laid out. As you think about it from an OFSE perspective, again, we've got the focus on the 20% EBITDA margins. As you look at international, we continue to see robust international growth, again, positive growth at a slower pace, but positive, and I think North America, still early days, but we do anticipate a rebound in at least the second half of '25 and from the area that it is today. On the IET side, again, a focus on the margin improvement. We've laid that out and that continues to be the case. And order momentum continuing. You've got LNG that, again, from the U.S. perspective has been dampened in '24, just given the pause, we anticipate that, that will reverse, and we'll see those LNG opportunities come back. Also, the international opportunities continue to be there. And as I just mentioned to Arun as well, the gas infrastructure, onshore, offshore production, the FPSOs and New Energy. Let's not forget the growth that we continue to see in New Energy, and we highlighted being at the upper end of our guidance on the New Energy at the $800 million to $1 billion range, and we continue to see positive momentum as we go into '25. So feeling very good, again, early days. And we'll be able to give more as we get later into '24."
},
{
"speaker": "Stephen Gengaro",
"content": "And just as a follow-up, you mentioned New Energy orders. Can you just give us a quick recap of the key technologies and areas that are driving the New Energy orders?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Definitely. And the great thing about our portfolio, Stephen, is we're able to go across many of these New Energy projects really from the sub-surface all the way to the actually reducing the CO2 and being able to store it and being able to move it. So if you think about our capability and you look at Wabash, for example, and I highlighted Wabash in the prepared remarks. You've got compression pumps, you've got valves, you've got instrumentation, condition monitoring. You've got, on the OFSE side, the sequestration, feasibility analysis, well construction, you're able to measure and verify. And we have a portfolio of capabilities, both across IET and OFSE that really allows us to play a differentiated role in these projects such as Wabash. And as you look at the New Energy orders that we booked so far this year, about 50% have been on the CO2 side. And we see CCUS continuing to be a key theme as we go forward. So feel good about New Energy and the continued momentum there, and we're uniquely positioned."
},
{
"speaker": "Operator",
"content": "That was our last question. I will hand you back to Mr. Lorenzo Simonelli, Chairman and Chief Executive Officer, to conclude the call."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you to everyone for taking the time to join our earnings call today. We look forward to speaking to you all again soon."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day."
}
] |
bkr | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Baker Hughes Company First Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded."
},
{
"speaker": "",
"content": "I would now like to introduce your host for today's conference, Mr. Chase Mulvehill, Vice President of Investor Relations. Sir, you may begin."
},
{
"speaker": "Chase Mulvehill",
"content": "Thank you. Good morning, everyone, and welcome to Baker Hughes First Quarter Earnings Conference Call. Here with me are Chairman and CEO, Lorenzo Simonelli; and our CFO, Nancy Buese. The earnings release we issued yesterday evening can be found on our website at bakerhughes.com. We will also be using a presentation with our prepared remarks during this webcast, which can be found on our investor website."
},
{
"speaker": "",
"content": "As a reminder, during the course of this conference call, we will be providing forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. Please review our SEC filings and website for the factors that could cause actual results to differ materially. Reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release."
},
{
"speaker": "",
"content": "With that, I'll turn the call over to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Chase. Good morning, everyone, and thanks for joining us. We are pleased with our solid first quarter results as we continue to build on the momentum from last year and shape our company. The resilience of our order book and margin progress in both OFSE and IET put us on a path towards achieving our full year guidance and overcoming external volatility. Overall, EBITDA margins continued to demonstrate strong year-over-year growth, increasing by 100 basis points. The margin upside was attributed to IET, where both Gas Tech equipment and Industrial Tech demonstrated strong performance."
},
{
"speaker": "",
"content": "As highlighted on Slide 4, we've had a positive start to the year on the orders front. This is particularly evident in IET where we booked over $2.9 billion of orders during the quarter, including large awards from Aramco for the Master Gas System 3 and Black & Veatch for Cedar LNG. LNG equipment orders totaled almost $200 million during the quarter. Excluding LNG equipment, our IET business booked more than $2.7 billion of orders, the second highest of any quarter since the 2017 merger. This was attributed to non-LNG Gas Tech equipment orders more than tripling from prior year levels. This really underscores the breadth and versatility of our IET portfolio."
},
{
"speaker": "",
"content": "In OFSE, we received 2 significant contract awards from Petrobras, with the first for integrated well construction services in the Buzios field. Baker Hughes has been working closely with Petrobras on the field development for many years, leveraging our expertise across both OFSE and IET, demonstrating the power of our combined portfolio. We have previously received awards that include turbomachinery equipment on 10 FPSOs for the Buzios field and multiple OFSE service contracts."
},
{
"speaker": "",
"content": "The second Petrobras contract awarded during the quarter was to supply electrical submersible pumps, variable speed drives and sand separation across 450 wells to help the customer in Brazil optimize efficiency, reliability and sustainability of its onshore operations in the Bahia-Terra cluster. We delivered strong first quarter operating results, highlighted by 50% year-over-year EPS growth. Importantly, we exceeded the midpoint of our EBITDA margin guidance driven by outstanding operational performance in IET. We booked $239 million of new energy orders and generated over $500 million of free cash flow."
},
{
"speaker": "",
"content": "As mentioned, IET got off to a strong start to the year. Compared to the first quarter of 2023, IET EBITDA increased by 30%, the best quarterly year-over-year growth rate in 3 years and represents 80 basis points of EBITDA margin improvement year-on-year. This was driven by the conversion of higher-margin equipment backlog, continued margin expansion in our industrial tech businesses and further efficiency and cost optimization efforts by the team, partially offset by continued tightness in the gas tech services supply chain."
},
{
"speaker": "",
"content": "In OFSE, we continue to make solid progress on the margin front, even with some lower offshore activity during the quarter. Segment EBITDA margins were in line with guidance and improved 80 basis points compared to last year, supported by year-over-year OFS incrementals of nearly 40%. On the activity front, we experienced some delays in rigs coming out of maintenance in both Mexico and the North Sea due to tight supply chains and busy shipyards. We expect these are only timing delays and see no impact to our overall outlook for OFSE this year."
},
{
"speaker": "",
"content": "In line with our previous commitments, we continue to enhance returns to our shareholders. During the quarter, we increased our quarterly dividend by $0.01 to $0.21, which represents an 11% increase year-on-year; repurchased $158 million of shares and remain firmly on track to deliver 60% to 80% of free cash flow to shareholders."
},
{
"speaker": "",
"content": "Turning to the macro on Slide 5. Since bottoming in December of last year, oil prices have rallied significantly, a resilient global economy, steeper-than-expected seasonal decline in U.S. oil production to start the year and the roll forward of OPEC+ production cuts have helped to keep global oil markets more balanced. OPEC+ timing on restarting idled oil production, the trajectory of global economic activity and the geopolitical risk will be key factors in determining the oil price path for the remainder of the year."
},
{
"speaker": "",
"content": "We reiterate our 2024 North America and international drilling and completion spending outlooks as we see potential offsets to higher oil prices. In North America, our outlook remains for a year-over-year decline in the low to mid-single-digit range. We continue to anticipate declining activity in U.S. gas basins, partially offsetting modest improvement in oil activity during the second half of the year. Across international markets, we maintain our expectations for high single-digit growth. This contemplates extended OPEC+ cuts through the end of the year as well as any potential timing differences between the transitioning of rigs from oil to gas in Saudi Arabia."
},
{
"speaker": "",
"content": "Looking out beyond 2024, we expect continued upstream spending growth despite the recent MSC target reduction in Saudi Arabia, although at a more moderate pace than we have experienced in recent years. We expect growth to be led by offshore markets in Latin America and West Africa as well as the Middle East."
},
{
"speaker": "",
"content": "As we move into the next phase of the upstream spending cycle, we anticipate increasing focus on optimizing production from existing assets. At our annual meeting in January, we launched mature asset solutions, an emerging business that maximizes the health and value of our customers' mature fields. It leverages our decades of experience, deep domain knowledge and industry-leading technologies, including Leucipa, and [ coveted ] franchises in both upstream chemicals and artificial lift. We continue to experience strong customer demand for Leucipa as this differentiated digital solution is driving next level efficiencies for our customers through automation, digital optimization and workflow orchestration."
},
{
"speaker": "",
"content": "Turning to global natural gas and LNG on Slide 6. The long-term demand outlook for both remains very encouraging. Through 2040, we expect natural gas demand to grow by almost 20%, representing a 1% CAGR driven growth in underlying energy demand and the desire to drive towards a net-zero energy ecosystem."
},
{
"speaker": "",
"content": "Looking at non-OECD Asia, coal still accounts for about 60% of power generation, which is 3x to 4x the level utilized in the United States and Europe. As this region increasingly focuses on reducing and abating emissions, we expect coal to-gas substitution to be more pervasive helping to drive a mid-single digit CAGR for both India and China natural gas demand through 2040, while the rest of Asia will grow at solid low single-digit rate."
},
{
"speaker": "",
"content": "Strong underlying natural gas demand was the robust growth in LNG over the coming decades. Through the end of this decade, we expect demand to increase by mid-single digits annually. We believe this will support and installed nameplate capacity of 800 MTPA by 2030. Looking out to 2040, we expect LNG demand growth to continue, requiring further capacity additions beyond 800 MTPA. While there could be periods of price volatility driven by temporary dislocations in supply and demand over this time period, we see these as opportunities for accelerated demand creation. LNG consumers who tend to be very price sensitive typically respond to lower prices with stronger demand. We have seen evidence of this recently. Global LNG demand is up 4% year-to-date against the backdrop of an approximate 50% decline in LNG prices over the same period."
},
{
"speaker": "",
"content": "As shown on Slide 7, we expect global LNG FIDs of about 100 MTPA over the next 3 years. This view, supported by customer dialogue and our internal LNG demand expectations would result in our installed capacity increasing by 70%. This growing installed base brings significant opportunities for Baker Hughes across the life cycle of the equipment. Like our industrial peers, our Gas Tech businesses typically generates more profitability on the less cyclical aftermarket services. For LNG equipment specifically, this accounted for less than 10% of our total company EBITDA last year."
},
{
"speaker": "",
"content": "On the new energy front, we continue to see good momentum with a number of positive developments across our 5 focus areas of CCUS, hydrogen, geothermal, Clean Power and emissions abatement. As mentioned, we booked $239 million of new energy orders during the first quarter including a Climate Technology Solutions award from Snam for compression trains driven by hydrogen-ready NovaLT 12 turbines. This equipment will support a new gas compressor station in Italy that will eventually transport additional hydrocarbons from Azerbaijan, Africa and the Eastern Mediterranean region to Northern Europe."
},
{
"speaker": "",
"content": "CTS also secured an order to supply ICL Zero emissions integrated compressor technology to be deployed by Total Energy for a process plant in the rock and water region of Argentina. We continue to expand our relationship with the key Middle Eastern industrial company, securing a CTS order for the refurbishment of steam turbines and centrifugal compressor trains. This upgrade drives process efficiency improvement and 5% estimated CO2 emissions reduction as part of the customer's energy transition road map."
},
{
"speaker": "",
"content": "As we look out at the rest of the year, we remain confident in achieving new energy orders between $800 million and $1 billion, which would amount to a tripling of new energy orders since 2021. Longer term, we continue to be encouraged by increasing opportunities to support growing energy demand and decarbonization efforts giving us confidence in achieving our $6 billion to $7 billion new energy orders target in 2030."
},
{
"speaker": "",
"content": "Turning to Slide 8. I wanted to take a moment to reflect on some of the emerging themes within the energy sector. It has been a busy quarter with several industry events, including our own annual meeting in Florence where we hosted over 2,000 customers, partners and industry leaders in January. Firstly, it is becoming clearer just how complex the undertaking is the transition of the world's energy ecosystem. This complexity is driving a slower-than-expected expansion of renewable energy capacity and leading to record levels of coal demand. Consequently, we are seeing more pragmatism towards a pathway for team carbonization."
},
{
"speaker": "",
"content": "We're growing urgency to affect this trend. There is mounting consensus that there is no possible route to decarbonize the energy system without driving greater efficiency and significantly increasing gases weighting within the overall energy mix. Energy providers face the multifaceted challenge of providing secure, sustainable and affordable energy against the backdrop of increasing energy demand. Gas is abundant. Lower emission, low cost and the speed to scale is unrivaled. This is the age of gas. Whether it be the super majors, the NOCs or the independent companies, all of our customers are messaging that they plan to increase their exposure to gas in the coming years. Baker Hughes is extremely well positioned to facilitate this through our upstream capabilities in OFSE and expertise in LNG and gas infrastructure in IET."
},
{
"speaker": "",
"content": "An excellent example of this is the reallocation of capital in Saudi Arabia, primarily towards gas, following the recent announcement to not pursue an increase to its maximum sustainable capacity. The country's shifting focus towards natural gas where production is now expected to increase by more than 60% through 2030 will require significant investment in gas infrastructure. This represents a sizable opportunity for our IET business as highlighted by our MGS3 award."
},
{
"speaker": "",
"content": "Considering this transition towards gas as well as increasing investments in new energy and chemicals, we see this announcement as a long-term net positive for Baker Hughes given our exposure to all 3 markets. In addition, we are seeing a number of gas infrastructure projects emerge around the world. These midstream opportunities, along with solid first quarter bookings give us confidence that non-LNG Gas Tech equipment orders will be up more than 50% this year. Adding further impetus to this growth theme is an increasing demand for artificial intelligence, which is expected to be a key enabler in driving significant productivity and efficiency improvement across the entire energy value chain and could enhance decarbonization efforts."
},
{
"speaker": "",
"content": "At Baker Hughes, we have been utilizing AI within our digital solutions for a number of years. We continue to make great progress with our Leucipa production optimization solution in OFSE and drive greater efficiencies and reliability with our Accordant solutions platform in IET, which both leverage AI. The efficiency and productivity benefits of AI will be balanced by the increased need for energy-intensive data centers. AI will likely drive substantial electrical load growth. Therefore, increasing both the challenge and opportunity to provide clean, reliable and firm power solutions."
},
{
"speaker": "",
"content": "Given the requirement for continuous power supply, the demand for distributed power systems will be substantial with gas to likely dominant fuel source. Baker Hughes is again well positioned to participate in this market through our clean power solutions, particularly our NovaLT fleet of turbines, which can run on natural gas and hydrogen. As the market scales, the size of data centers and power needs will also likely grow, which would benefit our larger scale solutions that include steam turbines for SMR solutions and Net Power."
},
{
"speaker": "",
"content": "With the growing realization that we need an all-of-the-above approach to the energy transition, the focus is shifting towards the emissions rather than the fuel source. I have spoken about this important shift for several years now, and we are pleased to see it taking hold in our customers' operations and policy initiatives. The market's increasing alignment towards the view is spanning stronger momentum, in particular, for CCUS. This is very encouraging to see and provides tailwinds for our technology solutions that play across the entire CCUS value chain."
},
{
"speaker": "",
"content": "Specifically, on the capture side, we continue to make progress across our portfolio, where we are developing a suite of solutions that have applications across various scales and purities of CO2, complementing our capture portfolio at the decades of experience we have in CO2 compression and storage. For CO2 compression, we have experienced a strong increase in demand, both for offshore and onshore applications, while we are also involved in several CO2 storage projects."
},
{
"speaker": "",
"content": "In summary, all of these themes play to the strengths of Baker Hughes and continue to heighten our conviction and our strategy. With our expansive portfolio, capabilities and solutions offerings, we are uniquely positioned to deliver value for our diverse set of energy and industrial customers. This is what differentiates Baker Hughes and enables us to deliver durable earnings and free cash flow across our free time horizons."
},
{
"speaker": "",
"content": "With that, I'll turn the call over to Nancy."
},
{
"speaker": "Nancy Buese",
"content": "Thanks, Lorenzo. I'll begin on Slide 10 with an overview of our consolidated results and then speak to segment details before outlining our second quarter outlook. We are very pleased with our first quarter results above the midpoint of our EBITDA guidance. Orders remain solid as the diversity of IET's end markets continue to support a strong level of orders. We continue to make progress on driving operational improvements across the business to enhance margins and returns, highlighted by the consistent improvement in EBITDA margins and ROIC. We remain confident in our full year guidance that points to another strong year for Baker Hughes."
},
{
"speaker": "",
"content": "Adjusted EBITDA of $943 million increased 21% year-over-year and came in above the midpoint of our guidance range which was due to stronger performance in IET. First quarter GAAP operating income was $653 million. Adjusted operating income was $660 million. GAAP diluted earnings per share were $0.45. Excluding adjusting items, earnings per share were $0.43, an increase of 50% compared to the same quarter last year."
},
{
"speaker": "",
"content": "Our adjusted tax rate continues to trend downwards, declining to 29.7% in the quarter as we continue to execute as planned. As a reminder, we guided to a midpoint of 29.5% in 2024, down from our average 2023 tax rate of approximately 33%."
},
{
"speaker": "",
"content": "Corporate costs for the quarter were $88 million, $2 million lower than our guidance. Total company orders of $6.5 billion maintained strong momentum, highlighted by continued strength in IET orders of $2.9 billion. Alongside a strong order book, IET RPO ended the quarter at $29.3 billion, up 10% year-over-year, while OFSC RPO remained at a healthy $3.4 billion, up 8% year-over-year. These RPO levels provide exceptional revenue and earnings visibility over the coming years. Free cash flow was robust, coming in at $502 million. For the full year, we continue to target free cash flow conversion of 45% to 50% and expect free cash flow to be more weighted towards the back half of this year."
},
{
"speaker": "",
"content": "Turning to Slide 11. Our balance sheet remains strong, as we ended the first quarter with cash of $2.7 billion, net debt to trailing 12-month adjusted EBITDA ratio of 0.8x and liquidity of $5.7 billion."
},
{
"speaker": "",
"content": "Let's turn to capital allocation on Slide 12. In the first quarter, we returned $368 million to shareholders. This included $210 million of dividends where we have increased the quarterly dividend 3x over the past 6 quarters. In addition, we repurchased $158 million of shares. We remain committed to returning 60% to 80% of free cash flow to shareholders. Since the company was formed in 2017, we've now returned over $10 billion to shareholders through dividends and buybacks. Our primary focus is to continue growing our dividend with increases aligned with the structural growth in the company's earning power. We will continue to use buybacks to reach our 60% to 80% target and we'll remain opportunistic on buybacks within this range."
},
{
"speaker": "",
"content": "Now I'll walk you through our business segment results in more detail and provide our second quarter outlook. Starting with oilfield services and equipment on Slide 13. The segment maintained its strong margin trajectory meeting our margin expectations despite heavier seasonality across our international markets. This is a testament to the work the OFSE team has done to drive cost efficiencies across the business."
},
{
"speaker": "",
"content": "Strength and flexibles helped to drive SSPS orders of $633 million, in line with fourth quarter levels. We expect the offshore market to remain strong and SSPS orders should remain at solid levels in 2024 and beyond. OFSE revenue in the quarter was $3.8 billion, up 6% year-over-year. International revenue was down 5% sequentially, while North America fell 3%. Delays in rig reactivations in Mexico and the North Sea impacted international activity, adding to the traditional seasonal declines typically experienced during the first quarter. In North America, offshore declined while North America land held flat."
},
{
"speaker": "",
"content": "OFSE EBITDA in the quarter was $644 million, up 11% year-over-year. This came in slightly below our guidance midpoint due to the previously mentioned seasonal declines and slower-than-anticipated activation of offshore rigs, factors that were considered in our guidance range. OFSE EBITDA margin rate was 17%, increasing 80 basis points year-over-year, driven by continued improvements in cost efficiencies, productivity enhancements and improved execution, particularly in SSPS."
},
{
"speaker": "",
"content": "Now turning to Industrial and Energy Technology on Slide 14. This segment performed above the midpoint of our EBITDA guidance during the quarter due to improving revenues and margins. IET orders were solid $2.9 billion with non-LNG Gas Tech equipment orders more than tripling compared to last year, highlighting the diversity of our customer base and end market exposure. CTS orders were $193 million in the first quarter, highlighted by strong orders for our NovaLT 12 turbines that can run on 100% hydrogen."
},
{
"speaker": "",
"content": "IET RPO ended the quarter at $29.3 billion, up 10% year-on-year. Gas Tech equipment RPO was $11.5 billion. Gas Tech services RPO was $14.6 billion. Gas Tech equipment book-to-bill was onetime, the 11th consecutive quarter of 1 or greater."
},
{
"speaker": "",
"content": "Turning to Slide 15. IET revenue for the quarter was $2.6 billion, up 23% versus the prior year, led by a 46% increase in Gas Tech equipment revenues as we continue to execute our robust backlog. IET EBITDA was $386 million, up 30% year-over-year and exceeding the high end of our guidance range of $380 million from better Gas Tech equipment backlog conversion and strong performance in Industrial Tech. Both drivers were previously identified as factors that would push us to the higher end of our guidance range."
},
{
"speaker": "",
"content": "EBITDA margin was 14.7%, up 80 basis points year-over-year against the backdrop of robust growth in Gas Tech equipment. Solid margin improvement in both Industrial Tech and Gas Tech equipment were partially offset by higher R&D spend related to our new energy investments and continued supply chain tightness in Gas Tech services."
},
{
"speaker": "",
"content": "Before walking through our updated outlook, which is shown on Slide 16, I would like to spend some time on the progress each business is making on achieving their 20% EBITDA margin targets. We're off to a strong start to the year in OFSE and IET. EBITDA margins increased 80 basis points for both segments when compared to the same quarter last year. Looking forward, we see good progression throughout the year and remain confident in our ability to achieve these targets in 2025 for OFSE and 2026 for IET. These are important targets that set a benchmark and demonstrate our operational progress since announcing the consolidation into our 2 segments from 4 segments previously."
},
{
"speaker": "",
"content": "These actions helped to streamline the organization and have created a simpler, leaner and lower cost structure that allows for faster decision-making and has driven more than $115 million of cost out across the company. In reality, we've been working on this since we brought the businesses together in 2017. To accelerate our transition to an energy technology company, we have long held the three-pronged approach of transforming the core, investing for growth and positioning for new energy frontiers."
},
{
"speaker": "",
"content": "To date, the success of transforming the core a key initiative to drive higher profitability and returns across the company has been most visible in OFSE. For this segment, margins are expected to approach 18% this year, up more than 400 basis points from pre-COVID levels. The OFSE team has done a tremendous job transforming the way the business operates with a focus on rightsizing operations, removing duplication and improving service to liberty to drive sustainable, structural improvement in OFSE margins."
},
{
"speaker": "",
"content": "Turning to IET's margin journey. This segment's margin progress has been more measured in part due to the tremendous growth in our Gas Tech equipment business, where we have consistently exceeded our order expectations. We are very excited by the robust growth in our equipment installed base that will drive decades of margin-accretive service growth in Gas Tech."
},
{
"speaker": "",
"content": "The IET team is committed to executing its margin expansion strategy, as the nucleus of this strategy is instilling a more rigorous process-driven culture across the organization. These changes are helping to drive enhanced operational discipline and dedication to continuous improvement. In addition, there is a cultural shift to focus more on value over volume. With these foundational elements in place alongside the opportunities for better R&D absorption, supply chain optimization and execution of higher-margin backlog, we remain confident in achieving 20% margins for the segment."
},
{
"speaker": "",
"content": "Next, I'd like to update you on our outlook for the 2 business segments. Overall, the outlook remains strong for our businesses, which will be complemented by continued operational enhancements, sustained improvement in backlog execution and margin upside. We continue to focus on operational excellence and service delivery across our 2 segments. For Baker Hughes, we expect second quarter revenue to be between $6.6 billion and $7.05 billion and EBITDA between $1 billion and $1.1 billion, resulting in EBITDA margin rate increasing quarter-over-quarter by approximately 70 basis points at the midpoint."
},
{
"speaker": "",
"content": "For OFSE, we expect second quarter results to reflect typical seasonal growth in international and flattish activity in North America. We expect second quarter OFSE revenue between $3.8 billion and $4.0 billion and EBITDA between $660 million and $710 million. Factors impacting this range include the phasing of 2024 E&P budgets, SSPS backlog conversion, realization of further cost-out initiatives and the pace of recovery and activity that was deferred in the first quarter."
},
{
"speaker": "",
"content": "For IET, we expect second quarter results to benefit from strong year-over-year revenue growth as we continue to execute on our new record backlog for Gas Tech equipment and convert our healthy backlog in Industrial technology. We also expect to see continued progress on our margins as we drive productivity enhancements and process improvements across the business."
},
{
"speaker": "",
"content": "Overall, we expect second quarter IET revenue between $2.8 billion and $3.05 billion and EBITDA between $425 million and $475 million. The major factors driving this range will be the pace of backlog conversion in Gas Tech equipment, the impact of any aeroderivative supply chain tightness in Gas Tech and operational execution in Industrial Tech."
},
{
"speaker": "",
"content": "Turning to our full year outlook. We maintain our 2024 guidance issued in January of this year. For the full year 2024, we continue to expect Baker Hughes revenue to be between $26.5 million and $28.5 billion and EBITDA between $4.1 billion and $4.5 billion. At the midpoint, our outlook results in EBITDA growing a strong 14% from the prior year. In addition, we still expect total company new energy orders of $800 million to $1 billion, which at the high end would amount to a tripling of new energy orders since 2021."
},
{
"speaker": "",
"content": "For OFSE, we maintain our full year forecast of revenue between $15.75 billion and $16.75 billion, and EBITDA between $2.8 billion and $3.0 billion as we expect continued strength across international markets to be modestly offset by softness in North America land. We expect IET orders to remain at robust levels this year and maintain a range between $11.5 million to $13.5 billion, driven by strong momentum across all aspects of the IET portfolio. As mentioned, we've already experienced a noticeable increase in non-LNG Gas Tech equipment orders in the first quarter."
},
{
"speaker": "",
"content": "As a result of continued momentum and exceptional orders performance over the last 2 years, we maintain our full year IET guidance for revenue between $10.75 billion and $11.75 billion and EBITDA between $1.65 billion and $1.85 billion."
},
{
"speaker": "",
"content": "In summary, we remain confident in our ability to generate double-digit EBITDA growth for the fourth consecutive year as we remain focused on execution, driving further operational improvements, and capitalizing on market tailwinds with our differentiated portfolio of products and services. Overall, we are very pleased with the progress demonstrated by our first quarter results and remain excited about the future of Baker Hughes."
},
{
"speaker": "",
"content": "I'll turn the call back to Lorenzo."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thank you, Nancy. Turning to Slide 18. 2024 is off to a strong start for Baker Hughes, highlighted by our strong margin performance in both OFSE and IET. Our continued focus on commercial enhancements and cost efficiencies are driving structural improvement in both segments underlying margins. With these transformational efforts gaining momentum, we remain on track to achieve our 20% margin targets for both segments."
},
{
"speaker": "",
"content": "Margin improvement and EBITDA growth are important parts of the Baker Hughes story. As important, we have significantly improved our returns on invested capital, which has increased by more than 3x compared to 2019 levels. Our focus on disciplined growth and margin enhancement facilitated by transforming the way we work is helping to drive meaningful improvements in returns across the company."
},
{
"speaker": "",
"content": "With margins, EBITDA and returns forecast to increase further over the coming years, we expect to see stronger free cash flow conversion of at least 50% through the cycle, and as a result, higher free cash flow. When combined with our balanced portfolio, untapped market opportunities and overhauled cost structure, Baker Hughes is becoming less cyclical in nature and capable of generating more durable earnings and free cash flow across cycles."
},
{
"speaker": "",
"content": "All of these metrics provide a healthy backdrop as we remain committed to returning 60% to 80% of free cash flow to shareholders. This will add to the impressive $10 billion plus that we have already returned to shareholders since forming the new company in 2017. To put this in context, this amounts to almost 1/3 of our current market cap. We have a history of returning cash to shareholders and expect to continue that trend well into the future."
},
{
"speaker": "",
"content": "With that, I'll turn the call back over to Chase."
},
{
"speaker": "Chase Mulvehill",
"content": "Thanks, Lorenzo. Operator, let's open the call for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Scott Gruber from Citigroup."
},
{
"speaker": "Scott Gruber",
"content": "So your IET margins were quite strong despite a headwind from more equipment revenues, which is great to see. And Lorenzo, you walked through the multiple drivers. Looking at 2Q, IET guidance is above our forecast, but you did list the full year. So can you walk through how you think about those margin drivers continuing? How do you think about the impact on the second half for IET? Are there reasons to believe the normal seasonality may be a bit more muted for both revenues and margins in the second half? Or is the high end of the range for full year revenues and EBITDA will be more likely now for IET?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, Scott, first of all, very strong quarter for the company. And as you said, led by also IET, but overall, very pleased by both segments. And IET, a very strong, solid quarter. And as we've said, we've been committed to our journey on IET towards the 20% EBITDA, and you're starting to see some of those levers coming through as you look at first quarter and as you look at the rest of the year, again, you've got strong backlog conversion in Gas Tech equipment."
},
{
"speaker": "",
"content": "As you can see in the first quarter, revenue up nearly 50% and year-over-year, and that helped the Gas Tech equipment. From a margins perspective, EBITDA was up nearly 200 basis points. And you're seeing the better backlog margin coming through as well as productivity in the factories. Of a bright spot was in IET from an Industrial Solutions perspective as you look at the revenue side, but also when you look at the projects and the services revenue, which was up 20% year-over-year and margins also improving in the Bentley Nevada with some of the supply chain constraints that we've discussed before that have been alleviated now."
},
{
"speaker": "",
"content": "And also Gas Tech services revenue increasing as we went through the first quarter, we continue to see that for the rest of the year, even though we're still constrained by some of the supply chain headwinds. So as you look at IET for the rest of the year, we continue on the basis that we've said and the journey that we've laid out with continued margin expansion and improvement towards that 20% as we go forward as we continue the journey."
},
{
"speaker": "Scott Gruber",
"content": "Got it. And then turning to the production side of OFSE. We recently saw one of your big competitors moved to enhance their position. How do you see the market evolving for the production vertical where you have a strong position? Does the growth rate for production start to rival the growth rate for drilling and completion spend in '25 and beyond? And how do you think about the competitive dynamics in the market? Your team was quite excited by your production optimization solutions at your annual meeting?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, Scott, it's a very good point. And for us, what's happening from the external perspective and the dynamics doesn't change the strategy, and we've been firmly focused on a strategy around production solutions for some time. As you know, from the comments that I made at the annual meeting, 70% of the world's production comes from mature assets. And a mature asset being a well that's produced 50% of its reserves or has been in production for over 25 years. And when we look at the future, there's a tremendous focus on improving that optimization."
},
{
"speaker": "",
"content": "And we've got some great capabilities with the largest global installed base of ESPs 44,000 pumps. And we're moving about 80 million barrels fluid daily. And again, as you look at continued chemicals that are being applied and 1% improvement just in mature asset production can give 2 to 3 years of global consumption. So as we go forward, no change, and we continue to see this as a space where between our RTS, our ESPs and chemical solutions and also the digital automation and AI that we can deliver through Leucipa, being a great opportunity for our customers and an increasing area of focus for our company."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Arun Jayaram from JPMorgan Securities LLC."
},
{
"speaker": "Arun Jayaram",
"content": "Lorenzo, I want to start with the Saudi MSC reduction. I wanted to get your perspective on the potential impacts to Baker from the changing mix of activity with the higher mix of onshore versus offshore. And perhaps you could just comment on the gas side of the equation with higher infrastructure spend chemicals and new energy spend, what that means for Baker as we think about rest of this year and into next year?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, Arun. We remain confident in the international market outlook. We expect E&P spending to be up high single digits this year. And as we look at, in particular, the MSC reduction, as we said in the last call, we don't anticipate any real changes. And in fact, when we look at Saudi, we see it as opportunities outside of just the upstream area given our presence. As you know, natural gas production is set to grow by 60% through 2030, and it's going to benefit our IET business. You saw the announcement that was made in 1Q relative to the Master Gas System 3, the pipeline project. There's going to be more opportunities down the road."
},
{
"speaker": "",
"content": "Also, this shift of CapEx is also across new energy and chemicals. We recently opened our new chemicals facility in the Kingdom. We're also, as you know, from a new energy perspective, participating in hydrogen on NEOM. So overall, this CapEx shift for us is a long-term net positive for Baker Hughes and doesn't change the outlook that we laid out at the beginning of the year."
},
{
"speaker": "Arun Jayaram",
"content": "Great. That's helpful. Maybe a follow-up, maybe for Nancy. Nancy, I want to get your take on some of the puts and takes around the 2Q guide. It looks to be about 3% above our model and it looks like just slightly better margins. And so just wondering if you could talk about some of the puts and takes and just the fact that you kept the back half, maybe a follow-up to Scott's question, the full year is the same. And are you getting a little bit more confidence on the full year outlook given what's transpiring in the first half of the year?"
},
{
"speaker": "Nancy Buese",
"content": "Yes, happy to take that one. So on Q2, I'd really say the strength in our guide for that quarter highlights our differentiated portfolio. And we've really been talking about how that's helping us to frame up more durable earnings and strong free cash flow generation and growth. Our midpoint for EBITDA guidance in Q2 really represents about 16% year-over-year growth, and that's about 20% EBITDA growth in the IET business. So there are a lot of good drivers there. We've talked about the really robust backlog levels that are driving the Gas Tech equipment acceleration and much higher margins in the backlog as we convert as we've been signaling. And then we're also seeing broadening strength across Industrial Tech."
},
{
"speaker": "",
"content": "I would also say the cost focus and the process-driven mindset deepen in the business is starting to signs of really solid momentum. And the midpoint of that guidance is indicating that margin expansion, and that's even as Gas Tech equipment growth continues to impact us. And again, we've talked very much about how the growth in equipment is great for us in the longer term, and we love that installed base."
},
{
"speaker": "",
"content": "I would say that's also offset a bit by a slower-than-expected start to the year in OFSE, and some of that's related to timing and offshore rig delays. So on balance, we'd say Q2 is showing modestly better seasonal recovery on the OFSE side as some of those rigs come out of maintenance and also some of the delayed product shipments came out of Q1 into Q2. But net-net, I would say for the year, we would retain our guidance as is. There's still a lot of unknowns, and it's still early in the year. We're very confident in our full year guidance. And we'll keep an eye on it. If there's more to tell, we'll be back to you next quarter with more information, but we feel very good about execution, and we're on the right track for Q2 and balance of the year."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Dave Anderson from Barclays."
},
{
"speaker": "John Anderson",
"content": "I was wondering if you could talk a little bit about the non-LNG side of the IET Gas Tech equipment order side. I think you made a couple of comments on there, you talked about is these have tripled this quarter and you expect to be up 50% this year. Could you kind of dig into that a little bit about where that's being driven from? I know we had an offshore side, which tends to be a little lumpier. I know you had the MGS3 award in there, but could you just sort of talk about the mix of that non-LNG business, please?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Definitely, Dave, and thanks for the question. Obviously, we've spoken a lot about LNG, and we will, I'm sure, in the future. And I think at times, we don't get a lot of time to talk about the non-LNG sector, and it's a very important part of our portfolio, and it's very expensive as well in the equipment and solutions that play across a number of end markets, including the upstream, midstream, refining, petrochemical, as you look at the pipelines and various industrial and other end markets. And it's really the versatility of our equipment that not only goes into LNG but goes into these other end markets. And 1Q was evident of that. And as you said, tripled in 1Q versus prior year."
},
{
"speaker": "",
"content": "Onshore/offshore production has remained consistently strong as part of the mix. As you see, both on the compression side, you see on the power generation side. You highlighted the Master Gas System. And as you continue to see the shift towards gas, that gas infrastructure plays towards a lot more compression, plays towards also the pipelines that place towards a lot of the onshore power generation that's going to be necessary."
},
{
"speaker": "",
"content": "Also, as you look at on the Industrial side, when you think about the need for distributed power generation, that plays to the Industrial gas turbines that we have, the NovaLT. So across it, we see an expanding base of non-LNG equipment. And again, it's part of the expansive portfolio that we have, including the pumps, the valves and the other areas that go into the other sectors when you think of refineries and also petrochemicals that are also increasing infrastructure builds that are happening around the world as we continue through an energy demand that is increasing."
},
{
"speaker": "John Anderson",
"content": "And Lorenzo, sort of expanding upon that, I'd like to dig into maybe a little bit of what's going on in Saudi here. You touched on here a bit. Obviously, we saw the award we saw this quarter. But I'd be curious if you could talk about how you're differentiated versus your competitors on both the IET side and the OFSE side. On the IET side, you're talking about displacing oil-driven power in the Industrial side of the natural gas. And so that seems like an enormous opportunity in Saudi, but it seems like it's a very unique opportunity for really just Baker. And then if I flip over to the OFSE side, one thing you've really done differently than others is manufacturing in country, could you talk to that a little bit about how that's a key initiative in the Kingdom and how that gives you an advantage?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, Dave, thanks. And I know that you and the team also had the chance to tour the region and also visit the Kingdom. And that's true. We focused a lot on localization. And as I mentioned, we've just recently opened our chemicals facility on new Petrolite. We've also got wellheads that are manufactured. We've also got compressors. And as we look at drill bits and across the Kingdom, we focused on localization to support not just the Kingdom, but also support the region and outside of the region through capability close to our customers. And that's been a strategy of focus."
},
{
"speaker": "",
"content": "And the diversification of Baker Hughes is across the 2 major segments. We play obviously within the oilfield services on the equipment side, but then the gas infrastructure side, the hydrogen when we think of NEOM and the facilities associated with hydrogen, the infrastructure that's going to be required when we think of distributed power generation. And as you think of also the opportunity for productivity and also with digital capabilities and solutions."
},
{
"speaker": "",
"content": "So across the board, I think what makes us unique is, again, the ability to play at the full value chain of the energy ecosystem within the Kingdom through local capabilities. And that's a strategy that we've also put into place in other Middle Eastern countries as well with facilities in the UAE and Qatar. And likewise, it's a region that's very important to us."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of James West from Evercore ISI."
},
{
"speaker": "James West",
"content": "Lorenzo, I wanted to touch back on carbon capture because it sounded like there was a bit of a shift in your tone there with respect to projects starting to move forward and to scale. So I want to know, one, is that accurate? Two, have you seen any change or have you put any change in your CCUS strategy? And how about an update on your kind of commercialization of some of the newer technologies in carbon capture?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, definitely, James. And as we look at what's happening, and we've been discussing for some time, the continued increasing demand for energy and the realization that we need in all of the above approach to the energy transition, it means there's a shifting focus towards emissions rather than the fuel source. And that puts the forefront CCUS. And as you know, we've been playing and participating in CCUS for many decades. But we've also been investing in CCUS capabilities. And so as we go forward, we think CCUS is going to be a first mover."
},
{
"speaker": "",
"content": "And as you look at our order intake also on the new energy front, you can see from last year also that a large portion of our orders was associated with carbon capture, utilization and storage. And we've got a wide array of capabilities that we've been developing. We've got the chilled ammonia process, which is for large-scale applications like power generation. We've got the mixed salt process and compact carbon capture, which is rotating bed solution, which is suitable for a smaller footprint of industrial applications."
},
{
"speaker": "",
"content": "And then we're also testing and piloting Mosaic materials for direct air capture technology and complementing all of this is the compression capability that we have and also storage and the knowledge of the reservoir and how to store and maintain the CO2 and compress it. So this is a theme that we see in projects that are going forward. And we think that's increasing as the year progresses and also going into the next few years. As people appreciate that it is an all of the above and we're going to need to focus more on emissions as opposed to fuel source."
},
{
"speaker": "James West",
"content": "Great. And then maybe a follow-up on the all of the above comment. Lorenzo, wouldn't you have relationships with all the major tech companies, and they're trying to scale data centers and that's being supercharged by AI. It seems to me that renewable deployment is not going to be able to keep up with that. So we're going to have to go towards some type of fossil fuels, and it sounds like gas is the one they're targeting. But all of these data center providers beginning to at least acknowledge that reality that for some period of time, we're going to have to build out potentially is more gas infrastructure to support this because the power generation needs are running well ahead of renewable or cleaner fuel sources?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, I'd agree with you that there's a growing realization that there's a growing demand for energy, and that's being driven by some of the data centers. And look, AI provides huge benefits both internally and also from an external perspective to us internally to drive optimization for our customers, but also externally to drive growth for our equipment and the services that we provide. And that's why we like the ready gas turbines that go on natural gas today, but then can switch to hydrogen, that's also why we like the solutions that we're offering with regards to other clean power solutions. And as we talk to our customers, that's what they're looking for."
},
{
"speaker": "",
"content": "And if you look at the data center developers, they're all coming to a realization that there is going to be a growing need for off-grid solutions as well as distributed power generation with a view to continuing the aspect of reducing emissions. So there's also opportunities for geothermal and others where we play. And we look at it as being a growing element of our equipment portfolio and a nice segment that, again diversifies us versus others because of the portfolio that we have."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Luke Lemoine from Piper Sandler."
},
{
"speaker": "Luke Lemoine",
"content": "The IET orders you had in 1Q put you on a nice pathway to hit the midpoint of the annual guide with GTE being the largest component. I'm sure most of the durability resides here. And you talked about some of the LNG awards outlook within GTE. But can you just talk about some of the puts and takes within the annual order guidance for IET?"
},
{
"speaker": "Lorenzo Simonelli",
"content": "Yes, I'll kick it off here, Luke. And we remain very confident in the orders range that we provided for 2024. If you look, we started the year very positive from the orders front, booking over $2.9 billion of orders, including large awards, again from Aramco, but also from Black & Veatch for Cedar LNG. And LNG equipment will still be a portion of the orders outlook as we go through the year. And again, it was significant last year. But it's also outside of LNG. It's onshore/offshore production. It's the gas infrastructure and also coupled with the new energy."
},
{
"speaker": "",
"content": "And as you look at the guidance that we've given of new energy orders between $800 million to $1 billion and stable growth in services and Industrial Tech. So very confident in the $11.5 billion to $13.5 billion orders range and a strong pipeline of activity. And when you look at what's being heard from our customers and also what's being seen, I think growing confidence on the elements of gas infrastructure and the opportunities that we have in the multiple sectors that we play in."
},
{
"speaker": "Luke Lemoine",
"content": "Okay. And then Nancy, on getting to the 20% margins next year, there were some finer points, but the broad buckets had kind of been on productivity cost, price volume. Could you just refresh us on the drivers here and maybe the confidence around the individual pieces?"
},
{
"speaker": "Nancy Buese",
"content": "Absolutely. We absolutely remain confident in hitting those 20% EBITDA margins, and you're starting to see some traction with a lot of the activities that have been done in the segment and continuing actions. And we do still see strength in international markets this year. We're also maintaining our outlook for high single-digit E&P CapEx. So those are good drivers as well. I would also just note that hitting that margin target does not require an acceleration of growth compared to where we already are. So that's all baked into it."
},
{
"speaker": "",
"content": "Alongside that, we do have a cost-out program that we've announced with Q4 earnings, and that's really helping to reset the cost structure within the segment, reducing further duplication and becoming more efficient. I would say the team is also focused on continuing to drive more cost efficiencies around the business, and we'll see more of that come to play as 2024 unfolds."
},
{
"speaker": "",
"content": "The other piece of it is on the SSPS side, we have higher margin activity in that backlog, and you'll see that drive up margins in '24 and '25. So overall, I would say that 20% margin target remains in place. We feel very confident on it and it doesn't require anything from market tailwinds to achieve. So that's within our control, and we continue to focus on that target."
},
{
"speaker": "Lorenzo Simonelli",
"content": "Thanks, everyone, for joining the call today, and look forward to speaking to everybody soon. And I think, operator, you can close the call."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day."
}
] |
bldr | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Alright. Please standby. Good day, and welcome to the Builders FirstSource Fourth Quarter 2024 and Full Year Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by management. I would now like to turn the call over to Heather Kos, Senior Vice President of Investor Relations for Builders FirstSource. Please go ahead."
},
{
"speaker": "Heather Kos",
"content": "Good morning, and welcome to our fourth quarter and full year 2024 earnings call. With me on the call are Peter Jackson, our CEO, and Pete Beckmann, our CFO. The earnings press release and presentation are available on our website at investors.cldr.com. We will refer to the presentation during our call. The results discussed today include GAAP and non-GAAP results adjusted for certain items. We provide these non-GAAP results for informational purposes and they should not be considered in isolation from the most directly comparable GAAP measures. You can find the reconciliation of these non-GAAP measures to the corresponding GAAP measures, where applicable, and a discussion of why we believe they can be useful to investors in our earnings press release, SEC filings, and presentation. Our remarks in the press release, presentation, and on this call contain forward-looking and cautionary statements within the meaning of the Private Securities Litigation Reform Act and projections of future results. Please review the forward-looking statements section in today's press release and in our SEC filings for various factors that could cause our actual results to differ from forward-looking statements and projections. With that, I'll turn the call over to Peter."
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Heather, and good morning, everyone. Before I get into my prepared remarks, on behalf of Builders FirstSource, I want to send our thoughts to all of those who have been impacted by the California wildfires. I'm proud of how we have come together as a company to support disaster relief efforts. We will work together with our partners to help communities rebuild in the years ahead. Our fourth quarter and full year results demonstrate our resilience and ability to drive results in the face of a complex operating environment while maintaining our focus on building the future. This begins with our strategic pillars, as we show on slide three. By continuing to invest in our value-added products and services, along with leveraging cutting-edge technology, we are addressing customer challenges and serving as a supplier of choice. We have a fortress balance sheet and consistently generate strong cash flow over the cycle, enabling us to remain disciplined and opportunistic as it pertains to capital allocation. Our investments today in organic growth opportunities and value-enhancing acquisitions position us to perform well in any environment. Let's turn now to our full year 2024 performance on Slide four. The strength of our differentiated platform and our operational excellence initiatives drove a mid-teens adjusted EBITDA margin and a nearly 33% gross margin in 2024. Results this year are further proof that our success is driven by the dedication of our hardworking team members and the support of our customers. Turning to slide five, I'd like to share more detail on the execution of our strategy. Our strong organic growth engine is fueled by our investments in value-added solutions and digital tools. In 2024, we invested more than $75 million in our value-added facilities to address demand in our growing markets. This included opening two new truss manufacturing facilities, upgrading nineteen truss facilities, and enhancing thirteen millwork locations. Our install sales increased by 8% year-over-year, and we leveraged our product expertise to help our customers progress along the value-added continuum. While we've always done install in some capacity, we have emphasized it in recent years by utilizing playbooks to expand into new markets and improve execution in existing ones. By growing install in a down market, I'm optimistic about this substantial opportunity for business going forward. In line with this optimism, adoption rates for our industry-leading digital platform are steadily climbing on the heels of consistent positive feedback from our customers. I'm pleased that we were able to achieve $134 million in incremental digital sales in 2024 despite the challenging environment that has persisted for our target customers. Our focus on operational excellence resulted in $117 million in productivity savings in 2024. We accomplished this mainly through supply chain initiatives and more efficient manufacturing. For instance, we were able to improve board foot per labor hour by 10% in truss and panel manufacturing. Not only do our productivity initiatives increase our efficiency, but they also drive additional revenue by enhancing available capacity and shortening lead times. We remain disciplined stewards of discretionary spending and are continuing to maximize operational flexibility. We consolidated roughly thirty facilities in 2024 while maintaining our service levels to our customers with an on-time and in-full delivery rate of over 90%. Single-family starts pulled back as builders manage the pace of building in the face of affordability challenges and uncertainty around potential policy changes. As expected and communicated, multifamily remains a headwind amid muted activity. In response to lower volumes over the last year, we have taken steps to align capacity across our facilities, reduce headcount, and manage expenses. On a normalized basis, multifamily represents about 9% to 10% of net sales and remains an attractive and profitable business for us. As we have signaled, multifamily will be a headwind again in 2025. To address the current environment and affordability challenges, builders continue to employ specs, smaller and simpler homes, and interest rate buy-downs to help buyers find affordable options. Builders of all sizes are working to navigate complex market conditions, including regulatory, land development, and infrastructure challenges. Smaller builders have been especially impacted by the availability of land and limited options to buy down rates. We are strengthening our partnerships with customers by offering innovative solutions to address affordability challenges. Our comprehensive product portfolio allows us to provide flexible options enabling builders to optimize their costs while maintaining quality. We continue to supply more lower-cost offerings and products like EWP, windows, and doors to help alleviate affordability challenges. Although these actions to support our customers mean less sales and gross profit dollars for BFS, our margin profile remains strong, and we are very well positioned for growth when starts increase and structural headwinds begin to subside. Turning to M&A on slide six, we continue to pursue high-return opportunities that augment our value-added product offerings and advance our leadership. Over the years, we have developed substantial improvement muscle memory to grow through M&A and have a proven track record of successful integration. In 2024, we completed thirteen acquisitions with aggregate prior year sales of roughly $420 million. In October, we acquired Douglas Lumber, which supplies building materials in New England. In November, we acquired Cleat Lumber, a leading provider of building materials on Long Island. In addition to the acquisitions we completed in 2024, in early January, we acquired Alpine Lumber, the largest independently operated supplier of building materials in Colorado and Northern New Mexico with twenty-one locations. Alpine's broad product portfolio includes prefabricated trusses and wall panels. And in February, we acquired OC Plus Lumber and Building Supplies, a leading supplier of lumber, building materials, and installation services in Pennsylvania, Maryland, and West Virginia. These acquisitions reinforce our commitment to invest in our strong value-added business through M&A, and we are excited to welcome these talented new team members to the BFS family. Turn to slide seven. Our disciplined capital allocation strategy focuses on maximizing shareholder returns through organic growth, inorganic growth, and share repurchases. In 2024, we deployed a total of $2.2 billion. We allocated $367 million to sustaining the business as well as ROI-generating growth investments in value-added capacity and digital. We spent $352 million on thirteen acquisitions to expand our footprint into high-growth geographies and enhance our value-added offerings. And we executed opportunistic share repurchases of approximately $1.5 billion, removing roughly 7% of shares outstanding. Now let's turn to slide eight and discuss the latest updates on our digital strategy. With our BFS digital tools, we are focused on creating value for our home builder customers and, in doing so, further extending our industry leadership position and driving substantial organic growth. Despite the challenging market, we have seen continued adoption and growth with our target audience of smaller production builders, in addition to interest from multiple top two hundred builders. We continue to release enhancements that are improving the user experience and helping to drive adoption. Since launching about a year ago, we have seen nearly $1 billion of orders placed through our digital platform, of which $134 million were incremental sales from existing and new customers. We're pleased with our progress to date, and we expect additional incremental sales of approximately $200 million in 2025 as we grow wallet share and win new customers. I'm incredibly grateful to lead such a talented and hardworking team that makes a difference every day. One shining example of our values is Bob Whitney in Issaquah, Washington, who recently celebrated forty-five years with BFS. Bob began his journey with us as an administrative assistant managing invoices on the location's first computer, a massive machine that filled a twenty by twenty-foot room. Fast forward to today, Bob, a senior designer, is frequently cited by home builders and framers in the area as the key reason they choose our engineered wood products. With detailed designs, expertise, and an innovative approach to finding more efficient ways to accomplish tasks, he has set a high standard. I'm proud of Bob and our countless other dedicated team members who continually raise the bar on service to our customers and each other. I'll now turn the call over to Pete to discuss our financial results in greater detail."
},
{
"speaker": "Pete Beckmann",
"content": "Thank you, Peter, and good morning, everyone. Our fourth quarter and full year results reflect our ability to execute by leveraging our exceptional operating platform and financial flexibility. Our fortress balance sheet, consistently strong cash flow generation over the cycle, and ability to prudently deploy capital to the highest return opportunities are positioning us for further success. Our scale and investments in innovation enable us to serve as a key partner to homebuilders, and we have a clear line of sight to compound value creation over the long term. We believe we are well positioned for meaningful operating leverage into the recovery. Let's begin by reviewing our fourth quarter performance on Slide nine and ten. Net sales decreased 8% to $3.8 billion driven by lower core organic sales as well as commodity deflation, partially offset by growth from acquisitions and one additional selling day. The core organic sales decrease was driven by a 29% decline in multifamily amid muted activity levels against strong prior year comps. Additionally, single-family declined 7% amid lower value, while repair and remodel was roughly flat versus the prior year. Valuated products represented 50% of our net sales during the fourth quarter and were roughly balanced between manufactured products and window doors in the work. As we have shared on recent calls, there are three main variables reconciling single-family starts to our core organic sales. The first variable is the lag between permits and starts. Like Q3, this was less of a factor, with construction times mostly back to normal for our larger customers. On average, we expect a roughly two-month lag between a single-family start and our first sale. Second, the value of the average home has fallen as size and complexity have decreased. Finally, we saw slight normalization in selling margins of non-commodity products and the lapping of manufacturer price reductions. To summarize, although macro headwinds persist and there are fewer sales dollars available for start today, we remain the market leader in building products and are a trusted partner to our customers as they grapple with affordability challenges. For the fourth quarter, gross profit was $1.2 billion, a decrease of approximately 16% compared to the prior year period. Gross margins were 32.3%, down 300 basis points, primarily driven by single-family and multifamily margin normalization. As discussed previously, our exit velocity at the end of 2024 was approximately 31.5% given normalization and competitive dynamics. Adjusted SG&A decreased approximately $35 million to $764 million, primarily attributable to lower variable compensation due to lower core organic net sales and intangible amortization expense, partially offset by acquired operations. On an annual basis, adjusted SG&A is approximately 30% fixed and 70% variable with volumes, enabling flexibility during challenging periods. We are focused on carefully managing our SG&A and are well positioned to leverage our fixed costs as the market grows. Adjusted EBITDA was approximately $494 million, down 28%, primarily driven by lower gross profit, partially offset by lower operating expenses after adjustments. Adjusted EBITDA margin was 12.9%, down 360 basis points from the prior year, primarily due to lower gross profit margins and reduced operating leverage. Adjusted EPS was $2.31, a decrease of 35% compared to the prior year. On a year-over-year basis, share repurchases enabled by our strong free cash flow generation added roughly $0.15 per share for the fourth quarter. Now let's turn to our cash flow, balance sheet, and liquidity on slide eleven. Our 2024 operating cash flow was $1.9 billion, a decrease of approximately $400 million, mainly attributable to lower net income. For 2024, we delivered higher than expected free cash flow of approximately $1.5 billion. Our trailing twelve months free cash flow yield was approximately 9%, while operating cash flow return on invested capital was 22%. Our net debt to adjusted EBITDA ratio was approximately 1.5 times. Excluding our ABL, we have no long-term debt maturities until 2023. At year-end, our total liquidity was approximately $1.8 billion, consisting of $1.6 billion in net borrowing availability under the ABL and approximately $200 million in cash. Moving to capital deployment, capital expenditures were $96 million in Q4 and $367 million for the year. We deployed approximately $90 million during Q4 on two acquisitions and $352 million on thirteen acquisitions in 2024. During the fourth quarter, we repurchased roughly two million shares for approximately $345 million. For the year, we repurchased 8.9 million shares or $1.5 billion. Since the inception of our buyback program in August 2021, we have repurchased 46.5% of total shares outstanding at an average price of $79.56 per share for $7.6 billion. We have approximately $500 million remaining on our $1 billion share repurchase authorization. We remain disciplined stewards of capital and have multiple paths for value creation to maximize returns. On slide twelve, we show our 2025 outlook. For full year 2025, our forecast assumes a flat single-family market and continued weakness in multifamily. As a result, we are guiding net sales in the range of $16.5 to $17.5 billion. We expect adjusted EBITDA to be between $1.9 to $2.3 billion. Adjusted EBITDA margin is forecasted to be in the range of 11.5% to 13%. In line with our long-term target, we expect our 2025 full year gross margin to be in a range of 30% to 32%. We expect full year 2025 free cash flow of $600 million to $1 billion. The change from 2024 to 2025 is primarily due to a $500 million swing in working capital as we move from shrinking to growing sales, as well as higher capital expenditures and interest expense. Our cash flow guidance also includes our ongoing ERP investment. As we have said, we will start our ERP pilots later this year and have a plan to complete a phased implementation by 2027. Our 2025 outlook is based on several assumptions, including average commodity prices in the range of $380 to $430 per thousand board foot. This does not assume significant changes to existing duties and tariffs. Imports account for approximately 13% to 15% of our total purchases. The price of 8% to 10% commodities and 3% to 5% non-commodity. Please refer to our earnings release and presentation for a list of key 2025 assumptions. As you all know, we do not typically give quarterly guidance, but we wanted to provide color for Q1 given extreme weather and macro volatility. We expect Q1 net sales to be between $3.5 and $3.8 billion. Year-to-date, we have lost sales of approximately $80 million due to extreme weather and the California wildfire at the start of the year. Q1 adjusted EBITDA is expected to be between $350 million and $400 million. While we expect our sales to rebound quickly as severe weather conditions subside, the areas impacted by the California wildfires will likely take much longer to recover. Turning to slides fourteen and fifteen, as a reminder, our base business approach normalizes sales and margins for commodity volatility. This helps us to clearly assess the core strength of the business where we have focused our attention on driving sustainable outperformance. Given expected 2025 commodity prices near the historical twenty-five-year average of $400 per thousand board foot, the base business guide is approximately the same as our total guide. As I wrap up, I am confident in our ability to drive long-term growth by executing our strategy, leveraging our exceptional platform, and maintaining financial flexibility. With that, I'll turn the call back over to Peter for some final thoughts."
},
{
"speaker": "Peter Jackson",
"content": "Let me close by reiterating that we remain focused on controlling the controllables. Our resilient business model enables us to win in any environment. Given our scale, breadth of product offerings, and investments in technology, I'm confident in the long-term strength of our industry due to significant housing underbuild across our core markets. We are well positioned to capitalize on this, driving growth for years to come as we execute our strategy. We continue to deepen our value proposition as a key partner to our customers by helping them solve problems through our investment in value-added products, digital tools, and install services. Our proven growth playbook, fortress balance sheet, and robust free cash flow generation through the cycle will help us continue to compound long-term shareholder value. We are making strategic investments today to enhance efficiency and drive sustainable growth for the future. Thank you again for joining us today. Operator, let's please open the call now for questions."
},
{
"speaker": "Operator",
"content": "Certainly. At this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. We will take our first question from Matthew Bouley with Barclays. Please go ahead."
},
{
"speaker": "Matthew Bouley",
"content": "Morning, everyone. Thank you for taking the questions. A couple of questions on the outlook. So organic revenues, core organic in 2025, I think you're speaking to sort of a very low single-digit decline if I back out the M&A. Correct me if I'm wrong, but I wanted to get a sense for what you're thinking on some of those variables that you mentioned earlier that impacted the business in 2024. You know, the declining home sizes and the value of homes, some of the vendor price reductions, I think you called out. Those seem like a bit of a headwind in Q4. So I wanted to get a sense if you're seeing any signs of stabilization across those variables and how those are contemplated in the guide. Thank you."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Matt. Maybe I'll frame it and let Pete fill in any details that I missed. But what I would tell you is that, broadly, the market is pretty stable at a level below where we would like. I think that as you listen to the builders, we're hearing a lot of the same things. Obviously, the challenges that they're seeing in the broader market or in the broader public discussions that they're having. There is a battle that's going on with affordability. We're all engaged in it and trying to make sure that we find ways to deliver homes that people can actually acquire. And it's been a bit of a rocky road. Interest rates haven't helped. Builders have been sort of modulating their build pace in order to maintain inventories at a reasonable level. Seems, by all accounts, they've done a pretty good job of it. But that's put us in this rather stagnant sort of stable but lower than we would like level. I think that continues. Some puts and takes around starts, some puts and takes around completions, but that's been sort of the storyline, and we continue to see that on the single-family side. Multifamily, it's down. I would say it's been leveling out. Stable, kind of like we've talked about. Unfortunately, again, at a fairly low level, haven't quite seen the recovery and the run that I think we're all hoping for. Maybe that's just dependent on rates, as people say. We'll see. Pete, I'm not sure what I missed."
},
{
"speaker": "Pete Beckmann",
"content": "Yeah. So regarding the average home size, we're seeing that start to level out. It's still downward pressure consistent with what the public builders have communicated. They're seeing some, I would say, mixed toward a smaller home, but it's very more modest than it has been over the past year. As Peter mentioned with the multifamily, that's included in our core business. And we indicated last quarter that we were gonna see about $400 million to $500 million headwind in sales really in the first half of this year as we continue to lap the prior year comps. So that's included in the core organic as we look forward through the year."
},
{
"speaker": "Matthew Bouley",
"content": "Okay. Perfect. Thank you for all that detail. Very helpful. And then I guess jumping down to the gross margin, obviously, the fourth quarter came in above the guide and you're calling for that 30% to 32% this year, in a year where starts are still fairly well below that normalized range. So is that, you know, you talked about that kind of mix of higher margin products, maybe it's lower value, but, you know, like EWP, solving challenges for builders. Is that piece primarily what's surprising you to the upside on the gross margin? Or, you know, as we kind of look out to this year, is maintaining that margin really where the priority is, or does it make sense in some cases to be more aggressive with share? Thank you."
},
{
"speaker": "Pete Beckmann",
"content": "That's a great question. It's a fine line and a balancing act that we deal with every day. Our exit velocity, just as a reminder, was around 31.5% even though our Q4 margins were a bit higher. Our exit velocity was still around that 31.5%. We see continued competitive pressures from the single-family side as we continue through 2025. Right now, given our current assumptions, we believe the 30% to 32% range is a reasonable range. Now if something changes from the assumptions, we'll have to evaluate it. But right now, we're seeing the strength in our value-added mix continue to help our margin profile. And as we come out of the seasonal lows of Q4 and Q1, seeing that mix strength from value add continues for our margin profile."
},
{
"speaker": "Peter Jackson",
"content": "Yeah. We're, I mean, we're seeing the pressure you would expect of an industry below normal in terms of total starts. And I think what we've baked in here is our desire, our intent, and I think our proven ability to protect share and manage margins in a thoughtful way. Gotta stay in the market. But we think what we've laid out is a plan that allows us to do that. Effect our share, to be aggressive, and make sure we're competitive but to still demonstrate, I would say, a very healthy margin profile."
},
{
"speaker": "Matthew Bouley",
"content": "Got it. Well, thank you both, and good luck, guys."
},
{
"speaker": "Peter Jackson",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Mike Dahl with RBC Capital Markets."
},
{
"speaker": "Mike Dahl",
"content": "Hi. Thanks for taking my questions. Just follow-up on the gross margins and, you know, with the exit rate comment on 31.5% from, you know, back of the envelope, it seems like maybe the Q1 guide implies something closer to, yes, 30% to 31.5%, maybe a little bit lower than that exit rate. But can you just talk a little bit more about what's really embedded in Q1 and how you see the progression through the year in gross margins?"
},
{
"speaker": "Pete Beckmann",
"content": "So, Mike, what I can tell you is we're seeing that continued normalization from the multifamily as we're exiting the year, and the competitive pressure on the single-family side, especially in the seasonal lows, having further pressure on the margins in Q1, not to a significant degree, but some degree from that exit velocity. We see that really being the entry point to the year and have some of that mix built in from the rest of the year to help keep that margin in the midpoint of what we guided."
},
{
"speaker": "Peter Jackson",
"content": "I guess the only thing I'd add to that is if you think about it at a higher level, we have been focused on the 2025 bids. Right? So at the beginning of the year, you frequently see a lot of builders coming out saying, okay, here we're gonna set up for the year. Let's put out our big bids. Let's work hard to set things up for the year. We've been engaged very heavily in that, as you might imagine. It's given us a sense of where the year is starting out and trying to give you that with our quote exit velocity. That's our sense of it. So I think it gives us a good flow into the beginning of the year for the core business. Layered on top of that is all of that sort of lapping of the final throws of multifamily in the first half of this year that Pete referred to. So those are kind of the two aspects of what we're looking at as we build out the forecast and give it back."
},
{
"speaker": "Mike Dahl",
"content": "Okay. That's helpful. And that segues into my other follow-up, which is about the comments on protecting share, competitive dynamics. You know, you've obviously been very selective in terms of the type of business and margin that you pursue over the last couple of years. You know, it sounds like maybe a little bit more focus on share, which maybe means participating in some of the commodity dynamics. So maybe can you just help us understand when you make that comment? Are you looking to hold share kind of in commodities and still grow share in your value add? How would you characterize the goals in terms of share for this year and where you need to be most competitive?"
},
{
"speaker": "Peter Jackson",
"content": "Sure. I guess for context, I do want to describe how I see the trend over the past couple of years. You know, when we came out of the big COVID build push, there were across-the-board elevated margins, elevated volumes, elevated prices. We've been talking about normalization forever, to the point where all of us are a little tired of using the word. Unfortunately, I don't think we're done. I think what we saw were waves of normalization that have flowed through this industry via the individual categories. So right out of the gate, you saw a large amount of normalization in the lumber and lumber sheet goods category. You saw normalization in price. And then you saw a normalization in margins as sort of the competition returned to what we would consider to be normal levels. We talked a little bit about what we saw in that and the share battle and what we were doing. We thought we lost a little. I would tell you right now, I feel pretty good about where we are. I think the team has done a nice job of responding and finding equilibrium and where margins needed to be. We have seen that flow through the other categories. And, you know, we've talked a little bit. Mike, you and I have talked about why has it been so difficult to forecast margins. What I would tell you is because the timing of how those normalizations have occurred has been a bit different than we anticipated. So I think what we're seeing now and have over the last year is the completion of that. Right? The normalization of those individual categories and the price versus share battle that ensues in each one in order to find equilibrium. I think we're closer to the end than the beginning, but that's where we're talking now in the other categories, even more so than I would say lumber and lumber sheet. Finding that balance and protecting that share in a way that we feel like we're able to have good value for our customers but still protect where we are so that as the growth returns, we're able to take advantage of our frankly superior capacity and capabilities to really show outsized returns for investors."
},
{
"speaker": "Mike Dahl",
"content": "Okay. That's very helpful. Thank you, Peter."
},
{
"speaker": "Operator",
"content": "We'll take our next question from John Mulaloe with UBS. Please go ahead."
},
{
"speaker": "John Mulaloe",
"content": "Hey. Good morning, guys, and thank you for taking my questions as well. Maybe starting off again with the first quarter outlook. I mean, it seems to be a number of, I guess, unusual items. There's the fires, weather, I think there's one less selling day as well. And you framed the quarter-to-date impact, I believe, from weather and the fires, but can you help us think about how you're thinking about that for the full quarter for each of those buckets? And maybe can you help us bridge from that 10.3% implied EBITDA margin in the first quarter to the full year range of, you know, 11.5% to 13%?"
},
{
"speaker": "Pete Beckmann",
"content": "Yeah. So the first quarter is definitely feeling the effects of the severe weather. We had a foot of snow down in the Gulfport through Emerald Coast, and it's unusual. We're not used to seeing that. So we lost multiple days of business from that extreme weather in the east and south. We expect that to come back. It's a matter of time as the builders are able to pick up momentum and work through it in the seasonal low. So that $80 million impact that we had outlined in the prepared remarks, it's something that we do expect to get back, but it may take longer than Q1 to get it all back. As far as the California wildfires, it's not a huge immediate impact in Q1, but for the full year, it's gonna have a lingering effect. So it'll be something we continue to monitor as we work through the year. And then the one last selling day, that's just a simple math equation. I think you understand that one. And we are looking through the full year on what we believe the year is gonna deliver as we go through it. And we start to see the churn a bit in Q2 where we start passing those negative comps and seeing continued, I would say, organic growth through the back part of the year in conjunction with the contributions from the acquisitions we've completed. So as we indicated in our press release regarding Alpine, their trailing twelve-month sales is roughly $500 million. But we also have the benefit of the thirteen acquisitions we completed in 2024, where we have stub periods that we haven't lapped yet that are gonna contribute to overall sales growth. As Peter mentioned, we are targeting $200 million of additional incremental sales from our digital platform in 2025. So all those things added up is where we're seeing some of the growth in sales. And I already mentioned the multifamily headwind that we're gonna continue to have to lap and compare to on the comps, as well as some of the margin normalization, which is price. That'll have a different pressure on."
},
{
"speaker": "Peter Jackson",
"content": "And, John, just to, I know you know, but to reinforce for the others on the call, you know, Q1 is easily by far our weakest quarter from a sales perspective. Distortions related to weather and fires have a sort of an outsized impact on our leverage and on our fall through. So just to keep that in mind as you're doing the analysis."
},
{
"speaker": "John Mulaloe",
"content": "Okay. I mean, that's helpful. And then just in terms of the expected $500 million working capital swing in 2025, can you just help us think about the high end and the low end of the sales range? I mean, at the low end of the sales range, it seems like sales could actually be pretty flat year over year. I mean, how would you kind of think about that working capital swing as you got the high and low end?"
},
{
"speaker": "Pete Beckmann",
"content": "It'll moderate, respectively. Really, the cash flow is a function of how you exit the year. So it'll be more skewed toward the exit rate from a sales velocity at that point compared to the prior year. It's just a point-to-point measurement. And as we mentioned, we were able to outperform our free cash flow guidance in 2024. So we did have a little bit of pull forward into the 2024 results. Roughly, $200 million that was recognized in 2024 that we had originally thought was gonna be in 2025. So some of that's washing between the years. Is the impact of the outsized change year over year."
},
{
"speaker": "John Mulaloe",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Charles Perron-Piche with Goldman Sachs. Please go ahead."
},
{
"speaker": "Charles Perron-Piche",
"content": "Thank you. Good morning, everyone. I guess, first, I want to talk about the product mix shift within your multifamily business. As you look for multifamily starts to contract this year, do you see risks of more degradation in your value-added content in there? And how is this factoring into your current guide expectations for your future business?"
},
{
"speaker": "Peter Jackson",
"content": "Yeah. You know, multifamily is a great product category for us. Right? It's a market segment. The majority of it is value add. So when we see declines in sales, it is disproportionately an impact on those value-added product categories, primarily truss and millwork. Those are both integrated into our guides and our forecast for the full year. So we have considered it. Got a fairly high degree of confidence in our forecast just given the amount of forward visibility we have in those categories given the backlog because of the types of projects and how far we can see."
},
{
"speaker": "Charles Perron-Piche",
"content": "Got it. No. That's good color. And then the new administration has been vocal about their stance on potential tariffs and labor and immigration policy. I guess, against that, how are you positioning the business against potential tariffs across your portfolio? Are you making any changes for inventory management, for example, if we were to get labor pressures in the construction industry, what do you think could be the repercussions for BFS and, you know, builders' willingness to use value-added content and your services?"
},
{
"speaker": "Peter Jackson",
"content": "And the new administration? I hadn't heard now. Just kidding. Just kidding. Yeah. So there's a lot going on. Right? The tariff world, as we described, about 15% of our total sales are exposed to potential tariffs given that it's not US. Of that, you know, in the high singles to 10% range is in that commodity product category. So for us, what we're doing differently, not much. Right? The dynamic around managing the flow of product is something that we are disciplined about, and given our lack of visibility into what the actual outcome is going to be, we've been pretty cautious about taking a position or changing our inventory levels in response. You know, I think that there's some optimism that there will be thoughtfulness around the potential impact on housing, but we'll see. We've always had a tariff regime on that Canadian softwood. That's not new. That was already expected to reset a bit higher this year based on the normal process there. But if there are significantly higher tariffs, if 25% were to be layered on top, that's pretty dramatic. That could be a 65% tariff. While a modest percentage of what we do, we have seen in the past that be a broader impact. Meaning, just because the Canadian wood goes up, the US wood will go up a bit as well. In short, we don't like it. You know? Any barrier or additional problem for housing right now we think is a net negative. It'll certainly be a tailwind to our sales per unit in the commodity space. But we think it will likely win it starts, and that's bad overall. On a net basis. The similar answer around immigration. You know, I think one of the things that Builders FirstSource has done better than anybody else is leaning into this idea of offering value-added products, which is essentially just finding ways to take skilled labor off the job site. We have a great portfolio of products that do that. We think we'll be advantaged if immigration were to tighten an already tight labor market in that skilled area. We think we'll be more advantaged than anyone else. The downside is we still think net net, any severe impact or radical impact on the labor force would be bad for the industry. It's bad for affordability, which is bad for starts, and we don't like it. So, you know, we think the trend is there. We think we're ready. We think we're gonna win. But we sure hope that there's some thoughtfulness around how it's executed in the market, both in tariffs and in immigration."
},
{
"speaker": "Charles Perron-Piche",
"content": "Got it. Got it. That's helpful color. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Rafe Jadrosich with Bank of America. Please go ahead."
},
{
"speaker": "Rafe Jadrosich",
"content": "Hi. Good morning. Thanks for taking my questions. Just thinking about some of the assumptions sort of embedded in the 2025 guidance, at the 2023 Investor Day, some of the long-term targets you laid out, you were assuming 4% market outgrowth from share gains. Just how are you thinking about that for 2025?"
},
{
"speaker": "Peter Jackson",
"content": "Well, I would say that the 2026 targets based on what the market has done and the way things have played out, they're not unachievable, but it sure is a long putt from here. You know, I think the dynamics around that, around the share gain that would go along with that, are influenced by that weak market. I think it changes the competitive dynamics. It changes a lot of things. For 2025, our share gain expectations are pretty modest. You know, I think they really center around what we think we can do in the digital space. And I think the rest of what we're trying to accomplish is really defending our share with a manageable margin impact."
},
{
"speaker": "Rafe Jadrosich",
"content": "And that's really helpful. Then the other question I have is just you mentioned install earlier. Can you just talk about how big that is today as a percentage of either EBITDA or revenue? What is the margin profile of install? And then, like, what are the categories or services where you see the most opportunity? Where is it growing?"
},
{
"speaker": "Pete Beckmann",
"content": "So our install is around 16% to 17% of our overall sales as of the end of 2024. It's about $1.7 billion of $2.7 billion of sales. Sorry. The margin profile, it's in line with what we see from the product categories that we're installing. And the opportunities, I think there's a lot there, right, that we can lean into. I mean, currently, it's framing, it's doors, it's windows, it's millwork more broadly. Those are the, I would say, main categories, but what we see are many opportunities to partner with customers depending on the local market need."
},
{
"speaker": "Rafe Jadrosich",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from David Manthey with Baird. Please go ahead."
},
{
"speaker": "David Manthey",
"content": "Yes. Thank you. Good morning, guys. When you issued 2024 guidance in February last year, the EBITDA range top to bottom was about a hundred basis points, and today's range is 150 on what appear to be smaller absolute numbers. I hope I'm not slicing this too thin, but maybe if you could just address the risk factors that you see as more volatile in today's environment versus what you might have seen last year."
},
{
"speaker": "Peter Jackson",
"content": "Yeah. No. That's fair. I would tell you that coming into last year, there was kind of an expectation that the year was building momentum. That we were gonna see rate cuts, that, you know, the tone out of the builders was just very consistently optimistic amongst the larger players. And the smaller players were saying, oh, yeah. We're gonna be right behind them. It's gonna be good. That's not how it played out. That is not the tone this year. That is not the messaging we're hearing. If you're looking at the dynamics of what the core market looks like today, I think we feel okay. You know? It's not fantastic. But we're doing well. I think what is more intimidating and the reason for the wider band around it is what will the unknowns generate in terms of volatility in the competitive environment? Builders are pretty vocal about, hey, we have an affordability problem. We're gonna push everybody down. You know, everybody needs to take a cut, and that's not really new. But if you start to overlay some of these questions about tariffs and, you know, policy changes around immigration, policy changes around housing, I think that's where our hesitancy to keep such a narrow band this year comes from."
},
{
"speaker": "David Manthey",
"content": "That's very clear. Thank you. And second on digital, the uptake has been a little slower than you expected so far. You got $134 million this year. I think you're expecting $200 million, which was, I guess, coincidentally, the fourth quarter exit rate. But if you're looking for $200 million in 2025, that implies that the exit run rate of the fourth quarter doesn't improve at all through 2025. So maybe you could address that. And then I see you still have the $1 billion target, but it doesn't say 2026 here anymore. Should we assume a slower ramp given the more complex environment today?"
},
{
"speaker": "Peter Jackson",
"content": "Yeah. No. Thanks for the question. So digital is a tremendous learning opportunity for us. I remain very confident that the technology and the solution is the right answer. As we go through the learning process, I think what we've identified is that, and you hit the nail on the head, our pace this year isn't quite what we wanted. And we spent a lot of time at the end of the year to reassess why is that. Why is the pace not picking up where we thought it would be? And I think the answer has a lot to do with the way we've approached adoption. We were more generalized than I think we would like to be. I think there's a more specific, more focused way to approach the adoption process. And that's where we're leaning in this year. We've really focused on a reset coming out of December into January with regard to that with new metrics, with the alignment around the teams. It's a little bit of go slow to go fast, which I think is what you're identifying in terms of our pace for 2025 and where we think we can get. I think what we're executing now is gonna ultimately get us to where we wanna be. In terms of the 2026 finish line, it's a great question. I don't think it's out of the question yet. Where I would tell you is we're gonna find out in 2025 whether this reset and new approach to adoption is delivering like we think. And we'll have a much better sense as we get through the end of the year. We've got another investor day coming up, so we'll be able to give you a much clearer sense of where we're gonna be when. I am still 100% confident in the billion. I think it's only a question of when."
},
{
"speaker": "David Manthey",
"content": "Alright. Thanks, Peter. Good luck."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Keith Hughes with Truist. Please go ahead."
},
{
"speaker": "Keith Hughes",
"content": "Thank you. My question is on multifamily. You've given us our view for the year, that mid-teens decline. Do you expect that to hit ratably during the year, or is there a chance this business could bottom out sometime in, you know, mid-second half 2025?"
},
{
"speaker": "Pete Beckmann",
"content": "Yeah. What we're seeing right now is the lapping effect of the $400 million to $500 million headwind year over year is really gonna be in the first half of this year. We're seeing our current volume levels right now are pretty consistent month over month sequentially. But we're lapping tough comps from the prior year. So it's certainly front half weighted on that headwind."
},
{
"speaker": "Keith Hughes",
"content": "Okay. Would that change? Would that within the it's in the midpoint of the guidance range? Does that allow EBITDA to show some level of growth in the second half of 2025?"
},
{
"speaker": "Pete Beckmann",
"content": "When you say growth, is it growth sequentially or on a year-over-year basis?"
},
{
"speaker": "Keith Hughes",
"content": "Year over year."
},
{
"speaker": "Pete Beckmann",
"content": "Yeah. I would say overall, it's not enough."
},
{
"speaker": "Keith Hughes",
"content": "Alright. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Philip Ng with Jefferies. Please go ahead."
},
{
"speaker": "Philip Ng",
"content": "Hey, guys. Appreciate all the great color. Peter, you gave some color on how perhaps your customers are progressing. But any early read on spring selling season? And you did mention in your prepared remarks, maybe some of the builders are testing out how they want to modulate build pace. My question is, have you seen them kind of really ratchet back spec homes? Are they working down inventory? Are you seeing any noticeable change in behavior in terms of buying out mortgages and stuff of that nature?"
},
{
"speaker": "Peter Jackson",
"content": "Yeah. No. Thanks for the question. So in general, I would say builders are behaving consistently. Continue to buy down pretty aggressively as their key lever for keeping the production moving. The larger production builders have really moved to sort of this land-light on one side, on the other side, very stable production mentality around how they want to put homes out. And what we've seen is modulation by market. So they're not doing it nationally. That's not how we see them thinking. It's very dependent on, you know, if you're in Florida or Denver or, you know, these individual markets. They'll behave in a way that, well, you'd expect them to behave. Right? So we have a little more inventory than we'd like. We're gonna goose up the buyback a little. We're gonna pull back on the new starts pace a little bit to ensure that we have this in a range that we like, but we're gonna move these houses. So I think consistent, but the pullback on starts is something that is probably the last maybe four to six months, certainly a much bigger part of the conversation than it had been in the prior period."
},
{
"speaker": "Philip Ng",
"content": "Okay. That's helpful. And then from an M&A standpoint, certainly, 2024 was an active year, and you guys have kicked off the year pretty busy. How is the pipeline looking in terms of seller expectations, evaluation you're seeing out there? Where are some of the big opportunities? How do you kind of balance that and buyback? You still have a lot of availability here."
},
{
"speaker": "Peter Jackson",
"content": "Yeah. You know, we've consistently talked about M&A as being a priority for us. To the extent that we can effectively execute acquisitions, it has been a tremendous creator of shareholder value. We think it's good for the overall business in terms of our competitive space, our footprint, our efficiency. You know, our ability to serve customers in an effective way is advantaged by these new teams that we brought on into the BFS family. There are a lot of assets out there. You know, as you saw with 2024 and coming into 2025, you sort of have a large population, a large potential target list within the smaller world, with a much fewer more opportunistic materialization of a larger target. So I'd say that's kind of consistent. We continue to see a number of smaller opportunities, you know, some a little bit bigger, and then every once in a while, a big one will pop, and we'll have an opportunity to do something more meaningful. But regardless of sort of the periodic nature of all that, we believe in M&A. We're good at it. We will continue to capture value through it. We'll continue to deploy cash that way. And, certainly, we have had, I think, a lot of success with share buybacks. But it continues to be the, you know, number five on our list of capital allocation priorities."
},
{
"speaker": "Philip Ng",
"content": "Okay. Super appreciate the color. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Trey Grooms with Stephens. Please go ahead."
},
{
"speaker": "Trey Grooms",
"content": "Yeah. Thanks for taking the question. Just circling back on the market share just real quick, and I don't want to beat a dead horse because I know we have spent some time on it. But I was just asking if this was, you know, you mentioned that you lost a little bit. Was this specific to any, you know, geographic market or maybe specific to production builders, or was it more widespread? Then, Peter, you know, you said you were thinking kind of, excuse me, modest share gains this year I think is what's kind of embedded. I guess, what's kind of changed there in the market where, you know, working multifamily is gonna be down a little bit and single-family is expected to be kind of flat. Is it just more discipline in the market kind of coming back, or what's going on?"
},
{
"speaker": "Peter Jackson",
"content": "Well, going back to the initial conversation or the initial statement around having lost some share in the past, I think we were pretty open and transparent that as we look at the analysis, it's not, you know, decimal level precision. But based on what we can tell, there were certain builders, and I think production is fair. Some of the folks that had a sharp pencil with regard to how they were doing their bids and attacking their cost position were trying to find ways to drive down cost, and commodities is one of those areas where there are times when certain players will get progressive. They just will. They want to buy share. They think that that's a strategy for them. So they'll lean in and do something we would consider irresponsible. And sometimes we'll walk away, and we walked away a fair amount. And I think at some point said, okay. That's enough. We're gonna take the business that belongs to us, and we're gonna stay competitive to do it. So again, that goes back to the normalization thing and what we saw on that balance between share and margins. But I think that's largely the review here. I haven't seen anything lately in the past quarter or two that would indicate that's still in play. But it's a dynamic market. Right? In terms of what's going on this year and our ability to gain share, I think what you will see are ebbs and flows. There'll be aspects of it that we're gonna win at. I think we will continue to win in install. I think we're gonna continue to be the preferred supplier for trusses and for pre-owned doors. I think those are areas where we have a demonstrated advantage. We have a cost advantage. It's merely a matter of deciding how much are we willing to lean in in those categories? How much do we have to lean in in those categories to protect our share position? And then as we think about the last sort of leg of the stool, the digital is an area where we continue to capture new customers, where we get a stickier and deeper relationship with customers because of the solution set that that digital tool set provides."
},
{
"speaker": "Trey Grooms",
"content": "Got it. That makes sense, and good to hear. So one follow-up for me, and, you know, you touched on tariffs and things like that. But we got a lot of questions around this, you know, earlier in the year, maybe a few weeks ago. And questions around more how, you know, if we were to see these additional tariffs come through and it meant, you know, $600 lumber as opposed to $400 lumber, whatever, pick the number. Can you remind us how, you know, this would flow through on the manufactured side, the prefab side, how margins would behave there in this kind of environment if we were to see this higher lumber? I know the old algorithm of years past seems to, I don't know if that's still kind of the best way to think about it. Seems like margins had been stickier both with lumber going up and down for you guys. So any help with that just so we can kind of put this into our scenario analysis as we think about tariffs, lumber, etcetera."
},
{
"speaker": "Peter Jackson",
"content": "Well, I mean, I'm happy to repeat a little bit about the rules of thumb that we've kind of given in the past, but I think it's important to give you a lot of caution and caveat around that. I'll let you know what's gonna happen. I mean, the dynamics here are a little bit different in terms of how aggressive these changes are being proposed. How aggressive the changes being proposed are and whether or not there's a time that is manageable or not. You know, we've talked in the past about commodities. You know, plus or minus 5% on the commodities. Be worth around $300 million in sales over the course of a year. At the fall through, you know, relatively normal fall through in that sort of $60 to $70 million range. So it's not an exact science. These are all kind of high-level numbers, but I would say the most important thing is the velocity of the change and how the market responds."
},
{
"speaker": "Trey Grooms",
"content": "Yep. Lot of still a lot of unknowns out there for sure, but that's still helpful. Peter, thank you so much, and best of luck."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, sir."
},
{
"speaker": "Operator",
"content": "Okay. We'll take our next question from Adam Baumgarten with Stellman Associates. Please go ahead."
},
{
"speaker": "Adam Baumgarten",
"content": "Hey, guys. Good morning. Could you give us some color on what you're seeing from a pricing perspective in the value-added products arena?"
},
{
"speaker": "Pete Beckmann",
"content": "Yeah. We're still seeing, and we've provided in the past with respect to value-added products relative to the lumber commodity margins. It still goes at a premium of about a thousand to twelve hundred basis points higher because of what we're able to provide with improved cycle times or lead times for getting the product to the job site, the reduced waste, and the requirement on skilled labor being reduced by having that completed in a dedicated manufacturing facility. We're still seeing that premium or benefit from the value add in our results."
},
{
"speaker": "Adam Baumgarten",
"content": "Okay. Got it. Thanks. And then just, you know, in a scenario maybe where we start to see more pronounced labor constraints across the single-family construction space due to the Adam, you still there? We lost you."
},
{
"speaker": "Adam Baumgarten",
"content": "Yeah. Can you hear me?"
},
{
"speaker": "Peter Jackson",
"content": "Yep. Oh, you're back now."
},
{
"speaker": "Adam Baumgarten",
"content": "Okay. Sorry about that. So just in a scenario where, you know, we start to see more labor constraints in construction due to some of the immigration policies, you know, you have an install business. Do you see that as a risk to your business or actually maybe an opportunity as maybe some of your customers are looking for incremental labor?"
},
{
"speaker": "Peter Jackson",
"content": "Well, I mean, it's both. Right? It's certainly an opportunity for us in order to be able to win in the marketplace. We've got the build capacity. We've got the best skill set. We've got the most locations. We are ready to go with this. The problem with it in my mind is it's disruptive. And more broadly speaking, if it was just us being impacted, I'd say win-win. We got this. But you're not just gonna get rid of framers, you're gonna get rid of gypsum wall, you know, wallboard hangers. You're gonna get rid of roofers. You're gonna get rid of siding folks. And there are parts of this industry that are gonna be impacted that don't have the same outlet that we offer. Right? You need the people. And if you don't have the people, it's gonna cause inflation. Inflation is bad for affordability, and affordability is bad for starts."
},
{
"speaker": "Adam Baumgarten",
"content": "Got it. Thanks, guys. Best of luck."
},
{
"speaker": "Peter Jackson",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Brian Deerez with Thompson Research Group. Please go ahead."
},
{
"speaker": "Brian Deerez",
"content": "Hey. Good morning. Thanks for taking my questions today. Just a little bit more on the install base, you know, impressive, I think, growth this year in a down market. Any expectations for install for 2025 or how that kind of factors into the guide?"
},
{
"speaker": "Peter Jackson",
"content": "So we haven't laid a guide specifically around that category, but we're believers in it. We certainly talk a lot about it. So, hopefully, that's an indication of which way we think it'll go."
},
{
"speaker": "Brian Deerez",
"content": "Makes sense. And then for single-family start guidance for the year, is there any way to think about variance by region in that guide for you guys? Or kind of where you're better or worse positioned across your footprint? Thank you."
},
{
"speaker": "Peter Jackson",
"content": "Yeah. I'd love to be able to provide a deeper guide on that, but I don't think it's in any of our best interest at this point. Forecasting is difficult, especially about the future. He loves a good yogi, isn't it? Come on."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Jay McCanless with Wedbush. Please go ahead."
},
{
"speaker": "Jay McCanless",
"content": "Guys. Thanks for taking my question. So the first one, just to clarify, Peter. Are you guys having to lean in on price now on value-add sales, or are you just saying if you need to to protect share, you will lean on price? Just kind of clarify where things are right now."
},
{
"speaker": "Peter Jackson",
"content": "Oh, yeah. No. That's already been going on. We've been managing through that for the last year. Eight months, I'd say more intently. It's implied. No question."
},
{
"speaker": "Jay McCanless",
"content": "Okay. And then the second question, and not to read too much into it, but I think your tone around multifamily last quarter may have been a little more positive than what you talked about this quarter. But it is nice to hear that we're finally lapping that. I guess any material change in bid processes or bid volumes on the multifamily side to maybe change your tone around that."
},
{
"speaker": "Peter Jackson",
"content": "Yeah. I would say any change in tone is unintentional. You know, I'd come back from a conference last quarter where there were some folks talking about some green shoots. I would say things have been pretty stable. Just sort of clicking along."
},
{
"speaker": "Jay McCanless",
"content": "Okay. Alright. Sounds great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our final question from Jeffrey Stevenson with Loop Capital. Please go ahead."
},
{
"speaker": "Jeffrey Stevenson",
"content": "Yeah. Thanks for taking my questions today. I wanted to go back to single-family mix headwinds this year from a decrease in value size and complexity of an average single-family start. So on a year-over-year basis, are you expecting single-family mix headwinds to moderate as we move through fiscal '25? Or does your guidance imply relatively stable single-family mix throughout the year?"
},
{
"speaker": "Pete Beckmann",
"content": "I would say our guidance reflects a pretty stable single-family mix from where we ended Q4 as we move through the year. The headwinds that we outlined throughout 2024, some of them are still there, and we'll have to lap that in the first half of this year. Some of that's related to the size of home and some of the complexity as well as some of that margin normalization on the single-family side with non-commodity products. So there's a little bit there, but we don't expect from a mix standpoint that it's gonna have a greater impact than kind of where we are exiting Q4."
},
{
"speaker": "Jeffrey Stevenson",
"content": "No. That makes sense, Pete. Thanks for that. And then appreciate the first quarter guidance and update on the first weather to start out the year. But historically, what percentage of first-quarter sales are from March? And could you experience some pent-up demand if weather cooperates as we move through the largest month of the quarter?"
},
{
"speaker": "Peter Jackson",
"content": "You're right. March is important. From your lips to God's ears, let's have a hell of a March, I guess, is where I'm headed. We'll see."
},
{
"speaker": "Jeffrey Stevenson",
"content": "Got it. Thank you."
},
{
"speaker": "Peter Jackson",
"content": "Alright. Thank you."
},
{
"speaker": "Operator",
"content": "There are no further questions at this time. With that, this will conclude today's program. Thank you for your participation. You may disconnect at any time."
}
] |
bldr | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Builders FirstSource Third Quarter 2024 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by management and the question-and-answer session. [Operator Instructions]. I'd now like to turn the call over to Heather Kos, Senior Vice President, Investor Relations for Builders FirstSource. Please go ahead."
},
{
"speaker": "Heather Kos",
"content": "Good morning, and welcome to our third quarter 2024 earnings call. With me on the call are Dave Rush, our CEO; Peter Jackson, our CEO designate and CFO; and Pete Beckmann, our CFO designate. As a reminder, on September 19, we announced a planned CEO and CFO succession. The earnings press release and presentation are available on our website at investors.bldr.com. We will refer to the presentation during our call. The results discussed today include GAAP and non-GAAP results adjusted for certain items. We provide these non-GAAP results for informational purposes, and they should not be considered in isolation from the most directly comparable GAAP measures. You can find a reconciliation of these non-GAAP measures to the corresponding GAAP measures where applicable and a discussion of why we believe they can be useful to our investors in our earnings press release, SEC filings and presentation. Our remarks in the press release, presentation and on this call contain forward-looking and cautionary statements within the meaning of the Private Securities Litigation Reform Act and projections of future results. Please review these forward-looking statements section in today's press release and in our SEC filings for various factors that could cause our actual results to differ from forward-looking statements and projections. With that, I'll turn the call over to Dave."
},
{
"speaker": "Dave Rush",
"content": "Thank you, Heather, and good morning, everyone. Before I get into my prepared remarks, on behalf of Builders FirstSource, I want to send our thoughts to all of those who have been impacted by Hurricane Helene and Milton. I am proud of how we have come together as an industry to help with disaster relief efforts in North Carolina and the Southeast. From the first morning after Helene's landfall, we had team members and suppliers reaching out from all over the region and even across the nation asking how they can help. Our Charlotte and Blairsville locations filled trucks with supplies and delivered them to the hard hit Western North Carolina region. Suppliers like Great Southern, BlueLinx, Weyerhaeuser, Orgle [ph] and many others immediately stepped up and joined our efforts. We are grateful to our partners for their help. And with BFS Cares initiative, we're providing grants to our team members -- to help get our team members back on their feet as soon as possible. I want to especially thank Tim McCall, an install manager in Nashville, who also serves as a volunteer firefighter in the region. Tim was involved in 20 calls in the first hours after Helene hit. One involved climbing over 250 yards of very unstable terrain to help rescue an 11-year-old boy who had been buried in the basement of his home by a massive land slide. Tim, we are so proud of your efforts, and thank you for your selfless service to the community. I'm sure you have all seen the news that I'm retiring as CEO. I never anticipated that 25 years ago, I would have this wonderful career with this great company. We have the best people in the industry and the opportunity to be CEO of BFS these last couple of years has truly been the joy and highlight of my career. I am so proud of how far we have come and I'm grateful to our leadership team and team members for their support. I have full confidence in Peter and Pete and their ability to drive our strategy forward. One of my first priorities when I became CEO was to develop a succession plan to ensure the consistency of our leadership and the execution of our long-term strategy. With many years of experience as our CFO, Peter is exceptional at navigating the public company landscape and has spent extra time with each of our regions to get a first-hand understanding of what it takes to support our leaders in the field. He has served as a close advisor to me and was essential in helping craft our current strategy. I'm working closely with him to ensure a thoughtful and seamless transition. Pete Beckmann is a brilliant financial leader and someone who is widely respected within the organization. I am grateful for our deep bench of talent and to lead BFS in such good hands. I want to wrap up by saying that I'm not going far away. I'll enjoy continuing to serve BFS as a member of our Board, and I am taking an active role to ensure a smooth transition in the near term. I'm excited to continue supporting our growth and success. Thank you, again. I'll now hand the call over to Peter."
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Dave, and good morning, everyone. I want to start by saying that we are indebted to Dave for his decades of service at BFS as a leader, steward and champion of the company and our people. Dave has truly done it all, and his legacy of excellence will continue to inspire us as we move forward. I'm truly honored and grateful to be named the next CEO of Builders FirstSource. I'm humbled to represent our talented, hard-working team and the fantastic business that we have built. BFS has had tremendous success and become a world-class organization because of the commitment and contributions made by this team. Let's get started with Slide 3 and our strategic pillars, which remain unchanged. As we continue to execute our strategy, I believe there are three areas that we can emphasize so we can continue to outperform today and transform tomorrow. The first opportunity is with our people. I want us to advance the industry standard in this area so that we are recognized as a premier destination for talent. I believe we can enhance how we invest in, develop and support our team members from our frontline operators to our leadership. The second opportunity is to further build and catalyze our growth prospects, from our products to our processes. I see potential to improve our consistency capabilities and ways of working, so we can extend our lead and grow a bigger, better BFS of tomorrow. And the third opportunity is to improve how we collaborate and learn from each other within the company. We have a wealth of expertise, knowledge and innovative technologies. I believe we have a real opportunity to enhance how we work together. So that what we are discovering in Charlotte is shared with Phoenix and what we are developing in Florida can be scaled in Texas. Let's turn now to our third quarter highlights on Slide 4. I'm proud of our resilient performance, which reflects our execution and operational rigor, even as we continue to see soft sales, amid rate uncertainty and extreme weather. Despite these challenges, we delivered strong gross margins of nearly 33%. Our adjusted EBITDA margin has remained in the mid-teens or better for 14 consecutive quarters, which highlights our transformed business model and our differentiated product portfolio and scale. Let's move to Slide 5, where we touch on some of the specific ways we are executing our strategy. Our portfolio of value-added products and services remains a competitive advantage for BFS and continues to bolster our partnerships with customers. We've seen steady progress with digital, as we continue to hear great feedback from customers and see increasing levels of adoption each week. We demonstrated operational excellence by delivering $27 million in productivity savings in Q3 and have driven $104 million year-to-date, primarily through more efficient manufacturing and procurement initiatives. Installed services continues to be a great opportunity for us as we leverage playbooks from successful markets. I'm pleased that our install sales increased by 11% year-over-year, as we focus on helping customers address labor challenges. We remain disciplined stewards of discretionary spending and are continuing to maximize operational flexibility. We have consolidated 11 facilities year-to-date, while maintaining our service levels to our customers with an on-time and in-full delivery rate of over 90%. Single-family softness continued in Q3, amid on-going affordability challenges and below normal starts. The initial reaction to the Fed's first interest rate cut in September has been mixed, with some homebuyers remaining on the sidelines and waiting for additional rate cuts as mortgage rates fluctuate in the near term. As a reminder, the value of a new start has fallen as the housing market has adapted to affordability challenges. Multifamily continues to be a headwind, amid muted activity is expected. Comparisons should get less negative as we lap record performance from last year. On a normalized basis, multifamily represents about 9% to 10% of net sales and is an attractive and profitable business for us. As we detailed on our Q2 call, our Q4 exit velocity indicates about a percentage point of margin erosion from '24 on a full year basis, roughly half of which is from multifamily. To address the current environment and affordability challenges, builders have employed specs, smaller and simpler homes and interest rate buydowns to help buyers find affordable options. Builders of all sizes are having to navigate this market in addition to regulatory, land development and infrastructure challenges. Smaller builders have been especially impacted by the availability of land and limited options to buy down rates. We are leaning in by partnering with our customers to help them lower the cost of homes for consumers as well as maintain their margins. This includes offering a balanced product mix that addresses builder needs while passing through lower material costs. For instance, we have continued to supply more engineered wood and have sold fewer floor trusses to help alleviate affordability challenges. We have also supplied more lower-cost offerings in products like windows and doors to help reduce costs. Although these actions in support of our customers need less sales and gross profit dollars, our margin profile remains strong, and we are well positioned for growth as starts to increase and structural headwinds begin to subside. Turning to M&A on Slide 6, we continue to pursue attractive opportunities, while remaining financially disciplined. Over the years, we have developed a substantial and proven muscle memory to grow through M&A and have an impressive track record of successfully integrating these transactions. In the third quarter, we completed six deals with an aggregate 2023 sales of roughly $190 million. In July, we acquired Western Truss & Components, having trust capacity in the Flagstaff, Arizona area and CRi SoCal, a dealer and installer of high-end windows and doors in Orange County, California. In August, we acquired Wyoming Millwork, the leading independent building products distributor in Delaware. September, we acquired Sunrise Wood Designs, a top custom cabinet manufacturer and installer in North Texas. And in the Reno area, Reno Trust, a leading trust manufacturer to the single and multifamily markets and High Mountain Door & Trim, a distributor and installer of windows doors and in Millwork. Additionally, in October, we acquired Douglas Lumber, which provides a range of building materials to contractors, remodelers and homeowners in the Rhode Island area. These acquisitions reinforce our commitment to growing value-added products. We are excited to welcome these talented new team members to the BFS family. On Slide 7, we provide an update on capital allocation. In addition to the six tuck-in acquisitions during the third quarter, we executed share repurchases of roughly $160 million. It's driven by our track record, we'll continue to allocate capital to high-return opportunities, including acquisitions and share repurchases. We deployed approximately $1.7 billion through the first three quarters of this year and remain on track strategically to $5.5 billion to $8.5 billion of capital from 2024 to 2026 and we outlined at Investor Day last December. Now let's turn to Slide 8, and discuss the latest updates on our digital strategy. With our BFS digital tools, we are focused on creating value for our homebuilder customers and in doing so, further extending our industry leadership position and driving substantial organic growth. We have seen strong adoption and growth with our target audience of smaller builders despite the challenging market. We have had broad acceptance of the platform so far, including interest from multiple top 200 builders. Since launching in late February, we have seen nearly $600 million of orders placed through our digital platform, of which $83 million were incremental sales from existing and new customers. While we're very pleased with the incremental sales to date, given market headwinds from our targeted segment of builders, we now expect total incremental sales of approximately $110 million in 2024 versus our initial goal of $200 million. Despite the slow start, we remain confident in our ability to meet our target of $1 billion in incremental sales in 2026, as we grow wallet share and win new customers. Before I turn the call over, I want to say that we are very fortunate to have Pete Beckmann step into the role of CFO. He has a long proven track record as a finance leader which I've witnessed first-hand. I look forward to partnering with him to deliver exceptional results and compound shareholder value. Pete, take it away."
},
{
"speaker": "Pete Beckmann",
"content": "Thank you, Peter, and good morning, everyone. I appreciate the introduction, and I am grateful for the opportunity to serve as CFO. For background, I have spent the last 25 years at BFS and legacy companies in roles of increasing responsibility, including being an integral part of the ProBuild and BMC mergers. Most recently, I served as SVP of Financial Planning and Analysis, where we have partnered with all levels of the enterprise and was responsible for our financial forecasting, strategic capital and annual planning. I look forward to helping enable profitable growth while maintaining our track record of prudent financial management through the cycle and disciplined capital allocation. Despite continued housing market choppiness we delivered resilient results during the third quarter as we continue to execute our strategy and operating model. We are leveraging our fortress balance sheet and free cash flow generation to drive disciplined capital deployment, as witnessed by our share repurchases and acquisitions during the quarter. Our scale and financial flexibility enable us to act as key partners to homebuilders, and we have a clear line of sight to compound value creation over the long term. We are well positioned for meaningful operating leverage when the market turns. I will cover three topics with you this morning. First, I'll recap our third quarter results; second, I'll provide an update on our capital deployment; and finally, I'll discuss our 2024 guidance, 2025 scenarios and related assumptions. Let's begin by reviewing our third quarter performance on Slides 9 and 10. Net sales were $4.2 billion, a decrease of 6.7%, driven by a 7.2% decline in core organic sales as multifamily continues to trend downward, and 2.9% of commodity deflation. The decrease in net sales was partially offset by growth from acquisitions of 2% and one additional selling day that contributed 1.4%. The organic sales decrease was driven by a 31% decline in multifamily as we lap the prior year's strong comps and a 4.6% decline in single-family amid lower value per start. This was partially offset by a small increase in repair and remodel of almost 1%, given strength in the central region. As we have shared on recent calls, there have been three main variables reconciled single-family starts for organic sales. The first variable is the lag between permits and starts. This quarter, unlike last quarter, we have seen the impact of early permit polls stay where we continue to see a generally extended permit completion cycle time. As a rule of thumb, we expect a roughly two-month lag between the start and our first setting. Second, the value of the average home has fallen as size and complexity have decreased. Finally, we have seen slight normalization in selling margins of non-commodity products and manufacture price cuts in some products. Summarized, although there are sales dollars built for start today, we remain the market leader and will begin to deliver strong operating performance. Value-added products represented 49% of our net sales during the third quarter. As a rule of thumb, our multifamily sales are made up of roughly 70% value-added products. Gross profit was $1.4 billion, a decrease of approximately 12% compared to the prior year period. Gross margins were 32.8%, down 210 basis points, primarily driven by multifamily and core organic normalization. SG&A increased $19 million to $958 million, primarily attributable to acquired operations and asset write-offs, partially offset by lower variable compensation due to lower net sales. As a percentage of net sales, total SG&A increased 190 basis points to 22.6%. Adjusted SG&A decreased approximately $1 million to $783 million, primarily attributable to lower variable compensation due to lower net sales, partially offset by acquired operations. On an annual basis, adjusted SG&A is approximately 30% fixed and 70% variable with volumes. For reference, we have an adjusted SG&A reconciliation schedule in the earnings release. We are focused on carefully managing our SG&A expenses and are well positioned to leverage our fixed costs as the market grows. Adjusted EBITDA was approximately $627 million, down 23%, primarily driven by lower gross profit, partially offset by lower operating expenses after adjustments. Adjusted EBITDA margin was 14.8%, down 310 basis points from the prior year, primarily due to lower gross profit margins, partially offset by lower operating expenses after adjustments. Adjusted net income of $360 million was down $174 million from the prior year, primarily due to lower gross profit, partially offset by lower operating expenses after adjustments and lower income tax expense. Adjusted earnings per diluted share was $3.07, a decrease of 28% compared to the prior year. On a year-over-year basis, share repurchases added roughly $0.22 per share for the third quarter. Now let's turn to our cash flow, balance sheet and liquidity on Slide 11. Q3 operating cash flow was $730 million, an increase of $81 million, mainly attributable to a decrease in net working capital. Capital expenditures for the quarter were $95 million, and free cash flow was approximately $635 million. For the last 12 months ended September 30th, our free cash flow yield was approximately 8% while operating cash flow return on invested capital was 25%. Our trailing 12 months net debt to adjusted EBITDA ratio was 1.4x, while base business leverage was 1.5x. At quarter end, our total liquidity was approximately $2 billion, consistent of $1.7 billion in net borrowing availability under the revolving credit facility and approximately $300 million in cash on hand. Moving to capital deployment. During the third quarter, we repurchased roughly 900,000 shares for approximately $160 million at an average stock price of $176.73 per share. Since the inception of our buyback program in August 2021, we have repurchased 45.5% of total shares outstanding at an average price of $77.62 per share for $7.3 billion. We have approximately $840 million remaining on our $1 billion share repurchase authorization. We remain disciplined stewards of capital and have multiple paths for value creation to maximize returns. On Slide 12, we show our 2024 outlook. We anticipate a regional financial impact from Hurricane Helene and Milton, around $40 million in sales, a relatively modest amount given our geographic diversification. For full year 2024, we have narrowed our range of expected total company net sales to be $16.25 billion to $16.55 billion. We expect adjusted EBITDA to be $2.25 billion to $2.35 billion. Adjusted EBITDA margin is forecasted to be in the range of 13.8% to 14.2%. We expect our 2024 full year gross margin guide to be in the range of 32% to 33%. This also remains in line with our long-term expectation of 30% to 33% and normalized single-family starts of $1 million to $1.1 million. We expect full year 2024 full year gross margin guide to be in the range of 32% to 33%. This also remains in line with our long-term expectation of 30% to 33% and normalized single-family starts of $1 million to $1.1 million. We expect full year 2024 free cash flow of $1.2 billion to $1.4 billion, assuming average commodity prices in the range of $380 to $400 per 1,000 board feet. 2024 outlook is based on several assumptions. Please refer to our earnings release and presentation for a list of these key assumptions. Moving to Slide 14. We recognize that 2025 is coming into focus as we approach year-end. Like we did last year, we have laid out a scenario analysis to demonstrate how we are positioned to generate resilient financial performance across a range of potential housing market and commodity conditions. I want to emphasize that this is not guidance, but these scenarios should help clarify our range of performance expectations for 2025 and demonstrate the strength of our best-in-class operating platform. Turning to slides 15 and 16. As a reminder, our base business approach showcases the underlying strength and resiliency of our company by normalizing sales and margins for commodity volatility. This helps to clearly assess the core aspects of the business where we have focused our attention to drive sustainable outperformance. Our base business guide on net sales for 2024 is approximately $15.4 billion. Our base business adjusted EBITDA guide is approximately $2.3 billion at a margin of 14%, which reflects a minimal impact from commodities. For context, Slide 16 shows that our 2020 base business adjusted EBITDA was roughly $1.1 billion and 991,000 single-family starts, and we are expecting better adjusted EBITDA at lower single-family starts this year. On Slide 17, we provide a bridge from our 2019 gross margin to the long-term normalized midpoint of 31.5%. Our improved margin profile has a greater mix of value-added products, productivity savings and commercial benefits. As I wrap up, I am confident in our ability to execute our strategy and drive long-term growth by leveraging our exceptional platform and financial flexibility. The Investor Day goals we laid out last December remain achievable, assuming a return to normalized single-family starts of $1.1 million in 2026. With that, I'll turn the call back over to Peter for some final thoughts."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Pete. Let me close by reiterating that we continue to execute. Our resilient business model allows us to win in any environment, and this is evidenced by our strong gross profit margins and cash flow generation in the third quarter. I'm confident in the long-term strength of our industry due to the significant housing underbuilt and favorable demographic trends. We are well positioned to take advantage of these tailwinds, which will help drive growth for years to come as we execute our strategy. We are a key partner to our customers and continue to deepen our value proposition by helping them solve problems through our investments in value-added products, digital tools and install services. Our proven playbook for growth, fortress balance sheet and robust free cash flow generation will help us continue to compound long-term shareholder value. Even in an uncertain and challenging environment, we are doing the hard work now and building for the future. By continuing to grow in value add and install along with leveraging IT and technological development, we are arming our team members with cutting-edge tools to continue to be the supplier of choice for our customers. By investing today, we are exceptionally well positioned to win in the future as the market continues to recover. Thank you again for joining us today. Operator, please open the call now for questions. As a reminder, with a lot of questions this morning, please limit yourself to one question and one follow-up."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. We'll take our first question from Matthew Bouley with Barclays. Please go ahead."
},
{
"speaker": "Matthew Bouley",
"content": "Good morning, everyone. I want to offer my congratulations and best wishes to Dave and best of luck to Peter and Pete. So, for my first question, I wanted to touch on your growth versus the market into these 2025 scenarios. So kind of looking into the second half here, I think the way you guys outlined the guide is, you obviously reduced the revenue guide by a bit while holding the end market guide. So, I'm curious around your balance of share and kind of how you're thinking about that in the near term. But then as you draw it into those '25 scenarios, it looks like you're talking about your growth relatively similar to the start number. So, I'm curious how you're thinking about your growth relative to market as we get into 2025 as well. And if some of these headwinds are starting to abate any visibility to that. I'll stop there, but thank you guys."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Matt. Yes, there's a lot in that question. So, a couple of factors. I would say where we are today, we have certainly seen the choppiness in the market. There wasn't a big relief rally when interest rates were cut, mortgage rates didn't necessarily behave as everyone was hoping in terms of a quick fall. And I think buyers have been appropriately or inappropriately nervous about both rates and the election. So, it's been a little choppy. I think we've seen that. We've been watching it all year. Still performing well. I think the business is still competing well, taking advantage of opportunities, we're investing. Those things have led to, I think, some solid performance on our part, but we have certainly faced headwinds. We've been hopefully pretty open about that. The value of these homes has fallen. That's really the biggest disconnect. when we look at what starts have done and what our sales have done, particularly in that single-family core organic category. That doesn't mean we're not happy and competitive. But certainly, it's been challenging out there, and we've talked about that. As we think about what that means into the fourth quarter and into next year, I think, broadly speaking, it's mixed out there. You've got markets that are doing quite well. They're sort of bouncing up and seeing some green shoots starting to perform. We've got other markets that have struggled and seen headwinds and seen a little bit of excess inventory and builders are reacting in a thoughtful way, we believe, to managing that. So, our guide for the fourth quarter is certainly focused on the visibility that we have into the market, the conversations we're having with customers, it's not a bad market by any stretch, but it's one that has certainly seen some challenges, not at all helped by the weather disruptions that we've seen. As we get into '25, it's early days. We’ve been looking at the commentary from the economists. We've been talking with our customers. It's a bit of a mixed bag, some doing better than others. We think there will be a bit of a differentiated reaction as rates are cut. We expect there will likely be at least a couple of more. We think mortgage rates will continue to settle that will have different advantages to different builders out in the market. So, this is what we're seeing today. There's certainly new news, some of the performance announcements over the past few weeks have saved our opinions as we go forward. But we thought like last year, this is a helpful starting point for helping people understand what we're thinking based on what we see today."
},
{
"speaker": "Matthew Bouley",
"content": "Got it. Thank you for that Peter and for addressing my long question there. Second one, the gross margin guide. I just wanted to confirm that given where the guide is that you're still looking at roughly 31% as the exit rate for 2024. And again, obviously, we can see the margin numbers in your 2025 scenarios. But between some of the pluses and minuses, productivity, value add, install, versus some of the competitive dynamics out there. How are you guys thinking that 31% could drift one way or the other as you go through 2025?"
},
{
"speaker": "Pete Beckmann",
"content": "Matt, thank you for the question. We're seeing a headwind as we exit 2024, of about another 100 basis points from the year-to-date average margin, 100 basis points, pretty consistent with what we said last quarter is half of it is made up from the multifamily normalization and the other half from the core business normalization. It is a competitive environment. We're going to continue to compete, especially on the commodity products with the install. Install has been a favorable result for us in 2024, and it continues to be a good arrow in the quiver, and we'll continue to compete every day and we expect to exit right around 31.5. Overall, we're certainly very pleased with the margin performance despite the challenging market, we've seen customers really continuing to benefit from the value-added products and services. That part of our business has certainly stayed strong, stay resilient, and it supported our margins in an environment where volumes are and values are down a little bit."
},
{
"speaker": "Matthew Bouley",
"content": "Got it. Okay, so you said 31.5 is the exit rate. So, I'll leave it there. Thank you, guys."
},
{
"speaker": "Pete Beckmann",
"content": "Thanks, Matt."
},
{
"speaker": "Operator",
"content": "We'll hear next from Charles Perron-Piche with Goldman Sachs. Please go ahead."
},
{
"speaker": "Charles Perron-Piche",
"content": "Thank you. Good morning, everyone. First of all, congrats, Dave, Peter and Pete on the promotion and retirement. Well, deserved. Maybe if I can go first to -- going back to Matt's question on the 2025 scenario. I just want to make sure that we understand this correctly, looking at the base case scenarios. It implies approximately 20% incremental EBITDA margin in 2025 once we moved it to $100 million of multifamily headwind. First of all, is that right? And as you see things flowing through next year, how do you see the ability to drive the gross margin versus the SG&A leverage across those scenarios? And just to follow up as well, do you see the deceleration in the sales that you've seen through 2024 in terms of the content per home as stabilizing and expecting through 2025 to be roughly consistent with what you see today in those scenarios?"
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Charles. Appreciate the comments and the questions. So, I would say the numbers and the performance of the business around margins in particular, there's a lot going on there, right? With the early look at what we have on the table, I think what it reveals is continuing performance in the areas that you'd expect us to deliver. We expect to see improved performance as a result of productivity initiatives. We continue to see the strength around the value-add. We continue to look for opportunities within that productivity category to drive both gross margins and EBITDA margins. That is, I would say, a core part of our operating model as a business and something you feel good about as time progresses. The dynamics around how the market will perform next year in light of the sales volumes in the various categories. I think broadly speaking, we continue to see weakness in multifamily. I would say our sense of it is it's stabilized, but it's been a big step down from the peak, but gotten to a level where we believe we can hold here and hopefully, start to see some recovery timing will depend on the dynamics of the market. Single family is a dynamic that's different between the types of builders, as I mentioned earlier, but certainly 1 that we think is directionally headed in a positive way. We continue to believe in the strength of the market, the desirability of new homes and the industry's ability to deliver those. We think there's a lot of pent-up demand and we are well positioned to help builders deliver and do it in a very efficient way. This -- again, early days on this guide, but for '25, but we think those scenarios can help add some color in that regard."
},
{
"speaker": "Charles Perron-Piche",
"content": "Okay. That's helpful, Peter. And maybe following up, where product prices in lumber in particular, have been trending higher over the last couple of months with the improving housing outlook for 2025, suggesting potentially more upside. I guess against this, how are you positioning your inventories in the business? And how do you see this recovery in commodity prices affecting demand and competitive dynamics across the different value-add products that you have in your portfolio if this ongoing upswing persist in 2025?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. So commodities continue to be an important part of what we do, although we are much smaller than it has in the past. It's nice to see the prices bouncing off the bottom. I'd say that below 400 window that we were in for a while was a bit, I would say, unpleasant more so for the mills and the delivery on the commodity side than for us. But certainly, we like to have a healthy sector in the commodity space and that lumber -- the dimensional lumber in OSB space in particular. We have seen a little bit of a boost I think it's early days. And I would highlight the fact that while new construction is an important driver of demand in that product category, R&R, the Repair and Remodel market is a far bigger influence. So, I think that's where, if I'm looking for support and tailwind in that category, that's an important factor to keep an eye on. You hit the nail in the head, it will certainly be a tailwind for sales and for margins as we see better absorption of our overhead costs. If that continues to increase in costs. Although, as always, we keep a close eye on affordability. We want to balance there. We not think any of us want to return to the $1,300 to $1,600 lumber days. That was pretty dysfunctional. So, a modest increase is, I think, healthy and good to stabilize the market."
},
{
"speaker": "Charles Perron-Piche",
"content": "Okay. Thanks for your time, guys."
},
{
"speaker": "Peter Jackson",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll hear next from Mike Dahl with RBC. Please go ahead."
},
{
"speaker": "Mike Dahl",
"content": "Morning, thanks for taking my questions. Congrats again to Dave, Peter and Pete. I want to start with gross margins and maybe a two-parter on both the contributors to the quarter and then thinking about that fourth quarter comment. I mean when you look at the outperformance in gross margin in the quarter, how would you bucket it out in terms of what -- whether or not there was some benefit from the rising wood-based product costs in the quarter versus maybe give us a sense of kind of on the recent M&A, whether the margin accretion from that or install, like if you could quantify any of any of that or kind of digital, really just what the drivers are? And similarly, looking into 4Q, it seems like your outlook slightly better than it than it was before. So, if you can talk to those contributing factors or any quantification there, that would be great."
},
{
"speaker": "Pete Beckmann",
"content": "Morning, Mike. Thanks for the question. With respect to fee performance and margin, we continue to see a normalization in the multifamily space. We continue to have positive uplift from productivity that we continue to deliver. And the rest of it is mix and mix within the core business, and it continues to deliver resilient margins better than what we had expected originally when we gave guidance last quarter. As we look forward to Q4, we continue to see margin normalization in the multifamily, which is a broken record, and we continue to share that each quarter and some continued pressure and normalization in the core business due to the competitive environment that we're still in. And part of it is going to be some of the seasonal build, and we'll see some of that volume kind of shoulder off as we exit the year."
},
{
"speaker": "Peter Jackson",
"content": "Yes. I think Pete's right on in terms of the key drivers. We continue to be under a bit of pressure on the competitive dynamic. You'll see some seasonality but I think, in general, what you're seeing is the continued strength of the core product offerings and the value add in terms of something that we have made a core part of what we do and has continued to be strong."
},
{
"speaker": "Mike Dahl",
"content": "Got it. Okay. Thanks for that. And then my second question, look, it's on the '25 scenarios, and I understand it is early days, as you say. But when I look across your range of start outcomes. I think some of the builders more recently have been a little more subdued in their outlooks than what some of these ranges would imply certainly the middle or upper ranges. And then taking into account the some of the mix factors that have played out this year, it seems like your revenue guide, it might be suggesting that you actually go back to outpacing the starts environment. So, two kinds of big assumptions in there in terms of some improvement in the overall market and then some improvement relative to that. I was hoping you could talk to that more how you built that and whether or not there are some bigger moving pieces in terms of like, okay, well, you're assuming x for digital and like some carryover M&A. Or maybe just help us kind of bridge when you both -- how you thought about starts, but also then framing your revenue versus starts, what some of those other big moving pieces are?"
},
{
"speaker": "Peter Jackson",
"content": "Sure. I can provide a little bit of color. I won't go into too much detail, but you're right. There's a lot that goes into it. No question. I would say the starting point is maybe where we're most maybe disconnected based on your comments and your concern about the overall starts we, at this stage of the game aren't folding in a lot of commentary, we're folding in mainly the economist forecasts and the averages of the leading forecasters around the start numbers. While an individual builder is certainly important and an important partner for us. There's no one builder that's going to move the entire market. So we generally will stay at the economist level forecasting for starts, especially at the point we're at in early November. We do have assumptions in there for commodity prices, for the M&A carryover for productivity. We've got certainly an expectation that we'll be able to gain share with some of the initiatives we've leaned hard into things like digital and install. And I think it's fair to say that our thinking around the average cost per start is aligning around it flattening out for the most part. We haven't seen continued decline. It's been more stable. I would say, since mid-summer on a year-over-year basis, we've certainly seen the comparisons, and we've tried to call those out, but it hasn't been something that's aggressively moved down after the reset earlier this year. So that's another variable that's included. But like I said, early days some high-level analytics, we tried to be inclusive of the variables that we think are important. But as you know, this is a challenging game given how volatile things are lately."
},
{
"speaker": "Mike Dahl",
"content": "Okay, I appreciate that Peter. Thank you."
},
{
"speaker": "Operator",
"content": "Next, we'll hear from David Manthey with Baird. Please go ahead."
},
{
"speaker": "David Manthey",
"content": "Thank you. Good morning and congratulations to everyone. My first question is clarification on Slide 17. When you talk about productivity, does that capture both process improvements as well as scale? And then could you also define other commercial benefits just definitionally for us?"
},
{
"speaker": "Peter Jackson",
"content": "Dave, thank you. I'm going to let Pete handle that one."
},
{
"speaker": "Pete Beckmann",
"content": "Yes. So within the productivity savings, that's process improvements. The scale that we get from the company really helps us leverage our knowledge and our expertise across the platform. But the productivity savings is process improvement on how we do things and how well we're buying, how well we're manufacturing and how well we're operating on a daily basis. Within the other commercial benefits of saying that there's customer supplier terms. We've talked about in the past where we used to have longer fixed-price contracts. We've worked to eliminate those, shorten the duration. So we don't get pinched or absorbing all the commodity risk. Our CRM tools that we put in place and how well we're managing our relationships with our customers and falling through, and that's where some of the scale is going to come into play. So you'll see that in the bullets on the side of that chart."
},
{
"speaker": "David Manthey",
"content": "Thank you and Peter Jackson, you might have just described this, but I want to be clear. You talked about the trends in single-family housing sizes. And I'm just wondering, in those scenarios, are you assuming any improvement or deterioration for that matter in any of those scenarios. It sounds like you're seeing that trend basically flatten out. Is that my understanding?"
},
{
"speaker": "Peter Jackson",
"content": "That's right. Yes. There are a bunch of pieces in there, certainly square footage of the home being one, but mix of products in the home value of those same products that are appearing in the home, all part of that. But yes, we're expecting it to flatten out based on what we're seeing right now. Little bit of a lapping impact but pretty modest."
},
{
"speaker": "David Manthey",
"content": "That's great. Okay. Thank you very much."
},
{
"speaker": "Peter Jackson",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And we'll go now to Rafe Jadrosich with Bank of America. Please go ahead."
},
{
"speaker": "Rafe Jadrosich",
"content": "Hi, good morning. Thanks for taking my question. And best of luck to Dave, and congrats to Peter and Pete. Just on the manufactured product segment, the year-over-year decline -- would it be possible if you could talk a little bit about the impact of the multifamily, specifically multifamily trusses relative to everything else? Like obviously, multi-families sort of going through that normalization. But excluding that, what are you seeing in terms of the manufactured product like revenue trends? And any commentary on margins there would be helpful."
},
{
"speaker": "Pete Beckmann",
"content": "Yes. Thanks for the question. I'll start and then I'll hand it over to Peter. What you're seeing in the manufacturing products, specifically on the multifamily side. We've been talking about the normalization, but also the volume declines that we've seen in that multifamily space. As a reminder, I mentioned in our prepared remarks that multifamily may value-added products was 70% of the multifamily overall. That used to be a much higher percent and that's also come down. And in the quarter or what we're seeing within multifamily, manufactured products is down almost 45% to 50% within that multifamily mix. We're anticipating that, that's going to continue to decline as what we're seeing from the starts and the volume normalize as we'd lap the higher year. The tough comps that we had last year was the peak, and Q3 being the highest point of that. It's just a big headwind, but we're seeing more stable volume and it's normalizing at a bottom as we exit the year."
},
{
"speaker": "Peter Jackson",
"content": "Yes. And I think just broadly speaking, the multifamily trust has been hardest hit. The multifamily work part of the business has performed a bit better, been a bit more stable. The team has competed well and found other opportunities to protect the business. I think that the side, the single-family side has certainly seen pressure, particularly in that category that we highlighted in the spoken remarks about floor trusses and the shift back to EWP. I think that's probably the only other color that I would add there. In general, we're still pleased with manufactured products in general. I think it's performing well from a support to customer perspective, from an affordability perspective, from a competitive dynamic, we feel good about and it's a productivity source for us. But it certainly on a comp basis has been challenging."
},
{
"speaker": "Rafe Jadrosich",
"content": "That's helpful. And then just on the gross margin bridge that you provided from 2019 to today, which is super helpful. The value-add portion that can you talk about how much of that is the margins changing within value-add relative to just value-add mix moving higher? And then like is there any changes we anticipate from the value-add margins today going forward?"
},
{
"speaker": "Peter Jackson",
"content": "There's a lot in there, right? I mean we've done a ton of acquisitions. We've added a ton of capacity. We've made tremendous investment. A lot of that had to do with productivity savings within the category itself that sort of generated through the size and scale of those operations. So there's certainly a lot in there. The performance generally speaking, I would say, is sustainable from the perspective that we have a lot more to offer. We have a wider portfolio and geography coverage than we did in the past. So I think that's the exciting part about where we can continue to grow this business into the future. That expansion of install, the investments we've made in that business over the years being harvested as we return to growth. I think that's an exciting history for us, but even more exciting is what the future holds in that category."
},
{
"speaker": "Rafe Jadrosich",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll go next to Philip Ng with Jefferies."
},
{
"speaker": "Philip Ng",
"content": "Hi, guys. Congrats on a solid quarter now, choppy environment. I guess to kind of kick things off. When you look at your scenarios for 2025, is there any assumption that mortgage rates actually pull back from here? And what are you assuming for non-commodity products from a pricing standpoint. And certainly, very great to see an upbeat view on the market in your various scenarios. Peter, it would be helpful to kind of give us some perspective. As you kind of pointed out, the market is still pretty choppy, what that earnings power or margin profile could look like if single-family starts are actually flat to down low single digits?"
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Philip, for your four questions. Let me try and jump at a couple of them and you can correct me in point me back in the direction you want me to go. We -- what I would say about the 2025 scenarios, we didn't do a downside. We could do a downside. I think generally speaking, like I said, the economists aren't signalling a downside. So it if that develops over time where we need to put something out there, we certainly can. We've done it in the past. We're not going to be shy about it. That hasn't been the predominant thinking in the recent past. I think that the ability of this business to perform in the downside is pretty positive. We have demonstrated the ability to size ourselves to be competitive to get after it, ability to protect and hold margins to do it by partnering with customers with products that they want. So I think that's probably the theme that I want to go with. You point me in a couple of other points you want me to highlight."
},
{
"speaker": "Philip Ng",
"content": "Your various scenarios, Peter, are you assuming any pullback in mortgage rates and how are you thinking about pricing of your products, not commodity?"
},
{
"speaker": "Peter Jackson",
"content": "So we don't have an explicit mortgage rate assumption in any of our stuff. I think what happens is it's basically embedded or implicit in what the economists are doing. My sense is most of them are taking the middle of the road dot plot and trying to step off of that, but we don't have an explicit assumption for it. In terms of pricing, I will say our sense from what we've seen from some vendors is that the era of cuts is ended. What we're seeing right now is stability in pricing in some modest, maybe low single-digit price increases. We'll see where that pans out. It's a little early to be calling that yet, but that's the tone right now."
},
{
"speaker": "Philip Ng",
"content": "Okay. That's super helpful. And then my next question is around M&A. How is the pipeline looking? Have you seen sellers come back to the market with some level of stabilization? And how do you kind of size the opportunities in front of you, smaller or larger deals in general?"
},
{
"speaker": "Peter Jackson",
"content": "Well, yes, I mean, there's no question the market is looking strong. I mean with six this quarter, I'd say the pipeline is strong. Smaller deals, by and large it make up this number, no question, but there are a number of really nice looking businesses out there. I would say that sellers have come to the market with an intent to sell. They're not exploring. They're looking to move, but a pretty wide portfolio of items that we're looking at and continue to look at it. It's a good time to be buying stuff."
},
{
"speaker": "Philip Ng",
"content": "Okay. Appreciate all the great color, guys. Thank you."
},
{
"speaker": "Operator",
"content": "We'll hear next from Jay McCanless with Wedbush. Please go ahead."
},
{
"speaker": "Jay McCanless",
"content": "Hi, thanks for taking my questions. Congratulations to everyone and thank you to you guys and your suppliers for helping out with the hurricane relief, really important work. So the first question I had going back to Slide 17, I guess could you talk about what you saw improved from last quarter to this quarter that gave you the confidence to go ahead and move the gross margin number up and the EBITDA margin up?"
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Jay. Talking about 17, that's the long range view. So one of the things we had done during Investor Day was to give people a rough estimate around what we think normalized gross margins were going to be between 30% and 33%. A frequent question that we received was wait a minute, help me get my head around this. What are the big pieces that I should understand if I bridge you from pre-BMC merger to what you're telling me is the future of this business. And we were a little hesitant to lay that out there until we have a little better understanding of what normalization was going to look like. And as things have kind of calmed down and we feel like there's a clearer line of sight to what this business is and how it will continue to perform. We decided to put this out for everybody to understand the buckets of what has driven it, where we have gotten our sort of inputs to defend that midpoint of 30% to 33%, which is about 31.5%. So this isn't a Q4 or a '25 thing. This correlates back to the 2026 target for us for Investor Day."
},
{
"speaker": "Jay McCanless",
"content": "Okay. Great. And then I guess the other question I had, Peter, you talked earlier about R&R being a much larger consumer of lumber than single-family starts. I guess could you talk to again what you guys are expecting for R&R this coming year and maybe what the industry kind of outlook is just so we know where things might go?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. I mean -- if you look at the overall, I want to -- just to clarify based on what we've seen from a couple of different sources, R&R is probably in DIY is about half of the demand for lumber and sort of the commodity product. We're closer to quarter or third with the rest of it being industrial and commercial. So certainly, that DIY R&R space is more important the tone has been pretty good. I think the sense is that there is a lot of pent-up demand for renovations as the housing stock in this country ages. There are certain commentators will, for example, who's pretty -- I won't say excited, but positive about what R&R can do if we start to see a little bit of pullback in the mortgage rates and it starts to release a little bit of that lock-in effect that people have experienced since mortgage rates went up. So that would certainly be a tailwind a balancing out in the market, I think a revival of what that represents for demand on the construction industry. I think all of that is pretty favorable for Builders FirstSource on balance. So that's certainly a positive we look forward to. Pretty modest and from what we see so far in the forecast for '25 itself, but over sort of '25, '26-ish we think there's good momentum there."
},
{
"speaker": "Jay McCanless",
"content": "Okay. That’s great. Thanks for taking my question."
},
{
"speaker": "Peter Jackson",
"content": "Thanks Jay."
},
{
"speaker": "Operator",
"content": "We'll go now to Jeffrey Stevenson with Loop Capital. Please go ahead."
},
{
"speaker": "Jeffrey Stevenson",
"content": "Hi, thanks for taking my questions today and congrats, Dave, Peter and Pete. So productivity savings are coming in better than expected this year through efficient manufacturing and procurement initiatives. I just wondered how long a runway do you have on the strong product it savings benefits you've seen over the last few years, and should we expect this trend to continue in 2025?"
},
{
"speaker": "Peter Jackson",
"content": "Thanks. Yes. Productivity is something this organization is really engaged in very effectively sharing of best practices, working together on feed ideas, ways of doing business that just takes out waste and inefficiencies at a real fundamental level has been super successful. We think there's more opportunity for that, but I won't overstate the impact of the transition that we'll see over the next couple of years towards our ERP conversion. So there has to be a balance there, both take a lot of time and energy from the organization. So we'll continue to balance it out from a timing perspective. But there's zero question, I would say, in my mind and in the minds of the operating leaders that we can continue to get better, that we can continue to drive productivity savings well into the future. I think we're just in the early innings of what we can do with just a fantastic business and a wonderful platform, particularly as we take advantage of technology and better tools for our teams."
},
{
"speaker": "Jeffrey Stevenson",
"content": "Okay. That's great to hear, Peter. And then I was wondering if you could talk more about the trade-off you're seeing, the lower value products such as an example in your prepared remarks of builders using EWP instead of floor trusses from the focus on lower value in complex home. I just wondered, how widespread is this across regions and do you expect it to continue well into 2025?"
},
{
"speaker": "Peter Jackson",
"content": "Well, we're certainly seeing it everywhere. I would say every homebuilder in their own way is trying to adapt to the affordability challenges. It's tough for home buyers just given the world that we live in to afford these new prices. And so we're all looking for ways to do what we do more efficiently. So whether it's size of the home, whether it's value of the products that are going in being a little more sharper with the pencil in terms of pricing or -- and this is, I think, more direct to your comment what's the mix of products that are going to show up in the actual, the home itself. I think you've seen even today announcements from manufacturers of building materials that have pointed to negative mix people have moved to the simpler, cheaper option in order to make sure the price point for these homes match up to the monthly payment capability of the current homebuilder. I think it has been a bit of a two years step down. We're not seeing the continued pace of those declines. They seem to have stabilized to a large degree. That's not to say we won't see some shifts in individual product categories. But I think what we have seen throughout the back half of this year so far, has been a more stable output in terms of what is going into homes, size of the homes, value of the products, that sort of thing."
},
{
"speaker": "Jeffrey Stevenson",
"content": "Very helpful. Thanks, Peter."
},
{
"speaker": "Operator",
"content": "We'll go next to Steven Ramsey with Thompson Research Group. Please go ahead."
},
{
"speaker": "Steven Ramsey",
"content": "Good morning. Wanted to ask on the R&R and other category, another quarter of solid organic growth versus the backdrop. I'm curious if you could share a bit more on the central region strength versus other regions? What is allowing you to outperform? And then maybe lastly, just to make my second question wrapped up into this, how much is value-added products a factor in this category? Thanks"
},
{
"speaker": "Peter Jackson",
"content": "So maybe second question first. Certainly, a smaller component of the R&R business. That is more varied from a product perspective, a lot more categories go through that. Just given the nature of what we sell and where we sell it. Certainly, a bit of variance between the individual divisions between those markets. I would say we've had some pretty nice success in some of our smaller markets, particularly in the North Central around the R&R space. They performed well. But in general, I think it's a strength for us just as we continue to have available capacity and open our doors to the smaller remodeler. We have a lot of value that we can provide them with subject matter expertise and product knowledge. And generally, we do have success in that category when we focus on it. But just to repeat it, it's a fairly small percentage of our overall business."
},
{
"speaker": "Steven Ramsey",
"content": "Great, thank you."
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Steven."
},
{
"speaker": "Operator",
"content": "And we'll hear next from Ketan Mamtora with BMO Capital Markets."
},
{
"speaker": "Ketan Mamtora",
"content": "Thank you. Coming back to multifamily. In -- when you talk about 2025, you've got 400 million to 500 million revenue sort of decline. Is that more of just lapping sort of year-over-year sort of deterioration as you move through 2024? Or are you sort of factoring in sort of further declines in 2025 because it's still a pretty meaningful sort of year-over-year drop?"
},
{
"speaker": "Peter Jackson",
"content": "It's primarily lapping. Yes. It's -- I would say we stabilized, but the lapping effect will still be there."
},
{
"speaker": "Ketan Mamtora",
"content": "Understood. And on the margin normalization side, both for multi-family and for single-family. Are you seeing signs that we are sort of closer to the end there in terms of sort of the competitive price pressures? Or is it sort of still continuing as we move into Q4 and next year?"
},
{
"speaker": "Pete Beckmann",
"content": "With the multifamily margin normalization, it's continuing to wane and fade. As we said on prior calls, we think it's going to kind of normalize out by Q1 of next year, but we're really hitting that exit rate. And most of the normalization you see in the results is a year-over-year comp to the prior year's strength that we had."
},
{
"speaker": "Peter Jackson",
"content": "I'd say overall, we're in late innings. We're much closer to the end in terms of the margin normalization. We certainly have teed up that 100 basis point sort of based on the exit velocity that we're seeing I don't want to miss the opportunity to highlight we're still well below normal starts. So that certainly creates pressure. But based on where we came from, we believe we're much closer than the beginning."
},
{
"speaker": "Ketan Mamtora",
"content": "Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "And we'll go next to Alex Rygiel with B. Riley. Please go ahead."
},
{
"speaker": "Alex Rygiel",
"content": "Thank you, gentlemen. A very nice quarter. As it relates to the installed sales, which increased about 11% in the quarter, what percentage of your overall net sales is that today? And how does that impact your gross margin?"
},
{
"speaker": "Peter Jackson",
"content": "So the 11% is a year-to-date improvement over the prior year. The margin profile on install is kind of at our normal mix across because we're installing products Windows, Doors, Millwork, as well as some framing and trusses and siting and other products. So it's very complementary to the overall margins that we have across all the product categories. Size of install, I think you want to know. So install was about -- I think it was 2.5 billion, 2.6 billion last year. It's increased. So it's going to be a relative increase from that."
},
{
"speaker": "Alex Rygiel",
"content": "And then as it relates to digital tools, given where we are in the housing cycle, how should we think about that as it relates to sort of your marketing of the product and its receptivity to the product?"
},
{
"speaker": "Peter Jackson",
"content": "Yes, I'm glad you asked that question. So digital is -- it's still very exciting. The product works -- it is absolutely cutting edge and unique in the industry in terms of what we can do versus any competition that exists out there. But it's new, right? It's technology in an industry that hasn't historically adopted it quickly. And it's a different way of thinking about how to be more efficient. We've got a lot of really good momentum it's certainly hard. I will confess, it's maybe even harder than we gave it credit for, but it's worked. And so we're continuing to lean in, continuing to partner with homebuilders continuing to leverage our team internally to utilize the tools and to help customers get comfortable with the tools. But given our focus on the sort of 50 to 250 starts a year builder, and how much pressure they've been under over the past couple of years because of rates, it's been challenging. I do believe this is one way they can compete, that they can be more efficient that they can be more professionalized and make their business better and more competitive against the big guys. So we think, ultimately, it will be a positive. But certainly, in the near term, it's serving a market that's been under pressure. No question."
},
{
"speaker": "Alex Rygiel",
"content": "Thank you very much."
},
{
"speaker": "Operator",
"content": "As there are no further questions at this time, ladies and gentlemen, that will conclude today's question-and-answer session and the Builders FirstSource third quarter 2024 earnings conference call. Thank you for your participation. You may disconnect your line at this time, and have a wonderful rest of your day."
}
] |
bldr | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Please standby. We are about to begin. Good day and welcome to the Builders FirstSource Second Quarter 2024 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by management and the question-and-answer session. [Operator Instructions] I'd now like to turn the call over to Heather Kos, Senior Vice President, Investor Relations for Builders FirstSource. Please go ahead."
},
{
"speaker": "Heather Kos",
"content": "Good morning, and welcome to our second quarter 2024 earnings call. With me on the call are Dave Rush, our CEO; and Peter Jackson, our CFO. The earnings press release and investor presentation are available on our website at investors.bldr.com. We will refer to the presentation during our call. The results discussed today include GAAP and non-GAAP results adjusted for certain items. We provide these non-GAAP results for informational purposes, and they should be considered in isolation from the most directly comparable GAAP measures. You can find the reconciliation of these non-GAAP measures to the corresponding GAAP measures where applicable, and a discussion of why we believe they can be useful to investors in our earnings press release, SEC filings, and presentation. Our remarks in the press release, presentation, and on this call contains forward-looking and cautionary statements within the meaning of the Private Securities Litigation Reform Act and projections of future results. Please review the forward-looking statements section in today's press release and in our SEC filings for various factors that could cause our actual results to differ from forward-looking statements and projections. With that, I'll turn the call over to Dave."
},
{
"speaker": "Dave Rush",
"content": "Thank you, Heather. Good morning, everyone, and thanks for joining our call. As we continue to operate in a complex environment, I'm proud of our resilient second quarter results, highlighted by our mid-teens EBITDA margin, which demonstrates the strength of our differentiated business model, and the hard work of our extraordinary team members. While we continue to see the expected affordability challenges and normalization in multi-family, we are executing our strategy by controlling what we can control, investing in value-added solutions, and driving adoption of our industry-leading digital platform, our ability to solve industry pain points with our best-in-class product portfolio and exceptional customer service makes us a trusted partner as our customers navigate this complex macro landscape. While near-term market dynamics are challenging as starts have lost momentum, we remain focused on executing our strategy in the weeks and months ahead, and we are well-positioned for growth as long-term housing tailwinds remain intact. Moving to our strategic pillars, on slide three, we continue to invest in value-added products, installed services, and digital solutions [technical difficulty] -- we are providing our customers with a more efficient and cost-effective way to manage home construction. This leads to increased customer stickiness, new business, and improved operational efficiency for BFS. We have a robust set of continuous improvement initiatives focused on leveraging our scale while delivering the highest quality products and services to our customers. Our highly experienced team members are delivering these critical initiatives while serving our customers with excellence and integrity every day. Finally, we continue to allocate capital in a disciplined manner with a proven M&A strategy and a track record of buying back shares at attractive prices over the long-term. Turning to our second quarter highlights on slide four, while navigating a market challenged by crosscurrents, we have seen softer than expected sales. However, we delivered strong gross margins of nearly 33% in Q2, and our adjusted EBITDA margin has remained in the mid-teens or better for 13 consecutive quarters. Our durable margin profile is a key proof point of our transformed business model and our differentiated product portfolio and scale. Given the strength of our base gross margin, we see opportunities to more aggressively go after profitable share. We have grown our mix of value-added products over the past five years, improved our manufacturing processes and efficiency, and positioned ourselves at the forefront of homebuilding innovation. Let's move to slide five where we show how we're executing our strategy. Our full suite of value-added products and services remains a competitive advantage for BFS, and continues to bolster our partnerships with customers. We're pleased with our progress on digital as we continue to hear great feedback from customers and see increasing levels of adoption each week. We demonstrated operational rigor by delivering $37 million in productivity savings in Q2, and had driven $77 million year-to-date primarily through more efficient manufacturing and procurement initiatives. As I've spoken about in the past, we continue to use playbooks to drive growth in our Installed Services business. I'm pleased that our installed sales increased by 15% year-over-year as we focus on helping customers address labor challenges. Our managers have best-in-class information to help them navigate this dynamic environment and make effective real-time decisions. We are also maximizing operational flexibility, and have consolidated seven facilities, while maintaining our service levels to our customers with on-time and in-full delivery rate of over 90%. We will remain disciplined managers of discretionary spending no matter the operating environment. We are continuing to take actions into the second-half of the year to flex the business where appropriate. The single-family growth momentum, occurring earlier in 2024, has stalled as the interest rate cuts have not materialized and starts have come in lower than expected. In addition, the value of a new start has fallen as the market has adapted to affordability challenges. Multi-family continues to be a headwind amid muted activity and relative to our record performance last year, which is creating an increasingly tough comparison. This was expected and detailed on prior [calls] (ph) as multi-family continues to normalize. Even at today's levels, multi-family continues to be a very profitable business for us. In the current environment, builders have employed specs, smaller and simpler homes, and interest rate buy-downs to help buyers find affordable options. Builders of all sizes are having to navigate affordability issues along with regulatory, land development and infrastructure challenges. Smaller builders have been especially impacted by the availability of land and limited options to buy down rates. We are partnering with our customers to help them lower the cost of homes for consumers, as well as maintain their margins. This includes balancing our product mix to address their needs while passing through lower material costs. For example, when engineered wood products or EWP was constrained, we supplied a larger number of higher-value floor trusses. As EWP supply normalized and prices came down, we have been able to provide customers with more EWP, and have sold fewer floor trusses, helping to specifically address the builders' biggest challenge, affordability. We have what the builders want and do what's right by them. Although this trend means less sales in gross profit dollars, our margin profile remains strong. We have the operational and financial flexibility needed to partner with our customers to meet their needs and capture growth opportunities. Coming to M&A, on slide six, we continue to pursue attractive opportunities while remaining financially disciplined. In the second quarter, we completed three deals with aggregate 2023 sales of roughly $72 million. In May, we acquired Schoeneman's Building Materials, which we detailed on our Q1 call, and TRS Components which establishes truss manufacturing within Metro Detroit. In June, we acquired RPM Wood Products, which enhances our ability to serve high-end custom builders in Northeast Florida. Finally, in July, we acquired Western Truss & Components, adding truss capacity in Flagstaff, Arizona area, and CRi SoCal, a dealer and installer of high-end windows and doors in Orange County. We are excited to welcome these talented new team members to the BFS family. Our disciplined approach to M&A includes increasing our market position in desirable geographies, extending our lead in value-added and specialty solutions, and enhancing customer retention. Our M&A pipeline remains healthy, and we believe we can continue to acquire in a fragmented market. On slide seven, we provide an update on capital allocation. In addition to the three tuck-in acquisitions during the second quarter, we repurchased nearly $1 billion of shares. I'm happy to announce that our Board has authorized a new $1 billion share repurchase plan. As proven by our track record, we'll continue to buy back shares while allocating capital to high-return opportunities. We remain on track to strategically deploy $5.5 billion to $8.5 billion of capital from 2024 to 2026, as outlined at Investor Day, last December. Now, let's turn to slide eight and nine for an update on our digital strategy. As the only provider of an end-to-end digital platform in our space, we believe BFS digital tools will be transformative for the industry and a substantial driver of organic growth. We have seen strong adoption and growth with our target audience of smaller builders even as they endure a challenging operating backdrop. We've had broad acceptance of the platform so far, including interest from multiple top 200 builders. Since launching in late February, we have seen the value of orders placed through the digital platform go from nearly 0 to over $250 million. Year-to-date through Q2, incremental sales have totaled $45 million. While we still have a long way to go, we remain confident in our ability to meet our target of $1 billion in incremental sales by 2026, as we grow wallet share and win new customers. I am thrilled to share a significant achievement that underscores our team members' commitment to making a positive impact in our communities. At our recent annual charity event, we successfully raised over $1 million on behalf of the Leukemia & Lymphoma Society. This brings total contributions to nearly $12 million since first partnering with LLS in 2006. These funds are crucial to advance in research, patient support, and advocacy programs aimed at finding treatments and cures for blood cancers. I want to extend our heartfelt gratitude to our industry partners and sponsors whose overwhelming support made this successful event impossible. I'll now turn the call over to Peter to discuss our financial results in greater detail."
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Dave, and good morning, everyone. We were able to effectively navigate a softer than expected housing environment during the second quarter by leaning into the pillars of our strategy and operating model. Leveraging our fortress balance sheet and exceptional financial flexibility, we executed nearly $1 billion of share repurchases into stock price weakness. And, made three tuck-in acquisitions to enhance and expand our footprint. We believe the sustainable competitive advantages and our extensive geographic coverage, value-added solutions, and strong financial position are enabling us to successfully manage market dynamics and deliver long-term value creation. I will cover three topics with you this morning. First, I'll recap our second quarter results. Second, I'll provide an update on our capital deployment. And finally, I'll discuss our revised 2024 guidance and related assumptions. Let's begin by reviewing our second quarter performance on slides 10 and 11. Net sales were $4.5 billion. A decrease of 1.6% as core organic sales declined 3.8% with the expected multi-family downward trend. The decrease in net sales was partially offset by growth from acquisitions of 1.9% and commodity inflation of 0.3%. The core organic sales decline was driven by a multi-family decline of 31%. Partially offset by increases in single-family of 1% amid higher starts and repair & remodel of 1.5%. I want to take a moment to discuss the variables impacting the disconnect between single-family start and core organic sales. As a reminder, historically there is a roughly two-month lag between a start and our first sale. In the current environment, we are seeing that lag extend as the relative timing of permit starts and completions has shifted in response to the changing market. Second, we have seen a meaningful decline in the sales opportunity of a start in 2024 as the size, complexity, and value of the average home has fallen. These changes are logical given the affordability challenges in the market. But, it means that we are seeing less dollars per start despite our strong operating performance. As an example, looking at the Phoenix market we are supplying material to roughly 45% more homes. But, our dollar sales are only about 15%. To summarize, despite a market where starts are smaller, less complex, and cheaper, we remain the market leader and will continue to deliver superior results. During the second quarter as we signaled and expected, multi-family declined more than 31% as we lacked the prior-year's strong comps. R&R and Other improved by over 1% given our retail strength in the faster growing West. Value-added products still represented approximately 49% of our net sales during the second quarter, despite the headwinds from multi-family. Gross profit was $1.5 billion. A decrease of approximately 8% compared to the prior-year period. Gross margins were 32.8%, decreasing 240 basis points, primarily driven by ongoing normalization, particularly in multi-family. SG&A decreased $45 million to $973 million, primarily attributable to lower variable compensation, partially offset by acquired operations. As a percentage of net sales, total SG&A decreased 70 basis points to 21.8%. The team has done an excellent job of managing SG&A, and we are well positioned to leverage our fixed costs as the market grows. Adjusted EBITDA was approximately $670 million, down approximately 13%, primarily driven by lower gross profit, partially offset by lower operating expenses. Adjusted EBITDA margin was 15% down 200 basis points from the prior year. On a sequential basis, adjusted EBITDA margin was up 110 basis points, primarily driven by operating leverage, partially offset by lower gross margin. Adjusted net income of $420 million was down $78 million from the prior year primarily due to lower gross profit partially offset by lower operating expenses. Adjusted earnings per diluted share was $3.50, a decrease of 10% compared to the prior year. On a year-over-year basis, share repurchases added roughly $0.22 per share for the second quarter. Now let's turn to our cash flow balance sheet and liquidity on slide 12. Our Q2 operating cash flow was approximately $452 million, an increase of $61 million, mainly attributable to a decrease in net working capital and more than offsetting almost a $100 million decline in adjusted EBITDA. This is a proof point of how our business generates a robust amount of cash in any environment. Capital expenditures for the quarter were $85 million, and free cash flow was approximately $367 million. For the last 12 months ended June 30th, our free cash flow yield was approximately 10%, while operating cash flow return on invested capital was 24%. Our net debt to adjusted EBITDA ratio was approximately 1.4 times, while base business leverage was 1.7 times. At quarter end, our total liquidity was approximately $1.7 billion, consisting of $1.6 billion in net borrowing availability under the revolving credit facility, and approximately $100 million in cash on hand. Moving to capital deployment, during the second quarter, we repurchased roughly 5.8 million shares for approximately $990 million at an average stock price of $170.01 per share. Since the inception of our buyback program in August of 2021, we have repurchased 45% of total shares outstanding at an average price of $76.65 per share for $7.1 billion. As Dave mentioned, the board approved a new authorization for the repurchase of up to $1 billion of common stock. We remain disciplined stewards of capital and have multiple paths for value creation to maximize returns. Now let's turn to our outlook on slide 13, which we are lowering, given a softer than anticipated housing market and weaker commodities. For full-year 2024, we expect total company net sales to be $16.4 billion to $17.2 billion versus our previous range of $17.5 billion to $18.5 billion. We expect adjusted EBITDA to be $2.2 billion to $2.4 billion versus the previous range of $2.4 billion to $2.8 billion. Adjusted EBITDA margin is forecasted to be in the range of 13.4% to 14% versus the previous range of 14% to 15%. And we are updating our 2024 full-year gross margin guidance to the range of 31.5% to 32.5% from 30% to 33%. This also remains in line with our long-term expectations of 30% to 33% at normalized single-family starts of 1 million to 1.1 million. Our long-term margin profile reflects a greater mix of value-added products, recent acquisition and disciplined pricing management. We expect full-year 2024 pre-cash low of $1 to $1.2, assuming an average commodity price in the range of $380 to $400 per thousand board feet. Our 2024 outlook is based on several assumptions. Please refer to our earnings release and slide 14 of the investor presentation for a list of these key assumptions. While we do not typically give quarterly guidance, we wanted to provide color for Q3, given ongoing housing uncertainty and multi-family normalization. We expect Q3 net sales to be in the range of $4.3 billion to $4.6 billion. Adjusted EBITDA is expected to be between $575 million and $625 million in Q3. Turning to slides 15 and 16, as a reminder, our base business approach showcases the underlying strength and resiliency of our company by normalizing sales and margins for commodity volatility. This helps to clearly assess the core aspects of the business, where we have focused our attention to drive sustainable outperformance. Our base business guide on net sales for 2024 is approximately $16.8 billion. Our base business adjusted EBITDA guide is approximately $2.3 billion at a margin of 13.7%, which reflects a roughly net zero impact from commodities. For context, slide 16 shows that our 2020 base business adjusted EBITDA was roughly $1.1 billion at 991,000 single-family starts. And we're expecting better adjusted EBITDA at lower single-family starts this year. As I wrap up, I want to reiterate that our exceptional positioning and financial flexibility gives us the confidence in our ability to execute our strategy and drive long-term growth. The Investor Day goals we laid out in December remain achievable, assuming a return to normalized single-family starts of $1.1 million in 2026. With that, let me turn the call back over to Dave for some final thoughts."
},
{
"speaker": "Dave Rush",
"content": "Thanks, Peter. Let me close by reiterating that we continue to execute as evidenced by our strong profit margins and cash flow generation. Our resilient business model allows us to win in any environment. In 2020, we had an 8.7% base business adjusted EBITDA margin at 991,000 single-family starts. This year, we expect the mid-teens adjusted EBITDA margin at a lower level of housing starts. This demonstrates the resiliency of our transformed business and is a strong base to build from as the housing market grows to meet demand. I am confident in the long-term strength of the industry due to the significant housing underbill and favorable demographic trends. We are well positioned to take advantage of those tailwinds, which will help drive growth for years to come as we execute our strategy. We believe we are the unquestioned leader in addressing our customers' pain points through our investments in value-added products, digital tools, and installed services. Our proven playbook for growth and robust free cash flow generation will help us continue to compound long-term shareholder value. Thank you again for joining us today. Operator, let's please open the call now for questions."
},
{
"speaker": "Operator",
"content": "Certainly. [Operator Instructions] We will go first to Matthew Bouley with Barclays. Please go ahead."
},
{
"speaker": "Matthew Bouley",
"content": "Good morning, everyone. Thank you for taking the questions. Maybe we will start on the gross margin side, looking at the new margin guide and the cadence that you are implying for the second-half, I am curious as we zoom into the fourth quarter, what that would imply for the exit rate around gross margins? And certainly what I'm getting at is, as we think about 2025, where your starting point on gross margins would be as you continue to highlight that the overall 30 to 33 guide, the long-term guide is kind of at normalized housing starts, and certainly it begs the question, if we're not quite at normalized housing starts yet in 2025, where the gross margin could land if there's an air pocket, given the starts outlook? Thanks, guys."
},
{
"speaker": "Peter Jackson",
"content": "Morning, Matt. Thank you for the question. Yes, so margins has been an important factor for us. It's changed a lot over the years. We certainly get a lot of questions on it. We're pleased with how margins have performed so far, right? We knew normalization was going to happen. We saw it coming particularly on the multi-family side, but we're certainly pleased with how it's progressed. If you look into the future, into the second-half of this year and into next year, more normalization is what we've outlined. And I think that we've been pretty clear about that. Hopefully no change in what expectations are. When it comes to '25 and the exit rate, so I want to be real clear, right, we don't have a crystal ball, we don't know. This is not intended to be guide for '25. We haven't done that work yet. But based on what we're seeing right now, we're coming out of this year at roughly 975 on starts, give or take. Based on that, we're kind of at that level of performance that we're guiding to, right in that 32% range. As you think about 2025 based on what we're seeing right now, we think it's probably another 100 basis points at this level, like if you just extend the line out you'd see another 100 basis points of headwind into 2025 made up of the two pieces you'd expect, right? About half of that is multi-family, and about half of that is core operations based on what we're seeing. So, we're definitely closer to the end than the beginning in terms of the normalization based on what we see. The multi-family is a story, no question. We think that if you look back to last year, we called out a little over 100 basis points of tailwind from multi-family. We'll give back 60, maybe a little -- right in that range basis points in '24, with the other 50 basis points coming in '25. That's probably about a couple hundred million dollars worth of EBITDA headwind from multi-family. And we feel like the rest of the business is performing really well, and we'll be in a strong position to overcome that as we get into '25."
},
{
"speaker": "Dave Rush",
"content": "Matt, the only thing I'd add is our focus and continuing focus on doing more for the customer with installed, doing more for the customer with value-add, those are higher margin profile products that we held, all said, any start variation."
},
{
"speaker": "Matthew Bouley",
"content": "Got it. Okay, that's very helpful quantification and color. And that dovetails into my next question. So, if I look at the total EBITDA guide for the year, I guess it's down about $300 million at the midpoint. But the base business EBITDA guide is only down by $100 million. So, I guess, presumably, the change in commodity prices is actually the largest change in the guide. I just want to clarify if that's the case. And if so, when we're talking about the kind of stability on the value-add side, can you speak to what has specifically changed in just the value-add outlook in terms of the growth side, starts, and specifically value-add margins, just what's really driven that piece of the guidance change there? Thank you."
},
{
"speaker": "Peter Jackson",
"content": "All right, so one question in 26 parts; let's see if I get them all."
},
{
"speaker": "Matthew Bouley",
"content": "Of course."
},
{
"speaker": "Peter Jackson",
"content": "So, overall, you're right, we have seen a shift in commodities, right? So the market's been weaker, the -- both lumber and OSB, OSB kind of ran up for a little bit, had absolutely reset and pulled back. That is largest component of the dollar value change in sales that we've called out. So, of the $1.2 billion, more than half of that is just the commodity valuation change. What that means to the business in terms of the rest of the output called down on EBITDA, the bulk of EBITDA call-down is deleveraging, it's the vast majority of it, right? It's the smaller business absorbs less of the fixed overhead costs. You can see this quarter; we had some pretty substantial improvement just because we are busiest in the summer months. We thought we'd be busier in the back-half than we're going to be, so we're giving some of that back. Value-add, more specifically, we continue to see strength. We continue to see the volumes moving very well, the demand is very strong; customers have consistently stayed with the product. We haven't seen a shift away from value-add broadly. What we are seeing and what we pointed out here -- what Dave pointed out in his remarks was really this mix dynamic, right? It goes to the customers focusing on affordability, how do they get cost out? One of the ways they're doing that is a shift within value-add, shifting from open-web truss to EWP, that's just -- it's a lower sales dollar value product, right? It's combined with a lot of other things. They're shrinking the square footage of the house, they're taking out basements, they're reducing the number of garages and bonus rooms. All things that are not a surprise, if you think about the affordability challenge. But that has had a broad pressure, that's not unique to value-add or not value-add. I think where value-add has seen pressure is really around the price pass-through in that type of mix. Volumes are still strong. Margins are still strong on the core product categories."
},
{
"speaker": "Dave Rush",
"content": "One thing I would add on the value-add components specifically, Matt, is even as truss volumes declined our ability to more efficiently manufacture increases. As we go from two shifts to one shift, our second shift is the least profitable, for obvious reasons, but you put up with that because you leverage 100% of the fixed costs. When we go to one shift, that's our most profitable shift, so even as the top line may be less because of the demand being less, the ability to maintain margins is actually easier because we're most efficient in that one shift."
},
{
"speaker": "Matthew Bouley",
"content": "Great. Well, appreciate the color. Thanks, Dave, Peter. Good luck, guys."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Matt."
},
{
"speaker": "Operator",
"content": "We'll hear next from Mike Dahl with RBC Capital Markets."
},
{
"speaker": "Mike Dahl",
"content": "Hi, and thanks for taking my questions. Probably going to just follow-up on a couple things there, look, Peter, I know that it's not a practice of yours to give pinpoint estimate on margins or certainly not to give formal guidance a year out at this point in the year. But I just want to be crystal clear on your last comment about exit rate in '25 gross margin just because there's been so much handwriting over this. When you're talking about -- it seems like you're saying, \"Hey, if my midpoint is 32% for this year, maybe my midpoint or my starting point in '25 is 31%.\" Or said another way, maybe my exit rate in 4Q of '24 is around 31% gross margin. Was that the intended message or could you clarify that a little bit more specifically on the 4Q gross margin here?"
},
{
"speaker": "Peter Jackson",
"content": "Morning, Mike. In short, yes, you got it right. You heard it right. We think we're around 32% this year. We think our exit rate is around 31% based on everything we're seeing today. This is not guide. It's not intended to be a crystal ball; it's just trying to give directionality. The short answer to that, and I think you've alluded to it, and so did Matt, our long-range normalized margins we're seeing are 30% to 33% at 1.1 million starts. This would indicate that we're going to be at 31% at 975,000 starts. What does that mean? Well, that means, right now, margins are strong. Ours are good. Ours are better than we expected, which is great. But it also means we're under pressure in a market that's got extra capacity versus what we're all dialed in for, which is 1.1 million-plus, right? So, that's the tug of war going on right now, and why we're not able to put our stake in the ground and claim it. We've got to see how this plays out. Pretty optimistic, like Dave said, about the overall market, the demos, the under build, it's good. That we think tone is playing out maybe belatedly but positively in terms of the interest rate environment right now. So, we'll see. But it's a strong business. It's really well-positioned, and margins look good."
},
{
"speaker": "Mike Dahl",
"content": "Okay, yes, that's helpful. And look, I agree and appreciate the zooming out and the perspective about the, hey, even if we're talking about 31%, it's 31% at these depressed levels of volume, which is longer-term actually quite constructive. Just shifting gears, all this stuff around the mix, the complexity, I -- this is, I think, another part that's hard for all of us and investors to appreciate when we're building out a model that tends to be volume focused. And so, I guess when you're -- all the moving pieces there, is there a way for you to articulate, hey, it's all equal, what we're seeing on the mix changes and complexity changes to date or to hold, here's how much of a delta we think it would drive relative to, if I think my single-family starts are low single, is that a -- is it a low single-digit headwind against that? Is it a mid-single digit headwind against that, any, any help you could provide on just kind of ballparking that and would be great?"
},
{
"speaker": "Peter Jackson",
"content": "Yes, so that's -- it's a great question. We spent a lot of time on this. As we spend a lot of energy, we're trying to understand our business at a granular level. We have a lot of data. Unfortunately, it's a lot of data, right? So, the ability to really understand the mix impact of hundreds of thousands of SKUs at 570 locations in 80 markets, it's sometimes an adventure to really get through the noise to get the signal. I think earlier this year, you saw us reacting to what we were seeing, trying to understand it. I think the storyline around this whole value conversation is that the order of magnitude is bigger than we expected. I think the storyline around the timing of starts versus permits is again, order of magnitude, a little bigger than we expected. So, Q2, if you use our roughly two month lag, we've got about a 20 point gap that we're tracking down that we're saying, why aren't we up a lot more? And it's broken down into a few pieces, right? Probably the single biggest piece is we think that the lag between permits and starts is a bit longer. The cycle time is a little longer. You saw large builders pulling large quantity of permits and doing it to beat code changes, doing it to beat the rush. Everybody thought the market was going up. And they haven't put those starts in the ground as quickly as the traditional custom builders would have. And I think we all know the large nationals, the big guys are winning, right? They've got a bigger share of the pie. We think that's causing a little bit of distortion in the starts number, that, that will settle out as the year progresses. But at least early on, it overstated starts a bit. The other pieces are pieces we've talked about, right? Maybe another third of it is probably related to the pricing changes. A lot of that is vendor. Vendors have cut. We talked about EVP, Doors, Millwork. There are a bunch of categories that have had to readjust to the current demand and they have adjusted prices in response. So, that's an important piece. And another roughly third is in that category of mix, right? It's what we're seeing in terms of, if you think about the traditional good, better, best, you're talking about best to better, better to good, good to let's not do it. It's that things we were talking about before with regard to going from basement construction to slab may not sound like a big deal, but that percent is changing in the statistics and that has a meaningful decline in the value of product that goes into the house. So, rough categories, that's kind of how we think about it, but I'd be lying if I told you we had those numbers with precision. I think we've got good directionality, but we're going to have to see how that plays out. The interesting part of all of it, though, Mike, is it's so volatile, right? It moved quickly one way. There's no reason it can't move quickly the other. We're just going to stay close to it and make sure we're serving our customers the best we can."
},
{
"speaker": "Dave Rush",
"content": "The only thing I would add, Mike, is it's primarily a top-line scenario for us that we have to manage through. Our margins, regardless, have stayed very consistent and very strong, and we're appreciative of that. But the best example is the one that Peter gave in Arizona. Forty-five percent number of houses that we've started, 15% is the increase in revenue. You can do that math and say in Arizona it's 30% impact. But at the end of the day, it varies depending on the market. What we're seeing, though, is we have the levers that we can pull to get the sale, depending on what the customer chooses to use to solve their problem. And at the same time, we're able to hold our margins because of having that ability to provide an alternative solution that works for both."
},
{
"speaker": "Mike Dahl",
"content": "Got it. That's all really helpful. Thank you both."
},
{
"speaker": "Dave Rush",
"content": "Thanks, Mike."
},
{
"speaker": "Operator",
"content": "We'll go next Rafe Jadrosich with Bank of America."
},
{
"speaker": "Rafe Jadrosich",
"content": "Hi, good morning. It's Rafe. Thanks for taking my question. Peter, I appreciate all the color so far and how we should think about the margin progression here. Just following up on the earlier comments about 60 basis points of headwinds from multi-family in '24 and another 50 basis points roughly in '25, how much of that is normalization of the multi-family margins off of excess levels versus multi-family mix. And how do you think about the multi-family margins today? Like how much have we seen a normalization off of the elevated margins you've had in the past? How much more is there to go?"
},
{
"speaker": "Peter Jackson",
"content": "Good morning, Rafe. Thanks for the question. Yes, so the dynamic around the multi-family is a tricky one. We've tried to be really open and honest about what we're seeing, but it's not convenient in terms of how it's playing out. In other words, it didn't just stop on January 1st and we didn't have a nice clean turn. So, I don't have nice clean numbers last year or this year. So, there's a little bit of this you're probably going to poke at, but I can give you sort of my best sense of the directionality. We continue to see strong business in multi-family throughout all of last year that really began to turn in that Q1 window. We are seeing meaningful declines in our margins in what we're seeing starting in Q1 and stronger in Q2, kind of that 50 to a 100 basis points in those periods headwind driven by multi-family, right? That's sort of the combination of the mixed shift because it's all value-added and that downward shift within the category. So, with that in mind, we do expect it to continue this year. I think I mentioned from a dollar perspective, Q2 is going to be a chunky one, right? That was going to hurt a lot and obviously it did, but we will continue to see headwinds throughout the year. Again, with that kind of rough average of around 60 basis points, 50 to 70, give me a band around it based on timing, but overall impact on the company from the full multi-family segment of our business."
},
{
"speaker": "Rafe Jadrosich",
"content": "Thank you. That's helpful. And then, you had an -- in the prepared remarks, there's a comment that I thought was interesting. They're talking about how given the strength of the base gross margin, you sort of see more opportunity to go after profitable shares going forward. How do you think about how your market share trended is kind of in the first-half of this year? And do you expect any changes going forward? And does any of that have to do with some of the mixed impacts that you're thinking about? Have you seen Builders multi-source more? Has that been a headwind? And then going forward, do you expect to try to take market share? Like, what are your expectations there?"
},
{
"speaker": "Dave Rush",
"content": "Rafe, this is Dave. I would tell you what we're looking at is a disciplined approach, right? We want to identify opportunities where it's a volume where we have an opportunity to have a win-win with our customer, where we can leverage that incremental volume against our fixed costs, whether it be manufactured product or even distributed product, and offset the volume incentive that we may use to go after that business. So, it will be a targeted approach. It'll be a disciplined approach. It will be only where the volume makes sense. And there has to be a win-win solution there. Thankfully, we had all the guys in the first part of July, and that was the focus of the meeting. And they all had a plethora of opportunities. They felt that description, and we're going to execute that strategy in the back half."
},
{
"speaker": "Rafe Jadrosich",
"content": "Thank you. I appreciate it."
},
{
"speaker": "Dave Rush",
"content": "Thanks, Rafe."
},
{
"speaker": "Operator",
"content": "We'll go next to Trey Grooms with Stephens, Inc."
},
{
"speaker": "Trey Grooms",
"content": "Hey, good morning, everyone. I appreciate all the color you've given thus far. And this one's I guess so on just the -- on lumber, kind of the competitive pricing that we've seen on the commodity lumber side. Nothing new, but wondering if you're seeing this become more widespread or intense, given the kind of weaker environment. But also, on the trusses and value-add, with multi-family pulling back, which was clearly taking up a lot of that supply, are you seeing any more competitive behavior on the truss side or value-add side now that multi-family has started to normalize?"
},
{
"speaker": "Dave Rush",
"content": "Hey, Trey. Thanks for the question. On the commodity part of the question, we always see the players in the marketplace that take commodities too low because it's all they have to offer. And we're not choosing to play in that game. What we will do, though, is partner with our customers that commodity becomes part of a package, and we value the overall packaging and create incentives to buy all products from us, whereby through the value-add piece of that package, we can earn back a level of whatever volume incentive we provide. So, our focus on building share has still got to be a win-win. It's not going to be only a win for the customer or only a win for BFS. It won't be sustainable if that's the way you approach it. With specifically the value-add, where we still and will maintain an advantage is over our efficiencies. We have continued to drive efficiencies, and I said in the earlier comment, if we're in one shift, we're as efficient as we can possibly be when we're one shift. So, we have the ability to leverage incremental volume in that idle capacity and, again, create a more profitable net-net number for us, even as we provide an incentive to customers for the incremental volume. So, that's kind of how, even as we've managed and tried to pick opportunities to drive the top line, we've been able to hold on to the market."
},
{
"speaker": "Trey Grooms",
"content": "Yes. That's helpful. I heard Peter mention something about price pass-through, and I think it was when you were talking about the value-add side, just trying to make sure I understand what that comment meant."
},
{
"speaker": "Dave Rush",
"content": "I'll answer it, then I'll let you follow up. That's actually when we get a cost reduction from our vendors on products, and we immediately pass that through. It is, again, impactful on the top line because now we're selling a lower-cost product, but our margin profile is not impacted, and we're kind of operating under the same model from a profitability standpoint. Is that right?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. Just to echo that same thought, we do stay very focused on making sure we're acting in a disciplined manner with our customers in key categories. As commodities, we pass it all through. A little color on that, I guess. I'm a bit disappointed. I would have hoped to have seen a lumber industry be a little more intentional about making money. Not everyone is a bad actor in that category, but I remain -- I continue to be surprised at how many players are willing to sustain loss or losing bills, business units, whatever you want to call it, longer than I would have expected. There's an awful lot of weeping and gnashing of the teeth out there, but not a lot of behavior that would indicate that we're moving in the right direction. Hopefully, we will, but that's disappointing. I think what you see are weaker lumber numbers that we absolutely pass through to our customers. What I was referring to before are certain price cuts that we've seen, specific actions taken by EWP players, Doors players, Millwork players, and some others where we've seen low to mid-single-digit reductions in overall sales attributable to nothing else than customer -- the prices we give our customers are adjusted because of the prices we're charged by our vendors."
},
{
"speaker": "Trey Grooms",
"content": "Yes, got it. Just a quick one for my follow-up, there's very I guess, differing views on kind of the multi-family outlook and maybe how quickly that could take to normalize. I'd love to maybe get your thoughts on that. I think you mentioned there may be a little bit more headwind to come in 2025, but any color on maybe the timing of when we might see that stabilization and multi-family? And then, I know it's hard to say, but directionally, do you think we could see maybe a pretty quick rebound there after it does find some stabilization, or do you feel like we could tread water there at that much lower level there for a while?"
},
{
"speaker": "Dave Rush",
"content": "Yes, Trey. I'll tell you the dynamic we've seen in 2024 is, in addition to people hesitant to start new projects, we've actually seen existing projects get delayed and pushed pretty consistently throughout the year. The project's still on the board. The project's still going to get done, but it's getting pushed, which, quite frankly, was part of the top-line headwind in the first-half, even though multi-family's a small piece of the overall. New projects take so long to get underway that I think the order that has to happen is we have to have the cost of capital come down. Then there's going to be new projects that come out of the ground, but they're going to take a while to get going. The one thing we are seeing, though, is a gap currently that is in favor of multi-family, where rental rates are now less than mortgage rates for essentially the same type of living arrangement. So, a lot of the excess capacity that we feel like we came into the year with, with multi-family, we do believe will burn off during the rest of this year, which will encourage a quicker rebound in multi-family in 2025. The problem is it just takes so long."
},
{
"speaker": "Trey Grooms",
"content": "Yes. Okay. Thanks for the color, Dave. I really appreciate it."
},
{
"speaker": "Dave Rush",
"content": "Truss wood is still a very profitable business for us at these levels and will continue to be at the levels we expect to have through 2024 and into 2025."
},
{
"speaker": "Trey Grooms",
"content": "Great. Thank you very much."
},
{
"speaker": "Dave Rush",
"content": "Thanks, Trey."
},
{
"speaker": "Operator",
"content": "We'll go now to Adam Baumgarten with Zelman."
},
{
"speaker": "Adam Baumgarten",
"content": "Hey, good morning, everyone. Just on the value of new starts declining, I guess, could you give us a sense for -- I know you gave the Phoenix example, but maybe overall what it's down and how much of that's from smaller square footage and how much of it is that lower mix of value at?"
},
{
"speaker": "Peter Jackson",
"content": "Good morning, Adam. Honestly, to know that answer with precision, I'd probably call you guys. We know there are data points that prove our point. What we don't have is confidence in the individual buckets. It's way too volatile and way too customer specific, regionally influenced for us. But again, if we're missing 20 points in terms of where is that sale, I think directionally, the biggest third is on the extended time, it's taking between permit and sale. We know another chunk of it is on the value, just the price is charged and the rest of it is that mix component. It's square footage. It's smaller. It's cheaper. Five to seven, I don't know. I'm guessing, to be honest."
},
{
"speaker": "Dave Rush",
"content": "We've done enough proof points to know that it's a thing, right? It's harder to decide what part of what aspect is -- for example, we took a bid for a national builder from last year and compared the exact same house, the exact same model this year. And it was down mid-teens in overall sale opportunity in the exact same house. So, we don't have that in every market and every builder, but at the end of the day, again, it was another proof point that what we suspected was happening is actually happening. And directionally, we know what we're dealing with. And again, as that changes, the encouraging thing is the margin profile is not also changing. And that's -- I'd love to have all the volume that we could possibly get, but at the end of the day, I at least want to keep the balance between what we're selling and what we're making and what we're selling and check along the way."
},
{
"speaker": "Adam Baumgarten",
"content": "Okay, got it. Thanks. And then, just a couple more, just on the digital sales, the incremental sales, you expect in '24, I think you've talked about $200 million in the past. Is that still expected for the year? And then, just on M&A, any changes in the strategy there given the increase in the share repurchase activity and authorization?"
},
{
"speaker": "Dave Rush",
"content": "Yes. Let me talk a little about digital. As we started to roll out the digital and the adoption, I think it probably isn't a surprise that we have gone first to our employees. And we've gotten them up to speed on the benefits of digital. So, they can more fully explain to their customers; the customers that we've gone to initially have been existing customers. So, it's while we give you that stat of orders through the system of $250 million, now we expect fully that existing customers push in orders through the system. That business we probably -- we have already had, we would have still gotten had we not had digital. But we still want to track it. It's an indication of acceptance. And so, the incremental business we get is going to come more from new customers, and as we continue to get existing customers more comfortable, incremental wallet from those guys. But, that obviously is going to be more in the form of a hockey stick. So, no, we are not giving up on the $200 million for this year. At this point in time, it is admittedly a tougher point to get a little bit to the hockey stick. But we still know that hockey stick is going be there. And, the acceptance for getting even as it is from existing customers is really encouraging. I'll let Peter talk to the M&A piece."
},
{
"speaker": "Peter Jackson",
"content": "Yes, I 100% agree on digital. It is encouraging. The momentum is good. On M&A, the momentum is good there too. I think you've seen the increasing number of acquisition targets that we are closing on. Still little bit smaller, but we really like to pace. The pipeline still looks very good. We are still pleased with the potential targets out there. And, the way that negotiations are going. Certainly, very optimistic about our ability to continue to grow the business in a healthy way with really, really nice assets like the ones we added this quarter."
},
{
"speaker": "Adam Baumgarten",
"content": "Great. Thanks. Best of luck."
},
{
"speaker": "Peter Jackson",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll hear next from David Manthey with Baird."
},
{
"speaker": "David Manthey",
"content": "Hi, everyone. Good morning. Peter, in your non-guidance, that 31% gross margin exiting the year, when you talk about the 2025, you said 100 basis points of headwinds. Fifty from multi-family makes sense. But then the other 50, is that corporations? And, just wondering if could explain that a little bit more. Is that just lower operating leverage because it will lower levels of starts and raw demand, or is that something else?"
},
{
"speaker": "Peter Jackson",
"content": ""
},
{
"speaker": ",",
"content": ""
},
{
"speaker": "David Manthey",
"content": "Got it, okay. Then on the EBITDA margin, in the base business which you raise by 20 basis points to 13.7%, could you share with us the source of your increased confidence despite the kind of lackluster macros here? And also, I assume that your 2026 ranges in that 14 for midpoint is intact as well? Is that right?"
},
{
"speaker": "Peter Jackson",
"content": "So, the second-half of the question, yes, our '26 is still intact. We would need volumes to rebound, but we feel good about the core business. And I think that informs where we are dialing in on the EBITDA number for that base business comp. We are getting better and better clarity around what our margin profile looks like in a healthy market, what our profile looks like in the current market, and being able to dial in the breakout from commodities kind of seeing the full-year really leveling out right around that 400 level without a ton of volatility, a bit, but not a ton is giving us the ability to dial it in a little bit more to what we think is a real sort of neutral commodity level or performance. Core business is still very healthy. As much as we wanted to be bigger, I think, what you're seeing here and what their base business chart lays out is a business that's really been transformed based on what we sell and how we service our customers, and the stability of that core business, even though you've seen kind of some ups and downs in the starts performance at the overall market."
},
{
"speaker": "David Manthey",
"content": "Sounds good. Thank you very much."
},
{
"speaker": "Dave Rush",
"content": "Thank you, Dave."
},
{
"speaker": "Operator",
"content": "We will go now to Reuben Garner with The Benchmark Company."
},
{
"speaker": "Reuben Garner",
"content": "Hi. Good morning, everybody. I'd like to harp on the multi-family, but I do have a quick follow-up about the top line for next year. I think your business is where multi-family starts are little over 40% off the peak level, but I think your business is limited to 25% to 30% range. Does that imply that at this current run rate for starts we have another 10 to 15 points of top line pressure within your multi-family business in '25?"
},
{
"speaker": "Dave Rush",
"content": "So, that's a tough question. It's very specific. Greetings, Reuben. Thank you for the question. Appreciate it. The question is very specific, and I'm not sure I can go all the way down, what I say is we do expect there to be lapping of the rest of the decline in multi-family. So, certainly we expect there to be continued headwinds on the sales line, kind of in that maybe 400-ish range, based on what we are seeing now, and around 200 of headwinds on the EBITDA line for multi-family, but remember, multi-family is all in. You got the full portfolio of multi-family products when we are talking about multi-family. I know in the past I've thrown out some color around truss. I'm going to try not to do that anymore, because I think I just muddy the waters, but when we are talking about the total, based on what we are seeing today, I would say that's the trend now. Certainly some headwind, but multi-family is only a 11% of our business this year. It's going to climb a little bit further next year in maybe smaller percentage, it's just a declining impact on the overall, as it strings back and kind of normalizes. Does that answer your question?"
},
{
"speaker": "Reuben Garner",
"content": "Yes, it does. Thank you. That's helpful. And then, can you update us pre-2020, the way it would work is the builders would set up a contract that you guys I think, at the time it averaged somewhere between 60 and 120 days for the framing package, and during the last few years that strung significantly. Are we still -- the length of this contract is still in the 30-day range and lined up with inventory. Are we seeing that move that all with kind of the reset of the commodity market?"
},
{
"speaker": "Peter Jackson",
"content": "It's still in the range with how we buy our inventory, which is what we have always tried to do. As long as we have the ability to cover what we soiled, we are willing to work with our builders however we need to match that up, also, with how they priced their homes. And it hasn't gotten to the point where it was 90-plus or whatever. But we are generally in a 45-day exposure rate, but that's exactly how much inventory we hold and how we carry it."
},
{
"speaker": "Dave Rush",
"content": "Yes. There has only been some pressure back. There are certain players that have been less disciplined. We've definitely tried to hold the ground on what we think is good, smart way of coding in the market, but today's point, we've tried to increase those 30 days numbers we talked about, back during sort of the busyness of the supply chain issues, where you really had to move it quick. Now that we are back into more of a normal cadence, where we got that 45-day-ish line of sight, if you will, between what's on the ground, what's on the order, it's a lot easier to work with customers and tie it together and use some 60-day terms, that sort of thing. We are still absolutely opposed to 90 and 120-day terms, because we think that's the wrong discipline and the wrong way of approaching the market."
},
{
"speaker": "Peter Jackson",
"content": "Well, and at that point, we actually do take market risk. I mean, what we are trying to do is mitigate their risk and mitigate our risk; we work with them to try to find that middle ground and make sure that they're covered and we are covered. And we'll adjust off of that, and touch markets specific if that solve the problem for our customer. But in general, we are in that 45-day range."
},
{
"speaker": "Reuben Garner",
"content": "Exactly where I was getting at; thanks, guys. Appreciate it, and good luck going forward."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Reuben."
},
{
"speaker": "Operator",
"content": "We will go now to Jay McCanless with Wedbush."
},
{
"speaker": "Jay McCanless",
"content": "Good morning, everyone. Thanks for taking my questions. The first one I had, when you think about lumber prices in the way you guys look at it, talking about $400 kind of being the base assumption, could you talk about what deflation you're seeing in 2Q '24 versus where it was 2Q '23?"
},
{
"speaker": "Peter Jackson",
"content": "We called it out in terms of what went through COGS. It was just basically zero, right, at 23 or whatever, small 3% headwind. That is something that does move a little out of sequence with what you see in random blanks. It is going to be a headwind in the second-half versus first-half, which is how you get to that sort of full-year number that's a little below the 400 level."
},
{
"speaker": "Jay McCanless",
"content": "Okay, thank you. And then, the other question I had, if you look at -- I came with slide a ton, but commodity number was up I think, 13% in sales for the second quarter, that's almost double the rate of single-family starts growth that the census numbers had for the national readings as well the south readings, I guess, with these in general serving down a little bit, are you trying to outgrow and take even more market share on the commodity side until value-add maybe comes back a little bit, because those were pretty impressive numbers, where of the rest of the market was?"
},
{
"speaker": "Peter Jackson",
"content": "Well, Jay, we always wanted to take all the shares about that comment. Now, in all honest and all sincerity, we always see a couple month lag, and if you think about the Q1 starts number, that was up in the 20s. So, you are just that swash over a little bit into Q2. We are seeing a comparable performance in the business. We will certainly see a graphic, like Dave said. We think when there're opportunities to lean in and take share, we are going to keep doing it. But that's not really the explanation, if you will."
},
{
"speaker": "Jay McCanless",
"content": "Okay, great. Thanks for taking my question."
},
{
"speaker": "Peter Jackson",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We will go now to Steven Ramsey with Thompson Research Group."
},
{
"speaker": "Steven Ramsey",
"content": "Hi. Good morning. Maybe just wrap my two questions into one here, the product mix at 49%, pretty impressive even with the complexity headwinds that you have, certainly love the dynamic here, but do you think that housing market normalizes complexity going up from current levels over the next couple of years to reach your plan, or do you needed that complexity level to move up, or can the current complexity level allow for that to allow you to reach your long-term targets? Thanks."
},
{
"speaker": "Dave Rush",
"content": "Yes. Thanks for the question. Keep in mind, the value-added products, the movement is within the category. The engineered wood products are still value-adds. So, as you go from truss engineered wood, we are not leaving the value-add product category, we are moving within it. The sale opportunity is less, but again, our margin profiles have held in there. And we are doing what we can to keep our customers addressing affordability, and at the same time, maintaining their margins as well. So, I don't see the shift in the incremental value-add products will come as the market returns to normal [technical difficulty] for those products in general. And right now we offer the full spectrum. We will send you sticks if you don't want value-add. But this we go from READY-FRAME to panel, to panel and truss. So, fully installed framing packages, all which you have would tunnel into the value-added product category in total. And we would expect it to maintain, for sure, and incrementally grow as housing starts return to normal levels."
},
{
"speaker": "Steven Ramsey",
"content": "Excellent, thank you."
},
{
"speaker": "Dave Rush",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, that will conclude today's question-and-answer session, and the Builders FirstSource second quarter 2024 earnings conference call. Thank you for your participation. You may disconnect at this time, and everyone have a wonderful day."
}
] |
bldr | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, everyone, and welcome to the Builders FirstSource First Quarter 2024 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by management and the question-and-answer session. [Operator Instructions] I would now like to turn the call over to Heather Kos, Senior Vice President, Investor Relations for Builders FirstSource. Please go ahead."
},
{
"speaker": "Heather Kos",
"content": "Good morning, and welcome to our first quarter 2024 earnings call. With me on the call are Dave Rush, our CEO; and Peter Jackson, our CFO. The earnings press release and presentation are available on our website at investors.bldr.com. We will refer to the presentation during our call."
},
{
"speaker": "",
"content": "The results discussed today include GAAP and non-GAAP results adjusted for certain items. We provide these non-GAAP results for informational purposes, and they should not be considered in isolation from the most directly comparable GAAP measures. You can find a reconciliation of these non-GAAP measures to the corresponding GAAP measures where applicable and a discussion of why we believe they could be useful to investors in our earnings press release, SEC filings and presentation."
},
{
"speaker": "",
"content": "Our remarks in the press release, presentation and on this call contain forward-looking and cautionary statements within the meaning of the Private Securities Litigation Reform Act and projections of future results. Please review the forward-looking statements section in today's press release and in our SEC filings for various factors that could cause our actual results to differ from forward-looking statements and projections. With that, I'll turn the call over to Dave."
},
{
"speaker": "David Rush",
"content": "Thank you, Heather. Good morning, everyone. Thank you for joining our call. Our resilient first quarter results reflect our differentiated product portfolio and scale, our team members consistent focus on executing our strategic priorities and our operational efficiency initiatives. As we expected, a weakening multifamily market and higher mortgage rates, driving affordability challenges were headwinds to start the year. Despite these micro challenges, we built on our successes and drove growth through our value-added products portfolio in our industry-leading digital platform. ."
},
{
"speaker": "",
"content": "We are committed to advancing innovation and delivering exceptional customer service as a trusted and preferred partner to our customers. We are focused on executing our clear strategic pillars, as shown on Slide 3. Our investments in value-added products, install services and digital solutions are driving organic growth, delivering greater efficiency and empowering the next generation of homebuilding. For those who are new to the BFS story, value-added products include manufactured components such as trusses, Ready-Frame and wall panels as well as windows, doors and millwork."
},
{
"speaker": "",
"content": "Through our value-added products and install services we help meet our customer needs, such as reducing cycle times, addressing labor constraints and improving home construction quality. With our digital tools, we are providing our customers with a more efficient and cost-effective way to manage the construction of their homes that will increase existing customer stickiness, win new business and improve our operational efficiency. We remain committed to innovation and continuously seeking to do things better."
},
{
"speaker": "",
"content": "We have a robust set of operational and productivity initiatives and are focused on leveraging our scale and fixed cost while delivering the highest quality products and services to our customers. We are deploying capital in a disciplined manner with a proven M&A strategy and a track record of buying back shares at competitive prices. Working alongside the best team in the industry, I am confident that we will continue to compound long-term shareholder value and achieve our strategic priorities."
},
{
"speaker": "",
"content": "Let's turn to our first quarter highlights on Slide 4. We continued to deliver strong margins in Q1, reflecting our end-segment diversification, focused execution and differentiated product portfolio and scale. Our gross margins of more than 33% reflect a higher mix of value-added products, including multifamily truss and our ability to manufacture more efficiently. We expect the multifamily end segment to progressively normalize over the course of this year, and we continue to see some normalization in core margins."
},
{
"speaker": "Moving to Slide 5. We're off to a strong start on our strategic initiatives. Our full digital product launch at the International Builders' Show in February was an exciting milestone. At a high level, our digital tools do 3 things",
"content": "one, solve customer pain points; two, make it even easier to partner with us and our suppliers; and three, help us gain incremental business from new and existing customers. It's a win-win, and we're excited about how everything is going so far after the launch."
},
{
"speaker": "",
"content": "We're focused on operational excellence and innovation and using playbooks of proven best practices to increase our safety, efficiency and wallet share with customers. One area where we're using playbooks is with our installed services business. Our install sales increased by 17% year-over-year as we leverage our capabilities to help customers address labor constraints. Additionally, we drove $40 million in productivity savings in Q1, primarily through procurement and SG&A initiatives. We believe prudent expense management leads to maximum operational flexibility. This includes optimizing our footprint and balancing cost reductions against future capacity demands."
},
{
"speaker": "",
"content": "We will remain disciplined managers of this discretionary spending no matter the operating environment. Early momentum in single-family has slowed as persistent inflation has cooled short-term expectations for interest rate reductions. However, low existing home inventories and pent-up demand provide an environment where growth has continued to build. Builders across the board are having to navigate affordability issues and challenges with the regulatory environment, land development and infrastructure."
},
{
"speaker": "",
"content": "It's evident that the large national builders have done a good job of utilizing specs, reducing home sizes and providing interest rate buydowns to assist buyers with affordable options. Smaller builders are more likely to benefit from rate cuts. We are staying in close contact with our customers of all sizes to maximize our business in the current environment. As we have detailed on prior calls, multifamily became a headwind in Q1 as our activity levels and record backlogs have declined versus the prior year."
},
{
"speaker": "",
"content": "It is important to note, however, that multifamily remains a strong contributor to gross margins and EBITDA even at current levels."
},
{
"speaker": "",
"content": "Turning to M&A on Slide 6. We continue to target attractive opportunities while remaining financially disciplined. In the first quarter, we completed 2 deals with aggregate 2023 sales of roughly $36 million. In early February, we acquired Quality Door and Millwork, a leading distributor of millwork, doors and windows in Southern Idaho."
},
{
"speaker": "",
"content": "In March, we acquired Hanson Truss, which further strengthens our value-added position in Northern California and Nevada. And last week, we acquired [ Schoeneman's Building Materials ]. [ Schoeneman's ] manufactures trusses and distributes building materials in the Sioux Falls, South Dakota area. We are excited to welcome these talented new team members to the BFS family. M&A and organic investments have increased value-added products as a percent of our overall mix by 700 basis points over the past 2 years and by 1,000 basis points if you go back to 2019."
},
{
"speaker": "",
"content": "Our success with this strategy has been a core component of our improved margin profile through the cycle. We believe there is a long runway of M&A targets in our fragmented market, and we are pleased with recent improvements in the pipeline. Our disciplined approach to M&A includes increasing our market position in desirable geographies, extending our lead in value-added and specialty solutions and enhancing customer retention."
},
{
"speaker": "",
"content": "On Slide 7, we provide an update on capital allocation. During the first quarter, we completed a $1 billion note offering which brought us additional financial flexibility to grow organically and remain acquisitive while maintaining a strong balance sheet. In addition to the 2 tuck-in acquisitions, we repurchased $20 million of shares as proven by our track record, we'll continue to buy back shares while allocating capital to high-return opportunities. We remain on track to strategically deploy $5.5 billion to $8.5 billion of capital from 2024 to 2026 as outlined at Investor Day last December."
},
{
"speaker": "",
"content": "Now let's turn to Slides 8 and 9 for an update on our digital strategy. As the only provider of an end-to-end digital platform in our space, we believe BFS digital tools will be transformative for the industry and a substantial driver of organic growth. Our easy-to-use portal myBLDR.com seamlessly delivers our full digital capabilities to our customers. It is designed to create efficiencies for our team members and improved service for our customers by offering increased transparency and engagement in the homebuilding process. Combined with our proprietary estimating and configuration tools, our customers will have more control over the entire building process. This will save time and money for both our customers and their clients while making the homebuilding process more personalized."
},
{
"speaker": "",
"content": "We were proud to highlight the full digital product capabilities at IBS in February. Our customers told us the new tools address an unmet need, and they were excited to use them in their businesses. Since launch in late February, we have seen orders on the digital platform go from nearly 0 to over $60 million. In Q1, we had incremental sales of over $10 million. We remain confident in our ability to meet our targets of $200 million of incremental digital revenue by the end of this year and $1 billion by 2026, as we grow wallet share and win new customers."
},
{
"speaker": "",
"content": "One of our digital tools, Build Optimize uses advanced 3D modeling to identify construction clashes and resolve mechanical design conflicts before breaking ground. It ensures architects, builders and trades are coordinated and building to the same plan. As a proof point of the advantages of using this transformative tool, we've seen interest from 4 large builders. One of these customers has used it in 3 markets and 13 communities across 34 plants. On average, we have identified 150 conflicts per plant, resolving those conflicts before construction leads to job site time and cost savings."
},
{
"speaker": "",
"content": "One of my favorite initiatives at BFS is acknowledging team members who go above and beyond. Ira Banks in Atlanta, Georgia personifies this quality. Ira began with BFS in 1996 as a driver helper and rose through the ranks to operations manager and now oversees our new Atlanta Millwork facility in Dacula. Ira has the respect of his team members because he's willing to do whatever it takes to solve problems and add value for our customers. Recently, when there was no available drivers for an urgent customer delivery that had to arrive that day, Ira drove the box truck himself to take care of the customer."
},
{
"speaker": "",
"content": "I'm grateful for Ira's drive to lead by example, a quality we find consistently in leaders across BFS. I'll now turn the call over to Peter to discuss our financial results in greater detail."
},
{
"speaker": "Peter Jackson",
"content": "Thank you, Dave, and good morning, everyone. Our first quarter results demonstrated the effectiveness of our strategy and operating model. We are maintaining our fortress balance sheet and prudently deploying capital to the highest return opportunities. We've included acquisitions and share repurchases during the quarter. We are leveraging our sustainable competitive advantages and strong financial position to drive future growth and value creation for our customers and shareholders."
},
{
"speaker": "",
"content": "I will cover 3 topics with you this morning. First, I'll recap our first quarter results. Second, I'll provide an update on our capital deployment. And finally, I'll discuss our 2024 guidance and related assumptions."
},
{
"speaker": "",
"content": "Let's begin by reviewing our first quarter performance on Slides 10 and 11. We delivered $3.9 billion in net sales, driven by growth from acquisitions of 1.9% partially offset by commodity deflation of 1.7%. Core organic sales in line with the prior year were driven by a single-family increase of more than 4% amid higher sales of early-stage homebuilding products. From a geographic perspective, E sales were down mid-single digits, Central was flat and the West was up mid-teens. As we signaled and expected, multifamily declined more than 13% as we lapped the prior year's strong comps. R&R and other also declined by almost 5% due to weakness predominantly in the Northeast from inclement weather."
},
{
"speaker": "",
"content": "As we mentioned last quarter, inclement weather negatively impacted our operations in Q1 by roughly 3% to 4% of our overall sales. Value-added products represented approximately 52% of our net sales during the first quarter, reflecting our strength and customer stickiness for these higher-margin products. During the first quarter, gross profit was $1.3 billion, a decrease of approximately 5% compared to the prior year period. Gross margins were 33.4%, decreasing 190 basis points, mainly due to a timing shift in product mix towards lower-margin, early-stage homebuilding products, as well as margin normalization, particularly in multifamily."
},
{
"speaker": "",
"content": "SG&A increased $22 million to $926 million, primarily attributable to acquired operations. As a percentage of net sales, total SG&A increased 50 basis points to 23.8%. The team has done an excellent job managing SG&A, and we stand ready to leverage our fixed costs into the growing market."
},
{
"speaker": "",
"content": "Adjusted EBITDA was $541 million, down approximately 14%, primarily driven by lower gross profit and higher operating expenses. Adjusted EBITDA margin was 13.9%, down 240 basis points from the prior year. Adjusted net income of $327 million was down $83 million from the prior year due to lower gross profit and higher operating expenses, primarily due to acquisitions."
},
{
"speaker": "",
"content": "Adjusted earnings per diluted share was $2.65, a decrease of 11% compared to the prior year. On a year-over-year basis, share repurchases added roughly $0.29 per share for the first quarter. Now let's turn to our cash flow, balance sheet and liquidity on Slide 12. Our Q1 operating cash flow was approximately $317 million, down $337 million compared to the prior year period, mainly attributable to lower net income and an increase in net working capital."
},
{
"speaker": "",
"content": "Capital expenditures for the quarter were $90 million, and free cash flow was approximately $228 million. For the last 12 months ended March 31, our free cash flow yield was approximately 6%, while operating cash flow return on invested capital was 22%. Our net debt to adjusted EBITDA ratio was approximately 1.1x, while base business leverage was 1.2x. In February, we completed a $1 billion private offer of 6.375% senior unsecured notes due 2034, which enables a maximum financial flexibility to grow organically and remain acquisitive."
},
{
"speaker": "",
"content": "Excluding our ABL, we have no long-term debt maturities until 2030. At quarter end, our total liquidity was approximately $2.4 billion, consisting of $1.7 billion in net borrowing availability under the revolving credit facility and approximately $700 million of cash on hand."
},
{
"speaker": "",
"content": "Moving to capital deployment. During the first quarter, we repurchased roughly 100,000 shares for $20 million at an average stock price of $202.67 per share. Since the inception of our buyback program in August of '21, we have repurchased 42.2% of total shares outstanding at an average price of $70.42 per share for $6.1 billion."
},
{
"speaker": "",
"content": "We have $980 million remaining on our share repurchase authorization. We remain disciplined stewards of capital and have multiple paths for value creation to maximize returns."
},
{
"speaker": "",
"content": "Now let's turn to our outlook, which we are reaffirming on Slide 13. For full year 2024, we expect total company net sales to be $17.5 billion to $18.5 billion. We expect adjusted EBITDA to be $2.4 billion to $2.8 billion. Adjusted EBITDA margin is forecasted to be 14% to 15%, and we are guiding gross margins to a range of 30% to 33%, which is in line with our long-term normalized expectation. Our recent margins reflect above normal multifamily performance on top of our greater mix of value-added products along with the disciplined pricing required to offset increased operating costs."
},
{
"speaker": "",
"content": "We expect full year 2024 free cash flow of $1 billion to $1.2 billion. The free cash flow forecast assumes average commodity prices in the range of $400 to $440 per thousand board feet. Our 2024 outlook is based on several assumptions and includes an expectation for improving single-family growth. Please refer to our earnings release in Slide 14 of the investor presentation for a list of these key assumptions."
},
{
"speaker": "",
"content": "As you all know, we do not typically give quarterly guidance, but we wanted to provide directional color for Q2 given the ongoing interest rate uncertainty and the geopolitical situation. On a year-over-year basis, we expect Q2 net sales to be down low single digits to flat as single-family growth is offset by expected multifamily headwinds. Year-over-year adjusted EBITDA is expected to be down high teens in Q2, primarily given the impact of continued multifamily normalization."
},
{
"speaker": "",
"content": "Turning to Slides 15 and 16. As a reminder, our base business approach showcases the underlying strength and profitability of our company by normalizing sales and margins for commodity volatility. This helps to clearly assess the core aspects of the business where we have focused our attention to drive sustainable outperformance. Our base business guide on net sales for 2024 is approximately $17.6 billion. Our base business adjusted EBITDA guide is approximately $2.4 billion at a margin of 13.5%."
},
{
"speaker": "",
"content": "As I wrap up, I want to reiterate that we are confident in the near-term outlook, our exceptional positioning to execute our strategic goals and our ability to create shareholder value in any environment. With that, let me turn the call back over to Dave for some final thoughts."
},
{
"speaker": "David Rush",
"content": "Thanks, Peter. Let me close by summarizing how we're set up to drive long-term profitable growth by executing our strategic pillars. We believe we are the unquestioned leader in addressing our customers' pain points through our focus on customer service, value-added products and install services. Our industry-leading digital innovations are bringing greater efficiency to homebuilding and will win us new customers and grow wallet share along the way."
},
{
"speaker": "",
"content": "Our robust free cash flow generation is funding disciplined capital deployment that will maximize returns and compound long-term shareholder value. We have a proven playbook for growth during complex operating environments, and we'll keep working to be the best and deliver excellence every day. Thank you again for joining us today."
},
{
"speaker": "",
"content": "Operator, let's please open the call now for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And it does appear we have our first question from Matthew Bouley with Barclays."
},
{
"speaker": "Matthew Bouley",
"content": "I'll start out on the second quarter. I'm wondering what's implied in the second quarter gross margin. It seems that you're kind of moving into that full year range of 30% to 33% in the second quarter, but correct me if I'm wrong. I know we're talking about normalization in both multifamily and the core, so within that second quarter gross margin, can we say that the over earn in both multifamily and the core is entirely rolled off or not yet entirely rolled off. So would there be sort of more to come beyond the second quarter?"
},
{
"speaker": "Peter Jackson",
"content": "Matt, thanks for the question. So the margins that we're seeing are really in line with what we were expecting. The multifamily business specifically, I think, outlined it a couple of times, but for everybody just to restate it, will continue to normalize, will continue to go down over the course of the year. We think that sales will continue to decline back towards normal, and we'll continue to see margins as a percentage return back to normal as the year progresses. So not over, but very much in line with what we were expecting."
},
{
"speaker": "",
"content": "Margins -- there's a couple of things going on. We've talked about margin normalization being between 30% and 33%. We think that's an accurate forecast. Just keep in mind that normalization in this instance, would assume normal starts which we're not quite back to yet. But that said, our guide for the year is still within that range. We've seen some good things hold on longer, and we think that's going to sustain us to be able to get to our guide for the year on margins. But it's performing about like we expected. It's not a surprise in terms of where the rates -- where the margin levels are."
},
{
"speaker": "Matthew Bouley",
"content": "Okay. Secondly, the multifamily revenue impact, clearly, it's quite concentrated in the manufacturing products. I see multifamily was down 13% in Q1. It looks like you have one more, I think, tough year-over-year comparison in multifamily here in the second quarter. So I guess within the second quarter guide, is the assumption that multifamily is down sort of more than it was in the first quarter. Would that imply that Q2 is sort of the low point for multifamily year-over-year with lesser declines in the second half? Or should we assume that we should look for kind of a consistent headwind for multifamily declines through the balance of the year?"
},
{
"speaker": "Peter Jackson",
"content": "Yes, it's the latter. You should expect a consistent decline from multifamily throughout the year. It's a long lead time product category. We've got pretty good visibility to what we're expecting to see. There's certainly a bit of slippage from one month to the next in any given period. But I think what we're seeing and expecting in multifamily is another big decline in Q2 and sort of a consistent year-over-year decline throughout the end of the year. We'll, of course, update you as we learn more."
},
{
"speaker": "Operator",
"content": "And we have our next question from Mike Dahl with RBC Capital Markets."
},
{
"speaker": "Michael Dahl",
"content": "I want to ask, I guess, is effectively a follow-up there. When we think about what's implied for the second half, if we look at the 1Q results and 2Q, directional color, at the midpoint, it requires double-digit top line growth and kind of 15% EBITDA margins. And the high end would be kind of like mid-teens top line growth and 16% EBITDA margin, both of those, just given the multifamily decline, your comments just now about further normalization in gross margin. It kind of seems difficult. So maybe you can help us there. I guess it's a roundabout way of asking more directly. When you look at the full year guide, is there a point in the range that you think you're leaning more towards at this point, like midpoint or lower or midpoint or higher. Maybe just help us understand how that's evolved."
},
{
"speaker": "Peter Jackson",
"content": "Mike, thanks for the question. In short, we're really confident in the forecast, the way it's laid out. That guide is something that you put out there and feel good about reaffirming. The growth that you're talking about is already happening. So I think it came through in some of our materials. I think there's maybe this expectation that our whole business moves in the same way in the same quarter. And that's really not what we're seeing here, right? You're seeing the early parts of the building process, the lumber, the truss, the stuff that hits the job site early after the start, doing great. we're growing. The momentum is building."
},
{
"speaker": "",
"content": "There are certainly some headwinds we're dealing with. I mean we talked a little bit about that. I'm sure we'll talk more. But the business is performing very well in that category. We've not yet started to see the tailwind, the uplift from some of the later building process products, right, the doors, the millwork, they are also good for us. But we have every confidence that that's coming, that that's going to continue to be a good tailwind for us. There are, of course, a lot of questions about what the overall market in single family is going to do, a lot of questions about interest rates."
},
{
"speaker": "",
"content": "But again, let's not forget, there's a lot of demand out there. There are a lot of confident homebuilders. There are a lot of good units and good production momentum going on, and we're participating. So we're not concerned about delivering based on everything we're seeing today, but we do have to digest multifamily. I think we've been very transparent about that. It's working like we expected, and things are playing out. So yes, the back half of the year needs to be growing. But again, we're seeing good momentum that we think will pass through on the early-stage products. We're seeing good growth in categories that we've leaned into, value-add, install, and we continue to be active in M&A."
},
{
"speaker": "",
"content": "So certainly, a lot to be confident in. We're happy with the business and not shy about what we're seeing for the rest of the year."
},
{
"speaker": "David Rush",
"content": "Yes. The only thing I'd add is -- echo the overarching demand profile continues to be strong. I think the timing of when they actually execute the buy is kind of what is a little more volatile than the expectation that they will execute the buy. And that's part of it but our builder customers are still indicating that they are seeing that demand, and they're expecting the similar trajectory that we've forecasted for ourselves for the back half."
},
{
"speaker": "Michael Dahl",
"content": "Okay. Got it. And then shifting gears just to capital deployment and maybe specifically the buyback. I mean you've got plenty of liquidity. Your leverage is low. The buyback was really just nominal this quarter for the first time in a while. What can we take away from that? And maybe anything more specific about how you envision deploying capital through the year?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. We're -- you're right, we're sitting on about $700 million in cash plus all of the capacity in the ABL, lots of cool M&A popping, right? I mean we've done a couple of small deals so far, but we're sitting on a bunch of dry powder and excited about what the opportunities look like. We'll have to see how they play out. But at this moment in time, we're ready to take advantage of the opportunities that are going to present themselves. That's kind of how you should read that. A little bit of a slow start to the year, but we're feeling good."
},
{
"speaker": "Operator",
"content": "And we have our next question from Trey Grooms with Stephens."
},
{
"speaker": "Trey Grooms",
"content": "I also want to touch on the guidance, believe it or not. You guys mentioned -- well, first off, you reiterated the full year, you mentioned that multifamily is going about as you expected. And clearly, you guys have been very vocal about your expectations and kind of the pullback there in multifamily and the impact it could have. But clearly, the 2Q guide is lower than what I think most were kind of modeling or expecting, but with you reiterating the full year guide, is it fair to say that kind of overall, the 2Q is kind of tracking as you would have thought? Any surprises there? Or maybe even any areas where it's coming in better or worse than you would have expected as we've moved so far through the year?"
},
{
"speaker": "David Rush",
"content": "Yes. Thanks, Trey. What I would tell you is multifamily in specific, some of that backlog is getting extended. So where at one point in time in the year, I may have thought more of those jobs would finish quicker. They're spread now. It's actually a good thing. It kind of smoothed that transition for us in one way. The other thing I'd tell you about multifamily, our team has done a great job going after pseudo multifamily."
},
{
"speaker": "",
"content": "Smaller multifamily projects, customers, they [ haven't ] typically gone after that are helping also transition that hasn't started yet, but we're seeing a lot of good momentum in that space, things like assisted living versus a 4-level apartment complex. So smaller jobs as you take them by themselves, but add it up, it will help the transition."
},
{
"speaker": "",
"content": "But single family is kind of operating the way we expected it to. There's been -- it's never retracted below a level. It's a build, and it's a continual build, but at the end of the day, is it as steep of a build as we would like? Of course, not, it's not as robust as we would like ever, but it's steady and it's there, and it doesn't retract. That's an important factor. It is a build even as it's a slower build than we'd love to see. And we're adjusting that as we need to, to those market conditions."
},
{
"speaker": "Peter Jackson",
"content": "The only thing I might add is there's nothing in what's happened that is a surprise to us in terms of the variables. All the variables I think. We've accounted for. There are a couple of variables that were, I would say, bigger headwinds than we anticipated. I think that weather thing has certainly thrown us a curve ball. It will bounce back, but that's been a tricky one to navigate, particularly regionally."
},
{
"speaker": "",
"content": "I think what builders have done to build homes more affordably, whether it be size of the home or complexity of the home there's some variability on that as well that we've been challenged with. But again, I think we're in line. We're doing what we said we were going to do despite those variables."
},
{
"speaker": "David Rush",
"content": "Yes. And I would add, a good indicator for me is always our truss backlog. Our truss backlog is at healthy levels. It's continuing to build. That's an indicator for us of what's to come. And that -- if that was starting to slack off, I might give a little more worried, but it's where it needs to be for us to be in a healthy situation."
},
{
"speaker": "Trey Grooms",
"content": "Got it. All right. Well, I appreciate it. And hearing that you're very confident in the guide and being able to reiterate it is encouraging. So -- we appreciate it, and thanks. Good luck for the rest of the quarter."
},
{
"speaker": "Peter Jackson",
"content": "Thanks, Trey."
},
{
"speaker": "Operator",
"content": "And our next question comes from Rafe Jadrosich with Bank of America."
},
{
"speaker": "Rafe Jadrosich",
"content": "I wanted to ask on the commodity pricing. In the first quarter, it was deflationary, but when you look at -- I think OSB prices were up, lumber prices seemed kind of flattish sequentially. So can you just talk about what you're seeing there either is it from a mix standpoint? Or how does the competitive environment evolve? And like how do you expect that to go going forward?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. So I would tell you right up front that commodities are where the war is happening. That's where the fight is. It's where historically, you've got the most aggressive players. You've got the most dynamic pricing, the volatility of it. I think what you're seeing in the numbers is really just around timing. A little bit of shift in terms of when we saw the OSB run versus when we were feeling it. That will come through at different points during the year. But I would expect sort of us to be pretty much done with the bad news around the prices of commodities."
},
{
"speaker": "",
"content": "What I will say, though, is while we saw the run in OSB that's starting to walk back. We saw a much smaller run on lumber and that's walking back as well. So I think you're seeing that mood of the market recognizing [ higher ] for longer and trying to triangulate on what that means to commodity prices. But again, that's not our game. We don't play the commodities up, commodity down bet. We're continuing to on product just in time, move it quickly, price appropriately, get paid for what we do, that our strategy hasn't changed at all in that category."
},
{
"speaker": "Rafe Jadrosich",
"content": "Got it. Very helpful. And then just on SG&A, there was some deleverage in the first quarter. How should we think about that going forward here, especially if sales turn in the second half of the year? And then just remind us of the base in terms of incentive comp from last year, do you have an easier comparison there and how we just about leverage versus what you have done historically?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. So SG&A, we saw a couple of one-timers come through in Q1 that hurt us a little bit. Some of it was -- we had some credits last year that we didn't repeat this year. I wouldn't -- from my perspective and take it what it's worth, I wouldn't read too much into it."
},
{
"speaker": "",
"content": "I think our consistent discipline around expenses will keep us in the ranges that you'd expect. Summer months are always our best leverage months, right, Q2, Q3, so you'll see that come through. In terms of the base business, I guess I would say there isn't much of an adjustment, maybe minor on the bonus side."
},
{
"speaker": "",
"content": "I think really the storyline around the year-over-year bonuses is that we gave ourselves as you've seen a more challenging target and plan for this year. Our performance is more in line versus vastly outperforming that target. So you will see a pullback in the total amount of bonus dollars just by nature of that performance, which you'd expect. I think that shareholders, management and the Board is all an alignment on that one. So that will be a bit of a tailwind versus the prior year just from a dollar amount perspective."
},
{
"speaker": "David Rush",
"content": "The only thing I'd add is our highest variable cost obviously is our labor. And the field and the team have done an exceptional job keeping labor as a percent of gross profit, which is our key metric, right in line with our operating -- within the parameters of what we set for ourselves in this level of sales and activity and our tools for managing that cost are as good as they've ever been in my 25 years with the company. So the key factor for us in managing SG&A is how well we manage our labor down at the field level, and they've done exceptional at that since the beginning of the year."
},
{
"speaker": "Operator",
"content": "And we have our next question from Keith Hughes with Truist."
},
{
"speaker": "Keith Hughes",
"content": "The question on the windows and doors segment. It was down 2%. You talked about some product costs declining. Can you talk about that a little bit more, which product and is that selling prices declining or inputs, any kind of details would be great."
},
{
"speaker": "David Rush",
"content": "Well, good morning, Keith, if you recall, Keith, this time last year or in the first quarter last year, we were just coming out of normalization of the supply chain, windows and doors were getting delivered timely again, and the national builders focus on completions in that first quarter was at a higher level just to catch up. That kind of was the [ PIG in the pipeline ] for us last year in higher millwork and [ window and ] the door sales in the first quarter than normal. I would tell you this first quarter was normal. So we had to roll over those numbers from last year where it was a bit more tilted towards completions where this year was more normal with respect to completions."
},
{
"speaker": "",
"content": "There has been some deflation in the category, and specifically, I think, with millwork -- on the millwork side. And that's affected it modestly. I think we saw pretty close. Our volumes did exactly what we expected our volumes to do and it was more along the lines of some of the deflationary impact along with rolling over that higher degree of completions last first quarter, that really explained the difference."
},
{
"speaker": "Operator",
"content": "And we have our next question from Adam Baumgarten with Zelman & Associates."
},
{
"speaker": "Adam Baumgarten",
"content": "Can you talk about what you're seeing from a non-commodity pricing perspective? And maybe specifically on the manufactured product side?"
},
{
"speaker": "David Rush",
"content": "So you're talking about customer pricing or vendor pricing."
},
{
"speaker": "Adam Baumgarten",
"content": "Your pricing to customers."
},
{
"speaker": "David Rush",
"content": "So it's -- as you would expect and why we play in those categories, that is less price sensitive on the manufacturing side because once you get locked in with the designer and you get locked in with somebody who's going to meet delivery schedules and whatnot. That becomes more important factor. Now as commodities have fluctuated and the fact that they are a component of manufacturing that affects the price as commodities go up or down, and they've been going down for lumber slightly."
},
{
"speaker": "",
"content": "But you know what we've been able to do is offset some of that with our efficiencies that we've been able to gain throughout since the merger with our automation investments and our continual improvement in actual board foot per labor hour produced has been a nice offset to some of those challenges. But as a whole, value add continues to hold in there better than commodities, which, of course, is in line with our strategy."
},
{
"speaker": "Adam Baumgarten",
"content": "Okay. Got it. That's helpful. And then just on the 3% to 4% impact from weather you saw in 1Q, how should we expect that to be recouped? Is it mostly in 2Q? Or is it going to span over a few quarters?"
},
{
"speaker": "Peter Jackson",
"content": "Well, I was happy to say Q2 up until Houston got buried or flooded out. Generally, it takes about quarter to a quarter and a half to catch back up. It doesn't unfortunately just whipsaw back the other direction, but that's probably a reasonable way to think about it, 3 to 4 months."
},
{
"speaker": "Operator",
"content": "And our next question comes from Stanley Elliott with Stifel."
},
{
"speaker": "Stanley Elliott",
"content": "can you all talk a little bit about what you're seeing on the services piece, some very strong numbers, up 17%. Is this kind of reflection of your efforts to take it into new markets. Is this existing your -- more services with some of your existing customers. And then I guess secondly, how should we eventually take it up -- this as either attach rate or pull through on some of the other things you're doing on the manufactured side?"
},
{
"speaker": "David Rush",
"content": "Yes. I would say all of the above. We had a strong install business. We did $2.5 billion in labor and materials installed in 2023. So we had a nice base to work from. And our initial focus, as you would expect, was on the products that we are already good at in one market and leveraging that platform to other markets. And it's the products that we're most familiar with and the products that we distribute every day. So we've got off to a great start. A lot of that increase is from existing markets that are already doing install because those are the ones that had the base to work from."
},
{
"speaker": "",
"content": "But we developed really nice playbooks, and we've had really good interest, which has been pull interest. So as people reaching out, I want to get into this business, how do I do it the right way versus us saying, \"Hey, you need to get into this business.\" Which is in my role, in my seat, that's what you want to see. And we've got really good people, really good plans, and we just think it's the next evolution for us as a company in solving our customer pain points and doing it methodically and in a way that we don't make mistakes. That's key for me, to do it the right way and make sure that what we are generating is customer value added solutions."
},
{
"speaker": "Stanley Elliott",
"content": "And curious kind of tagging on that, if you're willing to share. Are you seeing more of this uptake with some of the smaller builders, some of the more national builders? Just trying to kind of get a sense for the flavor there?"
},
{
"speaker": "David Rush",
"content": "It's a little, it depends on the product category first of all. But the national builders certainly like the install solution wherever they can apply it."
},
{
"speaker": "",
"content": "The custom guys like it, but they're a little more specific to millwork or a little more specific to install windows probably not so much installed framing, right? So it's a really good play for the national builders. They seem to like that the best, but there are applications for both segments."
},
{
"speaker": "Peter Jackson",
"content": "And to Dave's point, we do see a higher level of adoption of our value-added products to the larger players just generally."
},
{
"speaker": "David Rush",
"content": "Yes. And install is a natural evolution to the value add. It's the next part of value add, not only do you get the components delivered to the job site, but you actually install the components that are delivered to the job site, that's just a natural evolution of doing more for our customers."
},
{
"speaker": "Operator",
"content": "And we have our next question from Collin Verron with Jefferies."
},
{
"speaker": "Collin Verron",
"content": "I just want to start on the gross margin side of things. You talked about the shift in timing towards early-stage homebuilding products being a gross margin mix headwind. Can you maybe quantify that headwind either sequentially or year-over-year? And how it compares to the headwind you're seeing from multifamily normalization? And just following up on that, how you're thinking about that mix through the rest of the year, just given what you're seeing in starts, backlogs and conversations with your customers?"
},
{
"speaker": "Peter Jackson",
"content": "Yes. So I don't think I can give you the detail -- thank you for the question. I'm not sure I can give you the breakdown necessarily exactly what you're looking for. What I can tell you is on the mix side, it's an expectation that we're going to see a trend back to normal mix. I don't think that's much of a stretch, right? So what we're seeing right now is more of our growth being in the pure commodities and the truss and the relationship between just those 2 categories, biases it towards the commodities. And commodities like I was saying before, is where we've had the most aggressive normalization."
},
{
"speaker": "",
"content": "We've seen it across the board on the gross margins, right? We've seen gross margin normalization. We've talked about it a lot. It's not just multifamily, it's single-family, too. Matter of fact, this quarter, the bulk of it was single-family normalization. Much of that is the mix, but a good chunk of that is also just what we've been messaging over the last year, and that's -- we have seen this normalization play out. We've seen it across the business. And this year's margins are when you peel back that multifamily stuff, a step down from where they were. That was why we were so adamant last year that our mid-30s gross margin numbers weren't going to hold on because we were seeing it play out."
},
{
"speaker": "",
"content": "But that mix will certainly be a tailwind as we regain the later-stage building products, but we have, again, the lapping from the prior year. So that's why our guide is in that 30% to 33% range because we think that those 3 variables will play against each other, and we want to try and give you the best insight possible to where we'll end up."
},
{
"speaker": "Collin Verron",
"content": "Okay. That's helpful color. I guess I want to pivot towards the M&A pipeline. It sounds like it's pretty robust. Any color to the size of potential deals out there in the market and what those potential targets look like from a product offering perspective."
},
{
"speaker": "Peter Jackson",
"content": "We won't get that precise, but I think our strategy has not changed, right? The way we look at the market, where we're successful, where we can add the most value are all variables in the discussion. But I think that there's -- there are always a million rumors about what may or may not trade. I think for us, it's imperative that we stay disciplined and we stay focused. What's exciting is, as it stands today, we see a lot of assets out there that fit that screen, and now we just got to see if we can get them across finish line."
},
{
"speaker": "Operator",
"content": "And our next question comes from Tyler Batory with Oppenheimer."
},
{
"speaker": "Tyler Batory",
"content": "A question on the competitive environment. Are you seeing some of the smaller players out there may be trying to get more aggressive to take market shares. Is that having an impact on your performance and on your business?"
},
{
"speaker": "David Rush",
"content": "What I would tell you, Tyler, is not any more than usual. Again, where we differentiate ourselves is in the value-added solution in the value-added space, and that's for a reason. Anybody can do commodities, anybody can deliver lumber. It's hard to differentiate yourself in a straight distribution model. So we do see competition in that arena for sure. We try to leverage our relationships with those customers where we do other stuff for them very well and use that as a way to continue to maintain share on the commodity side versus just getting into a price war."
},
{
"speaker": "",
"content": "So we do see competition in that regard. We choose to compete where we want to compete in that regard. But we'll always do a high percentage of lumber. We're good at doing lumber. We're good at meeting schedules and making sure the lumber is there when the customer wants it. And we get recognized for that and where we get that recognition is where we play. But in short, a lot more competition on the commodity side than the noncommodity side and our reputation on the value-added space carries us a long way."
},
{
"speaker": "Peter Jackson",
"content": "The only thing I'll add, I think it might be embedded in your question is share. I think one of the variables that we struggle with is what's the real share number. Generally, we would use single-family starts as a proxy for the market and then we would compare our sales against that. In general, that's a really tricky thing right now because I think there are some meaningful differences between a start unit and a sales dollar."
},
{
"speaker": "",
"content": "Homes are smaller. The cost of those homes and what's being put into them and simpler and cheaper. And we have seen some not insignificant cost reductions or pricing reductions in terms of what we are getting from our vendors and what is selling into the market. Whether it be commodities which is the obvious one, but also EWP or millwork or any of the other ones we've talked about, those all represent sort of gaps or deltas between those 2 units of measure."
},
{
"speaker": "",
"content": "And then you layer on a little bit of the timing related stuff, whether it be how complete these homes are and what we're selling or the weather or whatever, it certainly has made that whole discussion and that analysis really challenging. But back to Dave's point, I think the only place we think we've maybe struggled or battled is in that commodity, the low end where smaller competitors are more willing to get down and dirty."
},
{
"speaker": "Tyler Batory",
"content": "Okay. Very helpful. And then a quick follow-up on the R&R side of things, down 5% in the quarter. I think weather probably impacting that. What are you seeing here in the second quarter, and there are a lot of differing views on the R&R end market out there? Just share your confidence in terms of your growth outlook this year in that end market."
},
{
"speaker": "Peter Jackson",
"content": "So as it relates specifically to the first quarter, we're higher concentrated in R&R in the Northeast. And the Northeast was that set area of the country for us. That was a great -- more greatly impacted by weather. I think 20 to 23 days had serious weather in the quarter. That's where we felt it. In general, I think R&R will be -- is kind of a two-edged sword, right? The bigger projects are facing some of the same kind of cost of money pressures that the small custom builder is facing. But the regular smaller projects, I think, are going to be along the same line as what you would expect."
},
{
"speaker": "Operator",
"content": "And we have our next question from David Manthey with Baird."
},
{
"speaker": "David Manthey",
"content": "My first question is on the digital. So the revenue uptick is good to see. Could you share with us any data on the number of net users today versus a year ago or the end of last year? Just to give us an idea of how that's ramping? And then is there any prototypical customer type that's implementing the system? Or is it just based on personality and choice?"
},
{
"speaker": "Peter Jackson",
"content": "Dave, yes, we're excited about digital. I don't unfortunately have user numbers. I might be able to get them for you, but I don't have them off the top of my head. It's going up. We're seeing that. They were -- gosh, I don't know what it was 500 or 700 leads that we took out of IBS. We've got a lot of customers as we do our adoption and our rollout around the country that are coming on board. While most of them are mid to smaller-sized builders. The profile, I think, that you're talking about are those that are leaning into digital and technology to be able to make themselves more efficient and more professional and better with their customers."
},
{
"speaker": "",
"content": "I think you've got -- sometimes it's generational. Candidly, sometimes it's not. It's just the mentality around leveraging tools to take waste out of the job, make the job go quicker, connect with the home buyer a little bit more easily, more visually. But it's such a -- in our opinion, it's such a compelling tool."
},
{
"speaker": "",
"content": "It's got so much that can help to build or just get a little bit better every day. That game we're all trying to play, creating efficiency, making it more transparent to the builder, to the trades and to the home buyer. So that -- those are the types of customers, the ones that really take advantage of technology to do that, that we're seeing early. But in general, I think our digital tool has become -- is increasingly becoming the new way of doing business just because it's so easy. It's very modern, it's very smooth. And so far, so good. We're excited about the ramp-up trend and how it's been progressing, so far early days."
},
{
"speaker": "David Rush",
"content": "What I would tell you juices me the most was the traffic we had at our booth at IBS. I have never in my 25 years of going to IBS seen the kind of excitement and the kind of traffic that went through our booth, primarily because of our digital platform and showing what capabilities that it was going to present. The other thing I would say is, think about it, if you're a smaller builder, 50 to 200 homes a year, you don't have the ability to invest in technology for yourself to get this to the level of platform that we're developing."
},
{
"speaker": "",
"content": "What we're doing is leveraging our ability to make those investments develop that platform for our customers of that size so that they can play in that space and be efficient without having to make a huge upfront investment themselves. So that's the rationale behind why we developed it and why we think it will be appealing to our customer base and if IBS is any indication, we hit it right on the head."
},
{
"speaker": "David Manthey",
"content": "Okay. In the interest of time, I'll just pass it on. Thank you."
},
{
"speaker": "Operator",
"content": "And we have our next question from Jay McCanless from Wedbush."
},
{
"speaker": "James McCanless",
"content": "So my first question, Peter, I think you called out some pretty positive sales trends for the Western U.S. Could you talk about how that's trended in April and May, similar pattern to what you saw in 1Q?"
},
{
"speaker": "Peter Jackson",
"content": "Yes, pretty similar. I think that the West got hammered out of the gate, and they bounced back really nicely, a little more stable through the other 2 regions. But yes, I think that's been pretty consistent. We have to see how this whole weather thing in Houston plays out. But for the time being, it's pretty good."
},
{
"speaker": "James McCanless",
"content": "Okay. And then taking the lumber question, especially some of the more commodity goods a step further. Is this a function of not only higher mortgage rates, but was there an oversupply of commodity lumber in the system to start the year? Just wondering if this is all rate-driven, if there's some other mitigating factors we need to be monitoring?"
},
{
"speaker": "Peter Jackson",
"content": "We didn't see a lot of unusual behavior in the market, no. Tough for us to see that from others perspective, but it's a strong I would think generally a strong and a stable market. So I don't know how people made bets with regard to where stuff was moving."
},
{
"speaker": "Operator",
"content": "And we have our next question from Ketan Mamtora with BMO Capital Markets."
},
{
"speaker": "Ketan Mamtora",
"content": "Peter, just one question. You've talked quite a bit about margin normalization and multifamily. On the core organic, the single-family piece, do you think at this point, we are sort of towards the end of that normalization, midway through? How would you characterize that? And are the competitive dynamics in that side of the business changing at all, given sort of pressure on EWP prices, given where lumber is today. Just curious to get your thoughts."
},
{
"speaker": "Peter Jackson",
"content": "Ketan, yes, I would tell you that we're closer to the end in terms of how we expect margins to normalize. We're still below normal in terms of volume. So that's a pressure-filled environment. It's always very competitive. It always has been. We expect it always will be on the commodity side. But that now needs to be a battle cry that we rise to, right? And it's something that we've done for years and we feel good about."
},
{
"speaker": "",
"content": "There's a -- there's an expectation that the little player will always be more competitive, and we think that will continue to play out. But by and large, I think margins have performed well. There's certainly been some aggressiveness from certain vendors, but in most cases, it's in response to past moves. So more of a normalization, more of a rebound back -- a mean reversion, if you will, rather than a, oh, we're in trouble, we need to do something dramatic. Does that make sense?"
},
{
"speaker": "Ketan Mamtora",
"content": "It does. Thank you very much."
},
{
"speaker": "Operator",
"content": "And it appears we have reached our allotted time for the question-and-answer session today. That will conclude today's program. Thank you for your participation. You may now disconnect."
}
] |
blk | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Jennifer, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the BlackRock Incorporated Fourth Quarter 2024 Earnings Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Martin S. Small; President, Robert S. Kapito; and General Counsel, Christopher J. Meade. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions] Thank you. Mr. Meade, you may begin your conference."
},
{
"speaker": "Christopher J. Meade",
"content": "Good morning, everyone. I'm Chris Meade, the General Counsel of BlackRock. Before we begin, I'd like to remind you that during the course of this call, we may make a number of forward-looking statements. We call your attention to the fact that BlackRock's actual results may, of course, differ from these statements. As you know, BlackRock has filed reports with the SEC, which list some of the factors that may cause the results of BlackRock to differ materially from what we say today. BlackRock assumes no duty and does not undertake to update any forward-looking statements. So with that, I'll turn it over to Martin."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Chris. Good morning and Happy New Year to everyone. It's my pleasure to present results for the Fourth Quarter and Full Year 2024. Before I turn it over to Larry, I'll review our financial performance and business results. Our earnings release discloses both GAAP and as adjusted financial results. I'll be focusing primarily on our as adjusted results. With over $600 billion in net new assets entrusted to BlackRock, 2024 was a milestone year of programmatic organic and inorganic actions rooted in client needs, investment capability expansion, technology, and scale. We executed breakthrough investment offerings and industry-leading partnerships. 2024 marks a quantum leap forward for BlackRock against our long-term value creation objectives and an invigoration of the future of asset management and technology services for our clients. We've spoken all year about how organic growth momentum and overall client sentiment has been improving. BlackRock saw record net inflows in 2024, powered by two back-to-back record flows quarters in the second half. Our annual revenue, operating income, and earnings per share each grew double digits. We made disciplined investments for profitable growth, delivering 280 basis points of margin expansion as our AUM grew to a new high of nearly $11.6 trillion. We enter 2025 from a position of strength, having generated 7% annualized organic base fee growth in the fourth quarter, our highest in three years. Our record client activity and the accelerating organic revenue growth we saw in 2024, they're independent of the lift that we believe will come from GIP, HPS, and Preqin. Our structural growth businesses, ETFs, Aladdin, outsourcing, fixed income, they're the strong foundations to serve clients and deliver on our through the cycle 5% organic growth objectives. We didn't need M&A to achieve and rise above our organic base fee growth target. Our expansions are about more deeply serving clients in high growth segments that can exceed our 5% goals. We enter 2025 on a new trajectory, with record AUM and operating income and having increased our effective fee rate by seven-tenths of a basis point. Over the course of 2025, we'll be integrating and adding the high-growth and earnings power of GIP, HPS, and Preqin. Clients have embraced our strategy. Our track record of successful acquisitions and integrations is bringing clients into deeper relationships with BlackRock. We finished 2024 with sequential quarters of at or above target organic growth. More importantly, that organic growth is broad-based across institutional, wealth, and technology and across regions. Clients want to consolidate more of their portfolios with a partner that's with them for the long term. They want portfolios that are seamlessly integrated across public and private markets that are dynamic and that are underpinned by data, risk management, and technology. BlackRock is now truly in a category of one. We've built a unique asset management and fintech platform that's integrated across public and private markets. With the close of the GIP transaction this past October and our planned acquisition of HPS, BlackRock's private markets and alternatives platform is expected to be $600 billion in client assets, a top-five provider, and over $3 billion in revenues or about 15% of 2024 revenues. BlackRock houses whole portfolio solutions for clients, the world's number one ETF franchise by assets, flows and breadth of exposures, a $3 trillion fixed income platform across active and index, $700 billion managed for insurance companies, over $350 billion in models, direct indexing and SMAs for wealth managers, over $900 billion in cash management AUM, leading advisory services and our proven Aladdin technology with $1.6 billion in revenues. Aladdin is powering a whole portfolio ecosystem across public and private markets with eFront in our planned acquisition of Preqin. On a pro forma basis for HPS and Preqin, private markets and technology are expected to make up over 20% of BlackRock's overall revenue. That's an ecosystem we feel wins with client needs and results in over 20% of our revenue base in long-dated, less market-sensitive products and services. Our mix continues to evolve towards higher secular growth areas with clients. We believe this will translate to higher and more durable organic growth, greater resilience through market cycles and multiple expansion. In 2024 BlackRock generated a record $641 billion of total net inflows and delivered 4% organic base fee growth. We finished the year strong in the fourth quarter with $281 billion of total net inflows and 7% annualized organic base fee growth. Full-year revenue of $20.4 billion was up 14% year-over-year. Operating income of $8.1 billion was up 23% and earnings per share of $43.61 increased 15%. Fourth quarter revenue of $5.7 billion was 23% higher year-over-year, driven by the impact of higher markets on average AUM and higher performance fees. Quarterly operating income of $2.3 billion was up 36%, while earnings per share of $11.93 was 23% higher versus a year ago. EPS also reflected a lower tax rate, partially offset by lower non-operating income and a higher share count in the current quarter. The higher share count included 6.9 million shares issued and delivered at the closing of the GIP Transaction. Non-operating results for the quarter included $7 million of net investment losses, primarily due to changes in co-investment valuations. Lower interest income in the current quarter reflected the delivery of cash at the closing of the GIP transaction, which was raised through our debt offering in March 2024. Our as adjusted tax rate for the fourth quarter was approximately 21% and benefited from discrete items. We currently estimate that 25% is a reasonable projected tax run rate for 2025. The actual effective tax rate may differ because of non-recurring or discrete items or potential changes in tax legislation. Fourth quarter base fees and securities lending revenue of $4.4 billion was up 23% year-over-year and up 10% sequentially, driven by the positive impact of market beta on average AUM, organic base fee growth, and approximately $230 million of base fees from GIP. Our annualized effective fee rate was approximately seven-tenths of a basis point higher compared to the third quarter. Over time and with continued growth in infrastructure strategies and the successful closing of the HPS acquisition, we would expect to see positive leverage to base fee revenue, average fee rates, and organic growth as we grow private markets with clients. This is evidenced by this quarter's fee rate increase, primarily reflecting the onboarding of higher-fee rate private markets assets following the GIP closing. Fourth-quarter and full-year performance fees of $451 million and $1.2 billion, respectively, increased from a year ago, led by higher revenue from alternatives. We saw strong broad-based performance across hedge funds. Quarterly technology services revenue increased 13% year-over-year and full-year revenue of $1.6 billion increased 8%, reflecting the successful onboarding of a number of new clients and expanding relationships with existing clients. Full-year technology services revenue growth also reflects the prior year revenue impact of several clients' renewals of eFront on premises licenses. Annual contract value or ACV increased 12% year-over-year. On a constant-currency basis, we estimate ACV would have increased 13% from a year ago. The need for integrated risk analytics and whole portfolio views across public and private markets is driving strong demand for Aladdin. We signed some of our largest clients ever in 2024. We remain committed to low to mid-teens ACV growth over the long term. Total expense increased 9% in 2024, primarily due to higher incentive compensation, G&A and sales, asset, and account expense. Full-year employee compensation and benefit expense was up 11%, reflecting higher incentive compensation as a result of higher performance fees and operating income. Recall that year-over-year and sequential comparisons of fourth-quarter compensation expense are less relevant because we finalized full-year compensation in the fourth quarter. Full-year G&A expense was up 5%, primarily from planned technology investment spend, higher professional fees, and GIP's G&A expense. During the year, we made disciplined investments in business to drive operating leverage and profitable growth. Our fourth-quarter as adjusted operating margin of 45.5% increased 390 basis points year-over-year and our full-year as adjusted operating margin of 44.5% was up 280 basis points. Looking ahead, we aim to maintain our systematic approach to investing for profitable growth on the budgeting principles we've consistently articulated for the last 12 to 18 months. We'll continue to be disciplined in prioritizing our hiring and overall investments with the ambition of delivering market-leading organic growth and operating margin. At present, subject to regulatory approvals and other customary closing conditions, we expect our planned acquisitions of Preqin and HPS to close in the first quarter of 2025 and in mid-2025, respectively. Based on these closing timelines, we'd expect BlackRock's headcount to be higher in 2025. Our planned acquisitions of Preqin and HPS are expected to bring approximately 2,300 new colleagues to BlackRock. Additionally, excluding HPS, we would expect a mid-to-high single-digit percentage increase in 2025 core G&A expense. Most of the core G&A expense growth should come from consolidating the G&A expense of GIP and Preqin and continued investment in technology as we look to operate more efficiently and better serve our clients. Our capital management strategy remains consistent. We invest first, both organically and inorganically, either to scale strategic growth initiatives or drive operational efficiency. We then return cash to our shareholders through a combination of dividends and share repurchases. After investing for growth, we returned over $4.7 billion to our shareholders through a combination of dividends and share repurchases in 2024. This includes open-market repurchases of approximately $375 million and $1.6 billion for the fourth quarter and full year, respectively. Share repurchases have been a consistent element of our capital management strategy. In the last 10 years, we've repurchased 28 million shares at an average price of $510 per share. Today, we're trading at almost double that. This represents a more than 15% annualized return for our shareholders. For both the GIP and HPS transactions, BlackRock Equity proved a valuable currency in consummating these transactions and structuring them for alignment with our shareholders. At present, based on capital spending plans for the year and subject to market and other conditions, we're targeting the purchase of 1.5 billion of shares during 2025. In addition and also subject to market and other conditions, we expect to seek Board approval later this month for an increase to our first-quarter 2025 dividend, consistent with our track record of continued dividend growth. Record full-year total net inflows of $641 billion were diversified across active index and cash as well as by region, led by $385 billion of net inflows from clients in the United States. BlackRock generated industry-leading ETF net inflows of $390 billion in 2024, representing 11% organic assets and 7% organic base fee growth. Record annual net inflows into our ETFs included $41 billion into our digital assets ETPs that were just launched in 2024. Fourth-quarter ETF net inflows of $143 billion reflected significant momentum into year-end, helped by seasonal portfolio reallocations. As U.S. equity indices and spot Bitcoin prices reached new highs in the quarter, clients used iShares products to re-risk and add these investment exposures to their portfolios. BlackRock's institutional platform generated net inflows of $74 billion in 2024, led by active net inflows of $64 billion, including the funding of several large outsourcing mandates from a variety of client types. Index net inflows of $9 billion were driven by $43 billion into fixed income. This was partially offset by $31 billion of net redemptions from low-fee index equity strategies. Several large clients, mostly outside the United States rebalanced their portfolios amid record equity market levels. Full-year retail net inflows of $24 billion were led by continued strength in Aperio and inflows into active fixed-income mutual funds. Aperio had another record year in 2024 with net inflows of $14 billion and active fixed-income added $12 billion of net inflows. Demand for private markets remains strong with $9 billion of net inflows during the year driven by infrastructure and private credit. BlackRock's full-year net inflows also included the impact of successful realizations of $13 billion, primarily from private equity, private credit, and infrastructure strategies. Distributions are a key metric for measuring performance in the private markets. GIP has a strong track record of operating portfolio companies and ultimately returning capital to investors through exits with strong uplift. At present, we expect to recognize approximately $5 billion of realizations in the first quarter from older GIP fund vintages executing on successful exits. Starting this quarter, we've updated our earnings supplement to provide additional transparency into organic growth drivers and realizations activity for our private markets assets. We expect to make disclosure enhancements, particularly around private markets beginning in the first quarter of 2025. Finally, BlackRock cash management saw $81 billion of net inflows in the fourth quarter and $153 billion in 2024. Flows were driven by both U.S. government and international prime funds and included multiple large new client mandates. We continue to see strong growth in our cash and liquidity platform built on our scale and integrated offerings with AUM up 20% year-over-year. BlackRock's platform delivered record results in 2024 and the consistency of our results stands out even more over the long term with over $2 trillion of client net inflows over the last five years. While 2024 was a watershed year for BlackRock, it's just the start of our next growth story. We're better positioned than ever to build with clients and create value for our shareholders. BlackRock is a meaningful outperformer when assets are in motion and investors are re-risking. We're optimistic about market opportunities for our clients into 2025. I'm going to pass to Larry in a minute. But for those of you keeping score at home, this is Larry's 100th earnings call. We did a little research and counted only 15 current CEOs in the S&P 500 that have celebrated 100 earnings calls as the CEO. Larry, congratulations on a century of earnings calls. How does it feel?"
},
{
"speaker": "Laurence D. Fink",
"content": "I can't say, I feel any older. I can't complain at all. It's been a fun journey and I think the journey going forward is it going to be better. There's a lot of change in the world in the last 25 years. Another lot that stays the same. My meal the night before earnings remains the same and a bowl of cereal last night with blueberry. So, I guess, everything is the same. But thank you, Martin. And also Happy New Year to everybody, and thank you for joining the call. And yes, it is our 100th. But I haven't done it alone. We have a number of shareholders that have been with us since the IPO 25 years ago. I remember that original roadshow when we tried to convince many of our shareholders remain today about the opportunities to invest in BlackRock. And we're also grateful for the analyst community in helping the markets understand our business. I think two of our equity analysts on the line are with us from the IPO. So I want to thank -- thanks to Bill Katz and Brian Bedell for your coverage over all these years. And the best is still in front of us. When we IPOed, we were a company of 650 employees and we managed $165 billion in assets. That same year, we began selling our Aladdin technology to our clients for the first time. Today, clients trust us with nearly $11.6 trillion of AUM and Aladdin has more than 130,000 users. Since our IPO, we've delivered an annualized total return for our shareholders about 21% compared to about 8% for the S&P 500. And as I said, this is just the beginning. As Martin said, 2024 was a milestone year for BlackRock. Clients entrusted us with a record $641 billion of net inflows, including $281 billion in the fourth quarter. We now had two consecutive record flow quarters. We entered 2025 at our strongest inflection point. We added $1.5 trillion of AUM, delivered record revenues and record operating income, and increased our effective fee rate by 5%. Historic client activity took place as we executed on the most significant acquisitions we've done since BGI over 15 years ago. It's not uncommon for companies to see clients pausing. As they wait out the M&A results, as they determine and -- determine whether BlackRock is focusing on their needs. At BlackRock, clients are instead embracing and rewarding our strategy. Clients activity accelerated into the fourth quarter, resulting in a 7% organic base fee growth and 12% technology services ACV growth. Our operating model delivered exceptional performance in a year of meaningful change. We crossed the $20 billion of annual revenues, up 14% from our 2023. Our adjusted operating income grew by 23% and our industry margins of 44.5% was up 280 basis points. We always raise the bar for ourselves and know our clients and shareholders do the same. Our results consistently beat even our high expectations and we surpassed Street estimates for flows, fee rate, base rate in addition to total revenues, margins, and EPS. Our record organic growth and financial results do not yet reflect the full integration or pending acquisitions of GIP, HPS, and Preqin. All three of these businesses have a track record of delivering strong revenue growth, profitability, and margin expansion. And we're steadily making organic investments ahead of our -- the structural trends that we believe will drive outsized growth in the years ahead. We've had strong momentum across our entire franchise, including our newly enhanced private market platform. We positioned ahead of market opportunities that we believe will drive outsized growth for BlackRock in the years to come. We invested in our talent, which is fundamentally the most important thing that we invest in each and every year. Our key driver of BlackRock's success has been our focus on developing leaders with a broad range of experiences and connectivity across all of BlackRock, what I've called horizontal leadership. We look to identify people ready for the next challenge and then move them into roles that both advance their professional journeys and drive our business forward. Today, we are excited to announce that many leaders across the firm are taking on new and expanded roles and responsibilities that will help drive our next phase of growth. Part of the leadership changes reflect on Mark Wiedman's desire to pursue his next chapter after nearly 20 years with BlackRock. We've discussed his transition over a number of months and he will be with us through spring and I want to take a moment to recognize and thank Mark. Mark is a great friend of mine, a great friend of the firms, and has helped drive strong growth for BlackRock for our clients and for our shareholders. He has also built a powerful team of leaders prepared to take on new responsibilities and drive our business forward. This includes a number of the senior leaders taking on expanded roles. Mark will work with our leadership team over the next few months to ensure a smooth transition. We thank him for his many contributions, his partnership, and his vision in shaping the successful evolution of BlackRock. Rob and I are proud of the deep leadership team at BlackRock. It reflects a breadth of experience and sustained excellence. Strategic acquisitions have also historically strengthened our firm, strengthened our culture, and bringing top talent, new skills and experience into our organization. Our culture has consistently evolved as we welcome new teams and colleagues to BlackRock. And today, it represents a blending of the best parts of the cultures that have come together across the years, across all the firms that became part of BlackRock. A few months ago, we welcomed the influx of talent with the close of GIP. We've already enjoyed great connectivity and our teams are energized. BlackRock's world-class leadership alongside the top talent from GIP, from HPS, and Preqin position us to serve our clients with excellence and seizing the opportunities ahead for us. In my conversations with clients around the world, they're eager to put capital to work and they want to do it through BlackRock. Public markets enter the year from a position of strength. Clients holding cash on the sidelines missed out on a 25% total return in equities last year. We expect 2025 to be a dynamic investing environment. As policies and economic questions play out, the most important factor will be the growth backdrop. Mega forces like AI and ongoing evolution in the debt financing and the low-carbon transition are transforming economies with long-term growth trajectories. Capital markets will play a key role in this transformation. Private market assets are an increasingly vital part of capital markets and blending both public and private markets will be critical to fully capturing growth opportunities. Long-held investing principles need to evolve, including the traditional 60-40 portfolio mix of stock and bonds. The diversifying nature of the stock and bond relationship is under increasingly strong pressure, making resilient portfolio construction more critical than ever. Clients are coming to BlackRock for advice on how to build portfolios, how to broaden out where they invest. For many, they will increasingly include private markets, especially private credit and infrastructure. We also think active strategies can provide an advantage in an environment that requires a more dynamic approach. BlackRock is well-positioned to capitalize on structural growth opportunities against a backdrop of economic and capital market evolution. We've made coordinated investments to build the premier long-term capital partner and technology provider across public and private markets. 2025 is a new launch point for significant growth for BlackRock, our clients, and our shareholders. Our recent acquisition of GIP, the planned acquisitions of Preqin and HPS, each position our platform ahead of evolving our client needs and structural industry trends. 15 years ago, we acquired BGI and we're the first scale provider to integrate both active and index investments. In 2024, we made bold moves to connect public and private markets through portfolio management and technology. The reaction to our recent announcement to acquire HPS has been extremely positive and we see great opportunities to partner more closely with clients and borrowers. The capabilities we're adding through these transactions allow us to serve clients even more comprehensively and position us to raise significant private capital. For our shareholders, we believe the increased contribution from private markets and technology will drive higher and more resilient organic growth, differentiating financial performance and multiple re-rating. In addition to private markets, we are executing on the strongest opportunity set we've seen across multiple growth engines. These include technology, ETFs, multi-asset solutions like outsourcing, and models. We invested for years to develop leading franchises and capabilities that our clients need most, and that are our long-term growth channels. Importantly, they're scaled and integrated onto one platform with a culture that is client-led, not product-led. We're able to serve our clients in a way that no other asset manager can. Aladdin has always been the operating system uniting all of BlackRock. It's grown and evolved as BlackRock has. It's the industry's most comprehensive operating system, supporting scale and commercial priorities for clients. We're growing our capability set in Aladdin, all with the aim of serving our clients through sophisticated risk management, scaled portfolio analytics across both public and private markets, and soon private market data through Preqin. Fourth-quarter ACV growth of 12% reflects several significant mandates with large financial and corporate partners. The Aladdin technology stack is resonating with over half the Aladdin sales involving multiple products. This includes clients using Aladdin's whole portfolio view, which grew out of our acquisition of eFront to seamlessly manage portfolios across public and private asset classes on one platform. It includes clients leveraging enterprise Aladdin alongside Aladdin Accounting or the Aladdin Data Cloud. Technology is at the foundation of BlackRock. ETFs are another example. We view ETFs as a technology that facilitates investments. Since our acquisition of iShares, BlackRock has led in expanding the market for ETFs by making them more accessible and by delivering new asset classes like bonds or crypto and investment strategies like Active. Approximately a quarter of the $390 billion of ETF net inflows were into products launched in the last five years. Our active ETFs delivered $22 billion of net inflows in 2024, while our Bitcoin ETP was the largest ETF launch in history, growing to over $50 billion of AUM in less than a year, and it was the third-highest asset-gathering ETF in the entire ETF industry behind only the S&P 500 index funds. We're innovating at the product and portfolio level and accelerating our distribution capabilities to deliver a differentiated investment solution. In Europe, we scaled our ETF offering significantly and the market is still much more nascent than it is in the U.S. We have seen double-digit organic growth in each of the last two years, including over $90 billion in growth in net inflows in 2024. Our European ETF platform is nearing $1 trillion of assets, which is larger than the next five issuers combined. Much of this growth is powered by individual investors as online banking platforms, digital-first offerings, and ETF saving plans are enabling more first-time investors to invest in their savings to start and beginning their retirement savings and to build a better and more robust future for themselves. From first-time individual investors to the most sophisticated institutions, ETFs are connecting investors to the growth of the capital markets around the world. Client's needs are driving industry consolidation and investors increasingly prefer to work with BlackRock as a scaled multi-asset provider. We see this in the wealth channels where managed model portfolios are the main way in which wealth managers are looking to scale their practices and better serve their clients. BlackRock has a leading models business backed by our multi-asset, multi-product capabilities across both ETFs and active strategies. We see this in our relationship with the largest asset owners, our pension funds, and corporates as these clients seek to deepen their ties with BlackRock. Many of these corporate partners see positive network effects to their core business and to their own shareholders by extending their relationship with BlackRock. This year, our clients entrusted us with more than $120 billion of scaled outsourcing mandates. Many of these outsourced portfolios are from pension plans and retirement schemes that we're investing on behalf of millions of workers to help them save for their future. Our LifePath target date franchise now manages more than $0.5 trillion of assets and we're extending our work in this important area to help more and more people save for retirement. In 2024, we launched our LifePath Paycheck offering, which pairs a traditional 401(k) plan with the option to purchase an annuity-based income stream as a worker approaches retirement. The solution is the fastest-growing lifetime income target date strategy in the defined contribution market with $16 billion invested at year end. We also adopted LifePath Paycheck as part of our U.S. retirement saving plan for employees here at BlackRock. We think this will become the default defined contribution offering for the entire industry and we're exploring opportunities to expand LifePath Paycheck to more partners and workers throughout the world. We have built our platform around a core strategy of connecting investors to the long-term growth of the capital markets. In my conversation with clients and government leaders around the world, there has been great focus on the strong capital markets we have in the United States. Countries want to further develop their own robust capital markets and this drives investment in their own local economies, which in turn provides opportunity for job growth, wealth creation for their own citizens. Over the last few years, BlackRock has partnered with governments and sovereign wealth funds to help deepen their local capital markets. We see tremendous opportunities in India where digital infrastructure efforts are facilitating widespread access to digital payments and financial products. Our joint venture, Jio BlackRock is expected to launch later this year, subject to regulatory approvals. We're combining our investment expertise with the local market knowledge of our partner, Jio Financial Services to launch digital-first assets with wealth management businesses. In Saudi Arabia, we're launching an investment management platform to partner with a public investment fund to drive investments and future growth in the local economy. And we're investing and layering the foundation today for opportunities that we believe will result in significant AUM over the next five to 10 years. We've had great success with our large asset owners in collaborations already, including our joint venture decarbonization partners with Temasek. Our recent AI partnership with Microsoft and MGX, which aims to mobilize data centers and infrastructure investments. These global partnerships are only available to BlackRock because of the deep relationships we built over many years with local partners, heads of states, and sophisticated asset owners. I have spent a lot of time on the road last year, as has Rob and other members of our leadership team. [indiscernible] and I have also traveled to see clients together in recent months. We're spending time with our institutional clients, our wealth clients, and increasingly with our largest asset owners in the world. Clients, corporates, and sovereigns are looking to assemble deeply intertwined partnerships, not just the set it and forget it investments that yield a good return. BlackRock is in a class of its own in being able to partner with clients comprehensively and in an integrated scaled way. We can build with clients across their entire portfolio and across the investment life cycle from ETFs to high-performing active and private markets to technology and data through Aladdin, eFront, and eventually Preqin. The strength of our platform and the commitment of our employees in serving our clients powered record results for our shareholders in 2024. And that was before significant growth unlocked from our strategic acquisitions and organic investments in high-growth markets around the world. 2024 was just the beginning, BlackRock enters 2025 with more growth and upside potential than ever. Operator, let's open it up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question comes from Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Hi, good morning, everybody. Happy New Year. I wanted to start with a discussion on Money Motion, that's something we talked about last year as well. As you think about 2025 and taking into account maybe the rates move we had recently, to what extent does that change the backdrop you're seeing in the marketplace today? And when it comes to more money in motion, what asset class do you guys expect to benefit most in 2025? Thanks."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Alex. Happy New Year. Listen, it all starts with clients. We had back-to-back quarters of above or at target organic base fee growth, 5% in Q3, now 7% in Q4. It's definitely putting the lift we want in the trailing 12-month trend for our long-term through the cycle target. Full-year organic base fee growth was 4%. And so we're really entering 2025 with continued momentum in a real position of strength. Larry talked a bit about continued ETF exceptionalism, very strong contribution to the 7% organic base fee growth in Q4, rounded out by private markets and alternatives, fixed-income, and cash. Even in ETFs like higher-fee rate segments like active ETFs gathered over $20 billion in new assets, digital assets ETFs are driving higher organic base fee growth. We see those trends continuing into 2025. I would note that GIP's organic growth contributed to about one-half of a percentage point to the overall 7% organic base fee growth. So it didn't have an outsized impact on this quarter's above target outcome. I do think it's a good indication that a growing infrastructure business, a growing private markets business can support obviously above trend, above target, long term targets. But looking into 2025, we've built the business around structural growers, ETFs, models, Aladdin, fixed-income, target date funds. They all drive sustainable organic base fee growth through market cycles. And in positive markets, our lived experience has been that these areas capture substantial upside, generate substantial earnings just like they did here in 2024, which where we hit records. Looking into 2025, we continue to see strength in structural growers, a bigger private markets business, and BlackRock as a meaningful outperformer and re-risking periods. Going back to previous election cycles, periods of central bank action, Alex, we had outsized upside capture. Look at 2017, 2018, 2021, we were well above 5% in those cycle targets. And I'd offer that I think we're even better diversified now. Even with higher for longer rates, we see short-duration active fixed-income yield strategies like our active ETF managed by Rick Rieder. BINK, the INC is the ticker, and our cash management platform as growth engines. And I think that recent macro events are also going to lead to some interesting opportunities in secondaries and private credit in a more supportive market. We've achieved our organic base fee growth target of 5% on average over the last five years. We hit 5% in Q3, 7% in Q4. We did it without the benefit of M&A. So we believe that HPS, Preqin, and GIP can help lift our business beyond those targets. It gives us a lot of conviction about our 5% or better goal going forward, Alex. So we look forward to updating everybody on progress."
},
{
"speaker": "Laurence D. Fink",
"content": "Alex, let me just talk about the rate market. We've been living in a world of the inverted yield curve. And you had the ability to earn the highest return, keeping your money in cash. Now you missed out on some great equity market movements. But as you notice, the yield curve is steepening. And so you're going to over the time you're going to be benefiting by going out the curve. That being said, there is close to $10 trillion of money in money market funds as that money will be put to work. And as I said, with the steepening of the yield curve and with higher rates, it's going to lead to some great opportunities in the fixed-income area. As Martin just said, I think more and more income-oriented products like private credit and infrastructure are going to play a larger role with our investors over the course of the next five to 10 years. And if -- and we can't underestimate the role of the capital markets as that is going to be developed more robustly even in Europe and other parts of the world where there's going to present even better opportunities. There's no place like the United States with the U.S. exceptionalism that you have -- if you're a small startup, a medium company that you have access to so much capital. That is one of the principal drivers of the U.S. economy. And I do believe that is -- hope to be replicated in other economies right now. And that development, having a strong banking system with a strong capital market system really plays well into our future growth."
},
{
"speaker": "Operator",
"content": "Your next question comes from Craig Siegenthaler with Bank of America."
},
{
"speaker": "Laurence D. Fink",
"content": "Hey, Craig, Happy New Year."
},
{
"speaker": "Craig Siegenthaler",
"content": "Hey, good morning, Larry, Martin. Happy New Year, Larry. Hope everyone is doing well. My question is on retirement. So BlackRock is the largest DCIO manager and one of the largest managers of AUM in 401(k) plans and target date funds. And currently, these strategies have a 0% allocation to Alts, but the red sweep in November has many of us debating if Alts will break in the retirement channel. So especially given your recent acquisitions of GIP and HPS, I don't know if any firm is better positioned for this team. So we wanted to get your updated prospects on Alts finally breaking into the U.S. retirement channel."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Craig. Happy New Year. I'll give it a go and then see if Larry has anything to add. But listen, we think of ourselves as a retirement company. More than half of the $11.6 trillion of assets that BlackRock manages are related to retirement. We've been at the forefront, I think, of product innovation. We've been at the forefront of advocacy for retirement solutions through our whole history. It was in fact Barclays Global Investors that pioneered the first target date fund back in 1993. It was a revolutionary concept eliminating, I think, some of the guesswork for retirement savers by automatically adjusting their investment mix over time. We now today, as you mentioned, have over $0.5 trillion of assets in LifePath and target date funds. We're the number-one DCIO provider. As Larry went through in detail, we've been innovating the target date structure to include guaranteed income with LifePath Paycheck. So we see real potential benefits that retirees could have with greater diversification, better retirement outcomes by blending public and private. I mean, people have won Nobel Prizes talking about the market portfolio. It wasn't just about public markets, it's also about private markets. And so we've been doing work, we've been doing work, we're always doing work on product innovation and we've been thinking about how to bring private markets potentially into target date structures. We think the same innovations that powered LifePath Paycheck could ultimately power a target date structure with private markets and alternatives as part of the glide path. We'd also think about things like managed accounts and models, where we've been working on including public-private models as we announced with the Partners Group model portfolios, which we think can make their way into retirement counts as well. And so, we do think this is a real opportunity with our leading presence in these channels, we've got the relationships, the distribution, the investment expertise to capitalize on these opportunities to create better retirement outcomes. We do think we're watching the space closely. For more tangible opportunities, we do think there'll have to be some reforms, potentially safe harbors litigation or advice reform in the U.S. to add private markets to DC plans. So we're watching the space closely, keeping in touch with the trade associations. We're doing a lot of work in keeping connected with Washington. But for years, we've tried to innovate. We've advocated on behalf of workers to improve retirement solutions. We think there is a real opportunity here. And if there is an opportunity to bring private markets to the retirement channel, we will aim to be at the forefront, Craig."
},
{
"speaker": "Laurence D. Fink",
"content": "Craig, let me add one more point that I think is essential. And that is having better analytics and data, that will be fueling. I think, regulatory opportunities to expand offerings in the space. As you know, the retirement system is heavily weighted with a lot of regulation. Fiduciary standard is very high. And so as a result of that, the need for better market analytics and data are essential. And this is one of the primary reasons why we sought out and acquired Preqin. Having the analytics that we have with eFront and Aladdin and the data that we will have will allow the entire market to have access to better information. And we believe more and more asset managers will then take on Aladdin with Preqin data and eFront to help them navigate this. And so to me, dovetailing relaxed regulatory oversight can only happen if we have better systematic analytics and data to work with the investors under our Arista laws. And I think this is essential and this is one of the key reasons why we made the acquisition of Preqin."
},
{
"speaker": "Operator",
"content": "Your next question comes from Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "Hey, good morning. Happy New Year."
},
{
"speaker": "Laurence D. Fink",
"content": "Good morning. Happy New Year."
},
{
"speaker": "Michael Cyprys",
"content": "It's been a little bit over a month since you announced the HPS acquisition. Just curious here in terms of the conversations you're having with clients, how that dialog has evolved given the expanded private credit capabilities that you have? I believe insurance and private wealth were some of the areas that you were most excited about. Just curious what steps you might take to best maximize that opportunity here as you're thinking about 2025, what sort of growth might this translate into and which of the opportunities do you see as more near-term versus more medium to longer-term?"
},
{
"speaker": "Martin S. Small",
"content": "Well, obviously, we need to close and we expect to close sometime in the second quarter that would be our objective. And we're very excited about the client feedback related to HPS. It has been extraordinarily positive across all the channels. HPS has incredible relationships with clients worldwide and that dovetails with our relationships across all the insurance companies. And so I do believe insurance will be one of the primary areas of growth for us. But as we were talking about earlier, if we could really expand in the wealth channels, HPS right now has about $20 billion in wealth channels already. And we believe with the BlackRock connectivity with all the wealth management organizations that we have an opportunity to really increase that size by a dramatic amount. And our conversations that we've had globally worldwide from Japan to the Middle East and throughout Europe, probably one of the great surprises to me was the conversations we're having about expanding private credit as a part of these portfolios. And as I said earlier, when we did not do the HPS acquisition as a singular expansion, you have to overlay the design around buying Preqin and having eFront and bringing that together and having the ability to provide better data and analytics to these markets to -- and that will then provide much more expansion of the market. And we've seen that over the last 40-odd years, we've been in business and throughout my career when you have better data and analytics as you're expanding new and frontier markets, they become large-scale markets through data and analytics. And so we believe we will be the best-suited organization to take advantage of that expansion of the private credit markets in the future."
},
{
"speaker": "Operator",
"content": "Your next question comes from Mike Brown with Wells Fargo."
},
{
"speaker": "Michael Brown",
"content": "Great. Good morning, everyone."
},
{
"speaker": "Laurence D. Fink",
"content": "Mike, Happy New Year."
},
{
"speaker": "Michael Brown",
"content": "Happy New Year. I wanted to follow up on the expense guidance for the year. So thank you for the core G&A guide. I guess, as we think about the contribution from HPS, assuming that mid-2025 close, how should we think about kind of the guide including that? And then as we think about the margin, I appreciate that markets and FX are really going to impact the outcome. But could you just give us some thoughts on maybe the puts and takes that we should consider for the margin in 2025 relative to 2024?"
},
{
"speaker": "Martin S. Small",
"content": "Sure. Thanks for the question. So let me just put some context around it. I think our approach to shareholder value creation is to generate consistently market-leading organic growth. It's to drive operating leverage and industry-leading margins and to execute on a consistent capital management strategy, we have a strong track record of investing in our business for growth and scale while expanding capability. It's not just about growth, it's about profitable growth over the long term. Our growth comes from being disciplined in making and managing continued investments in the business. We're keeping the rules-based budgeting principles that I've outlined over the last 12 to 18 months that's sizing our operating investments in line with a prudent lens on organic growth potential. It's aiming to put flexibility in our cost base and variabilizing more expenses where we can. And most importantly, it's looking to generate fixed-cost scale, especially through investments in technology. We've got a -- I think, consistent track record in delivering industry-leading margins and improving them. I think you see in 2024, those scale indicators came through in the results. We grew operating income by over 20%, generated close to 3 percentage points of margin improvement versus 2023. We improved margin by 390 basis points year-on-year in Q4 while operating income was up 30%. And since the end of 2022, a more rope metric is BlackRock AUM is up $3 trillion, while headcount is up by a more modest 1,300 employees, about 7% headcount growth. So we really see ourselves as continuing on that strategy of driving scale and productivity, which shows up in margin expansion. On the outlook for 2025, the guidance is mid-to-high single-digits, excluding HPS, as I mentioned. In terms of the major influences, we think our budgeting approach in a positive market environment should drop more profitability into operating income. Market movements are our highest-margin item, Mike, both on the way up and on the way down. We see the conditions for reasonably positive growth in markets over the near-to-intermediate term. So we believe we can continue to invest to accelerate growth and deliver margin expansion through this rules-based budgeting that I've outlined. And we expect that the impact of positive markets on AUM and revenue through this budgeting approach would drive further margin expansion into 2025."
},
{
"speaker": "Operator",
"content": "We'll go next to Ken Worthington of J.P. Morgan."
},
{
"speaker": "Martin S. Small",
"content": "Happy New Year Ken."
},
{
"speaker": "Ken Worthington",
"content": "Hi, good morning. Happy New Year. Thank you for taking my question. I wanted to piggyback a little bit on Alex's question. What are your thoughts on the outlook for fixed-income flows as we look out to the next 12 months? I guess, maybe starting, where do you see investors position in fixed-income as we begin 2025? And do you get the sense generally that investors are under or over-allocated to fixed-income broadly? And how do you see those allocations evolving this year? I think you've successfully made the case that the allocations are also be increasing. You made the case for a while that the allocations to cash are probably too high. How do we think about this sort of flowing into fixed-income allocations for the next 12 months?"
},
{
"speaker": "Robert S. Kapito",
"content": "So I'll take that one. Last time I mentioned I thought it would reign fixed-income. I'm going to continue that for 2025, but I won't go as far as a Nobel Prize, Martin, in fixed-income. But a more balanced term structure of interest rates is an indicator that we're going to watch to indicate the potential demand for intermediate and longer duration fixed-income. And this has been negative for years and now the U.S. term premium has reached its highest level in a decade. Now we see that people are underallocated to fixed-income and we see that through our models business and we see that they're looking to increase their weightings in longer duration fixed income. And whether there's above market steepener or a bear market steepener, I do believe some of that large allocation to cash that Larry mentioned being around $10 trillion is going to look for opportunities to increase their income. And with countries around the globe at deficits, there is going to be a lot of issuance and you'll see the premium over treasuries be significant enough to move that money from cash into intermediate and longer-term duration fixed-income. So last year, we saw a strong demand. Our fixed income flows were $164 billion in 2024. That's driven 6% organic asset growth and that included $24 billion in the fourth quarter alone. Now one of the other reasons for this demand is better wrappers to express your interest in fixed income. So we saw a demand across iShares, non-ETF index, and active fixed-income, and active fixed-income continue to include scaled institutional assignments as well, not just retail, and this came primarily from insurance partners. So I think spread income presents a great opportunity even if duration is not as reliable a diversifier as it used to be. And we see a lot of clients that want to clip solid yields at the front end of the curve and now we expect that to continue into the longer end of the curve. So the other part is the run-up in equities last year actually over -- made them over-allocated to equity, so they need to catch up in fixed income. So I think it continues to roll into cash and then cash as rates change move into intermediate and longer duration fixed-income paper and that will not only be in the public markets, but it will be in the private markets as well, which describes part of the acquisition you were asking Larry and Martin about."
},
{
"speaker": "Operator",
"content": "Your next question comes from Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Oh, great."
},
{
"speaker": "Martin S. Small",
"content": "Hey, Brian."
},
{
"speaker": "Brian Bedell",
"content": "Thanks. Good morning, guys. Hi, Happy New Year."
},
{
"speaker": "Laurence D. Fink",
"content": "Happy New Year. [Multiple Speakers]"
},
{
"speaker": "Brian Bedell",
"content": "Yes. Thanks. It's -- actually I was just thinking, I certainly couldn't imagine you've become what you've become sitting back in 1999 as the leading fixed-income manager at the time. I always knew the strategy was great, but the firm has certainly involved -- evolved, I think well beyond anyone's expectations. So congrats on that journey."
},
{
"speaker": "Laurence D. Fink",
"content": "So have you turned 35 yet?"
},
{
"speaker": "Brian Bedell",
"content": "Yeah. Exactly. It's been a long time for sure. Yeah. But -- so maybe just thinking about this evolution of the strategy in alternative and particularly the retail end of that. So maybe just talk a little bit about your confidence, clearly, you have a lot of ways to go into the retail on the Alts side. But your confidence on that building up because it's obviously, there is still a lot of your roadblocks into growth in those channels. And I know you talked about the 401(k) channel earlier. Maybe within that answer, you can comment on your view of the likelihood of Safe Harbor provisioning in the 401(k) market and the demand from 401(k) plan sponsors to actually adopt Alts. Within their portfolios clearly would obviously benefit the planned participants substantially. So just, I guess overall, just your confidence on the retail market for Alts building in -- even in 2025 and into 2026 for you inclusive of potentially 401(k)."
},
{
"speaker": "Martin S. Small",
"content": "Thanks so much. So we -- this is one of the -- I'm most fond -- one of the businesses I'm most fond of here at BlackRock. We have strong relationships in wealth and retail markets across the globe. As Larry mentioned in his remarks, our aim is to help wealth managers build long-term portfolios that blend public and private market exposures. The market is still early, as you said, wealth manager and retail allocations to private markets still in the low-single digits on most of the Cerulli dinner data. We are focused on innovating to provide better access to private markets for wealth managers and retail investors, and that's across taxable and non-taxable accounts, retirement accounts. Let me tell you about a couple of things we're working on and what I think are some of the bigger opportunities. As we had previously announced, we're working on a first-of-its-kind managed model solution with the Partners Group. We think this will simplify Wealth Access, offering a single subscription model product with varied allocations based on risk tolerance, but moving the private markets into a model portfolio with different risk tolerances that blend public-private, that manages the cash flows that's on a single subscription document. We think that's a huge unlock. One of the barriers to adoption with wealth managers is just the operational burden and tax of managing multiple subscription documents and cash flows and distributions for private markets products. We think a managed account can do that better and increase access. In Europe and Asia, those markets are in a different place in the United States when it comes to our private markets in retirement accounts. We recently launched our new evergreen fund offerings under the LTIF 2.0 structure. Those initial offerings are in private equity solutions and multi-alternatives. Those evergreen funds, we're planning to also have infrastructure and private credit offerings into the future. We're looking at bringing similar structures in terms of evergreen -- evergreen products for the United States as well. The planned acquisition of HPS is going to bring real scale and expertise in the wealth channel for us, including more than $20 billion of wealth-focused assets in HLEND, one of the high-performing BDCs in the market. We think there is a great opportunity to continue to scale that in the channels where HPS is, but also bring that to the RIA market where BlackRock has a particularly large footprint. We have really excellent momentum in many of the strategies that we have in B debt. Our non-traded BDC has about $600 million plus in growing. Our credit interval fund CREDX, same deal has had a lot of growing. I do think that the biggest opportunity ahead of us is to integrate semi-liquid products and to integrate private markets into our over $300 billion managed models and SMA franchise. That would be the biggest unlock. And I really do think it's our competitive advantage. It's at the heart of the model venture we have with Partners Group. It's at the heart of many of the previously announced partnerships we have with Envestnet, GeoWealth, iCapital, Case, and Vestmark. So we think the two best execution channels for us here to help clients are target date funds and retirement accounts, assuming that we can have favorable conditions to do so and manage models in wealth and retail channels and the LTIF structures in UK and Europe."
},
{
"speaker": "Operator",
"content": "Your next question comes from Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Okay. Thank you very much."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi, Bill."
},
{
"speaker": "Bill Katz",
"content": "Good morning, guys. Thank you very much."
},
{
"speaker": "Laurence D. Fink",
"content": "25 years."
},
{
"speaker": "Bill Katz",
"content": "Yes, indeed, it goes quick. It goes quick. I remember that IPO conversation. Anyway, thank you for the shout-out. It's been a pleasure. Just maybe -- I know, one gentleman, just think about the evolution of the platform and then your guidance around buyback. As your earnings power continues to scale and become more diversified and more durable, how are you thinking about maybe the payout relative to the earnings power? And then how about the allocation underneath that between dividend growth and repurchase? Thank you."
},
{
"speaker": "Martin S. Small",
"content": "Thanks a lot, Bill. Our capital allocation strategy is consistent. As I mentioned earlier, like first to invest in the business. That's our main focus is investing the business to drive organic growth. We preferenced the dividend and then the size of our share repurchases, they're an output after those allocations of capital. We don't manage the company to hoard excess cash on BlackRock's balance sheet. So we have a very strong track record of returning that excess cash through share repurchases that are systematic. I think the size of future repurchases would result from a whole variety of factors. The levels of cash flow generation in organic growth and market beta and FX, the sizing of organic and inorganic investments, the leverage ratio of the company, the reasonableness of debt financing versus equity financing. So, all of these things would influence ultimately the sizing of the share repurchase program. But the share repurchase is an output, not an input into our capital management strategy. But this year, we had $4.7 billion return to share to shareholders. We know that BlackRock has become an attractive compounder between dividends and buybacks, and we want to keep that track record up for our clients and shareholders."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, we have reached the allotted time for questions. Mr. Fink, do you have any closing remarks?"
},
{
"speaker": "Laurence D. Fink",
"content": "Yes, I do. Thank you, operator. I want to thank everybody for joining us this morning and your continued interest in our firm BlackRock. Our record results in 2024 are just the beginning of our next phase of growth. We invested ahead of our structural growth trends and drivers that we believe will define the future of the capital markets and asset management. We have a lot of exciting work ahead of us, including the planned addition and integration of Preqin and HPS. And we entered 2025 better positioned than ever to deliver differentiating performance to our clients and value-creation for our shareholders. Everyone, have a really wonderful quarter. Enjoy. Talk to you in next quarter. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes today's teleconference. You may now disconnect."
}
] |
blk | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Jennifer, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the BlackRock, Inc. Third Quarter 2024 Earnings Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Martin S. Small; President, Robert S. Kapito; and General Counsel, Christopher J. Meade. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. [Operator Instructions] Thank you. Mr. Meade, you may begin your conference."
},
{
"speaker": "Christopher J. Meade",
"content": "Good morning, everyone. I'm Chris Meade, the General Counsel of BlackRock. Before we begin, I'd like to remind you that during the course of this call, we may make a number of forward-looking statements. We call your attention to the fact that BlackRock's actual results may, of course, differ from these statements. As you know, BlackRock has filed reports with the SEC which list some of the factors that may cause the results of BlackRock to differ materially from what we say today. BlackRock assumes no duty and does not undertake to update any forward-looking statements. So with that, I'll turn it over to Martin."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Chris. Good morning, everyone. It's my pleasure to present results for the third quarter of 2024. Before I turn it over to Larry, I'll review our financial performance and business results. Our earnings release discloses both GAAP and as-adjusted financial results. I'll be focusing primarily on our as-adjusted results. On our previous earnings call, we spoke to improving client sentiment and steadily improving organic growth. We sounded optimism about our growth trajectory in the second half of the year, and in the third quarter organic growth surged and BlackRock delivered some of the best financial results in our history. We generated $221 billion of net inflows, our highest net flows quarter ever. We delivered record levels of quarterly revenue and operating income. We expanded our margin by 350 basis points year-over-year. We generated 5% annualized organic base fee growth, our highest quarter in three years. Organic growth is accelerating as we execute on a strong pipeline and clients turn to BlackRock to move in size into public and private markets. Our structural growers, iShares, whole portfolio outsourcing in Aladdin, the structural growers all delivered strong third quarter growth and are poised to accelerate into year end. iShares, iShares leads the industry in global flows with approximately $250 billion through the third quarter and historically sees upwards of 40% of its total annual flows in Q4. Fixed income ETFs built chiefly on organic growth, iShares fixed income ETF assets now stand at over $1 trillion, nearly 40% higher than at year end 2021. And Aladdin, Aladdin logged 15% ACV growth consistent with our long-term low to mid-teens target with excellent momentum and key wins with growing clients. Finally, fixed income. Fixed income delivered across the platform with over $60 billion of net inflows. We believe a continued path of central bank normalization will support sustained inflows across bond funds, ETFs, and institutional accounts. Fixed income remains a compelling organic growth opportunity for BlackRock. Private markets are a strategic priority for BlackRock, delivering world-class private markets capabilities to more deeply-served clients across the whole portfolio. On October 1st, we closed on our acquisition of Global Infrastructure Partners. The combination triples infrastructure AUM and doubles private markets run rate management fees. We're already seeing the power of BlackRock and GIP together. Our partnership with Microsoft and NGX, It aims to realize the enormous investment potential of infrastructure to support AI innovation. And it's just the first proof point of the growth synergies we can create together. We're bringing private markets to wealth clients. BlackRock manages more than $300 billion of assets across model portfolios and separately managed accounts for wealth managers. These portfolios would benefit from increased exposure and more efficient access to the private markets. We believe the model portfolio solution we're building with Partners Group will revolutionize access to private markets for wealth managers and improve portfolio outcomes for millions of households on an even bigger scale than what's been done with Evergreen Funds. And as long observed in markets, information about capital has become almost as important as capital itself. Our planned acquisition of Preqin is accelerating this exciting private markets data and analytics journey for BlackRock and our clients. Our focus remains on delivering BlackRock's platform to clients through access to unique opportunities, expertise, and world-class client service. We're also moving swiftly and aggressively to position our firm to continue to achieve or exceed our 5% organic base fee growth target over the long term. We're building our mix towards higher secular growth areas like private markets, technology, whole portfolio mandates and model portfolios. We believe this will translate to higher and more durable organic growth, greater diversification and resilience in revenue and earnings through market cycles. Successful execution of these goals should also result in multiple expansion for our shareholders. We ended the quarter with AUM near $11.5 trillion. $11.5 trillion units of trust, clients building with BlackRock. Our business tends to be seasonally strongest in the fourth quarter and we maintain line of sight into a broad global opportunity set of new asset management and technology mandates that should fuel organic growth. BlackRock generated total net inflows of $221 billion in the third quarter, representing 8% annualized organic asset growth. Third quarter revenue of $5.2 billion was 15% higher year-over-year, driven by 5% organic base fee growth, the impact of market movements on average AUM over the last 12 months, and alpha generation in our liquid alternative strategies. Operating income of $2.1 billion was up 26% year-over-year. Earnings per share of $11.46 increased 5%, reflecting a higher tax rate compared to a year ago. Non-operating results for the quarter included $108 million of net investment gains, driven primarily by gains linked to a minority investment and unhedged seed capital investments. Our as adjusted tax rate for the third quarter was 26%. The prior year quarter included $215 million of discrete tax benefits, while the third quarter of 2024 was impacted by $22 million of discrete expense. We continue to estimate that 25% is a reasonable projected tax run rate for the remainder of 2024. The actual effective tax rate may differ because of non-recurring or discrete items or potential changes in tax legislation. Third quarter base fee and securities lending revenue of $4 billion increased 9% year-over-year, reflecting the positive impact of market beta and foreign exchange movements on average AUM and organic base fee growth, partially offset by lower securities lending revenue. Sequentially, base fee and securities lending revenue was up 4%. On an equivalent day count basis, our annualized effective fee rate was approximately four-tenths of a basis point lower compared to the second quarter. This was due to the relative outperformance of lower fee U.S. equity markets and client preferences for lower fee U.S. exposures and lower securities lending. The closing of GIP added $116 billion of client AUM and $70 billion of fee-paying AUM on October 1st. We expect GIP to add approximately $250 million of management fees in the fourth quarter of 2024. The GIP portfolios contribute competitive private markets fee levels that are typically over 100 basis points. They add primarily long dated non-redeemable assets to BlackRock's overall business, which further diversify our revenue and earnings mix. We expect these private market assets to positively impact BlackRock's overall effective fee rate by 0.5 to 1 full basis point. Performance fees of $388 million increased significantly from a year ago, primarily reflecting strong alpha generation over the last 12 months from a hedge fund with an annual lock in the third quarter. Quarterly technology services revenue was down 1% compared to a year ago due to the prior year quarter revenue impact of eFront on-premises license renewals for several large clients. Excluding this impact, technology services revenue would have increased approximately 9% year-over-year. Sequentially, technology services revenue was up 2% reflecting successful client go lives. Annual contract value or ACV increased 15% year-over-year, driven by sustained demand for our full range of Aladdin technology offerings. In the third quarter, a large U.S. asset manager selected Aladdin to unify its investment management technology platform across public market asset classes. Our ACV results include the impact of this client announcement and a number of other new client mandates. Our results highlight the power of Aladdin as a unifying technology. Aladdin provides a highly scalable operating backbone to clients that's tailored to meet their needs. It enables new capabilities to drive top line business growth for clients, while also unlocking scale and efficiency. Clients recognize a direct positive impact to the bottom line. Total expense was 8% higher year-over-year, primarily driven by higher incentive compensation, G&A, and sales, asset, and account expense. Employee compensation and benefit expense was up 10% year-over-year, reflecting higher incentive compensation as a result of higher performance fees and operating income. G&A expense was up 8% year-over-year, primarily due to the timing of technology spend last year and higher professional services expense. Sales asset and account expense increased 6% compared to a year ago, driven by higher direct fund expense. Direct fund expense increased 7% year-over-year and 6% sequentially, primarily as a result of higher average ETF AUM. Our as adjusted operating margin of 45.8% was up 350 basis points from a year ago, reflecting the positive impact of markets on revenue, significantly higher performance fees, and organic base fee growth. As markets improve, we've executed on our financial rubric, aligning controllable expense and organic growth, adding more resilience to our operating margin through greater variabilization of expenses and driving fixed cost scale. This approach is yielding profitable growth and operating leverage. In line with our guidance in January and excluding the impact of Global Infrastructure Partners, Preqin and related transaction costs, at present we would expect our headcount to be broadly flat in 2024. And we would also expect a low to mid-single digit percentage increase in 2024 core G&A expense. In line with this outlook, we would also expect Q4 core G&A to reflect execution of planned technology investment spend at levels more consistent with Q3 and seasonal increases in marketing spend. We welcomed approximately 400 new colleagues to BlackRock following the close of the GIP transaction. Inclusive of the GIP acquisition impact, at present, we'd expect full-year core G&A expense growth to be closer to the high end of the previously communicated range of a low to mid-single digit percentage increase. Our capital management strategy remains first to invest in our business, to either scale strategic growth initiatives or drive operational efficiency, and then to return excess cash to shareholders through a combination of dividends and share repurchases. At times, we may make inorganic investments where we see an opportunity to accelerate growth and support our strategic initiatives. At the closing of the GIP transaction, we issued and delivered approximately 6.9 million shares of BlackRock common stock, subject to a two-year lockup period. Approximately 30% of the total consideration for the transaction or 5 million shares is deferred and is expected to be issued in approximately five years based on achievement of certain performance milestones. We repurchased $375 million worth of common shares in the third quarter. At present, based on our capital spending plans for the year and subject to market and other conditions, we still anticipate repurchasing at least $375 million of shares in the fourth quarter consistent with our previous guidance. At present, we expect our planned acquisition of Preqin to close around year-end 2024, subject to regulatory approvals and other customary closing conditions. BlackRock's third quarter net inflows of $221 billion were well diversified and positive across client type, product type, active and indexed and regions. Momentum in our ETFs continued to build with $97 billion of net inflows in the third quarter. Fixed income and core equity led net inflows of $48 billion and $32 billion, respectively. Precision ETFs had $20 billion net inflows as clients efficiently adjusted tactical portfolio allocations with tilts towards U.S. and international developed market equities. BlackRock's cryptocurrency ETPs continue to grow and added $5 billion of net inflows in the third quarter. Institutional clients continue to consolidate more of their portfolios with BlackRock, and our institutional franchise raised $56 billion of net inflows in the third quarter. Our institutional active franchise saw $27 billion of net inflows, primarily in fixed income and multi-asset. Flows benefited from the funding of several large insurance and pension outsourcing mandates. We also saw positive flows into systematic equity, LifePath target date offerings, and private market strategies. Institutional index net inflows of $29 billion reflected large mandate wins and client-specific asset allocation and rebalancing decisions. Retail net inflows of $7 billion were led by continued strength in Aperio inflows into U.S. active fixed income mutual funds. Fixed income flows were positive across our municipal bond, high yields, unconstrained, and total return franchises. Demand for our illiquid alternative strategies continued in the third quarter with $1.5 billion of net inflows driven by infrastructure and private credit. Net inflows also reflected the impact of successful realizations of over $3 billion, primarily from private equity and infrastructure strategies. Finally, cash management saw net inflows of $61 billion in the quarter, driven by both US government and international prime funds, and included multiple large new client mandates. Clients recognize the benefits of our scaled and integrated cash offerings, and this is contributing to sizable inflows of BlackRock. BlackRock delivered one of the strongest quarterly results in our history, and we're in an excellent position to grow with our clients, moving ahead into the end of the year and beyond. BlackRock's historically delivered outsized organic growth in periods of investor re-risking, around election cycles, and changes in central bank policy. The fourth quarter's also been historically strong for inflows, so we're staying connected with our clients. We see significant opportunity to deepen relationships and to grow our share. As clients increasingly turn to BlackRock, we believe this will result in sustained market-leading organic growth, differentiated operating leverage, and earnings and multiple expansion over time. With that, I'll turn it over to Larry."
},
{
"speaker": "Laurence D. Fink",
"content": "Thank you, Martin, and good morning, everyone. Hopefully everyone has had a good summer and a really fun fall. Last week we happened to cross two milestones on the same day. We celebrated the 25th anniversary of BlackRock becoming a public company and we closed our acquisition of Global Infrastructure Partners. We're incredibly excited to officially welcome our GIP colleagues to the BlackRock family. We've enjoyed great connectivity with Adebayo and Raj and all the GIP founding partners. And we look forward to Adebayo joining our Board of Directors this quarter. Reflecting on these milestones and those came before, I believe our relationships with clients, with corporations, and with other partners are the strongest they've ever been. The long-term connectors and our relationship span many years as holders of company debt and equity. Our position as a consistent long-term investor differentiates us from opportunistic capital. We are not transactional. We are effectively perpetual capital, particularly through our index holdings. Those longstanding relationships, underpinned by long-term ownership positions are unlocking differentiated partnerships, especially as we expand into private markets. We founded BlackRock based on our belief in the long-term growth of the capital markets and the importance of being invested in them. BlackRock has grown as the capital markets have become a bigger and bigger part of the global economy. In my conversations with clients and policymakers around the world, I hear how more and more countries recognize the power of American capital markets and would like to build their own type of capital markets. Record government deficits and tighter bank lending means people, companies, and countries will increasingly turn to markets to finance their retirements, their business, and their economies. The growth and prosperity generating power of the capital markets will remain a dominant economic trend in the coming decades. And BlackRock will be an important player in that growth. The opportunities ahead are never been better than we've seen now. We see this through unique deals and partnerships with BlackRock at the center and are an accelerating client activity. 2024 net inflows have already surpassed the full year net inflows of both 2022 and 2023. The asset we manage on behalf of our clients reached a new high, ending the third quarter at $11.5 trillion. AUM has grown $2.4 trillion or 26% over the last 12 months. In that time, clients have entrusted BlackRock with $456 billion of net assets, including a record $221 billion in the third quarter. Third quarter net inflows and corresponding organic base fee growth of 5% represents our highest level in the last three years. And 15% technology services ACV growth is also at a fresh high. On our earnings calls earlier this year, we discussed with our shareholders our visibility to a strong pipeline. We shared how this would lead to accelerating organic growth in the second half and we're seeing that in our results today. We continue to grow our pipeline across the breadth of the Aladdin investment management mandates and we expect momentum to further build into year-end in 2025. We are effectively leveraging our technology, our scale and our global footprint to deliver profitable growth. Quarterly revenues and operating income both set new records, up 15% and 26%, respectively, year-over-year. And our 45.8% operating margin is up 350 basis points. Importantly, organic growth has great breadth and is diversified across BlackRock. Above the third quarter and the first nine months of 2024, flows were positive and active and indexed across all asset classes, across all client types, and across all regions. Actives have contributed $28 billion in the third quarter, including positive results in active equities. ETFs remain a secular growth driver, adding $97 billion in net inflows in the quarter and $248 billion year-to-date. We're seeing a broadening of ETF adaptation globally, leading to increased levels of utilization which we believe will only continue. A number of significant whole portfolio institutional mandates funded in the quarter, and we continue to be chosen for large global solutions. Last month we were selected as a fiduciary manager for over $30 billion dollar Dutch pension fund with more than 30,000 members. Our performance, our technology, and our in-depth knowledge of local investment nuances increasingly make us the preferred partner for institutional clients. Many investors have large cash holdings. Money market industry assets are hitting new records in the quarter, including BlackRock's own cash position, which had $61 billion in net inflows. But investors will have to re-risk to meet their long-term return needs. And we see great opportunities in investors across a number of structural trends continue to build this. These include rapid advancements in technology and AI and rewiring of globalization and the unprecedented need for new infrastructure. BlackRock is exceptionally well positioned in front of that $9 trillion of money market funds across the industry as it makes its way into public and private markets. We are connecting our clients to opportunities and working with them in an integrated whole portfolio lens to help them deploy their capital. We know our strategy is ambitious and our strategy is working. Black market is becoming the premier long-term capital partner across public and private markets. Private markets are becoming increasingly important in the financing of the economy. Growing public deficits are only going to expand the role of private markets and powering economic growth. These dynamics are reshaping the landscape of how our clients invest and how they allocate capital within their portfolios. Throughout our history, we have never shied away from making big bets to better serve our clients. As we did when we created Aladdin, unlocking new markets through ETFs and pioneered whole portfolio advisory across active and index, we made coordinated investments to bring private market opportunities to our clients in a better way. By an enthusiasm for the planned integration of GIP and the closing of Preqin has exceeded our own high expectations. Our clients are excited to see how GIP and Preqin capabilities are amplified by being part of BlackRock. The private markets and the client's allocation to them will continue to grow. Standardized, transparent private market data and analytics will be increasingly important. As with Aladdin, we believe we can add more value to Preqin as both a user and a provider of private market data and risk analytics. Aladdin expanded into new asset classes and markets as BlackRock and our own clients evolved. And we expect the same for Preqin. The growth of private markets is underpinned by the continued rise of infrastructure. It presents a generational investment opportunity. Over the next 15 years, the world will need to invest $75 trillion to repair aging infrastructure to invest in new projects like data centers and decarbonization technology. The current cash flow inflation-protected return profile of infrastructure makes it an attractive sector for our clients, most of whom will represent investor savings for retirement. For the close of GIP, we are now offering our clients access to market-leading investment and operating expertise across infrastructure private markets. Clients will benefit from a substantial scale as the second largest private market infrastructure managers in the world, with $170 billion in client assets. We have differentiated performance. GIP brings a track record of well-timed and disciplined entries into strategic exits, having returned over $45 billion of capital to investors. With higher rates, distributions to paid-in capital are a critical measure of success in where we are an industry leader. The combination of BlackRock’s infrastructure platform with GIP is already unlocking meaningful opportunity for our clients. We recently announced our partnership with Microsoft and MGX to launch the Global AI Infrastructure Investment Partnership. We will make investments in new and expanded data centers to meet growing demand for compute power. We will also invest in energy infrastructure needed to create new sources of power for these facilities. Mobilizing private capital to build AI infrastructure like data centers and power will unlock a multi-trillion dollar long-term investment opportunity. BlackRock is uniquely positioned at the center of this opportunity through our longstanding relationships with corporates, including hyperscalers and energy suppliers and governments around the world. We look forward to be working with our stakeholders in this ecosystem to navigate opportunities and challenges while we also are delivering investment returns for our clients. This partnership is a powerful demonstration on how our expanded capabilities will enable us to do even more with our clients investing in one of the largest growth imperatives in the coming decades. In addition to infrastructure, private credit is an important component of our client's portfolio. We've grown our own broader private market -- private debt business organically and inorganically in recent years. Today we manage over $85 billion in diversified across lending, investment grade, private placement, infrastructure and real estate debt. And we've been a top 10 fundraiser over the last decade. BlackRock’s nearly $4 trillion in assets across public fixed income cash and private credit means we both provide integrated fixed income solutions for our clients and deliverable scale benefits. Our scale enhance our proprietary deal sourcing access to the execution of deal flow, deeper liquidity, lowering trading costs, all of which benefits each and every one of our clients. Private markets have mainly been accessible to institutional investors while private wealth holding underweight by comparison. For many wealth investors, the addition of private markets to the portfolio may provide diversification benefits to better returns. To help bridge this gap, we recently announced a partnership with a Partners Group to develop a first-of-its-kind private markets model portfolio solution. We believe it will transform retail access by enabling financial advisors and their clients to add broad-based exposures to the private markets, including to the BlackRock funds. We continue to innovate new investment strategies to improve private market access for our clients backed by our own investment expertise, our proprietary sourcing of deals, and our technology. As market complexities and opportunities grow, clients need to scale enablers like Aladdin. Clients use Aladdin to consolidate a patchwork of legacy technologies resulting in greater and better business agility and resilience. It combines risk management, the investment book of record, its performance, its accounting, its risk, and data all on one platform. Clients research shows that Aladdin's scalable capabilities allow clients to grow faster, operate more efficiently, better risk management with their technology spend over the long term. The power of Aladdin is resonating with both asset owners and managers. The ACV growth reflected several significant client mandates, including a large public asset manager, and one of our largest Aladdin assignments ever. Aladdin is core to the consistent performance our portfolio managers deliver for clients. We leverage our investment insights and technology to bring the performance they demand and deserve. Flows into BlackRock active strategies accelerated in the third quarter with $28 billion of net inflows, bringing our year-to-date total of $39 billion. This includes demand for active equities led by our high-performing quant strategies, where more than 90% of the AUM is above the one, three, and five year period. Across asset classes, investment performance remains strong over the long run. This is resonating in our active flows and our liquid performance fees, and performance positions us well for future growth. Index ETFs are increasingly being used with an active management and the ETF structure is being used to pair the alpha generation of leading investors with the liquidity, tax efficiency and transparency offered by ETFs. These dynamics are contributing to client demand globally for iShares ETFs. BlackRock generated in the third quarter ETF net inflows of $97 billion. ETF flows were positive across all segments and major regions, including double-digit organic growth in Europe. There's more to come with the fourth quarter, which typically brings our seasonally strongest period of the year. iShares fixing an ETF platform recently cost $1 trillion in assets, and standalone, it would be a top-five bond manager by itself. Assets have nearly doubled over the last five years. All of that growth has been organic and mostly in a flat to down fixed income beta environment. A more normalized, relatively high rate environment has the potential to encourage investors back even more into fixed income. We continue to innovate in our exchange traded products to provide better access to markets. This quarter we launched our Ethereum ETF which has garnered more than $1 billion of net inflows in the first two months of trading. It follows the successful launch of our Bitcoin product, which has now grown to $23 billion in its first nine months. And we will continue to pioneer new products to be making investing easier and more affordable. On October 1st, 1999, BlackRock listed on the New York Stock Exchange for $14 a share. Today, we're trading somewhere around $960. When we went public, it was with a belief in the importance of growth and the depth of the global capital markets. We wanted to share our success with a broader population of people investing for the future, including our employees that all still holds true today. Our relentless focus on clients, having a growth mindset and a willingness to change and evolve has generated a compounded annual total return of over 20% for our shareholders since our IPO 25 years ago. BlackRock has exceeded the total return of the S&P 500 in 19 of those 25 years, representing a business model to serve all our stakeholders. We are better positioned than ever to serve our clients and to deliver growth for our shareholders in the years to come. I've never felt more optimistic in our positioning as I do today, even after 25 years of being a public firm and 37 years of being a firm. I want to thank all the BlackRock employees for their commitment to upholding our culture and serving our clients with excellence. And again, we welcome our new colleagues and clients from GIP. Operator, let's open it up for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll go first to Craig Siegenthaler from Bank of America."
},
{
"speaker": "Martin S. Small",
"content": "Hey, Craig."
},
{
"speaker": "Craig Siegenthaler",
"content": "Hey, good morning, Martin. Hope everyone's doing well. So my question is on the net flow trajectory. From your broad-based client conversations and your current institutional and funded wind pipeline, do you expect the acceleration of re-risking activity continue into next year post the election? And if your long-term net flows strengthen or stay strong given that they're already pretty strong in the third quarter. Should we expect any outflows in your money market business, which I know might be somewhat protected given the institutional scale?"
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Craig, for the question. So new inflows are strong, as you said, very healthy on any and all of the measures we track. No question, Craig, we're winning share with our clients. The $221 billion of Q3 flows, they showed great breadth across the business. Positive flows in U.S. active fixed income mutual funds, systematic equity, LifePath target date. Larry talked about just our long-term active business really shows resilience. Since 2019, I think we've had positive active flows in 18 of 23 quarters. So, we just continue to have a very strong flow performance, 25% higher than full year 2023, and we still have this seasonally strong Q4 ahead. So, we feel like a very healthy trajectory on asset growth. It's an affirmation for us that we're focused on the right things with clients. And I think for where we are in the cycle, BlackRock's always been a meaningful out performer in re-risking periods. So going back to previous election cycles or central bank action, if you look at BlackRock, we had outsized upside capture if that was in 2017, 2018, 2021, and we saw very strong organic asset growth as well as organic base fees growth that was over our long-term targets. So we see that the market and we think the world is lining up for that with our clients. And then with respect to money markets, our business is largely institutional. It's been very durable. The $61 billion of flows that's come there I think have been good. The trajectory has been very strong this year. I think Craig when we look at it, our money market fund business is at $850 billion today. It's nearly 70% bigger than it was five years ago. Cash is a meaningful part of client portfolios, but we're seeing that sort of return to fixed income as well, which has been good for the flow trajectory."
},
{
"speaker": "Laurence D. Fink",
"content": "I would just add one thing is, as the global capital markets become a larger player in the economic activity here and other places in the world, the opportunity for us and our positioning for us is fantastic. And that will allow the backdrop for better flows and more exciting opportunities."
},
{
"speaker": "Operator",
"content": "We'll go next to Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "Hey good morning."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi Michael."
},
{
"speaker": "Michael Cyprys",
"content": "Hey, congratulations on the strong quarter here. Great to see the meaningful operating leverage as well in the quarter. Just curious how you're pacing investments spent here into 2025. How is that evolving? And what are some of the levers to drive margining in the 12 to 18 months? Maybe you can update us on where you are along the journey of variablizing your expenses."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Mike. I appreciate it. It’s Martin. So just contextually, right, our approach to shareholder value creation is to generate industry-leading differentiated organic growth, to drive operating leverage and industry-leading margins and to execute on a consistent capital management strategy. We've got a strong track record at BlackRock of investing in the business for growth and scale, while also expanding profitability. It's not just about growth, it's about profitable growth over the long term. As our growth comes from being very disciplined in making and managing continued investments in our business. We've dubbed this our financial rubric, which I mentioned. We size our operating investments in line with a prudent lens on organic growth potential. We're aiming to put more flexibility in our cost base and variablizing more expenses where we can, and we've made a lot of progress there. And most importantly, we're looking to generate fixed cost scale, especially through investments in technology. We've got a consistent track record of delivering industry leading margins and improving them. And I'd say the scale indicators, they're really coming through the results. We generated 350 basis points of margin expansion year-over-year, while operating income rose 26%. And since the end of 2022, BlackRock assets under management are up $3 trillion, while headcount is broadly flat. So we're delivering the benefits of scale and productivity which showing our margin expansion. We continue to believe that technology, automation, firm foot printing are the major levers there for us to continue to drive that margin expansion. The last thing I'd say is just market movements, market movements beta, that's our highest margin item, both when markets move meaningfully up or down. And we continue to see conditions for reasonably positive growth in the markets over the near to intermediate term. So we believe we can continue to invest to accelerate organic growth and deliver margin expansion using this financial rubric that we've laid out."
},
{
"speaker": "Operator",
"content": "We'll go next to Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Hey, Larry. Hey, Martin. Good morning."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi, Alex. How are you?"
},
{
"speaker": "Alex Blostein",
"content": "I'm good, thanks. Question for you guys on private markets, there's a couple of topics, but maybe starting with GIP, helpful to maybe just to get a market to market on some of the financial elements. I know Martin, you talked about $250 million, I think, in management fees in the fourth quarter. Can you talk a little bit about how you see that evolving into 2025? What are some of the kind of fun flow dynamics on the legacy GIP side and what are some of the things that you guys are working with them together? And also if you could just remind us what the operating margin on that business is as well out of the gate as well. Thanks."
},
{
"speaker": "Martin S. Small",
"content": "Thanks Alex. So just the closing of GIP, it's a great milestone in BlackRock's history. We're really excited to welcome over 400 new colleagues, to welcome the leadership team, Adebayo, Raj, Michael, John, everybody. Our clients are excited. The consultants that we've been working with are excited. The corporate partners are excited. So we're really eager to partner on this new platform. And the reception, as Larry mentioned, has been overwhelmingly positive. For us, this is a revenue growth story. This is about expanding capabilities. We're working to unlock substantial growth synergies across origination, capital formation, and platform scale. We're seeing excellent momentum in fundraising for -- across the platform at GIP, at BlackRock, and have, I'd say, really strong ambitions, especially around the AI Innovation Fund that Larry mentioned. As I mentioned on the call in my earlier remarks, we're consolidating $116 billion of GIP AUM, client AUM, $70 billion of fee-paying AUM. We're doubling private markets run rate management fees at BlackRock in the transaction. Think about GIP adding, as we said on the call, annualized north of $400 million of earnings at sort of 50-ish percent margins, $250 million in management fees we expect to come in the fourth quarter. So I'd model sort of a $1 billion of fees with an FRE margin north of 50% when we think about 2025 in terms of GIP."
},
{
"speaker": "Operator",
"content": "We'll go next to Dan Fannon with Jefferies."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi Dan."
},
{
"speaker": "Operator",
"content": "Caller, your line is open. You may be on mute."
},
{
"speaker": "Dan Fannon",
"content": "Sorry, can you hear me?"
},
{
"speaker": "Laurence D. Fink",
"content": "Yes, we can now, Dan."
},
{
"speaker": "Dan Fannon",
"content": "Okay, great. Sorry about that. I was hoping you could discuss your appetite for additional M&A and what constraints you have financially, but more importantly as a management team to appropriately integrate the recent deals and really maximize the opportunity you have with these transactions?"
},
{
"speaker": "Martin S. Small",
"content": "All right, thanks so much for the question. As I said, we're really excited for our clients about GIP and Preqin. This is a meaningful accelerant in our private markets capabilities. And I think just, as I mentioned in the last question, it's a major financial contributor for BlackRock, but it's going to take some work to integrate well and realize the plan synergies of the transaction. So right now we're very focused on integrating GIP and closing Preqin, and we're focused on delivering a great integration experience for clients and employees. We've always thought of making organic and inorganic investments in our business. And inorganic is a tool that we have in order to optimize organic growth, but we don't need M&A to meet our organic growth targets. Look at this quarter, we've hit our 5% organic base fee growth target and we see excellent momentum. So, we'll continue to be prudent with our capital and financial position and consistent with our long-term approach. We'll evaluate inorganic opportunities that have the benefit for our clients and shareholders. We're always going to be very rigorous and selective in those criteria and entertain possibilities that have clear alignment with our culture, strategy and long-term organic growth. We have great capabilities here, Dan. So across infrastructure now, we've got $170 billion platform. We have an $85 billion private credit platform. We have a huge opportunity to grow inorganically in private credit with our insurance clients. We're the largest core fixed income manager in the world for insurance companies -- organic, we have the largest organic opportunity to grow -- organic opportunity to grow with our insurance clients. We manage $700 billion of insurance company general account assets for them. So if you think about the conversations we're having with CIOs to integrate our private credit capabilities into that GA. If we can just flip seven -- if we can flip 10% of the $700 billion into private credit strategies, that's $70 billion of opportunity sitting with existing clients with the capabilities that we have today."
},
{
"speaker": "Operator",
"content": "We'll go next to Glenn Schorr with Evercore."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi, Glenn."
},
{
"speaker": "Glenn Schorr",
"content": "Hi, thanks very much. So I think we're all pretty impressed with the broad growth that you keep putting up and huge margins too. So, I want a high-level question. You mentioned the word multiple expansion once or twice during the conversation and it's just -- I think earnings growth needs to be part of the equation too. When you have strong growth and everything, you have big margins. I'm just curious why 5% EPS growth this quarter, should we expect these initiatives as they layer in and you consistently hit your base fee targets to actually bring the earnings growth along with it too. I appreciate that. Thanks."
},
{
"speaker": "Martin S. Small",
"content": "Thanks so much for the question, Glenn. So we're focused on driving differentiated organic growth, meeting our 5% organic growth targets through the cycle driving operating leverage. And as you said, I think you see those results very much coming through. We think if we are able to drive 5% organic growth, continue to execute on this financial rubric I laid out. We should be able to drive industry-leading margins and margin expansion and double-digit EPS growth. I think in the quarter, I mentioned our effective tax rate was 26% in the quarter. And that's the main driver between some of that lighter EPS here was the $22 million of discreet expense that we had in this quarter versus the $215 million of benefit that we had last year from discreet."
},
{
"speaker": "Operator",
"content": "We'll go next to Brian Bedell with Deutsche Bank."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi Brian."
},
{
"speaker": "Brian Bedell",
"content": "Hi, good morning. Congrats on a great quarter. Maybe just back to the 5% organic base fee growth and maybe a different angle on this in terms of the fee rate. Obviously, the rate is going up with the GIP acquisition of that 0.5 to 1 basis point. Do you feel better now than you have maybe in a long time on the potential for the fee rate to either be stable or even move up sequentially in the next several years versus the fee pressure that you've seen. And I know it's all been due to mix in the past, but now the composition of your future organic growth seems to be tilted more towards the private markets, towards higher fee products versus, obviously, some of the lower mandates that you've been bringing in and also the core iSeries -- iShares, [Core Series] (ph) iShares, sorry. So bottom line is, do you feel better about that fee rate growth potential? And maybe if you can just touch on the model portfolios partnership as well in terms of the organic growth potential there."
},
{
"speaker": "Martin S. Small",
"content": "Absolutely. Thanks so much for the question. So we generated 5% annualized organic base fee growth in the quarter. So 5% annualized organic base fee growth. We're excited about that. Continue to see great momentum just in our organic growth. We're growing revenues and operating income at double digit rates and expanding margin. Average AUM growth was 18% higher than base fee growth, and that was mainly due to relative outperformance of lower fee rate US equities, or what you all in our analyst community would call divergent beta. So spot AUM of $11.5 trillion ended the quarter about 4% higher than average AUM. And so our annualized effective fee rate was approximately four-tenths of a basis point lower sequentially. More macro just on the fee rate. On our AUM, the fee rate, it's a backward-looking output basically of the mix of the stock of assets that we manage and net new flows and net new fields on the fee rate. It's primarily affected by beta and FX and also by organic growth. And so over more recent periods, US public equity markets, which are a lower fee rate segment, They've grown faster than international equities. And that's been a driver of these fee rate trends on our platform. And in those environments of strong US equities, also the new base fee growth tends to occur at relatively lower fields to international or EM equities. Fee rate for us, it's primarily an output. It's not the basis or driver of the strategy. We're focused on meeting client needs across the whole portfolio. We're focused on technology. We're focused on driving organic growth in the most efficient way possible. But I do think you're grabbing on the point that we see, which is as we grow our private markets business, and we're going to go from $170 billion of client AUM with GIP to call it $285 of client AUM, as we grow our private markets business, we would expect to see positive leverage to base fee revenue. We'd expect to see positive leverage to average fee rates and organic growth over time. Going into Q4 ex-GIP, we'd expect the entry rate to be flat. And as I noted, consolidation of the GIP portfolios into our business is expected to lift the fee rate by about a 0.5 to 1 full basis point. So in the longer term, as we see a liquids and private markets as a bigger contributor to our business mix, we would expect that to have positive leverage on the fee rate."
},
{
"speaker": "Operator",
"content": "We'll go next to Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Okay, thank you very much. Good morning everybody. Happy anniversary. I think I was there at the beginning. Sad to say. Indeed, I remember that meeting like it was yesterday. So question for you, I was very intrigued by your statement about revolutionizing the wealth management opportunity. I was wondering if you could maybe unpack that a little bit. I think you mentioned that the whole portfolio opportunity could be better than everything on the evergreen side to date. And just wondering if you could expand your thinking a little bit just so we get a sense of the magnitude and the opportunity and maybe any go-to-market strategy we should be thinking about as we look into the new year? Thank you."
},
{
"speaker": "Martin S. Small",
"content": "Thank you. Thanks, Bill, very much. Very much appreciate the question. So we have strong relationships in wealth and retail markets across the globe. Our aims to help wealth managers build long-term portfolios that blend public and private markets exposures. I think if you go back to the last several investor days we've had, we've talked about building the portfolio of the future for wealth managers, which is digitally enabled, it's public-private, and this market, I think, is still very early. Retail allocation to private markets still remains in low single digits. Just on capabilities for us here, we have a great established leading franchise in retail liquid alternatives. We've got over $40 billion of assets here across merger [ARB] (ph), systematic multi-strategy commodity exposures. We've had a lot of success in bringing retail [alts] (ph) to retirement in the UK and Europe through the LTIF and LTAP for structures. We've been building out our evergreen and credit integral funds here in the United States. We have a credit strategies integral fund [CredEx] (ph). We have a non-traded credit BDC [BDET] (ph), which are combined to be over a $1 billion today. BDET's well placed for RIAs, independent broker dealers, offshore wealth. We think this can be a strong grower for us. But as you said, longer term, our aspiration is to integrate semi-liquid products into our over $300 billion of managed models and SMAs. That would be the most significant unlock and we feel competitive advantage we have. It's at the heart of the models venture that we've entered into with Partners Group. But I'd say, it's consistently, it's part of the partnerships we have with InvestNet, with GOL, with iCapital, with Case, with Vesmark. Our goal is to make model portfolios seamless in terms of public-private in the same way we've been able to do that with ETF and mutual fund active model portfolios. So we have a lot more work to do on that, but we're excited about the opportunity."
},
{
"speaker": "Laurence D. Fink",
"content": "Bill, let me add more to that answer. As we believed when we acquired BGI that ETS would become the instrument of so much of the activity in the capital market that it's really been that way. Even in 2012 when we said ETS are going to be expanding heavily in fixed income to the surprise of so many people and we crossed $1 trillion from that. What we are seeing now in private markets of blending of public and private and that's going to continue to blend. Institutional clients are going to be looking at measurements of liquidity, and they're going to be trading in between public and private. That will become the new domain. And so, we're not going to look at private markets in the same way. Like we're not going to say there are alternatives. They're just part of the marketplace itself. And one of the reasons why we were so driven to acquire Preqin, we believe that data and analytics will accelerate that movement of making public and private ubiquitous together and what we're going to look at is liquidity as the driver of risk. And so, we're going to be blending liquidity from the public markets, the liquidity of the private markets and making risk assessments. And if through the data analytics that we could have combining Preqin, Aladdin and eFront, if we could build that platform into more transparency in privates, more opportunities for privates, this idea of the blending in public and privates will become a reality, just like the reality of how ETFs became the driving force of so many of the markets now, and we believe that will happen too, but it's going to happen with the acceleration of data and analytics. So when you think about these retail platforms that will be driving more private type of exposures, it will accelerate only when we have better data analytics transparency indexing and that is a major component of our strategy going forward."
},
{
"speaker": "Operator",
"content": "We'll go next to Ben Budish with Barclays."
},
{
"speaker": "Laurence D. Fink",
"content": "Hey Ben, good morning."
},
{
"speaker": "Ben Budish",
"content": "Good morning and thank you for having me on the call. I wanted to ask about your ambitions in digital assets to maybe change it up a little bit. It seems like one way or another we're going to have a new president next year who's going to be more friendly to the industry. And while it could take some time to see new rules and regulations, I'm just wondering, what do you see as the key opportunities for BlackRock that this change in posture from Washington could unlock sort of beyond the ETF business and some of the other custody things you do? Thank you."
},
{
"speaker": "Laurence D. Fink",
"content": "Well, first, I'm not sure if either president or other candidate would make a difference. I do believe the utilization of digital assets are going to become more and more of a reality worldwide. Conversations we’re having with institutions worldwide, conversations about how should they think about digital assets, what type of asset allocation there should be. We believe Bitcoin is asset class in itself, it is an alternative to other commodities like gold. And so I think the application of this form of investment will be expanded. Two, the role of Ethereum as a blockchain can grow dramatically. So if we can create more acceptability, more transparency, more analytics related to these assets, then it will be expanded. But I truly don't believe it's a function of regulation, of more regulation, less regulation. I think it's a function of liquidity, transparency, and then through that process, no different than when you -- years ago when we started the mortgage market, years ago when the high yield market occurred, started off very slow, but it built as we build better analytics and data and then through better analytics and data, more acceptance and a broadening of the market. And I truly believe we will see a broadening of the market of these digital assets. And then we'll see how does each and every country look at their own digital currency. That's a very different asset than a Bitcoin in itself. But I do believe what we're going to witness as we build out better analytics. And then the question is, as you mentioned, regulation. How do we see in this country the role of digitizing the dollar? And what role does that play? That's a very different question related to, let's say, Bitcoin and other items like that. But all of that is going to be under discussion. And what we're witnessing in other countries that we're seeing big success in India and Brazil in the digitization of their own currency for various different reasons. But we believe the technology of these blockchains are going to become very additive. And then it will overlay AI and having better data analytics. The applicability and the broadening of these markets will occur."
},
{
"speaker": "Operator",
"content": "We'll go next to Brennan Hawken with UBS."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi, Brennan."
},
{
"speaker": "Brennan Hawken",
"content": "Hey, good morning. Thanks for taking the question. Curious whether you all have seen any changes in the RFP activity on the fixed income side. There's recently been some regulatory issues at a large institutional bond manager. So kind of curious about what you're seeing in the market there on the back of that?"
},
{
"speaker": "Laurence D. Fink",
"content": "So if you look at our announcement this quarter, we announced we won a $30 billion mandate from a pension fund. It is not uncommon to see big, large changes in the marketplace. I don't want to talk about one client or another client or what's happening with one manager versus another manager. There is no question, money is in motion. Rob Capito talks about this a lot. We are seeing this. There's a very large institutional mandate that are going to be up for -- there's an RFP right now. And so, I don't look at this as any different. Obviously there are some issues around that are in the press, but money in motion occurs every quarter. There are large opportunities every quarter. And I think one thing that we see consistently as OCIO mandates occur, they're occurring with more regularity and with more opportunity. And this is away from the topic that you brought up. But it's important to just note this is not uncommon seeing large blocks of business moving around. And I'll leave it at that."
},
{
"speaker": "Operator",
"content": "At this time, this does concludes today's Q&A session. And I'd like to turn the call back to Larry Fink for any additional or closing remarks."
},
{
"speaker": "Laurence D. Fink",
"content": "Thank you, operator. I want to thank all of you for joining us this morning and your continued interest in BlackRock over these last 25 years. Our third quarter results are possible because of the global network of relationships we've created, our data analytics that are differentiated by all imagination, and importantly our integrated technology that we built over many, many years. We have a long history of good integration, whether it is integration of BGI, Malim, Aperio, eFront, and now we're working on a successful close and integration of GIP. And we expect the same thing of a closing and integration of Preqin around year end. And I believe our position has never been better. And I believe as we look forward in delivering strong performance for our clients, we will create differentiated growth for you, our shareholders, in the coming years ahead. Everybody, thank you and have a nice and positive quarter. Thank you. Bye-bye."
},
{
"speaker": "Operator",
"content": "This concludes today's teleconference. You may now disconnect."
}
] |
blk | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Jennifer, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the BlackRock Incorporated Second Quarter 2024 Earnings Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Martin S. Small; President, Robert S. Kapito; and General Counsel, Christopher J. Meade. All lines have been made on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions] Thank you. Mr. Meade, you may begin your conference."
},
{
"speaker": "Christopher J. Meade",
"content": "Thank you, operator. Good morning, everyone. I'm Chris Meade, the General Counsel of BlackRock. Before we begin, I'd like to remind you that during the course of this call, we may make a number of forward-looking statements. We call your attention to the fact that BlackRock's actual results may of course differ from these statements. As you know, BlackRock has filed reports with the SEC, which list some of the factors that may cause the results of BlackRock to differ materially from what we say today. BlackRock assumes no duty and does not undertake to update any forward-looking statements. So with that, I'll turn it over to Larry."
},
{
"speaker": "Laurence D. Fink",
"content": "Thank you, Chris. I'd like to begin by addressing what occurred over the weekend. The assassination attempt on former President Trump is abhorrent. I was very relieved he wasn't seriously injured, and I'm thinking about the victims of this shooting, especially the innocent person who was killed. As I wrote to my BlackRock colleagues in the hours immediately following the horrific event Saturday evening, we must condemn political violence of any kind, period. And as Americans, we must stand united to do our part to promote civility and unity for our country and provide hope for all Americans. I'll turn it over to Martin now."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Larry, and good morning, everyone. Before I turn it back to Larry, I'll review our financial performance and business results for the second quarter of 2024. Our earnings release discloses both GAAP and as-adjusted financial results. I'll be focusing primarily on our as-adjusted results. The first half and second quarter of 2024 saw some of BlackRock's strongest performance and highest growth rates of the post-pandemic period. We're growing faster than last year. We delivered double-digit operating income growth and expanded our margin by 160 basis points year-over-year. Clients entrusted us with over $80 billion of net new assets. It was $150 billion of flows excluding episodic client activity. We generated 3% annualized organic base fee growth, our highest second quarter in three years. We ended the second quarter with record AUM of over $10.6 trillion. Our business tends to be seasonally stronger in the back half of the year and we have line of sight into a broad global opportunity set of new asset management and technology mandates that should fuel premium organic growth. We're executing on the strongest opportunities we've ever seen in our core business and building for the future. We're moving swiftly and aggressively to position our firm to achieve or exceed our 5% organic base fee growth target over the long term. At the same time, we're putting the future building blocks of accelerated all-weather organic growth, that's private markets and technology. We're putting them into place with our planned acquisitions of Global Infrastructure Partners and Preqin. We're building our mix towards higher secular growth areas like private markets, technology, whole portfolio mandates, and model portfolios powered by both ETFs and active. We believe this will deliver greater diversification and resilience in revenue and earnings through market cycles. Through strong organic growth and scaling of our private markets and technology platforms, we believe we can drive compelling earnings growth and multiple expansion for our shareholders. We continue to build with our clients and more than $10.6 trillion in assets under management, $10.6 trillion units of trust, BlackRock's platform is becoming the premier long-term capital partner across public and private markets. We're connecting investors, corporates and the public sector to the power of the capital markets. Through the iShares and indexing platforms, we've developed longstanding relationships, highly aligned shareholder relationships with global corporates. Through our advisory and technology capabilities, we are a trusted partner to governments and the public sector. These relationships are creating a wealth of opportunities for unique transactions, especially in infrastructure and private markets, and they benefit our clients' portfolios, they fuel organic growth. In the second quarter, we saw equity markets power to another record high and more clients starting to re-risk. Investors waiting in cash have missed out on significant equity market returns over the last year and more investors are stepping back into risk assets. BlackRock is a [sheer] (ph) winner when there's assets in motion. Periods when investors are eager to deploy capital are historically when BlackRock's platform sees its most outsized growth. Clients are coming to BlackRock as a thought leader, as a partner as they rethink their portfolios and investment technology. We continue to execute on a strong set of large opportunities that are contracted near-funding or in late-stage contracting. And over the past few months, the slate of client mandates we've been chosen for is the most broad and diversified has been in years across active equity and fixed income, customized liquidity accounts, private markets and multi-product Aladdin assignments. BlackRock generated total net inflows of $82 billion in the second quarter, representing 3% annualized organic asset and 3% annualized organic base fee growth. Flows were impacted by an approximately $20 billion active fixed-income redemption from a large insurance client linked to M&A activity. Excluding this single client specific item and low fee institutional index equity flows, we saw nearly $150 billion of total net inflows in the quarter. Second quarter revenue of $4.8 billion was 8% higher year-over-year, driven by positive organic base fee growth and the impact of market movements on average AUM over the last 12 months. Higher performance fees and technology services revenue also contributed to revenue growth. Operating income of $1.9 billion and earnings per share of $10.36 were each up 12% year-over-year. Non-operating results for the quarter included $113 million of net investment gains, driven primarily by non-cash mark-to-market gains on our unhedged seed capital investments and minority investments. Our as-adjusted tax rate for the second quarter was approximately 24%. We continue to estimate that 25% is a reasonable projected tax run rate for the remainder of 2024. The actual effective tax rate may differ because of non-recurring or discrete items or potential changes in tax legislation. Second quarter base fee and securities lending revenue of $3.9 billion was up 7% year-over-year and reflected positive organic base fee growth and the impact of market appreciation on our average AUM, partially offset by lower securities lending revenue. Sequentially, base fee and securities lending revenue was up 3%, reflecting higher average AUM and 3% annualized organic base fee growth in the current quarter. Our annualized effective fee rate was flat compared to the first quarter. Ending spot AUM was 2% higher than quarterly average AUM as market sharply recovered after April declines. Performance fees of $164 million increased 39% from a year ago, driven by both liquid alternatives and long-only products. Quarterly technology services revenue was up 10% compared to a year ago and up 5% sequentially, reflecting successful client go lives. Annual contract value, or ACV, increased 10% year-over-year, reflecting sustained demand for our full range of Aladdin technology offerings. 80% of new logo sales this year have come from opportunities, including multiple products. We have a strong multi-product pipeline and remain committed to low- to mid-teens ACV growth over the long term. Preqin is expected to accelerate planned technology services ACV growth within our target range. Total expense increased 5% year-over-year, primarily driven by higher incentive compensation, G&A, and sales, asset and account expense. Employee compensation and benefit expense was up 4% year-over-year, reflecting higher incentive compensation as a result of higher operating income and performance fees. G&A expense was up 7% year-over-year, primarily due to the timing of technology spend in the prior year and higher professional services expense. Sales, asset and account expense increased 4% compared to a year ago, primarily driven by higher direct fund expense. Direct fund expense increased 4% year-over-year and 6% sequentially, primarily as a result of higher average ETF AUM. Our as-adjusted operating margin of 44.1% was up 160 basis points from a year ago, reflecting the positive impact of markets on revenue and organic growth this quarter. As markets improve, we expect execution on our financial rubric to drive profitable growth and operating leverage. In-line with our guidance in January and excluding the impact of Global Infrastructure Partners, Preqin and related transaction costs, at present, we would expect our headcount to be broadly flat in 2024 and we would also expect a low- to mid-single digit percentage increase in 2024 core G&A expense. Our capital management strategy remains first to invest in our business to either scale strategic growth initiatives or drive operational efficiency, and then to return excess cash to shareholders through a combination of dividends and share repurchases. At times, we may make inorganic investments where we see an opportunity to accelerate growth and support our strategic initiatives. We repurchased $500 million worth of common shares in the second quarter, which exceeded our planned run rate as we saw attractive relative valuation opportunities in our stock. At present, based on our capital spending plans for the year and subject to market conditions, we still anticipate repurchasing at least $375 million of shares per quarter for the balance of the year consistent with our previous guidance in January. At present, we'd expect our planned acquisition of GIP to close in the third quarter of 2024, subject to regulatory approvals and other customary closing conditions. And just a few weeks ago, we announced our planned acquisition of Preqin, marking both an extension of our private markets capabilities and a launching point into the adjacent fast-growing private markets data segment. We expect it will accelerate the growth and revenue contribution of technology services. The bigger longer-term opportunity is leveraging our engines in Aladdin and indexing with our capital markets expertise to build the machine for the indexing of private markets. With the creation of public benchmarks did to drive stock markets, especially visible through iShares, we believe the combination of BlackRock and Preqin can do for private markets. The momentum we spoke to last quarter is visible in our flows with $82 billion of total net inflows in the second quarter, which include the previously mentioned large outflow from one client. Excluding that single client outflow, flows were positive across product types and active in index. BlackRock led the ETF industry in flows for the first half of 2024 and the second quarter, and our flows are more diversified by product type, channel and region than any other issuer. Second quarter BlackRock ETF net inflows of $83 billion were led by fixed income and core equity ETFs, which saw $34 billion and $32 billion of net inflows, respectively. Precision ETFs added net inflows of $14 billion in the quarter, as clients reassessed their tactical portfolio allocations, adding exposures to growth equity. BlackRock's Bitcoin ETF continues to lead, gathering another $4 billion in the second quarter for $18 billion of net inflows in its first six months. Retail net inflows of $6 billion reflected continued strength in Aperio and broad-based net inflows into active fixed income. Aperio recently crossed the $100 billion AUM milestone, logging over 20% organic growth since we acquired the business a little over three years ago. As fee-based fiduciary wealth advisors grow across the world, managed model portfolios are the main way in which wealth managers are looking to scale their practices and better serve their clients. BlackRock has the leading models business and we grow through distribution of our own models, as well as through distribution of third-party models that typically include strong allocations to iShares. Our partnership with Envestnet continues to help Envestnet advisors grow and to drive assets into BlackRock products through models. In the second quarter, we saw our best net sales month on the platform in nearly three years and have generated 20% annualized organic growth in 2024. Last month, Envestnet and BlackRock announced new programs to expand personalized investment strategies on the Envestnet platform across direct indexing, models and portfolio consulting. Also in June, we announced a partnership with GeoWealth to expand our custom models offerings, which represents the fastest-growing model segment. The custom models offered through GeoWealth's platform will provide advisors with a streamlined and scalable approach that combines public and private markets in one portfolio solution. Institutional active net outflows of $2 billion were impacted by the previously mentioned single client redemption. We saw the funding of several whole portfolio assignments and strength in private markets as clients seek out and leverage our comprehensive multi-alternatives platform. Institutional index net outflows of $35 billion were concentrated in low fee index equities. Several large clients, mostly outside the United States, rebalanced their portfolios amid record levels for equity markets. Private markets generated net inflows of $2 billion. Continued demand for our infrastructure and private equity solutions were partially offset by successful realizations of about $4 billion, primarily from private equity strategies. Finally, cash management net inflows of $30 billion were driven by government and international prime funds. Flows benefited in part from clients reinvesting in cash strategies in early April after redeeming balances during the last week of March. Net inflows included multiple large new client mandates, as connectivity between our cash and capital markets teams allows us to deliver clients holistic advice and market insight. Our scale and active approach for clients around their liquidity management are driving sustained growth in our cash platform. BlackRock's strategy and platform evolution, they're rooted in our convictions about future client needs, about required investment capabilities, about technology, about scale generation. Teams across BlackRock are connected in delivering on significant client opportunities, driving product innovation and operating more nimbly and efficiently. Momentum continues to build across our platform. We're better positioned than ever to grow our share with clients and deliver profitable growth for our shareholders. I'll turn it over to Larry."
},
{
"speaker": "Laurence D. Fink",
"content": "Thank you, Martin. BlackRock's core business growth is the strongest we've seen in nearly three years, with a significant upward shift ever since our last earnings call in April. Second quarter core net inflows were approximately $150 billion, excluding lower fee episodic M&A and institutional index activities. Our structural growers areas, like ETFs, models, Aladdin and private markets, are powering steadily higher organic base fee growth. Organic base fee growth represented the best second quarter since 2021. 2024 has been our ETF strongest start in a year on record with $150 billion of net inflows and iShares' June flows were the strongest month in our history and for any other issuer. We are executing on landmark mandates across our platform and on closing our planned acquisitions of GIP and Preqin. Client and stakeholder feedback on both GIP and Preqin has been increasingly enthusiastic. We are on a differentiated path to transform our capabilities and infrastructure and to meet the growing need for private market technology, data and benchmarking. We believe this will deepen our relationships with our clients and deliver value to you, our shareholders. Our growth in private markets provides a whole new engine for premium diversified organic growth and less beta-sensitive revenues, both of which should drive future earnings and multiple expansion. We have strong conviction we are on pace to reach our 5% organic base fee growth target. And the expected third quarter closing of GIP will add on to our organic base fee growth potential, doubling our private markets base fees and adding approximately $100 billion of AUM focused on infrastructure. At BlackRock, we always intensely push ourselves to anticipate where markets are going, what clients will need and how we can deliver better outcomes in better ways to each and every client. We set the standard for buy-side risk management technology by launching Aladdin on the desktops of investors over 20 years ago. We acquired BGI and iShares to redefine whole portfolio investing by blending both active and indexing to build better outcome-oriented portfolio. iShares AUM was about $300 billion when we announced our acquisition in 2009. Today, iShares is approaching $4 trillion of client money. We recently celebrated the five year anniversary of the eFront acquisition, where ACV has now more than doubled since becoming part of BlackRock. We have never been shy about taking big, bold, strategic moves to transform ourselves and most importantly to transform our industry. Our successful business transformations are delivering our strong performance today and opening up meaningful new growth markets for our clients and for our shareholders. We continue on our mission to transform private markets. BlackRock is unique in delivering an integrated approach to help our clients across all aspects of private market investing, enabling a seamless view into investment management, into technology and data onto one single platform. With a strong common culture of serving clients with excellence, together with GIP, we will deliver for our clients a holistic global infrastructure manager across equities, debt and solutions. We will provide the full range of infrastructure sector exposures and we will offer our unique origination across developed and emerging world markets. Our recently announced agreement to acquire Preqin is another step in the transformation of our private markets and technology platform. As private markets grow, data and analytics will become increasingly more important. We believe our planned acquisition of Preqin will help to compete the whole portfolio by delivering high-quality data integrated with workflows. Ultimately, this should drive increased accessibility and efficiencies in private markets. And the combination of Preqin with Aladdin and eFront presents an opportunity to find a common language for private markets, powering the next generation of whole portfolios. We envision we could bring the principles of indexing to the private markets through standardization of data, through benchmarking and through better performance tools. BlackRock has developed a broad network of global corporate relationships through our many years of long-term investments in both their debt and equity. For companies where we are investors, they appreciate that we are long-term, consistent, always-there capital. We are not transactional. We invest early and we stay invested through cycles. Whether it's debt or equity, pre IPO, post IPO, companies recognize the uniqueness of our global relationship, our brand and our expertise across markets and industries. This makes us a valuable partner, in turn unlocks the opportunity and performance we could provide for clients. Unique deal flow and track record of successful exits create a flywheel effect, enabling future fundraising and more scaled funds. Corporates and clients increasingly want to work with BlackRock, and we are executing on the best opportunity sets we've seen in years across iShares, private markets, whole portfolio solutions and Aladdin. Importantly, our business has great breadth with organic growth diversified across our platform. In the first half of 2024, flows were positive in active and index and across all asset classes. Our active platform, including alternatives, contributed $11 billion. ETF remains a secular growth driver, processing $150 billion of net inflows, and already representing more than 70% of our total flows of last year. And our technology services revenue grew double-digit in the first half of the year. Importantly, we have notified fundings for a number of scaled institutional wealth management that we expect to fund over the coming quarters. For example, in the second quarter, we were selected to manage a $10 billion US corporate plan, a multi-billion fixed-income portfolio for a large defined benefit scheme and scientific active equity strategies for several global financial clients. These add to the global mandates which we have seen -- that we have been chosen over the last six months, including a large US RIA, a UK pension fund, a European captive asset management are just a few examples, as we look to onboard these mandates and more in future quarters and delivering the outcomes of our clients and their constituents and what they need. Growing business momentum across our scaled asset management and technology platform is driving strong financial results. BlackRock's operating income was up 12% year-over-year or 160 basis points of margin expansion. Earnings per share was up 12%, and we remain committed to delivering differentiated organic growth at a premium margin to our investors. We continue to generate leading organic growth and our operating margin of 44.1% is over 10 points above the traditional peer average. [indiscernible] 5% yields in cash have kept many investors overweight in cash and nearly $9 trillion still sits in money market funds. Those waiting in cash would have missed out on a broad stock market returns of over 26% over the last year, including 17% so far in 2024. Long-term outcomes and future liability matching needs more than a 5% return. Investors will have to re-risk, which should improve flows into equities and credit markets. BlackRock is always a sheer winner when assets are in motion and a meaningful outperformer in periods of investors re-risking. BlackRock operates from a position of strength. We have a clear path to our 5% organic base fee growth target and we're transforming ourselves to build a firm that can exceed that target. Clients increasingly see the value in the BlackRock model, a single unified platform designed for clients unmatched in breadth, powered by BlackRock and totally built on trust. And it goes beyond clients simply wanting to do more with BlackRock. They are looking for a partner that innovates and helps them grow. The world's largest asset owners want deep strategic partnerships, increased customization and innovation, approaching that might include a creative co-investment opportunities and co-development of strategies. BlackRock's Decarbonization Partners, joint venture with Temasek, is one example of this type of relationship. In the second quarter, we announced that its inaugural fund had a final close above its fundraising target raising $1.4 billion. The first-time fund attracted over 30 institutional clients representing 18 countries. The diversity and debth of the investor base is a testament to our long-standing client relationships and strength of our team. Insurers represent some of our most long-standing relationships in clients and we are leveraging our insurance expertise and diversified global platform to deliver fixed-income technology and increasingly private market solutions. BlackRock manages nearly $700 billion in long-term AUM for insurance clients. And we are the industry leader in managing core fixed income for insurance companies general accounts. Insurance CIOs are expanding their mandate with BlackRock to include private markets and structured assets. Just a few weeks ago, we awarded our first large-scale general account allocation for a private structured credit mandate. We also had success with insurers and dedicated SMAs for infrastructure debt where we have differentiated capabilities. We have deep long-standing relationships across our insurance client channel with a dedicated insurance portfolio management team. We see significant opportunity to work more closely with our insurance clients as we leverage our GA business as a potential durable source of long-term capital for our private debt franchises. The industrial logic that informed our planned acquisition of GIP has only begun even clear in the last six months. There is a generational demand for capital and infrastructure, including the finance data centers for AI and for energy transition. Private capital will be critical in the meeting these infrastructure needs both standalone and through public private partnerships. Clients' reception to GIP has been overwhelmingly positive with strong reverse inquiry from clients excited to partner with a newly scaled infrastructure platform. We see particularly strong demand for opportunities in the AI, data centers and energy transition spaces. Through BlackRock's relationships with corporates and sovereigns, BlackRock is at the center of the investment opportunity being shaped by the demand for generative AI. AI cannot truly happen without investments in infrastructure. These technologies require a new generation of upgrade data centers, which will need enormous amounts of energy to power them. With the AI fueled need to build data centers, we see great potential to monetize the 4.3 gigawatts of power production capacity of generational assets currently owned by BlackRock's infrastructure funds. When we talk to leaders in industry and governments, they express their desire to build out data centers, AI, technology, at the same time to decarbonize. Our Diversified Infrastructure fund recently invested in Mainova WebHouse, a first-of-its-kind partnership, to invest in a hyperscale data center platform in Frankfurt, run entirely on renewable energy. And our planned acquisition of GIP will add a number of global data centers assets in our portfolio. We plan to be a leader in this space, leveraging our expertise to drive capital formation and unique deal flow to generate return for our clients. For decades now, BlackRock has helped investors benefit from the growth of the capital markets, supporting their path to financial security and long-term objectives like retirement. Early in the second quarter, we successfully launched LifePath Paycheck with a subset of committed clients. We expect additional commitment plan sponsors to fund over future quarters and we have a very strong late-stage pipeline. More than half the assets we manage are related to retirement. Our growth investments to enhance our capabilities and strategies like active target date and infrastructure underpin our commitment to improving retirement outcomes. BlackRock continues to create more access and connections between long-term investors and capital markets, both in the United States and throughout the world. Early this quarter, we announced an agreement with the Public Investment Fund, the PIF, to launch an investment management platform in Riyadh, which aims to accelerate the development of our local capital markets and enable foreign investment into the region. We expanded our Jio-BlackRock joint venture in India beyond asset management to brokerage and wealth management. And just last month, we joined a new coalition to mobilize infrastructure investments in the Indo-Pacific region alongside GIP and other global investors. In the US, we announced the new opportunity for BlackRock to help expand domestic capital markets by investing in the creation of the Texas Stock Exchange. The exchange aims to facilitate greater access and increase liquidity in US equity capital markets for investors. Our investment builds on a history of investing in similar market structure opportunities for the benefit of BlackRock clients. ETFs will continue to grow as a technology that provides simple efficient access to capital markets, making investments easier for clients of all sizes. Our investments over time are driving accelerated momentum across our ETF platform. Second quarter ETF flows of $83 billion were positive across our core equity, strategic and precision categories. ETF flows of $150 billion in the first half of 2024 represents a best start to the year in iShares' history and are more than double what they were in the first half of last year. BlackRock leads the ETF industry in flows. We are also facilitating market expansion. Our Bitcoin ETF reached nearly $20 billion in its first six months and is the third highest grossing exchange-traded product in the industry this year. Three of the five top asset gathering bond ETFs are iShares and our active ETFs are growing contributors with $12 billion of net inflows in 2024. We remain focused on innovating our product offerings, particularly with active ETFs, growing bond ETFs with extending distribution partnerships to make iShares the provider of choice across all wealth platforms. In June, we expanded access to our alpha-seeking expertise through the launch of active US equities and high-yield ETFs managed by some of our leading investors. And we are partnering with a number of international banks and brokerage platform to expand distribution and access to our products. Examples include our relationship with ETF savings plan providers and our recent selection as a premier partner to Envestnet. From winning our first client to serving millions of investors today, Aladdin has been the technological foundation for how we deliver our clients across our platform. Aladdin isn't just the key technology that power BlackRock, it also powers many of our clients. We see clients increasingly using the technology investments across the fintech and data ecosystems. We're partnering with clients who are increasingly looking for comprehensive technology solutions across their entire portfolio from risk analytics, investment management and to accounting capabilities. The need for integrated investment and risk technology as well as whole portfolio views across public and private markets is driving durable ACV growth. Years ago, we anticipated that clients would benefit when alternative investments were evaluated inside a portfolio-level risk management framework. As allocation to private markets increased, we knew the ability to seamlessly manage portfolios and risk across public and private asset classes on a single platform would be critical. BlackRock invested ahead of these clients' needs, acquiring eFront in 2019 and going on to integrate it with Aladdin to deliver a whole portfolio view. And our planned acquisition of Preqin will expand our capabilities beyond private markets, investment management and technology to data. We see a significant runway ahead as private market allocations from our clients will continue to grow alongside their need for an integrated enterprise-level investment technology, data and analytics. Much of BlackRock's success and our momentum today has come from anticipating and making calls and what our clients will need as they pursue long-term outcomes like retirement and financial security. We constantly innovate, we constantly evolve, we transform ourselves and we make sure we deliver for each and every one of our clients. We've spent decades building our global network of relationships of data and analytics, integrating technology and these are the key differentiations to deepening our relationship with clients and accessing unique investment opportunity and partnerships. With our planned acquisition of GIP and Preqin and core business strength, BlackRock's capability has never been stronger. We have the most comprehensive platform in the asset management industry integrating across public markets, private markets and our Aladdin technology, and we are creating a differentiating private markets approach. We're building what our clients need for success, a skilled private market platform encompassing investment, workflow through eFront and data and risk analytics through Preqin. By bringing together investments, tech, data across public and private markets, we have the opportunity to drive better portfolio outcomes for investors and open up a diversified higher multiple earning streams for our shareholders, you. We look forward to delivering strong performance for our clients along differentiated growth, which will be an opportunity for you, our shareholders. Operator, let's open it up for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from Alex Blostein of Goldman Sachs."
},
{
"speaker": "Laurence D. Fink",
"content": "Good morning, Alex."
},
{
"speaker": "Alex Blostein",
"content": "Hey, good morning, Larry. Hello, everybody. So, lots of optimism on the firm's trajectory for organic growth, and I heard you guys, obviously, echoing maybe some of the comments from last quarter around the strong pipeline and Martin's comments around premium organic growth. So, maybe help contextualize this a little bit more. What did the pipelines look like today? What kind of the timing of some of these conversions that you anticipate? What asset classes? And ultimately, what that means for the firm's organic base fee growth for the back half of '24? Thanks."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Alex. I'll start and I think Larry will add some color. But Q2 organic base fee growth, as I mentioned, was 3%. We had that typically seasonally slow start of the year in Q1. So, 3%, it's just about at our target for where we thought we'd be in May and June. We really see excellent momentum, and I think you got that in Larry's comments. But I'd say on the measures we look at for fee growth velocity sort of last three months, last six months, last 12 months, organic base fee growth, Alex, keeps grinding up by 1 percentage point; it's 1% to 2% and now 3%. And we really feel that markets are on this precipice of a reset. Rate cuts should normalize bond markets, they should normalize fixed-income allocations, they should fuel equities, they should really drive flows. We've been a really meaningful outperformer in these re-risking periods. If I look at sort of previous election cycles, rate reductions, BlackRock had huge upside capture. In '17, '18, '21, we were well above our through-the-cycle targets for organic growth in those periods. And I think when we look at growth, it's going to come from these strong structural growers, and those things grow even faster in supportive markets, ETFs, models, Aladdin, our expanding private markets business. We're closing in and growing our AUM by over $100 billion in private markets with our planned GIP acquisition, and we see that as a huge growth opportunity. So, we'd expect those engines to really capture additional growth that hits our targets, and even on the most modest growth assumptions, I think, for beta end markets to really drive significant differentiated durable earnings and multiple expansion. We look at this all the time as a team. We've achieved our premium organic base fee growth target of 5% on average over the last five years, and BlackRock has a lot of positive leverage to re-risking periods in the market that gives us a great deal of conviction about the path to 5% in the back half of '24 and also our longer-term ambition, I think, to be at 5% or better as we grow private markets and technology."
},
{
"speaker": "Laurence D. Fink",
"content": "Alex, let me just add a little more holistic texture. We have never had more dynamic conversations than we ever had now across the world, across products. I truly believe our positioning in iShares today has never been more robust. Our delivery now of active ETFs, our innovation in crypto, having more precision-type products when there is, I would say, more fragmentation going on in the world allows us to have more conversations with differentiated products for our clients. But the feedback now close -- over six months of feedback of our planned acquisition of GIP and the conversations we're having with some of the most sophisticated investors worldwide has never been more robust about how we could partner, how we could be trying to develop more things. And in my prepared remarks, I talked about the confluence of power and AI and data centers. And I believe this is going to be one of the world's biggest growth engines as we start trying to develop AI for everyone, AI not just for the big powerful organizations, but AI utilization for everybody, for every country in the world, and it's going to require just -- we're talking trillions of dollars of investments. And our conversations with the hyperscalers, our conversations with governments, our conversations with the chiller suppliers, the cogeneration suppliers, the opportunities we have in infrastructure is way beyond I've ever imagined even just seven months ago when we were contemplating the transaction and formalizing it. Our conversations with investors from the most sophisticated sovereign wealth funds to our conversations with the RIA channels, the need for data and analytics across the private sector is only going to be growing, and no firm right now has the position that we have with Aladdin, eFront and now with Preqin that we could assist more and more investors. So, we are taking a differentiated approach that obviously we have done that in the past. And I would just like to just say that, and I said in my prepared remarks, we do these things pretty boldly. When we bought eFront, everybody thought there was a big price and yet we've doubled ACV. Martin talked about Aperio where we crossed over $100 billion in AUM. I do believe -- we've talked about AI at BlackRock AI for Investments. One of the big opportunities I see is going to be systematic equities, where we've had now a 10-year track record of approximately 90% outperformance. And I do believe that we saw now close to about $5 billion of flows. I believe this is only going to be accelerating now. As more and more investors are looking at how can you use AI for investments, and we have one of the finest platforms utilizing AI, utilizing big data. So, I'm very excited about the high-growth potential we have in more and more high-fee products, but I'm just as excited about how we can provide better product across the board utilizing our ETF platform."
},
{
"speaker": "Operator",
"content": "Your next question comes from Craig Siegenthaler with Bank of America."
},
{
"speaker": "Laurence D. Fink",
"content": "Good morning, Craig."
},
{
"speaker": "Craig Siegenthaler",
"content": "Hey, good morning, Larry. So, our question is on the outlook for technology services revenue growth. With tech ACV growth at 10%, which is the low-end of your long-term target range, we want to see if you have visibility into the future trajectory given the timing of larger contract wins within your existing pipeline, in conversations with clients. And now that you have Preqin, how will that also impact the 10% to 15% target in 2025 after the deal closes?"
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Craig. I'll start and I know Larry will add. Technology, it's just the main engine for investment performance, right? It's the main engine to drive operating leverage. It's what great firms, I think, are using to have great client experiences that fuel growth. And we see a very consistent growth rate in how clients are investing in more technology. I can tell you as a CFO, if I could invest in tech spend, I would. Generally in the marketplace, there's just an acceleration in tech spend across the board. But I think importantly, clients are trying to retire this kind of spaghetti patchwork of legacy systems they have. They want to leverage fewer providers. They want to do deep integrations across the fintech and data ecosystems. They want to have a whole portfolio view across public and private markets. That's always been the thesis of the Aladdin platform. It's how we use it at BlackRock and with our external clients. It was what drove the integration of eFront and Aladdin. And now with Aladdin, eFront and Preqin, we think we have even more opportunities to benefit new clients and the pipeline is very strong. Tech services revenue was up 10% year-on-year, 5% sequentially. As we continue to get the big assignments and new sales from the prior years going live, we expect those revenue numbers to stay strong. Our ACV target, Craig, it's over the long-term. We've achieved it on average since we first started disclosing ACV in 2020. And we think we have a real opportunity to apply and drive indexing principles using Preqin, Aladdin, eFront together across tech data and investments. Preqin is expected to accelerate our planned technology services ACV within our target range. It's going to increase current ACV dollars by about 15%. So, we'll continue to target low- to mid-teens growth in tech services ACV, and we'd expect bringing together Aladdin, eFront and Preqin to be the way that we can get there over the next few years."
},
{
"speaker": "Laurence D. Fink",
"content": "Craig, but our line of sight, we are in conversations right now with probably the broadest and largest potential Aladdin assignments ever had. So, the conversations we're having are with broad deep conversations than we've ever had and much of it has to do -- the serious big giant conversation we're having right now are based on the ability that Aladdin can provide both public and private data analytics. And two, we deliver. There are many examples where people made big, broad promises, and there were years, I want to underline years, delayed in the implementation. We have a deep history of delivering on time. That doesn't mean it doesn't take long time to do it, but we are -- we have a huge reputation because of our expertise in delivering the technology platform on time. These are very big and complex, and we do it very well. And now with the combination of Preqin alongside eFront and Aladdin, we have probably the biggest opportunity we've had in 10 years or more in delivery even a more differentiated technology and analytical platform. And by doing so, it could really then expand our entire platform in towards the benchmarking and indexing. As you know, that's been a province of other organizations. Historically, asset managers were precluded the SEC to be into this business. This is why we were never in this business. Asset management firms can now be in it, as you know, and we create some type of customized index, but we look at this as a unique opportunity now for BlackRock. With our position, with our role, we are going to do this with the same, I would say, industrial fortitude as we did in the early years when we were just an asset manager needing risk analytics, so we did it ourselves and then we are so proud of what we did ourselves, we offered it in the '90s to our clients. We are going to do this in the private markets. And we're going to -- this is going to take time, but I think we have a real ability to provide a very differentiated platform in this and this is something of sheer excitement. And if we succeed, this will add a whole new revenue line on BlackRock's revenue side. Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "Hey, good morning, Larry."
},
{
"speaker": "Laurence D. Fink",
"content": "Hi, Mike."
},
{
"speaker": "Michael Cyprys",
"content": "Hey. Just a question on the alts business and GIP with the deal expected to close in the third quarter. Can you just talk about your expectations for flows there in the infrastructure space? What strategies are you in the market raising or could be in the market raising over the next 12 months? And maybe talk about some of the steps that you may be able to take to bring some new products to the marketplace, including extending into the private wealth channel?"
},
{
"speaker": "Laurence D. Fink",
"content": "Great question. Thank you. Well, obviously, we are doing whatever we legally can in terms of making sure that we are making sure that there are two operating entities until we get legal approvals and we close. But that being said, BlackRock is having incredible conversations. GIP is having incredible conversations. We have business integration meetings, which were allowed to do. And the enthusiasm between our team and their teams have -- are way beyond our imagination. This feels so fantastic right now between our organizations and the opportunity we have. As we said, we expect this to be announced in the third quarter. Hopefully, later in the third quarter, we have other announcements of things that we could be talking about, but I'm not really permitted to talk about what are the deals, what are the things we're doing. What I need to be just showing you is our incredible enthusiasm that what we have and the opportunities we have and I do believe we will have post-closing some amazing opportunities and then therefore some amazing announcements."
},
{
"speaker": "Operator",
"content": "Your next question comes from Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Okay. Thanks very much for taking the question."
},
{
"speaker": "Laurence D. Fink",
"content": "Good morning, Bill."
},
{
"speaker": "Bill Katz",
"content": "Good morning, everybody. Thank you for opening comments. Just coming back to the opportunity for Preqin and you sort of think through the evolution of the private markets, how do you sort of see the product evolution? And is there a pathway here for ETFs given the underlying illiquid nature of the investments? Thank you."
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Bill. So, we're extremely excited about this Preqin transaction. We think it really unlocks a whole new segment of growth for our clients, and we think it unlocks a whole new data services segment for BlackRock. And we see really the opportunity to grow Preqin by connecting it with our complementary Aladdin and eFront capabilities, as well as obviously we have a lot of client relationships and significant distribution reach. We'll continue to offer Preqin Pro in the data products as standalones. I think there's really three things that we're focused on here in driving a successful Preqin transaction. The first is simply driving more sales, building out comprehensive fund deal level databases and really integrating data and workflow into a unified platform that better serves clients. The second is, by innovating and launching new data products. I think it's fairly remarkable when you think about the public markets, you think about this symbiotic relationship that risk models and indexes and data have done to create public market indexing, benchmarking, asset allocation, all of those opportunities are ahead of us in the private markets by bringing together risk models, benchmarks and investable indices. We think this opportunity to index the private markets is really one of the most attractive that we've had in the history of BlackRock. And last, we have the ability to drive a lot of scale. We have data factories. Preqin has data factories, not the primary rationale for the transaction, but we really think that we can drive profitable growth, increased scale and efficiency by making this a seamless operating organization. We've had a really good reaction to the transaction from GPs, from LPs, from service providers, all of which who are strong enthusiastic Preqin clients. They're excited about the opportunity to bring together the eFront and Preqin data sets. And so, we think there's a lot of great opportunities here to continue to grow and we're looking forward to closing the Preqin transaction before the end of the year."
},
{
"speaker": "Laurence D. Fink",
"content": "I would just add one more point to that. The inquiries that we've had from big vendors, from exchanges, from different organizations about how can we take what Aladdin, Preqin and eFront has, how can we make that -- how can we -- and how are we going to be able to distribute that and utilize that is a great sign that the ecosystem sees the opportunity that we have. And I don't -- I think it was very clear that because of -- we have eFront and Aladdin, we were just in a very unique position to take this and add it to it. And I think this is one of the real strengths of BlackRock. And now we got to -- obviously, we got to close it and we got to execute upon it, but I'm -- as I said earlier, this is something that we can really be transformational and really change the whole foundation of public and private markets. And if we do what we did for public markets with Aladdin and data, what we did for public markets with ETFs and iShares, if we do that and transform more and more private products into more retail products using our data and analytics, we'll transform the capital markets and that's something that BlackRock has been proud of how we've moved the capital markets and this is just another step for us how we could be additive to the global capital markets."
},
{
"speaker": "Operator",
"content": "Your next question comes from Dan Fannon with Jefferies."
},
{
"speaker": "Laurence D. Fink",
"content": "Good morning, Dan."
},
{
"speaker": "Dan Fannon",
"content": "Thanks. Good morning. Wanted to follow-up, you talked a lot -- about a lot of momentum across the business. Fixed income has been a topic for some time, flows have been a bit more mixed here year-to-date. I guess in the conversations you're having, do you still see that as one of the big areas of incremental growth as the interest rate environment evolves?"
},
{
"speaker": "Laurence D. Fink",
"content": "Well, I think, as I said in my prepared remarks, sitting in 5% yield makes a lot of sense unless you put in the -- if your liabilities are long dated, you lost money actually because with equity markets up 24% and 17% this year alone. But that being said, we are beginning to see other clients starting to re-risk and they're re-risking other. And let's be clear, if you look at iShares fixed-income flows, the market was basically flat. If you look at the -- so all the AUM growth in iShares fixed income was really re-risking. And what -- I think this is a good statement saying, one, we're going to see more and more ownership in fixed income through ETFs. That's evolution that's going on. Obviously, you're seeing growth in private markets and private credit that continues on. We are widely bullish as more and more clients are going to be using infrastructure debt. And so, I think you're going to start seeing as all this plays out, like we've seen in equities. We used to talk about equities more of a barbelling effect, I think we're starting to see that here in the bond market where more and more people are in their core fixed-income portfolios, they may continue to just use ETFs as a foundation. And our growth in bond ETFs this year in a flat market is a great example that more and more people are getting fixed-income exposure as a core element they are using ETS more and more. And if they are starting to try to get more beta -- excuse me, more alpha in their fixed income side, excuse me, they're going to do it and they're going to do that in more the illiquid space of private credit, they're going to do that in mortgage-backed securities and they're going to do that in infrastructure debt. So, I believe we're very well positioned for that moment when people are recalibrating out of cash. And it's going to be heavily into fixed income, bond funds, it's going to be also more of the alternative ETFs -- alternative income-oriented products."
},
{
"speaker": "Operator",
"content": "Your next question comes from Ken Worthington with JPMorgan."
},
{
"speaker": "Laurence D. Fink",
"content": "Good morning, Ken."
},
{
"speaker": "Ken Worthington",
"content": "Hi. Good morning. Thanks for taking the question. Cash management had a strong quarter. To what extent are you seeing or still seeing different and additional institutional clients migrating out of banks to money market funds to get higher yield? And where would you say the global markets are in terms of this transition to higher-yielding forms of cash management? And then to the last question, you called out re-risking a couple of times. Are you seeing re-risking coming out of cash, or is re-risking really a migration within other asset classes either extending duration or going out the risk curve in equities? What are you sort of seeing in terms of that re-risking?"
},
{
"speaker": "Martin S. Small",
"content": "Thanks, Ken. It's Martin. So, cash flows, $30 billion, as I mentioned, largely driven by government and international prime funds. We had that dynamic at the end of March and the Good Friday dynamic where clients have come out and then we saw a significant kind of return and an increase in balances in early April. We had multiple large new client mandates. I flagged that the cash platform today is about $780 billion. It's grown more than 50% over the last five years. And investors, they are earning a real return in cash. We expect that investors will re-risk. But I'd say a couple of dynamics we've definitely seen in the platform. Post Silicon Valley Bank, we saw through sort of Cachematrix, we saw in our institutional business, I think clients just being more mindful, tactical and kind of operationally flexible in how they manage cash. We think that largely for an institutional manager like BlackRock that's been a good trend of being able to put together technology and customized liquidity accounts in a way that we can grow. And then, ultimately, we have seen this business grow, but I'd also flag that bond ETFs have been a real surrogate, I think for kind of how clients are managing cash. And as Larry mentioned, over the last year we've seen $100 billion basically of organic growth in bond ETFs, which I think have been used as cash or cash proxies along the way as clients manage their liquidity dynamically across money funds, separate accounts and traded instruments like ETFs."
},
{
"speaker": "Laurence D. Fink",
"content": "But let me add a little more towards the asset allocation into more re-risking. I think it's a mixed bag, Ken, as we said in our prepared remarks. We're seeing a lot of pension funds who are saying, \"I'm at my liability. My assets reached my liability level. I don't need to own as much equities.\" That's going to be persistent if we continue to have rising equity markets. And on top of that, if -- with rates staying higher longer, that gave those pension funds the liability rate that's set, but obviously if interest rates go back down, the liabilities will go out a little bit. And so, we're seeing some clients actually derisking because they can, but where are they derisking? A lot of clients are not just derisking going from out of equities into cash, they're going into equities into other fixed-income instruments. This is where I believe you're going to see more and more investments into infrastructure where you have less volatility in the investments, higher probable returns, high fixed coupon. So, we're seeing clients around the world recalibrate their risk. There are some clients who were sitting in way excess -- too much cash, and they're obviously paying for that, and we'll see how they re-risk. But overall, I think probably if I had to say the headlines for the first six months, the clients that are overweighted in illiquid strategies like private equity where they had liquidity issues, you saw them keeping more cash balances. If and when the private equity markets unlock itself and there's a little more distribution, maybe you could see some of that cash going out and re-risking. So, you're seeing a whole mixed bag. But I do believe the macro trends towards more bond allocation because of the extensive equity rally over the last 10 years, deeper allocation towards private, especially private credit and infrastructure is going to continue. And I do believe the tools of using ETFs as a core component of portfolios is going to become a larger and larger component of how investors invest. They're going to use more core fixed-income ETFs, more equity ETFs and then barbell against using more -- I would say, more diversified, maybe more illiquid strategies across the board. And I do believe BlackRock is as well positioned for that as any firm in the world."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, we have reached the allotted time for questions. Mr. Fink, do you have any closing remarks?"
},
{
"speaker": "Laurence D. Fink",
"content": "I do, operator. Thank you. And thank you for all joining us this morning and for your continued interest in BlackRock. Our second quarter results are possible because of our deep partnerships with our clients around the world and our One BlackRock approach in everything we do. We are well-positioned to execute on our landmark mandates across our platform and we're closing in on our planned acquisitions of GIP and Preqin. We see unbelievable growth opportunities for our clients and our shareholders for the rest of 2024 and beyond. Everyone, please stay safe, stay cool, have a lovely summer as best you can. Enjoy our political conversations over the next few weeks. Be active, and have a great quarter."
},
{
"speaker": "Operator",
"content": "This concludes today's teleconference. You may now disconnect."
}
] |
blk | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Katie, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the BlackRock Incorporated First Quarter 2024 Earnings Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Martin S. Small; President, Robert S. Kapito; and General Counsel, Christopher J. Meade. All lines have been made on mute to prevent any background noise. [Operator Instructions] Mr. Meade, you may begin your conference."
},
{
"speaker": "Chris Meade",
"content": "Thank you. Good morning, everyone. I'm Chris Meade, the General Counsel of BlackRock. Before we begin, I'd like to remind you that during the course of this call, we may make a number of forward-looking statements. We call your attention to the fact that BlackRock's actual results may, of course, differ from these statements. As you know, BlackRock has filed reports with the SEC, which lists some of the factors that may cause the results of BlackRock to differ materially from what we say today. BlackRock assumes no duty and does not undertake to update any forward-looking statements. With that, I'll turn it over to Martin."
},
{
"speaker": "Martin Small",
"content": "Thanks, Chris, and good morning, everyone. It's my pleasure to present results for the first quarter of 2024. Before I turn it over to Larry, I'll review our financial performance and business results. Our earnings release discloses both GAAP and as adjusted financial results, I'll be focusing primarily on our as adjusted results. BlackRock's first quarter results reflect sustained momentum across our entire platform. We ended the quarter with record AUM of nearly $10.5 trillion and one of the strongest opportunity sets ahead across multiple growth engines, including technology, outsource solutions and private markets. Momentum is accelerating and we have line of sight into a breadth of significant mandates in investment management and technology, spanning client channels and geographies. Teams across BlackRock are energized and organized to execute on these opportunities and deliver BlackRock's platform to clients through world-class client service. We've built BlackRock to be a structural grower with industry leadership in secular growth areas like ETFs, private markets, model portfolios and technology. With supportive markets and more optimistic sentiment from clients, we're confident in our ability to both grow assets on behalf of clients and drive profitable growth for our shareholders. First quarter long-term net inflows of $76 billion continue to lead the industry, driving positive organic base fee growth alongside double-digit growth year-over-year in revenue and earnings, as well as 180 basis points of margin expansion. Excluding low fee institutional index equity flows, we saw a $100 billion of long-term net inflows in the quarter. As equity markets powered to record highs in the first quarter, investors who were waiting in cash missed out on significant returns across broader markets. With long-term investing time in the markets is often more important than market timing. Although cash remains an attractive safe haven with the prospect of fewer rate cuts for 2024, the nearly 30% increase in equities over the last year continues to propel clients towards re-risking into stocks and bonds. Clients choose BlackRock for performance. They continue to consolidate more of their portfolios with us, which is driving our growth premium. With more clarity on interest rates and a supportive market backdrop, the assets we manage on behalf of our clients, our units of trust, ended the quarter up $1.4 trillion from a year ago, an increase of 15%. Organic asset and basic fee growth, again, accelerated into the end of the quarter and we see broad base momentum growing across client channels and regions. In the first quarter, BlackRock generated long-term net inflows of $76 billion partially offset by seasonal outflows from institutional money market funds. Total annualized organic base fee growth of 1% reflected seasonally softer flows earlier in the quarter before coming back to target in March. First quarter revenue of $4.7 billion increased 11% year-over-year, driven by the impact of market appreciation over the last 12 months on average AUM and higher performance fees and technology services revenue. Operating income of $1.8 billion was up 17% and earnings per share of $9.81 was 24% higher versus a year ago, also reflecting higher non-operating income. Non-operating results for the quarter included $90 million of net investment gains, driven primarily by mark-to-market non-cash gains on our unhedged sheet capital investments and minority investment [in invest debt] (ph). Our as adjusted tax rate for the first quarter was approximately 23% and included discrete tax benefits related to stock-based compensation awards that vest in the first quarter of each year. We continue to estimate that 25% is a reasonable projected tax run rate for the remainder of 2024, though the actual effective tax rate may differ because of non-recurring or discrete items or potential changes in tax legislation. First quarter base fee in securities lending revenue of $3.8 billion was up 8% year-over-year and up 5% sequentially driven by the positive impact of market beta on average AUM and positive organic base fee growth. On an equivalent day count basis, our annualized effective fee rate was 3/10 of a basis point lower compared to the fourth quarter. This was mainly due to the relative outperformance of lower fee U.S. equity markets, client preferences for lower fee U.S. exposures and lower securities lending revenue. Performance fees of $204 million increased from a year ago, primarily reflecting higher revenue from alternatives. Quarterly technology services revenue was up 11% compared to a year ago, reflecting sustained demand for our Aladdin technology offerings. Annual contract value or ACV increased 9% year-over-year. Beginning in the first quarter of 2024, earnings recognized from minority investments accounted for under equity method will be presented as part of our non-operating results. Advisory and other revenue increased from a year ago, primarily reflecting this change. In addition, as many of you know, we updated the presentation of expense line items by including a new sales asset and account income statement caption. This category includes distribution and servicing costs, direct fund expense and sub-advisory and other sales asset and account-based expense. Sub-advisory and other expense, which are variable non-compensation expenses associated with asset and revenue growth was previously reported within general and administration expense. We believe this change provides investors a clearer view of both BlackRock's variable non-compensation expense and G&A, which represents more fixed costs. It represents how we'll execute on our financial rubric of aligning investment spend with our highest conviction growth areas, variabilizing more of our expense base and generating fixed cost scale. Total expense increased 8% year-over-year, reflecting higher compensation, G&A and sales asset and account expense. Employee compensation and benefit expense was up 11%, primarily reflecting higher incentive compensation as a result of higher operating income and performance fees. G&A expense increased 6% due to the timing of technology investment spend in the prior year. Sequentially, G&A expense decreased 12%, reflecting timing of technology investment spend and seasonally higher marketing and promotional expense in the fourth quarter. While one quarter's results can be impacted by timing of spend, we expect technology to be one of our primary areas of investment within G&A. Sales asset and account expense increased 5% compared to a year ago, primarily driven by higher direct fund expense. Direct fund expense was up 7% year-over-year, mainly due to higher average index AUM. Sequentially, direct fund expense increased due to higher average index AUM in the current quarter and higher rebates that seasonally occurred in the fourth quarter. Our first quarter as adjusted operating margin of 42.2% was up 180 basis points from a year ago. As markets improve, we remain committed to driving operating leverage and profitable growth. BlackRock's industry leading organic growth is a direct result of the disciplined investments we've made consistently through market cycles. Looking forward, we'll continue to prioritize investments with differentiated organic growth potential or that will expand operating leverage through enhanced scale. In line with our guidance in January and excluding the impact of global infrastructure partners and related transaction costs, at present, we would expect our headcount to be broadly flat in 2024 and we would also expect a low to mid-single-digits percentage increase in 2024 core G&A expense. Our capital management strategy remains consistent. We invest first, either to scale strategic growth initiatives or drive operational efficiency and then return excess cash to our shareholders through a combination of dividends and share repurchases. At times, we may make inorganic investments, where we see an opportunity to accelerate organic growth and support our strategic initiatives. Last month, we announced our agreement to acquire the remaining equity interest in SpiderRock Advisors, a leading provider of customized option overlay strategies in the U.S. wealth market. This transaction expands on BlackRock's minority investment in SpiderRock Advisors made in 2021 and builds on BlackRock's strong growth in personalized separately managed accounts via Aperio and ETF model portfolios. At present, we expect the transaction to close in the second quarter of this year, subject to customary closing conditions. In March, we issued $3 billion of debt to fund a portion of the cash consideration for our planned acquisition of GIP. Our offering consisted of three tranches of senior unsecured notes across 5, 10 and 30 year maturities. The offering was well received by fixed income investors, especially our inaugural 30 year bond. We currently have invested the proceeds of the offering at substantially the same rate as the cost of borrowing, effectively eliminating incremental cost of carrying additional debt prior to the close of the GIP transaction. We continue to target the third quarter of 2024 for the closing of the GIP transaction, which remains subject to regulatory approvals and other customary closing conditions. We repurchase $375 million worth of common shares in the first quarter. At present, based on our capital spending plans for the year and subject to market conditions, we still anticipate repurchasing at least $375 million of shares per quarter for the balance of the year consistent with our January guidance. More positive sentiment from clients and markets persisted into the first quarter. Clients increasingly turned to BlackRock to reposition and redeploy across their portfolios. First quarter long-term net inflows of $76 billion were positive across active and index strategies as well as each of our client and product types. ETF net inflows of $67 billion were led by core equity and fixed income ETFs with net inflows of $37 billion and $18 billion respectively. These inflows were partially offset by seasonal tax trading related outflows from our U.S. style box exposure and precision ETFs. As you will hear from Larry, our Bitcoin IBIT saw surging demand after launching in January, gathering $14 billion of net inflows in the quarter. This is just the latest example of BlackRock’s innovating to provide better access and transparency to a wider range of investment exposures. Retail net inflows of $7 billion were led by continued growth in Aperio as well as renewed demand for active fixed income. Financial advisors are increasingly looking to customize whole portfolios at scale, driving growth across our SMA and managed model platforms. Our partnership with in Envestnet is one channel powering flows through model portfolios. We saw our best growth sales month ever on the platform and year-to-date organic asset and revenue growth has more than doubled compared to this time last year. Sales on the platform aren't just accelerating, they are diversifying. We similarly saw record growth flows and custom models and record AUM and our global allocation models both of which have larger active components. Within SMAs, our previously mentioned acquisition of SpiderRock Advisors will further enhance our product offerings and provide even greater personalization across our wealth segments. Institutional active net inflows of $15 billion were driven by our LifePath target date franchise and outsourcing mandates. We see significant momentum across our whole portfolio capabilities. Our pipeline remains strong as more and more clients turn to BlackRock for outsourcing outflows of $13 billion were concentrated in low fee index equities, as several large clients rebalanced their portfolios amid significant equity market appreciation in the last six months. Our private markets franchise saw $1 billion of net inflows continued demand for our liquid offerings was offset by alpha generation for our clients, reflected in over $3 billion of fund monetization and LP distributions or change in fee basis, primarily for more seasoned private equity solutions programs. Finally, BlackRock's cash management platform saw $19 billion of net outflows in the first quarter in line with institutional money market industry trends. Our cash business can experience seasonal rotations in the first quarter as many institutional clients withdraw these liquid assets for operational purposes, including tax and bonus payments. Cash management flows were impacted by approximately $14 billion of net redemptions during the last week of March ahead of the Good Friday holiday. Outflows were driven by clients redeeming balances to have cash on hand during a time when many businesses are open, but the financial markets are closed. This phenomenon is not uncommon or unique to BlackRock. Balance has largely returned with approximately $20 billion of money market net inflows in the first week of April. BlackRock's differentiated business model has enabled us to continue to grow with our clients driving industry leading organic growth and margins. Looking ahead as markets trend to be more supportive and clients re-risk, we see significant opportunity to expand our market share and consolidate our position with clients. We've set ourselves up to be a structural grower with the diversified platform that we've built. Enthusiasm is growing, momentum's building across the platform. All of us at BlackRock are excited about our future and the growing opportunities for BlackRock, for our clients, for our employees and, of course, for our shareholders. With that, I'll turn it over to Larry."
},
{
"speaker": "Laurence Fink",
"content": "Thank you, Martin. Good morning, everyone and thank you for joining the call. BlackRock is partnering with clients to navigate structural and secular changes in business models, technology, monetary and fiscal policies, always staying focused on each and every client goal. Through this connectivity, we are having richer conversations with clients than ever before about their whole portfolio and in many cases deepening our relationships with them. This is driving accelerating momentum with a strong pipeline that has some of the best breadth of opportunities across all our client channels and regions that we've ever seen. BlackRock's integrated investment technology advisory platform and durable performance are resonating. In my conversations with clients around the world, I'm hearing about how they want to put their money to work. But they want to do it differently than they did in the past. They want their portfolios to be more holistically blending public and private markets active in an index. They want their portfolios to be nimble, customized, text-enabled. They want to work with fewer providers or maybe just with one provider. BlackRock is the only asset manager that can partner in this way having the most diverse, integrated investment and technology platform in the industry. Clients around the world are choosing to do more with BlackRock and this is resonating in our results. But I'm actually more excited about the building momentum we're seeing across our entire platform. BlackRock's AUM ended the first quarter at a new record of nearly $10.5 trillion, up $1.4 trillion or 15% over the last 12 months. Also, at that time, BlackRock has entrusted BlackRock with than $236 billion of net new assets. BlackRock generated positive net flows across active and index and across all client types. And we grew our technology service revenues and ACV as clients leverage Aladdin to support investments, processes and in their entire platform. We've had a number of real large marquee wins in Aladdin and are working on a number of significant new opportunities. Momentum remains strong as we grow with new and existing clients. We continue to deliver sustained asset and technology services growth at scale. BlackRock's operating income was up 17% year-over-year and we increased our margin by 180 basis points. Earnings per share were up 24%. Activity is notably accelerating. As Martin said, we generated $76 billion of long-term net flows in the first quarter, which represents nearly 40% of last year's long-term flows in just the first three months of this year. And long-term net inflows across retail and ETFs and institutional active was actually $100 billion, which excludes the episodic institutional equity activity Martin mentioned. Some of these are public, some aren't, but over the last few months, we've been chosen for a breadth of mandate from both wealth and institutional clients across regions that will fund over future quarters and we're in active conversations on a number of unique broad-based opportunities, including several large mandates for Aladdin. There is still a record amount of cash on the sidelines and money market fund balances are now approaching $9 trillion. I think this stems from fear and uncertainty, but it's hard to achieve retirement or long-dated objectives by holding cash. Clients worldwide are coming to BlackRock for advice on where and how to deploy their capital and in many ways how to help them reduce that fear and putting that money to work. Being a growth company requires continued innovation, lots of investments and intense client focus. BlackRock has invested ahead of these themes, we believe will define the next decade of asset management. I see the greatest opportunities I've ever seen for BlackRock for our clients and for our shareholders and I'm very optimistic about the momentum into the rest of 2024 and beyond. The uncertain backdrop does not mean a lack of opportunities. Instead, we see great opportunities for investors across a number of structural trends with near-term catalysts. These include rapid advancements in technology and AI, the rewiring of globalization, accelerated economic growth in certain emerging markets and an unprecedented need for new infrastructure. BlackRock is connecting with clients to these opportunities and providing them the confidence to continually investing in the long run. In a world where clients are looking for more certainty, the higher coupon, longer duration returns of infrastructure private markets are increasingly becoming more attractive. Demand for all forms of infrastructure is surging around the world from telecom networks to power generation to transport hubs for data centers and new ways of securing energy. Over the last 12 months, BlackRock's infrastructure platform has delivered 19% organic asset growth. BlackRock's infrastructure franchise and our private markets business more broadly benefited from the firm's global footprint, our deep network of clients and distribution relationships and access to high-quality deal flow. As we spoke in January, we believe the planned combination of BlackRock's infrastructure platform with GIP will provide clients with access to market-leading investments and operating expertise across infrastructure private markets. We have a deep conviction that this planned combination will be another transformational moment for BlackRock. It will be another example in our long-term history of staying ahead of client needs, positioning ourselves against accelerated macro trends. I believe this structured private markets are approaching the upward trajectory of their J curve just as ETF did when we announced our acquisition of BGI and iShares nearly 15 years ago. We always viewed ETF as a technology that facilitated investing. Since our acquisition of iShares, BlackRock has led in expanding the market of ETFs by making them more accessible by delivering new asset classes like bonds, investment strategies like actives. As a result of that success, the ETFs evolved beyond what started as an indexing concept. It is recognized as an efficient structure for a range of all investment solutions. First quarter ETF net inflows of $67 billion reflected sustained demand across our client categories, led by core equity and bond ETFs. ETF flows demonstrated accelerating activity with March accounting for more than half of the quarterly net inflows and our flows in the month were 80% higher than the next largest issuer. We continue to innovate across our ETF platform to give our clients better access to the most diverse range of exposures in the industry. Our Bitcoin fund, which was launched in January was the fastest growing ETF in history and already has nearly $20 billion in AUM. Our active ETF drove $9 billion of net inflows in the first quarter led by our equity factor rotation and flexible income ETFs. These products offer alpha generation with some of our leading investors at BlackRock in a more efficient, more transparent ETF wrapper. Across BlackRock, we continue to scale our product offerings to democratize access to new strategies, increase transparency and drive cost efficiency. To that end, last month, we announced the launch of our first tokenize fund as well as our minority investment in Securitize, a blockchain-based tokenization platform. This builds on our existing digital asset strategy and we'll continue to innovate in new products and wrappers all with the aim of providing greater access and customization to each and every of our clients. We continue to see demand for customization with our own wealth business as financial advisers and their clients they serve increasingly turn to SMAs to personalize their portfolios. We acquired Aperio three years ago in anticipation of this trend and organic growth in that business has been over 20% since our acquisition. To further booster our SMA capabilities, we announced our planned acquisition of the remaining equity interest of SpiderRock, as Martin discussed. Among wealth clients, we are also seeking the renewed demand for our high-performing active fixed income strategies with particularly strength in high-yield and unconstrained bond funds. In the post-QE market, we see more opportunity ahead for active management with greater potential for selective risk taking to generate superior returns. Quarterly active net inflows of $15 billion reflects strength in systematic equity and fundamental fixed income, including the funding of several institutional outsourcing mandates. Across our active franchise, BlackRock has delivered durable investment performance with 82%, 90% and 93% of our fundamental equity, systematic equity and taxable fixed income AUM above benchmarks or peer medium for the last five years. Our active investment insights, our strong investment performance, our integrated Aladdin technology differentiates BlackRock and ultimately drives better outcomes for our clients. We first built Aladdin as a risk management enabler, empowering investors to better understand their portfolios through technology. Today, Aladdin is much more than that. Our clients are leveraging Aladdin as a whole enterprise operating system, connecting multiple asset classes, data, technology partners and a single platform. Aladdin's integrated offering continues to resonate with the majority of our sales this quarter, spanning multiple Aladdin products. We are in the late-stage conversation with several large potential Aladdin clients and we look forward to executing on more opportunities ahead to be bringing the benefits of Aladdin to new clients and by expanding relationships with our existing clients. From the early days of developing Aladdin to now managing nearly $10.5 trillion across our platform, our ambition has always been to help investors benefit from the growth of the capital markets and achieve financial futures that they seek. More than half of the assets we manage are related to retirement, making this an outcome central to many of our client conversations. BlackRock has been at the forefront of innovation and advocacy for retirement solutions for years. In fact, we pioneered the first target date fund called LifePath back in 1993, when we introduced the concept. It was a revolutionary, eliminating some of the guesswork for retirement savings by automatically adjusting their investment mix over the time frame. Fast forward 30 years, Target Date funds have become the most common default investment option in defined contribution plans in the United States, where we're entrusted to manage the retirement assets of 35 million Americans. We continue to evolve LifePath to help deliver the retirement outcome participants need. That has meant introducing LifePath options in new countries and in new wrappers such as LifePath, Target Date ETFs we launched last year. Our LifePath Target Date franchise now has nearly $470 billion in assets and has risen over $115 billion in assets just over the last five years. In addition to helping people save for retirement, we also work to expand the LifePath solution to help people spend throughout their increasingly longer retirement. Society focuses a tremendous amount on helping people live longer and healthier lives, but spend just a fraction of that time and effort on helping them afford those extra wonderful years. The shift from pension to defined contribution models have put the large ask the large burden on individual savers. They have to first build up the retirement estate, which in and itself is a formidable challenge. Then even as they have this sizable savings at retirement, there's not much guidance about how to spend and or not -- and how not to overspend these savings. We've been working for years to address this de-accumulation challenge and we believe this will help increase hope in America. In 2020, we announced the LifePath Paycheck, the next generation of Target Date solutions. It will include an option to purchase a lifetime income stream from insurers selected by BlackRock and is expected to go live towards the end of the month. We are partnering on implementing LifePath Paycheck right now with 14 planned sponsors, representing over $25 billion in Target Date AUM and now have 0.5 million participants. We'll pair the flexibility of a 401(k) investment with a potential for a predictable paycheck life income stream similar to a pension. I believe it will be in one day, the most used investment strategy in defined contribution plans. This pioneering structure can help address global gaps in funding retirement security, improve the quality of life and retirement for millions of Americans and bring back hope for those who were retiring. It's been four years since the start of the pandemic and the subsequent geopolitical upheavals. Leaders of countries, leaders of companies need to create hope for the future for all of their stakeholders. That's certainly what we're doing at BlackRock. I've spoken before about the fear we see today, some is stoked by increasingly political polarization in the world. Our industry and BlackRock have been a subject of political dialogue mostly in the United States. We recognize some of this with being the industry leader. We have done a better job now of telling our story so that people can make decisions based on facts, not on lies and not on misinformation or politicization by others. Unfortunately, there are still others out there who put short-term politics, who continuously lie about these issues. They are putting those issues above the long-term fiduciary responsibilities. As a fiduciary, politics should never outweigh performance. I do believe that with the vast majority of our clients, our long-term fiduciary approach and performance are resonating. We heard it in our dialogue with them, and we see it in our flows and I know all of you as shareholders see it in our flows. Over the last past five years, clients have entrusted BlackRock with an aggregate of $1.9 trillion of total net inflows, $1 trillion over the last three years and nearly $300 billion last year. It has been in the United States where client led inflows in every one of these areas. It is true also in the first quarter of this year. This is in all is in the environment where the industry has experienced flat or negative flows, BlackRock saw inflows. Our sustained growth, our accelerating momentum are made possible by the trust of our clients and shareholders and the dedication of all the BlackRock people. Across our firm, we're delivering BlackRock to meet all our clients' individual needs, we're helping each and every client unlock their new opportunities and the power of BlackRock's integrated platform has enabled us to drive better outcomes for each and every client and providing them a differentiated growth for them, which then entails providing differentiating growth for you, our shareholders. I believe at this time, our momentum has never been stronger. The opportunity we have in front of us has never been stronger. And I look forward at BlackRock to be delivering on a significant broad base of opportunities across the world, across our platform, across all of our products and delivering the responsible fiduciary responsibilities that we provide to each and every client. Operator, let's open it up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll go first to Craig Siegenthaler with Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "So my question is on your commentary around building momentum and line of sight into significant fundings, so if we exclude fee rate issues like divergent beta, when do you think BlackRock can get back to 5% base fee organic growth? And with the law of large numbers as a factor, what is your confidence that this objective is still achievable at your current $10 trillion AUM size?"
},
{
"speaker": "Laurence Fink",
"content": "Martin?"
},
{
"speaker": "MartinSmall",
"content": "It's Martin. Listen, I'd start by like Q1 net flows were solid at $76 billion. And on a more granular look, we just see durable growth in that flows mix. We had about $100 billion across ETFs, retail, institutional active, institutional fixed income. Of course, we saw some of these $19 billion redemptions from cash with the Good Friday quarter-end dynamic and the $26 billion rebalanced away in institutional index equities. You know those institutional index equities happen from time to time. They're not meaningful revenue impacts or fee rate detractors, but they weigh on kind of the long-term flow totals. When we look at this core momentum on flows, excluding the episodic index redemptions, Q1 flows were $100 billion. It's a healthy trajectory. It's an affirmation for us that we're focused on the right things to grow with clients. And on base fees, the management team here, we really feel like we've turned a corner. Over the last two quarters, we see really solid trends in organic fee growth. They're really some of the best since the end of 2021. We saw excellent momentum to finish the fourth quarter, which we talked about on the last call. We closed out in November and December higher than target. And this quarter, March new base fees annualized at target after we had a slower start. So over the last six months, we see organic base fee growth ticking up and trending more halfway or halfway plus to our long-term targets. It's not a straight line, but we're moving to target. And I say this because we see key positive trends in this sort of critical base fee growers for us. Retail posted $7 billion of flows in that 40 basis point to 50 basis point bucket. Money is going back to work, redemption rates are moderating. We see really excellent momentum in active overall with $15 billion of flows and good velocity in institutional and retail active fixed income, in particular, at $9 billion. And I think what Larry is getting at, we've been selected for a breadth of mandates across investment management and technology that we see supporting 5% organic growth and will fund over future quarters. Our planned acquisition of GIP will help us build and bump from there. So we look forward to closing that transaction, executing on these mandates and keeping you guys posted on our progress."
},
{
"speaker": "Laurence Fink",
"content": "I would just add, the breadth of conversations we're having with clients worldwide. Rob Kapito right now is in Asia, the type of conversations we had there. The opportunities we see in Europe, in the U.K., Middle East. These are just very large opportunities, large mandates, big opportunities. And if you then overlay the opportunities and you overlay what infrastructure can do related to the build-out of power with all the AI promise and the need for data centers and the need for power is going to be extraordinary. And all of this is going to lead to much bigger opportunities. And then more importantly, more and more clients are going to be seeking those organizations who deliver the proprietary differentiated products."
},
{
"speaker": "Operator",
"content": "We'll go next to Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "Just wanted to ask about balancing investment spend with margin expansion. In the past, we've heard BlackRock talked about being margin aware. So, just curious how the thinking of that has evolved. What does that mean in today's environment? And how might you quantify the opportunity for margin expansion over time? How do you see some of the levers to achieve that?"
},
{
"speaker": "Martin Small",
"content": "Our approach to shareholder value creation is obviously to generate differentiated organic growth, it's to drive operating leverage in a premium margin and it's to execute on a consistent capital management strategy. We have a strong track record of investing in our business for growth and scale and expanding profitability. And I want to emphasize, it's not just about growth. It's about profitable growth over the long-term. And that growth comes from making continued investments in our business. And I've talked a lot about on the last several calls and obviously, some of the other meetings we've had, we're looking to size our operating investments in line with the prudent lens on organic growth potential. We're aiming to put more flexibility in our cost base and variabilize expenses where we can. And most importantly, we're looking to generate fixed cost scale, especially through investments in technology. We're consistently delivering industry leading margins, which is a goal and we've expanded our margin in six out of the last 10 years. And I think those scale indicators are coming through in our results. We're delivering profitable growth. We generated 180 bps of margin expansion year-on-year, while revenue op income and EPS all rose double-digits. And we delivered 60 basis points of sequential margin improvement. Over the last 18 months, AUM is up $2.5 trillion, while headcount is actually flat or slightly lower. So I feel like we're delivering benefits of scale and productivity, which is showing in margin expansion. As I mentioned, we're planning for full year low to mid-single digits core G&A growth, flat headcount both excluding the GIP transaction. So you've heard on our last few calls and I hope today and some of Larry's color, we're looking to drive more fixed cost scale. That comes from technology. It comes from automation. It can come from AI. It comes from organizational design, global foot printing using some of our innovation hubs around the world. We see those as our major levers to drive margin expansion. And in the end, we're just looking to optimize organic growth in the most efficient way possible, deliver growth for clients and shareholders and ultimately expand our margin over time."
},
{
"speaker": "Laurence Fink",
"content": "Michael, I would just add, as we continue to be investing in AI, our most recent experience of having $2.5 trillion more assets with the same headcount is a real good indication of how we are trying to drive more efficiencies, more productivity. I think this is critical. We're going to bring down an inflation in America. This is how it's going to have to be done, driven through technology and which will increase more productivity. And overall and actually through that process, we continue to drive more productivity. What it also means is rising wages. So people do more and the whole organization is doing more with less people as a percent of the overall organization. That is really our ambition."
},
{
"speaker": "Operator",
"content": "Your next question comes from Ken Worthington with JP Morgan."
},
{
"speaker": "Kenneth Worthington",
"content": "Fixed income flows have picked up for U.S. -- the U.S. mutual fund industry so far this year, but the same data services that track the industry don't show a proportionate pickup for BlackRock. Your fixed income ETF sales were solid at $18 billion but below levels seen last year. Can you talk about the competitive landscape for fixed income retail and fixed income ETFs, both inside and outside the U.S.? And to what extent do you think investor appetite may have changed in 2024?"
},
{
"speaker": "Robert Kapito",
"content": "So, Rob here. The conversations that we're having across all of the distribution systems are about a new allocation into fixed income. It's been very much clouded by all the noise around inflation and the Fed. So the yield curve remains inverted and investors are currently getting paid to wait. And a more balanced term structure of interest rates is going to be the indicator to watch and that's where we'll start to see demand for intermediate and longer-term fixed income. So the first quarter for us flows of $42 billion, which I think is considerable, we saw the strength in the bond ETFs from immunization activity in institutional and about 25% of the flows were into active strategies. So we're seeing renewed demand for active fixed income and that's led to flows into the high yield, the unconstrained and the total return strategies and the fact that our longer term performance has about 93% of our taxable active fixed income AUM above the benchmark or peer medium in the last five years are really set up to capture this. But I do think the noise that's out there focused on inflation and the fact that you can still earn 5%, which is very attractive right now is causing the delay in more allocations to fixed income. The other part of why I'm more encouraged is we are finding a growing interest in high-performing active fixed income strategies alongside private market strategies. So I think that we stand to bode very well once you see some changes in the yield curve."
},
{
"speaker": "Laurence Fink",
"content": "Let me just add, operator to Ken's question. Ken, I do believe as an industry, the large pension funds that have an over allocation of private equity and the rotation of money in the private equity area has slowed down precipitously. We are also seeing evidence that more and more clients are keeping a higher balance of cash to meet their liability discharges. And so without the momentum and the velocity of money in private equity, they actually have to keep higher cash balances, too. So I think that is something to be watched to. If there is an unlock in the movement of private equity, I do believe you would see a factor allocation for the industry in fixed income and other income-producing products."
},
{
"speaker": "Operator",
"content": "We'll go next to Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alexander Blostein",
"content": "My question is related to private markets and GIP. Larry, you referred to it again this morning as a transformational deal for BlackRock maybe similar to some of the other large ones you've done. Does this give you enough in terms of what you're trying to accomplish in the private markets broadly? Or do you expect to pursue more acquisitions that are related in this area? And I guess somewhat related to that, growth in private markets, retail products has been quite significant and still early days. Maybe just remind us on how BlackRock is pursuing that opportunity."
},
{
"speaker": "Martin Small",
"content": "It's Martin. I'll offer a few thoughts and then Larry will jump in. Let's say, look, all of our clients continue to increase their allocations to private markets. That's what drove our acquisition of eFront. It's what drove our planned acquisition of GIP. And it's also a great focus of the organic investments we've made to build in a liquid alternatives business of size. There are sort of liquid alternatives business, we've reached $167 billion of assets, roughly $140 billion fee paying. We had a good quarter there. Infrastructure and private credit deployment added $1 billion of inflows offset by a return of capital that I talked about. We're getting close on our final closes for our BlackRock Infrastructure IV Fund for decarbonization partners, which has been a great first time funded vintage. We've got $30 billion of committed but uninvested capital. So there's good dry powder in the system. As Larry mentioned, we're originating really strong unique transactions there. So we think our capabilities are expanding in a way that's going to plan. Just yesterday, we announced an infrastructure debt deal with Santander where we're going to be financing about $600 million of infrastructure loans in a structured transaction. And we just see good fundraising momentum, which we think we can kick into next year with GIP. Since 2021, we've had $140 billion of gross capital across the platform continue to see good momentum with clients. And to the topic you mentioned, we've been building out our semi-liquid products for retail with credit strategies. Our credit strategy is interval funds and our non-traded credit BDC, BDEAT have a combined $1 billion plus of AUM. We received a really important placement for BDEAT as a National Wirehouse, so we think that will be a strong accelerant for organic growth. And then finally, that planned acquisition with GIP is going to really extend our capabilities. We think the business can be a much stronger platform for capital formation of scale and build on this philosophy we have in illiquid alternatives. We also think there's a great opportunity to bring GIP's capabilities to private wealth globally, retail retirement platforms in the U.K. and Europe with the LTIP and LTAP structures. And obviously, we'll keep you updated on our progress."
},
{
"speaker": "Laurence Fink",
"content": "I would just add that the feedback we're having from clients, including a dinner I had with a major energy company last night. The opportunity we have for driving more unique proprietary origination is going to be driving accelerated growth for us in the private markets, especially in infrastructure. I do believe the combinations of our two organization is going to open up so many more avenues. Avenues with companies but also avenues with countries. And that being said, look, we're always in the market and are looking for different opportunities and we're not slowing down, looking at different opportunities. We're not here to suggest we're doing anything that is forthcoming because the number one through five things to do is to close GIP. But the doors are knocking at BlackRock to see if there's other opportunities we want to pursue. And if it makes sense one day, we will continue to be open minded to pursue more private market opportunities."
},
{
"speaker": "Operator",
"content": "We'll go next to Dan Fannon with Jefferies."
},
{
"speaker": "Daniel Fannon",
"content": "Martin for your comments on improving trends throughout the quarter for flows, can you put in context what that means for maybe exit fee rate? And also on this pipeline of activity that's building, can you talk about the mix of fees and products more specifically and how that might inform your base fee outlook going forward?"
},
{
"speaker": "Martin Small",
"content": "As I mentioned, we see good base momentum. At the end of Q4, we were running at higher than target. At the end of this quarter, we're at target. And as I mentioned, when we look at the trends over months, not days, we feel like we're half or halfway plus to our target growth. So we've got good base fee momentum. First quarter base fees, excluding securities lending were $3.6 billion, which is up 9% year-on-year, which is largely due to the impact of market movements on AUM and organic growth. And if -- the Q2 entry fee rate ex-fee lending is pretty much flat compared to the Q1 fee rate on a day count equivalent basis. But overall, I think as we see good flows into active with the $15 billion we've had, as I mentioned, retail flows of $7 billion coming in. We see good fee rate trends, which we think are about -- mostly about mix. We focus really on driving organic base fee growth in the most efficient way possible, focusing on the clients, focusing on the investments they want to make. We don't focus on a specific fee rate or product. We focus on the clients and the fee rate is more of an output. But the trends in terms of where we're raising assets on the fee rates we think are good. But as I mentioned, Q2 fee rate -- Q2 entry fee rate excess funding is flat compared to the Q1 fee rate on the same day count."
},
{
"speaker": "Operator",
"content": "We'll go next to Bill Katz with TD Cowen."
},
{
"speaker": "William Katz",
"content": "Appreciate the update. Maybe a different vein. Your performance fees continue to run pretty high. And just sort of wondering, are we reaching a new level of normalized performance fees? And how might that translate into sort of the comp ratio as we look ahead, particularly as you continue to migrate to a bigger pool of private markets post-GIP?"
},
{
"speaker": "Martin Small",
"content": "So on the performance fees of $204 million in the quarter, obviously, they're up about 4x year-on-year. If you could put yourself in a time machine and think back to that first quarter in '23, it was a really difficult market. We had SVB, we had some volume in the rate markets, et cetera. So I think it was a tough time. This quarter, we've really seen good performance coming through on our teams, which has been very, very strong and I think reflected in those performance fees. Rough just is about half of that performance fee is coming from kind of our private equity funds and private equity programs where we had some very successful realizations that Larry talked about last year, which was created in some of the distributions associated with that. And the other half is more in illiquid hedge funds in our strategic equity hedge funds and some of our systematic strategies as well. Ultimately, our goal is to deliver long-term performance with clients and where we see performance fee revenues picking up, obviously, there's healthy alignment there and more supportive markets and stronger markets and strong performance, we'd expect a lot of that leverage to drop to a lower comp to revenue ratio. But ultimately, talent is one of our key investments and we'd expect it to be on a go-forward basis."
},
{
"speaker": "Operator",
"content": "We'll go next to Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Maybe just to focus on the multi-asset category and a couple of areas within that. I think Martin, you were talking about obviously the build of the organic growth pipeline and also in conjunction with Larry, with your comments about the conversation pipeline. Can you talk about two areas, in particular, as that developed throughout the year. That would be OCIO deals and then also, as we start up LifePath Paycheck, how you anticipate that contributing to organic growth, I guess, as the year unfolds, obviously very early, but even over the next couple of years?"
},
{
"speaker": "Martin Small",
"content": "Sure. I guess maybe I can start with a little color on the multi-asset flows and then Larry can comment on LifePath Paycheck. So, multi-asset strategy saw inflows in the quarter of about $5 billion after we had a really strong 2023 with $83 billion. Those strong inflows were driven by the continued demand for our LifePath Target Date offerings. And obviously, we see significant growth ahead in that core business but also in the upcoming launch of LifePath Paycheck. Our LifePath Target Date franchise has about $470 billion in assets, generated $9 billion of flows in the first quarter, thanks to the funding of several large mandates. We have about an organic growth rate of 8%. So we're leading the market there in terms of growth and we continue to outperform relative to the industry. Again, we're building on a strong core business there. We had $25 billion of flows in '23, which was about 7% growth. We're the number one DC investment-only, DCIO firm. We have 70,000 DC plans and we're the only provider, I think that's really global. Most of the assets at BlackRock are investing to finance retirement, and we've been at the forefront of innovation and advocacy for retirement solutions throughout our history. It's a key part of our growth. And the innovation that we're doing in LifePath Paycheck, we think is exciting and a significant area of our future organic growth."
},
{
"speaker": "Laurence Fink",
"content": "As I said in my prepared remarks, we have 14 corporations that are preparing to transform their defined contribution plan to LifePath Paycheck. So the conversations we're having with so many other clients is enormous. Many clients wanted to see actual implementation of these plans. As we said in the prepared remarks, the first implementation of the first plan is going to be in the next few weeks. We'll have many announcements about that and we plan to really make that a big issue for us going forward. We believe, as I said before, this is going to change retirement. The movement away from defined benefits to defined contributions have left many, many individuals stranded in making the decisions of their own retirement by themselves. And this eliminates some of the uncertainty for retirement. The Target Date has eliminated a lot of the variability of retirement, but there has been no transformation in terms of bringing -- once you are retired, how do you know what you have. And through this innovation of integrating investment strategies around insurance wrappers can really narrow the outcomes that the individual can have a very narrow corridor of what the dollar amount that they're going to be earning each month. And as I said in my letter, with growing longevity, retirement is going to become a bigger and bigger issue. And having this type of certainty really will alleviate some of the fear. As I said, our conversations are broad. And let me be clear, the conversations are also now beginning in Europe and other places, too. So we look at this as a major component of our future growth rates over the next three to five years. Obviously, it's not the highest fee-based product. It is like a Target Date product. But -- so it's -- but it can generate more connectivity with more clients, deeper relationships with all our clients. And so this is something that I'm very proud of what the firm has created and I do believe it's going to transform BlackRock as a leader in retirement benefits."
},
{
"speaker": "Operator",
"content": "We'll go back to Patrick Davitt with Autonomous Research."
},
{
"speaker": "Patrick Davitt",
"content": "My question is on Europe ETFs. Obviously, the active to passive equity flow mix continues to track more like the U.S. and Europe so far this year. So firstly, could you update us on the defensibility of your positioning around that theme? And to what extent you're seeing more aggressive price competition? And finally, higher level, to what extent you're seeing a real change in how ETFs are bought and sold in Europe that could portend this so called trend continuing more indefinitely?"
},
{
"speaker": "Martin Small",
"content": "As we mentioned, we had about $67 billion of iShares inflows in the first quarter, led by core fixed income. I bet the business is running in a very strong way, high single-digit asset growth, mid-single-digit base fee growth. All the trends globally are very strong. But we have been stressing and I'm glad for the question, just the real strength and competitive position of the iShares business in Europe. European iShares continues to lead the market with about 30% market share of inflows that's 2x the inflows of the number two player. And our inflows exceed the two and three players combined. Our iShares franchise in Europe is $850 billion AUM that's bigger than next five players combined. So we think we have a real outsized opportunity to grow ETFs in the U.K. and Europe. And obviously, the competitive dynamics there, I think are very, very different than they are here in the United States in terms of the buying units, how buying units are sold. This is largely a private banking market that uses exchange traded funds through discretionary private management programs and iShares is really a very strong and preferred provider. I want you to think about it this way. The United States built trillions and trillions of dollars ETF business with a national best bid, best offer system, a unified securities regulator, national exchange. Europe has more fragmented markets and has been growing, growing and growing. So we really see, obviously, regulation is trending favorable in Europe, the buying dynamics as very favorable and iShares is in a great market leadership position there, we think to post outsized growth."
},
{
"speaker": "Operator",
"content": "Thank you. Ladies and gentlemen, we have reached the allotted time for questions. Mr. Fink, do you have any closing remarks?"
},
{
"speaker": "Laurence Fink",
"content": "Yes, operator, one last comment. I want to thank everybody for joining us this morning and for your continued interest in BlackRock. Our performance is a direct result of our steadfast commitment to serving our clients -- and each and every client and evolving for the long-term trends ahead of their needs. We started 2024 with great momentum, and I strongly believe that there are more opportunities ahead for BlackRock more than any other time before. Thank you, everyone and have a great quarter."
},
{
"speaker": "Operator",
"content": "This concludes today's teleconference. You may now disconnect."
}
] |
bmy | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Welcome to the Bristol-Myers Squibb Fourth Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Chuck Triano, Senior Vice President and Head of Investor Relations. Please go ahead."
},
{
"speaker": "Chuck Triano",
"content": "Thank you, and good morning, everyone. We appreciate you joining our fourth quarter 2024 earnings call. Joining me this morning with prepared remarks are Chris Boerner, our Board Chair and Chief Executive Officer; and David Elkins, our Chief Financial Officer. Also participating in today's call are Adam Lenkowsky, our Chief Commercialization Officer; and Summit Hirawat, our Chief Medical Officer and Head of Global Drug Development. Earlier this morning, we posted our quarterly slide presentation to bms.com that you can use to follow along with Chris and David's remarks. Before we get started, I'll remind everybody that during this call, we will make statements about the company's future plans and prospects that constitute forward-looking statements. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in the company's SEC filings. These forward-looking statements represent our estimates as of today and should not be relied upon as representing our estimates as of any future date, and we specifically disclaim any obligation to update forward-looking statements even if our estimates change. We'll also focus our comments on our non-GAAP financial measures, which are adjusted to exclude certain specified items. Reconciliations of certain non-GAAP financial measures to the most comparable GAAP measures are available at bms.com. Finally, unless otherwise stated, all comparisons are made from the same period in 2023 and sales growth rates will be discussed on an underlying basis, which excludes the impact of foreign exchange. All references to our P&L are on a non-GAAP basis. And with that, I'll hand it over to Chris."
},
{
"speaker": "Christopher Boerner",
"content": "Thank you, Chuck, and thank you all for joining us this morning. As we'll discuss today, 2024 was a year of good execution across multiple fronts. Importantly, our performance last year establishes a solid foundation to continue our multiyear journey to achieve top-tier sustainable growth by the end of the decade. I will begin with some comments on our fourth quarter and full year accomplishments. Then I will speak to the promise we see with Cobenfy and the steady cadence of clinical data catalysts that will begin this year, further defining our future growth potential. I will end with an overview of our 2025 guidance. Starting on Slide 4. We closed 2024 with strong fourth quarter performance, reflecting another quarter of double-digit percentage increase for our growth portfolio. In addition, we saw strong performance across key parts of the company and achieved notable commercial and R&D milestones. Looking at the full year, let's turn to Slide 5. I'm pleased with the progress we have made executing on our multiyear plan. For the year, the growth portfolio delivered double-digit revenue growth led by BREYANZI, Krazati, Reblozyl and Opdivo. In the latter part of the year, we reestablished our presence in neuroscience with the U.S. approval and launch of Con which is the first novel mechanism for the treatment of schizophrenia in decades. We also received U.S. approval of Opdivo Quvantic in late December. This new subcutaneous formulation of nivolumab will help extend the reach and impact of our immuno-oncology franchise to patients into the next decade. Throughout 2024, operational excellence and financial discipline were top priorities for us. As part of this effort, we reallocated significant spend towards high potential growth opportunities, achieving most of our targeted $1.5 billion in savings. We expect to capture the remainder of this year. Additionally, we put considerable focus in 2024 on improving R&D productivity. As a result, we have been able to accelerate several programs in our late-stage pipeline. Notable examples include CEMZIOS, where we completed enrollment in the ODYSSEY non-obstructive HCM study 6 months earlier than expected and now anticipate top line results next quarter. With Coben, the ADEPT 2 study in Alzheimer's disease psychosis is expected to have a top line readout in the second half of this year versus our original expectation of 2026. This is due to our focus on accelerating patient recruitment following the acquisition of Karuna. And with our ibertamideexcaliber trial in relapsed/refractory multiple myeloma, enrollment is complete, and we have an opportunity for a data readout this year, also ahead of schedule due to the recent addition of MRD as a co-primary endpoint. Looking ahead, we will continue to sharpen our focus on operational excellence. You saw the early steps of this strategy last year. As a continuation of that, we are taking deliberate steps to become a leaner, more focused company and have identified an additional $2 billion in savings. We expect approximately $1 billion of these savings to be realized this year and the remainder by the end of 2027. David will provide more detail shortly. These actions are consistent with our strategy of investing in our growth portfolio and promising areas of science while maintaining financial discipline. As I've said, this is a journey, but we're already seeing progress. I'm confident the actions we are taking are the right ones that will further advance our long-term sustainable growth strategy. Turning to Slide 6. The U.S. approval of Cobintian schizophrenia was an important achievement in 2024, and the launch is off to a great start. While we're focused on delivering on the schizophrenia indication today, we see the potential for additional benefit to patients and have made strategic investments in a broad clinical development program. We expect to have important data readouts starting this year and every year thereafter for the remainder of the decade. This year, we're initiating 7 Phase III studies across 3 indications: Alzheimer's disease agitation, Alzheimer's disease cognition and bipolar 1 disorder. And next year, we plan to begin Phase III studies in autism spectrum disorder irritability. The significant ramp-up in spending on Cobenfy illustrates our focus on continuing to invest behind key growth drivers while simultaneously maintaining financial discipline. Moving to Slide 7. We are entering a data-rich period with multiple catalysts over the next 24 months across a significant number of assets. In 2025, we have multiple important registrational catalysts, as you can see on this slide, including several that I already mentioned as well as the Cobenfy-ARIE study in adjunctive schizophrenia. Then in 2026, we expect to have registrational data for numerous potential first and/or best-in-class medicines, including Milvexian, in acute coronary syndrome and secondary stroke prevention, Admiral parent in idiopathic pulmonary fibrosis, and mezigdamide in multiple myeloma. We also expect to have registrational data for Arlocell,our GPRC5D CAR-T in multiple myeloma and for RAISE101 in Gepnets. We believe these data readouts will further derisk the pipeline and provide meaningful insight into the future growth profile of the company. Now let me give you an overview of our 2025 guidance and how we see this year playing out on Slide 8. In terms of the top line, we estimate revenue to be approximately $45.5 billion, reflecting, as expected, the near-term impact of generics across multiple products and the continued strength of our growth portfolio. As it relates to the bottom line, we expect our 2025 non-GAAP earnings per share to be in the range of $6.55 to $6.85. This reflects the expanded savings program I mentioned earlier. David will provide more details on our guidance. Finally, turning to Slide 9. BMS is evolving into a fundamentally different company with a clear multiyear plan, strong execution and an accelerating pipeline. We now have a younger and more diversified growth portfolio. This includes Coben which has the potential to be a significant contributor to growth over the coming years. We have a multitude of important data readouts over the next 24 months with the potential to launch 10 or more new medicines and pursue over 30 indication expansion opportunities over the next 5 years. And we remain focused on the therapeutic areas where we have a long track record of success and delivering transformational medicines to patients. We are confident in the steps we are taking to reshape BMS. And by the end of the decade, we expect to have a transformed portfolio of marketed products driving top-tier sustainable growth. Now I'll turn it over to David."
},
{
"speaker": "David Elkins",
"content": "Thank you, Chris, and good morning, everyone. I will begin my review of our 2024 financial results, focusing on our fourth quarter performance. I will follow up with the introduction of our non-GAAP financial guidance for 2025 and some important considerations to help you better understand our financial outlook for this year. Our performance in 2024 is marked by focused execution on driving top line growth, generating strong cash flow and managing our cost structure. We have entered 2025 with a stronger foundation to deliver on our long-term growth strategy. Starting with Slide 11. Sales in the fourth quarter grew 9% to approximately $12.3 billion, driven by volume growth across the portfolio and higher inventory levels in the market. Our growth portfolio delivered another strong quarter with sales up 23% and represented slightly more than half of our revenue. Key brands like Reblozyl, KENZO and Optolag all achieved significant growth. Within the legacy portfolio, higher sales of Electus were offset by the expected impact of increased generic volumes across several other brands including Revlimid, ABRAXANE, SPRYCEL and POMALYST. Overall, our performance in the fourth quarter capped off a very good year for our company, making progress in building a foundation for long-term sustainable growth. Turning to product performance on Slide 12, starting with oncology. Opdivo delivered solid growth in the fourth quarter, primarily due to higher volume. In 2025, we are focused on conversion and educating the U.S. market on the benefits of Opdivo Kuventeg, and we expect low single-digit growth for this product and OPDIVO taken together. With Optolag, we delivered another quarter of double-digit growth driven by demand in the U.S. where it remains a standard of care in first-line melanoma ex U.S. sales benefited from uptake in newly launched markets. Moving to cardiovascular on Slide 13. Eliquis delivered over $3 billion in fourth quarter sales. U.S. sales grew 19%, benefiting primarily from continued strong demand and the typical inventory build. Importantly, as you think about the impact to Eliquis from Medicare Part D redesign, Q1 U.S. sales growth will be tempered sequentially due to the implementation of the 10% manufacturer responsibility in the initial coverage phase. The remaining quarters of 2025 should steadily increase, particularly in the second half of the year due to the elimination of the coverage gap. Turning to KEmZyOs, sales in the fourth quarter more than doubled, benefiting from higher demand and a large inventory build. -- as a standard of care and obstructive HCM, KIMZYOs continued to show strong momentum as evidenced by the approximate 1,300 new patients added to commercial drug in the fourth quarter. Additionally, we recently received a label update for KEMZIOS in Europe to ease the echo monitoring requirements in the maintenance setting for obstructive HCM. Importantly, we are pleased to announce today that we have a PDUFA date in April for a similar easing of the REMS echo monitoring requirements in the U.S. Let's turn to hematology on Slide 14. Rebase delivered more than 70% growth, reflecting solid uptake across first and second line MDS-associated anemia patients. Sales in the U.S. benefited from demand and included onetime gross-to-net benefit outside the U.S. rebase sales more than doubled, driven by demand across newly launched markets in Europe and a strong launch in Japan. In cell therapy, BrionZ's fourth quarter sales more than doubled, driven by its best-in-class profile and strong demand growth across all its approved indications. Now moving to immunology on Slide 15. Global sales of STC grew more than 30% and U.S. sales benefited from higher demand, tempered by gross to net impacts from higher rebates associated with expanded access coverage. Starting in 2025, we further improved our access position with 80% of covered lives having 0 step edits, which will help us drive demand growth. As a result of this improved access position, however, we expect additional headwinds from higher rebates notably across the immunology franchise. Regarding CERTIKTU specifically, this will temper our reported sales in the first half of the year until demand volume can offset these impacts. I will wrap up reviewing our performance for the quarter on Slide 16 with neuroscience and cube fee. Covent sales in the fourth quarter were approximately $10 million and represent roughly 2 months of sales and initial stocking. And we've seen strong prescription uptake during these early months of launch. Feedback from both patients and physicians has been favorable, highlighting the benefits of Cobenfi's differentiated efficacy and safety profile. Let's now move to the P&L on Slide 17. As expected, gross margin declined about 240 basis points in the fourth quarter, driven primarily by product mix. Excluding in-process R&D, operating expenses increased approximately 8%, largely driven by R&D investments, partially offset by our ongoing cost savings program. Regarding our operating expenses, we made significant progress during 2024 against our $1.5 billion strategic productivity initiative. As of the end of the fourth quarter, we realized approximately $1.1 billion in savings and expect the remaining $400 million to be realized in 2025. Our effective tax rate for the quarter was 19.9% compared to 14.9% in the prior year, primarily driven by earnings mix. For the full year, excluding in-process R&D charges, our effective tax rate was 18%, Overall, diluted earnings per share were $1.67 for the quarter and full year diluted earnings per share came in at $1.15. Turning to the balance sheet and capital allocation highlights on Slide 18. Our financial position remains strong with approximately $11.2 billion in cash equivalents and marketable securities as of December 31. We generated strong cash flow from operations of approximately $4.4 billion in the fourth quarter. In terms of capital allocation, we continue to ensure we employ a strategic and balanced approach. Business development remains a priority, as does our plan to pay down debt. As of the end of 2024, we have repaid approximately $6 billion of the $10 billion of debt we committed to pay down relative to our March 31, 2024 balance. Our capital allocation priorities also include returning cash to shareholders through a commitment to the dividend. 2025 marks our 93rd consecutive year of dividend payments. On Slide 19, I'll provide more detail on our expanded strategic productivity initiative that Chris mentioned earlier. Building on the work we did to capture cost savings last year, we identified additional opportunities to streamline operations further leverage technology and drive greater efficiency in our ways of working. As a result, we expanded the existing program to include approximately $2 billion of incremental run rate operating expense savings with approximately $1 billion to be achieved in 2025 and the remainder by the end of 2027. Under this expanded initiatives, savings will be driven by changes in organizational design and efforts to enhance operational efficiency with each accounting for roughly 50% of the targeted savings. Within organizational design, we will continue to optimize and streamline our workforce to better align with the future needs of the business. To further optimize resources and enhance productivity, we will drive operational efficiencies across multiple areas of the business. In contrast to the initial $1.5 billion cost savings program, where savings were mainly reinvested. This expanded program will see the incremental $2 billion in savings drop to the bottom line. Overall, our focus is to become a leaner, more efficient company while investing behind our growth portfolio and promising areas of science. With that in mind, let me walk you through our non-GAAP 2025 guidance on Slide 20, starting with revenue. As Chris said earlier, we estimate revenue in 2025 to be approximately $45.5 billion, primarily reflecting the near-term impact of generics across multiple products and the continued strength of our growth portfolio. We expect an 18% to 20% decline in the legacy portfolio due to the stacking of LOEs and anticipated headwinds from foreign exchange of approximately $500 million. This will be partially offset by higher revenue and continued strong performance of our key growth brands. Now continuing with our 2025 guidance for certain P&L line items, we expect our gross margin to be approximately 72%, which reflects the impact of product mix. Excluding in-process R&D, we expect total operating expenses to show a meaningful decline to approximately $16 billion, driven by the expanded cost savings program I just mentioned. We anticipate our overall expenses to be more evenly phased throughout the year. Operating margin is expected to be approximately 37% for 2025. We're expecting OI&E income of approximately $30 million and we expect to maintain our tax rate of approximately 18%. Considering these factors, we expect to deliver non-GAAP earnings per share in the range of approximately $6.55 to $6.85. Before closing, let me provide some insight regarding our expected quarterly progression of revenue for 2025. As it relates to quarterly phasing, we expect the first quarter to be impacted by the typical inventory destocking we see each year following the build in Q4. as well as the additional gross-to-net pressures from Medicare Part D redesign, which will be accentuated within Eliquis. As I said earlier, we expect Eliquis revenue for the remaining quarters of 2025 to steadily increase. particularly in the second half. As a result of this, we expect the legacy portfolio to decline approximately 10% to 12% on a sequential basis, reflecting these dynamics and continued generic impacts as previously communicated. However, on a total company basis, we expect the inventory and gross-to-net dynamics to normalize beginning in Q2, with second half revenues to be higher than the first half of the year. In closing, our strong performance in 2024 has strengthened our confidence in our ability to deliver long-term value for our patients and shareholders. We remain focused on executing our growth strategy and rightsizing our cost structure. We also look forward to multiple data catalysts, which will accelerate over the next 24 months and will derisk our pipeline and provide more certainty on the future shape of our company. And with that, I'll now turn the call back over to Chuck for Q&A."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, David and Chris for the prepared remarks. Alison, could we please poll for questions?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question today will come from Chris Schott of JPMorgan."
},
{
"speaker": "Christopher Schott",
"content": "Just 2 quick ones for me. First on Cobenfy. It seems like feedback and coverage dynamics are progressing well. Can you just elaborate on how you're thinking about the ramp of the drug from here as we balance as you highlight kind of entrenched physician prescribing habits against what seems like a relatively poor standard of care and pretty large unmet need in the space. I just trying to get so like the ramp, how you're thinking about it for '25? And the second 1 is just on the cost program. once you're done with this incremental $2 billion, should we think about additional cost opportunities as you go through that 2028 LOE cycle, or is this going to really put the company in the, I guess, the right place as we think about the longer-term model and longer-term business. So basically kind of thinking about is, is the 27% run rate kind of a good way to think about this? Or is there another step down as we head into Eliquis and OPDIVO?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the questions, Chris. I'll have Adam take the first question, and then I'll take the second. ."
},
{
"speaker": "Adam Lenkowsky",
"content": "Great. Thanks, Chris. So regards to the Coben fee, we're very pleased with what we're seeing with Coben with 3 months post launch, and the launch is really off to a strong start. We're now at approximately 1,000 TRxs per week. And we made very good progress achieving our access goals. So for Medicaid and Medicare, we're tracking ahead of our expectations. We've achieved over 90% Medicaid access and over 80% Medicare access, recall those 2 payers represent over 80% of the covered lives in this category. And as expected, the majority have 1 step edit post generic. We're also making very good progress with commercial payers. The feedback over the last several months has been very positive. There's been a lot of enthusiasm around the efficacy and safety profile. I'm also pleased with the number of trialists that we're seeing since launch, and we have an opportunity to further expand and increase adoption with roughly 30,000 psychiatrists. So as you said, this is the first new mechanism of action in decades in the treatment of schizophrenia. And so we're out with our teams educating customers on Cobenpi's differentiated profile and we're breaking reflexive prescribing habits, and that's going to take some time. So we would expect to see continued strong uptake through 2025. And as we said, with the ramp back half of this year. But taken together, we are really pleased with what we're seeing so far, and we plan to make this a very big product for the company over time."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Adam. And Chris, with respect to the second part of your question on the cost program, let me say a few things. First, as you think about this cost program keep in mind that our focus as a company continues to be on investing for growth. That's investing in the products that we have today, investing in the pipeline, both the late-stage pipeline as well as promising early areas of science. And maybe just give you quick vignettes on that. We plan to initiate 7 Phase III programs starting this year on Coben, clearly illustrating that we'll continue to invest in our pipeline. And then Adam can speak to this, but we made significant up investments in commercial last year which explains, we believe part of the progress that we've made on products like CEMZYOS, OPDIVO and BRIAN. So investing in growth is a priority for us, and that's the top priority. With respect to the cost programs, just a bit of context. As we were executing on last year's program, we cataloged a number of opportunities for us to become a more agile company, to become more nimble and speedy in terms of how we operate. And given where we are on that program as well as where we are with respect to LOEs, we think that it makes sense for us to capitalize on those opportunities now. So that's really driven the timing of this announcement, and we think it puts us in a good position going forward. With respect to this -- the follow-up to that, which is, will there be additional cost-cutting efforts there, I think we're always going to align the organization to the needs of the business. This is an extension of last year's program. It gives us more financial flexibility. That financial flexibility gives us strategic flexibility but we're always going to be focused on ensuring that we've rightsized the organization, and we've got the right level of spend, given where the business is."
},
{
"speaker": "Chuck Triano",
"content": "Thanks, Chris. Alison, can we go to our next question."
},
{
"speaker": "Operator",
"content": "Next question will come from Luisa Hector of Berenberg."
},
{
"speaker": "Luisa Hector",
"content": "I just wanted to take your assumption for Part D redesign, if you can quantify it in 2025. And then just an update on cendakimab, I don't see it on the slides, but any updates on the filing plans there."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the question, Luisa. I'll have Adam take both of those questions."
},
{
"speaker": "Adam Lenkowsky",
"content": "Thanks, Luisa. As relates to Part D redesign, there are pushes and pulls. Overall, we're going to see favorability with Eliquis due to the elimination of the coverage gap and with that, we're not going to see the historical dynamics with Eliquis, where first half sales have been higher than the second half sales. In fact, what we're going to see in Q1 is going to be the lowest quarter of sales for Eliquis mid-single-digit sequential growth from Q4 to Q1 globally. And we'll see second half sales be higher than first half sales. But for the full year, we expect strong year-on-year growth for Eliquis. Now when you look at products like REVLIMID, POMALYST, ORENCIA and CAMZYOS, for example, that's going to offset the Eliquis favorability as we see increasing gross to net pressure starting in as patients enter the catastrophic phase. And as you know, we're responsible for 20% in the catastrophic phase and 10% in the initial coverage phase. But as we've said previously, we project it to be roughly net neutral across our portfolio this year. As it relates to cendakimab, given the data that we have seen, we've made the decision not to commercialize cendakimab. We're going to continue to prioritize investments and opportunities where we have a competitive advantage. We can deliver the highest return for the company in areas where we believe that we have an opportunity to deliver potentially transformational outcomes for patients. We made a similar decision late last year with Zeposia in UC. As we saw the unsuccessful trial in Crohn's disease. And based on our competitive position with opposing in IBD, we made that decision as well."
},
{
"speaker": "Operator",
"content": "The next question will come from Geoff Meacham of Citi."
},
{
"speaker": "Geoffrey Meacham",
"content": "Thanks so much for the question. I had another 1 on CoVENFI. I know, Chris, you highlighted the expansion opportunities on Slide 6. I guess, are there others that you could add or accelerate beyond what you have? I guess the main question is, since the emracladine failure are there changes to the investment plan that you're contemplating? And then on the policy front, I want to get your perspective as RFKJ's nomination or a confirmation looks I think fairly imminent, what are the potential puts and takes on IRA revisions? Obviously, been a lot of chatter on what discounting could look like in the outer years."
},
{
"speaker": "Christopher Boerner",
"content": "Sure. I'll take the first part of that question and then turn it over to Samit and Adam, and then I'll come back and talk about the policy bit. Just let me give you a top line on Cobenfy. Obviously, the competitive dynamics and changes on the competitive front haven't impacted the short term on that product. We have always been focused on delivering that product as quickly as possible. patients. However, we do believe that those competitive dynamics provide a more significant long-term opportunity for us and so we have put a full court press on ensuring that we do everything we can to capitalize on that opportunity in the long term, and that includes accelerating programs where possible. So maybe Samit and Adam want to comment."
},
{
"speaker": "Samit Hirawat",
"content": "Yes, it's absolutely true what Chris just said because if you think about the dual muscular agonism mechanism of action that draft carries, it opens up the door for investigating and exploring many of the dementia associated psychosis and agitation disorders. So we will continue to explore where the drug could be applied, where additional indications could be added and how we can accelerate the development of this molecule and as well as continue to look into our pipeline, what other molecules we can bring forward in the neuropsychiatric space to be able to manage the unmet clinical need that exists for these patients at this time."
},
{
"speaker": "Adam Lenkowsky",
"content": "I'll just add, Sumit. Our focus has been on ensuring a successful launch where generic atypical have about 80% market share, and co-benehas significant safety and ethically advantages there. As Sumit just mentioned, we see the unique efficacy advantages around the 3 domains of schizophrenia. -- hitting on positive symptoms, negative symptoms and cognition due to its unique maxes action. So we didn't expect competition from other muscarinic in schizophrenia until late 26, early '27. And the failure of erracladine, we have a clear path forward in schizophrenia and we're excited about the opportunity with Cobenfy. And we believe that we're going to drive meaningful growth for Covent really into the middle of the next decade."
},
{
"speaker": "Christopher Boerner",
"content": "On the policy front, maybe a few things. First, as a company, as you well know, we have a long history of working across both sides of the aisle. We actually look forward to working with the new Congress as well as President Trump's administration, including nominees like RFK once those nominees obviously are confirmed. Our focus as a company is going to continue to be on policies that strengthen the ecosystem for innovation to make sure that we're ensuring to address the needs of patients and our employees. Also, I would add ensuring that the FDA has what it needs to fulfill its mission. And so that's going to be our focus as a company. With respect to IRA specifically, I do think there's an opportunity for us to address in the coming administration some of the challenges as 1 of the first companies to go through the IRA price setting process. We've been very clear on concerns that we have with that law. And we see the need to have a number of fixes that will avoid some of the more damaging aspects of the law and some of the more perverse incentives and I would highlight addressing the billet and addressing the spillover impact as 2 of the most important areas that we'll be focused on. And of course, there are other policy priorities -- but in general, we look forward to working with this administration, and we think we've got some opportunities to do so."
},
{
"speaker": "Operator",
"content": "The next question will come from Chris Shibutani of Goldman Sachs."
},
{
"speaker": "Unknown Analyst",
"content": "I'm struck by the ability to do several things at the same time while trying to realign your costs and integrate these businesses. There have been several advancements of time lines in terms of data readouts. And there's also been an absence of slippage across integrating aspects of the pipeline that are very important what are the keys in your opinion, to being able to deliver on this progress and in particular, the advancement of time lines?"
},
{
"speaker": "Christopher Boerner",
"content": "Maybe I'll start and then turn it over to Samit. I think, Chris, you've correctly pointed out there a lot of moving parts. But I would say One of the reasons that we've been fixated on operational excellence, becoming a more nimble and focused organization is making sure that we're staying absolutely focused on those things that are going to drive value to the company and value to shareholders. And so one of those things has been a very laser-like focus on R&D productivity. The work that we've done in that regard has enabled us to accelerate a number of programs that are going to add value for the company. In fact, one of the reasons we have this wave of catalysts that are coming forward over the next 24 months, is that we have been focused on ensuring we hit the time lines that we set internally and where possible, accelerate and Samit and the team has done a nice job of helping us do that. So Samit, do you want to comment on specifics."
},
{
"speaker": "Samit Hirawat",
"content": "Yes, absolutely. Thank you for the question, Chris. As Chris said, the laser focus is the start. But then again, following the principles we laid out a few years back, in fact, between Robert and myself from the research and discovery perspective, the cause of biology to discover the drugs matching the modality to the mechanisms and then picking the right diseases. And then after that, accelerating that proof of concept generation. But then if you look at the late development, we broke down the process into multiple pieces and dig deeper into where we were doing well, whereas wherever the space is where we had the opportunity to shorten the time lines. And there, we identified several opportunities, and then we started to dig deeper into it. The other thing we did last year is also prioritize our portfolio and made certain decisions what we will pursue versus what we will not pursue. Some assets, some trials were stopped and then we started focusing on where the most amount of scientific rigor was there to be able to achieve the proof of concept. And once that was achieved, how do we then accelerate that into generation of the data to bring the drug to the patients and to commercialization all of that has helped. And the examples that are right in front of you, last year, we were able to accelerate and deliver the psoriatic arthritis data early --,, this year, we'll be able to give KENZYOSdata early. This year, we'll be able to bring in ADAPT. And now we are working on the next trial as well as we think about multiple myeloma, LPA1 and IPF as well as SLE trials, for SOTC. And of course, that mindset will go in all of these 7 trials that we've talked about for Coventry as well. So overall, very pleased with the progress we've made, but we have a little bit more distance to go, and we'll continue to focus on our portfolio to deliver."
},
{
"speaker": "Christopher Boerner",
"content": "And just to put a finer point on what Samit said, Chris, we have the potential for 15 or more registrational trials that will read out by the end of next year. And so the work that Samit's team is doing to ensure that those are delivered, delivered on time is, we think, critical, and we've made good progress in 2024. And as Samit said, we're heads down continuing to execute on that."
},
{
"speaker": "Operator",
"content": "And the next question will come from Tim Anderson of Bank of America."
},
{
"speaker": "Timothy Anderson",
"content": "I have a couple of questions. So the revenue guidance for '25 is about $1 billion less than consensus in as much as you've looked at consensus, where are you seeing the biggest differences could Codensa be 1 of those contributors of the delta? And then a longer-term question on earnings. In the past, Chris, you've suggested trough earnings would really be in the very late 2020s. And to me, it felt like maybe 2028, 2029. Is that still the right way to think about it? And could a product like Covent fee or some of these other programs possibly pull that forward?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the questions, Tim. Maybe I'll start and then turn it over to David for the first part of your question, and then I'll come back for the second part. Look, with respect to how we thought about guidance and the outlook for this year, I think you as well as I think everybody knows the LOE exposure that we have as a company as expected. This year, we're seeing the increased step down on Revlimid as well as the stacking of full year impacts products like POMALYST, which lost exclusivity in Europe as well as in the U.S. price and our guidance reflects that. But keep in mind, those are short-term impacts. And the long term, which is what we're focused on, we feel good about the progression that we're making on the new product portfolio. And then as we discussed just in the last question, we have an exciting set of assets that are going to be reading out that will frame out what the company looks like in the back part of the decade. And maybe I'll ask David to fill in some of the specifics on the LOEs and the guidance."
},
{
"speaker": "David Elkins",
"content": "Yes. Tim, thank you for the question. And just as a reminder, Bloomberg's for the total company is sitting around 46.2% we're guiding approximately 45.5%. If you remember in my prepared remarks, -- so there's a headwind of currency, which we don't believe has been built in, which is around $500 million. So as we look at where we are versus consensus from a revenue perspective, we're broadly in line with where it is. Any minor differences is really as we keep highlighting is around the legacy portfolio, in particular, REVLIMID coming down to 2, 2.5 as well as the other generic impacts that we mentioned on the call. But overall, we feel pretty good where we are versus consensus."
},
{
"speaker": "Christopher Boerner",
"content": "With respect to the trough question, first, I think the way you're thinking about the drop in general is the right way to think about it. As we've said before, we're not going to be giving long-term guidance as a standard course. This reflects the philosophy that we have that we're going to guide to what we and you can hold us accountable for. But what we've also been very clear on is that our focus continues to be on driving top-tier growth exiting this decade. And specifically, that means increasing the velocity of growth that we have in the last couple of years exiting this decade and into the next. So as it relates to trough, we're working to do everything we can to change the timing, the depth and duration of that. And how we do that is to continue to do more of what we frankly did last year, dry brand growth brand performance. accelerate the pipeline so that we derisk some of these future catalysts as quickly as possible, use our capital to accelerate growth. Frankly, that's what we did when we acquired Karuna to bring a product like Cobinfi into the portfolio. And in fact, as a result of that and what we see as the long-term potential, we believe we've accelerated the velocity of growth as we exit this decade. So we're going to continue to be focused on finding ways to use capital to continue to accelerate their growth profile. And we're going to become more nimble as a company so we can move quickly to capitalize on those. That's what we're focused on, and that's what we're going to be transparent about our performance against on these calls."
},
{
"speaker": "Chuck Triano",
"content": "Great. Thank you, Chris. Alison, let's move to the next question."
},
{
"speaker": "Operator",
"content": "Next question will come from Mahi Banzel of Wells Fargo."
},
{
"speaker": "Mohit Bansal",
"content": "My question is regarding Aliquis. So I mean -- so there was some thoughts about Eliquis getting some tailwind because of design given that there's no donut hole now. And maybe the like given the price point the impact of party design may not be a lot. So in the context of that, how are you thinking about the growth for this brand for this year? ."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the question, Mohit. Adam, do you want to take that?"
},
{
"speaker": "David Elkins",
"content": "Yes, Thanks Mohit, for the question. As I mentioned, we're going to see favorability with Eliquis this year in the U.S. due to Part D redesign with the elimination of the coverage gap. And so I talked about the dynamics historically, where the first half sales were higher than the second half sales. So we're going to see something very different this year, where Q1 sales will be the lowest quarter for Eliquis, and we'll see higher sales in the second half of the year. For the year, we expect strong double-digit growth for Eliquis overall. And when we look at where we are positioned in the market in the U.S., we have a market share that continues to grow linearly. Our share in the U.S. NBRx is roughly 75% and -- and we know that with Xarelto out of the market, we've got a great opportunity to continue to drive this important brand for the company."
},
{
"speaker": "Operator",
"content": "Next question will come from Trang Han of UBS."
},
{
"speaker": "Unknown Analyst",
"content": "Just 2, please. So firstly, can you just give us some color on the gross margin cadence for 2025? You touched upon 1Q dynamics, but should we just follow the REVLIMID step downs for the year? -- is there any other considerations that we should think about here? And then just wondering if you can give us any early insights into the access and coverage of Opdivo Quantic -- and any thoughts on the uptake for '25."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the questions, Fran. David, do you want to take the first 1 and then Adam, you can comment on the second."
},
{
"speaker": "David Elkins",
"content": "As we said, the step down will be mainly driven by REVLIMID and POMALYST. -- volumes coming through with those gross margins being slightly higher than the average. And the only other consideration obviously is Eliquis. And I think as Adam had covered typically Eliquis is larger in the first half of the year than the second half of the year. This year, that's going to be inverted in that our lowest quarter for Eliquis the first quarter but our sales will be higher in the second half of the year than the first half of the year. So that would be the other consideration as you think through the gross margin of the company in total."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. So as it relates to Opdivo Quvantic, these are very early days. The team is out in the field educating health care practitioners on the benefits of subcu versus IV. As we said previously, we believe physicians will convert at least 30% to 40% of the IV business ahead of our LOE in late 2028, which will extend the franchise into the 2030s. We have seen so far very positive feedback early on is around usage in adjuvant patients, patients who are treated in combination with YERVOY, like in first-line metastatic melanoma, first-line RCC. The feedback specifically has been positive regarding the 3- to 5-minute infusion time taking all that treatment burden for both physicians and for patients. We've also seen a number of NCCN guidelines updated for your reimbursement question to include optavialcuvantig within just a few weeks after approval. And I think the most common question that we're getting is around the reimbursement dynamics here. We've had conversion from IV subcu in the first half of the year is going to take some time, mainly due to a temporary J code, which is routine for any new product in this category. And conversion will accelerate in the second half of the year once we transition to a permanent J code on July 1. And so we're excited about the launch and what this means for patients, physicians and importantly, the durability of our IO franchise."
},
{
"speaker": "Operator",
"content": "Next question will come from Evan Seigerman of BMO Capital Markets."
},
{
"speaker": "Evan Seigerman",
"content": "One on BD, more specifically, now that we're on this side of the muscarinic debate with Coventry approved and peer acuity not showing an efficacy, can you walk us through kind of your process in determining why you went for Karuna when you wanted to get into schizophrenia. And on kind of a more mechanistic perspective, what's happening with Kemira? We saw a nice step up. What are you seeing in the field that's driving the uptake there? ."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the questions, Evan. 'll start and then turn it over to Adam. There's no magic bullet with respect to how you approach business development from our standpoint. But I think there were a few things that we did well with the Karuna acquisition that will frame how we continue to do business development. First, I would note that the senior leadership team of the company owns the decision to move forward with that acquisition. Capital allocation is critically important as we've discussed. Business development is a top priority for us as a company. It's important as we navigate the back part of this decade, and when you're allocating investor capital at that scale, it's critical that senior leaders take ownership and accountability for it. So we did that. Second, we were very disciplined in the approach. It started with making sure that we really like the science, we considered multiple options and we zeroed in on the science that was coming out of Karuna as compelling in our view. And beyond that, we felt strongly that this had an opportunity to strengthen our therapeutic areas as well as to give us opportunities to accelerate growth in the back part of the decade. And of course, we were very disciplined on the financials. We needed to make sure that we could put a compelling case together that it would add value to the company and ultimately to shareholders. You actually saw how we executed against that post the decision to acquire in that we spent a lot of time with the Heritage Karuna team to fully develop this asset in ways that they were unable to do so. And we think that's important in terms of how we think about the long-term opportunity. And maybe the last lesson learned that I'd highlight is we moved very quickly -- and so those lessons, I think, will frame out how we continue to do business development at the company. And then Adam, do you want to take the second question?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Evan, regarding CMIOs, we've seen strong and consistent growth from Kim Zios -- as you heard from David's opening remarks, year-end, 2024, there were approximately 12,000 patients in the hub and roughly 9,500 patients on commercial drug. So we've established a strong revenue base, and we expect continued growth from the expansion of our prescriber base. We're seeing high persistency and duration of therapy. And we're continuing to add new patients each and every week. So our focus is now on increasing depth of prescribing in the larger COEs while at the same time, increasing breadth in some of the smaller institutions and larger community practices, and we're making some good progress there. We also have a couple of things. David mentioned, one, we look forward to the PDUFA date that's coming in April. So similar to what we've seen in Europe, our goal is to ease the burden of echo requirements for patients and physicians, and we expect that to open up additional capacity at the COEs. And as a result, physicians will be able to treat more patients. And as you're also aware, we have a data readout in nonobstructive HCM, and we're looking forward to seeing the ONS data in Q2, and that will and the eligible patient population by about 30% or so. And so that's going to allow Kamo to have a nice first mover advantage in both indications and across the full spectrum of patients with symptomatic HCM."
},
{
"speaker": "Operator",
"content": "Next question will come from Akash Tewari of Jefferies."
},
{
"speaker": "Akash Tewari",
"content": "So what's the risk around the adjunct schizophrenia trial for KabEnfI? Because we haven't seen a lot of companies run that specific trial. And if they have, they've often failed. So why wouldn't the probability of success for this trial be more like a 50-50 coin flip? And on the Camis label update, are you aiming for 6 months echo monitoring requirements? And if so, how do you think that will help expand access into the community setting?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the question, Samit and Adam."
},
{
"speaker": "Samit Hirawat",
"content": "Sure. Thank you for the question. On the adjective schizophrenia, I remember where we started off and how patients are treated in the in the real world. So we obviously have developed the drug as a monotherapy, but these patients were primarily before they got onto the trial, we're receiving the D2 agonist and thereafter, there was a washout period, patients came on the drug and then, of course, the trial evaluated the primary endpoint in emerging 1, 2 and 3 at a shorter window. But remember, merging 4 and 5 have now read out with a 52-week follow-up. Many of those patients obviously, are also taking concomitant medications in the background. So -- and we've seen that efficacy continued to be maintained within -- as we look towards the 52-week data point as well. So overall, from that perspective, we are confident on the overall safety profile that is emerging on that. And then, of course, from a blinded data perspective, the study has continued at this point. So now we are only a few months away from the readout for that trial. And of course, on top of that, we'll look at ADAPT trials also reading out beginning at the back end of this year. Coming to Camzyos, a point that I would like to make is -- it is very important that we continue to decrease the burden on the site on the patients and the treating physicians. And from that perspective, it was important the data that we've collected from the real world as well as in the clinical trials suggest that the overall safety profile of Camzyos is maintained. Many of the patients are treated actually at the lowest holes of 2.5 and 5 milligrams and considering all of that data is where we approach the health authorities, and you've already seen the action taken in Europe and now looking forward to the April action as we think about the maintenance for these patients with a longer duration in between echos as we look to the U.S. reviews as well. Adam, if you want to add anything?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Just adding just 1 bit, and point you to the the European label. The label was updated late last year to reduce the frequency of echo monitoring for patients taking CAMZIOS from every 12 weeks to once every 6 months when patients are in the maintenance phase. So that's after week 12. And what we would expect is not so much in the community, but this will open up additional capacity at the centers of excellence. And as a result, physicians will be able to treat more patients."
},
{
"speaker": "Operator",
"content": "Next question will come from Terence Flynn of Morgan Stanley."
},
{
"speaker": "Terence Flynn",
"content": "Great. Maybe 2 for me. David, I just wanted to clarify on the new productivity initiative, should we think about the run rate year-end '27 as being $15 billion. So an incremental $1 billion off of the $16 million now. I just wanted to make sure I understand it correctly. And then on iberdomide, the addition to the MRD endpoint, did FDA sign off on that? And if so, are you able to get approval on just an MRD endpoint? Or do you need follow-up data from the PFS? And anything you can say about what kind of efficacy delta you'd need on MRD?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Terence, David in Samit."
},
{
"speaker": "David Elkins",
"content": "Yes. thanks for the question. Yes, you have that right. So we said an incremental. It's a $2 billion program, all that dropping to the bottom line. We said $1 billion of that which dropped this year with operating expenses of $16 billion the further $1 billion achieved by 2027 would get you to operating expenses of $15."
},
{
"speaker": "Samit Hirawat",
"content": "In terms of thinking about iberdomide, of course, quite excited that based on the discussions that you probably followed from the ODAC setting perspective at MRD as an endpoint is more and more becoming important because in multiple myeloma, there are multiple lines of therapies that are available, but still no cure available for patients with multiple myeloma. So it is important that we continue to figure out how to accelerate the process of drug development and that's why newer end points are needed. So of course, we've discussed with the FDA the ability to include MRD as 1 of the primary endpoints in the clinical trial, and we'll certainly be reading that out most likely in this year. Now everything in the regulatory world will be dependent on the risk benefit ratio and the overall magnitude that we'll observe at the end of the day. So when the data is available, that's when we will engage with the regulators in terms of how they will see that data and what else they would need Remember, we have not taken out PFS as the second primary endpoint within the trial as well. So of course, the patients will be followed for PFS and as well as the secondary endpoint, which is overall survival as well. So we are going to collect maximum data from the clinical trial and engage the authorities based on the magnitude and the timing of the readout."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Samit. The only thing, Terence, I would add, and David got it right with respect to how the cost savings will flow is to -- as I said earlier on this call, keep in mind that as we think about the overall cost structure, as we see compelling opportunities for growth that exist, we're going to make sure that we continue to invest in those -- so just keep that in mind as framing all of this discussion around cost."
},
{
"speaker": "Operator",
"content": "Our next question will come from Courtney Breen of Bernstein."
},
{
"speaker": "Courtney Breen",
"content": "I think you spoke a little bit about business development in an answer before and referenced it as a top priority from a capital allocation perspective. Can you just talk a little bit about TA alignment, kind of what good looks like, particularly in the context of the organization you have right now, I think, last year was a little bit of digesting the deals that you've done quickly. And so wanting to understand kind of how you're thinking about that appetite now and over the course of the year? And then the second was just around kind of codentfeand specifically kind of gross-to-net evolution as we're thinking about this access evolving from kind of initial private pay to more of the government setting to then adding on a little bit of the commercial environment, that would be really helpful to understand how you're expecting that to flow."
},
{
"speaker": "Christopher Boerner",
"content": "Both good questions. I'll start and then turn it over to Adam. As we said earlier, and as you reiterated, business development is a top priority for us. Think about that both in terms of partnerships and where it makes sense, acquisitions. And the way we think about therapeutic areas is that we're really focused on strengthening our position in the core therapeutic areas that we have today, and that we can do by bringing promising areas of science into the company as well as looking for assets that can improve the growth profile of the company. And I think you saw shortly after I became CEO in 2023, we did both of those things. What's important and the way we think about it is that we need to like the science and feel that we're the rightful owners of it, the financials have to make sense. And again, we've included in that thinking strengthening the growth profile as a key factor we're considering. And we have to believe that we can drive value for the company and ultimately for shareholders. And as we look across the core therapeutic areas that we have today, we see opportunities as we see opportunities to strengthen our position in those therapeutic areas. The nice thing is that we're in a very strong financial position. And as I said earlier, that financial strength and flexibility gives us strategic flexibility and that flexibility includes doing business development where it makes sense."
},
{
"speaker": "Adam Lenkowsky",
"content": "Believe I'll just answer the question around SP261127157 Courtney. Thanks for the question. Relates to gross to net, the brand is going to continue to lean heavily towards the public sector Medicare and Medicaid. And you think about the evolution of schizophrenia and seton indications or our Alzheimer's indications, whether it be Alzheimer's the psychosis or Alzheimer's cognition. These are patients who are going to be in Medicare and Medicaid. Commercial patients are less than 10%, you will see that more commonly in some of the indications such as autism and in bipolar disorder, but the majority of the brand will largely be in the public where there are Medicaid best price."
},
{
"speaker": "Operator",
"content": "Next question will come from Seamus Fernandez of Guggenheim Securities."
},
{
"speaker": "Seamus Fernandez",
"content": "So just quickly on Cobenfy, I was hoping you could talk about the patient experience that you're seeing so far in the field. We know that patients certainly feel better cognitively, but there are questions around the tolerability and the BID dosing. So just interested to know if there's any early signs of sort of and how you're managing the GI profile that's been talked about a bit by some thought leaders in that regard. And then the second question is just as we think about the overall kind of multiple myeloma opportunity, just hoping to get a sense of where you think novel oral drugs like iberdomide or resignomide could appropriately fit within the context of the overall multiple myeloma market. given the availability of generic Revlimid and POMALYST?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Seamus. Adam, and then maybe, Samit, you can chime in as well."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes, Seamus, thanks for the questions. We've been really pleased with what we're hearing from both physicians and patients. The feedback has been very positive with a lot of enthusiasm on the efficacy and the safety profile. So what we're hearing is patients are seeing improvement in positive symptoms as early as the first week of treatment and on really the lowest dose of 50 milligrams. And we're also hearing good successes on negative symptoms and what we were really excited about this asset for improvement in clarity of thought, improvement of cognition, patients being able to reengage with their families and even start thinking about going back to work. The AEs, what we've heard from physicians, they're manageable, including the nausea and vomiting because what we're seeing is the majority of physicians in the real world are treating patients at the lowest dose. Just starting with 50 milligrams, they're taking a week or 2 before they titrate up to the next dose at 100 unlike what you saw in the clinical trials, which moved to 125 milligrams within the first 8 days of the trial. So that has been incredibly positively received, and so we're not hearing a lot of the top tolerability issues from physicians. But our teams are out there making sure that we're educating on what to expect. As it relates to BID -- we know that on average, patients are on 7 pills per day. And so we're not hearing this as a major objection to prescribing. And last thing I'll mention is we've got an ongoing study looking at taking Covent with food that will read out this year. So that will also improve the ease of prescribing for physicians and make it easier for patients as well."
},
{
"speaker": "Samit Hirawat",
"content": "So I'll just take it off from there. And 1 thing that I would just add on opened. So prior to Cobenfy, what drugs were doing was treating the symptoms of schizophrenia, meaning the positive symptoms primarily. With Cobenfy, now we are treating schizophrenia, meaning also impacting the negative symptoms, and we are seeing the impact on cognition as we have recently published the data on multiple myeloma switching gears it's important to understand where the patients are treated and what the drugs are available. If you think about the cell therapies and the T cell engagers or bispecifics, they are to be primarily used in the academic settings whereas most of the patients with multiple myeloma, especially with the relapsed/refractory disease are being treated in the community setting, where it is very difficult to get these therapies with the side effect management and the rents programs that go along with them. And that's where it is very important to continue to develop small molecules, which are easy to deliver and can be combined with the standard of care therapies. And that's exactly where Iberdomide Music might sit. And you know mesictamide is being compared head-to-head versus pomalidomide and that's how you replace somalitomide. And then, of course, there's another trial looking head-to-head iberdomide versus Revlimid, which certainly will read out later, but it is a very important component of the overall development plan."
},
{
"speaker": "Operator",
"content": "Our next question will come from David Risinger of Leerink Partners."
},
{
"speaker": "David Risinger",
"content": "Congrats on all the updates. Sorry, I have another call coming in here. So my apologies. They want me on the box to speak. So I have 2 questions. First, with respect to the performance in '25. So obviously, the worse that the LOEs perform in '25, the better the setup for the trajectory of growth for the company in '26. But if the loss of exclusivity products performed better than expected, then it makes it a little bit tougher to grow in. Could you just discuss that a little bit and provide some initial context for '26? I know that you're not providing guidance at this time. And then second, just with respect to RV, it's been performing very strongly, growing 20% roughly in the fourth quarter and roughly 20% for full year 2025 sorry, 2024, can you comment on growth prospects for YERVOY going forward as well?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, David. David Elkins and then Adam."
},
{
"speaker": "David Elkins",
"content": "Yes. So just on your question around 25 and what to think about heading into 26. First, REVLIMID, as we said, we have additional generic entry coming. So about 70% of the market will be supplied by generics. Remember, for REVLIMID, full generic entry in January of 26. So we'll be through that by the end of the year. And we have a generic entry APOMALIS next year as well. And the only other headwind that I would mention is we provided that guidance on IRA, which really took out the worst-case scenario for Eliquis as we head into the IRA. But really, our focus remains on investing in the growth drivers. You saw the strong execution in that growth portfolio that's now greater than 50% of our business. We exited double-digit growth last year. We feel really good about the position that we're in this year. And then as you think about going into '26 with that growth portfolio, you heard Adam talk about the additional indications in Censis and STK as well as Real -- and we got some really important data readouts that we're going to be able to add up to 6 new NMEs here over the next 2 years. So that growth portfolio is really coming together. We're adding to that. And then you've heard all the commentary around Cobenfy further adding to that growth portfolio. So there's pushes and pulls there. But what's becoming clear is the strength of the growth profile as we go into the second half of the decade here."
},
{
"speaker": "Adam Lenkowsky",
"content": "As it relates to YERVOY, we're seeing solid demand growth across our core indications, first-line lung, first-line RCC as well as first-line melanoma, where YERVOY is using combination. And that growth is coming both from the U.S. and from our international markets. In the U.S., we continue to see good adoption in the community. And as you know, last year, we presented I think is a remarkable 10-year long-term data in first-line melanoma. I think the last thing I'd means we're also preparing for launches this year in first-line HCC and first-line MSPCRC, both in combination with Yervoy, which will help drive your voice performance. And we also have Opdivo YERVOY lung approval that's pending in China. So taken together, we would expect continued growth from YERVOY in '25."
},
{
"speaker": "Operator",
"content": "Next question will come from Matt Phipps of William Blair."
},
{
"speaker": "Matthew Phipps",
"content": "Following up on the MRD primary endpoint for the Abertimide trial, is there a time course that the FDA wants as far as how much durability on that MRD? And why not add MRD endpoints to the teziimide trials? It does look like you already have MRD on the ArlosQuintEssential II and then similarly, in multi myeloma, is there a point at which Abema what is kind of the profitability breakpoint for Abema -- and the success of Arlo cell really kind of gate the need for a beckoning."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Matt. Samit then Adam."
},
{
"speaker": "Samit Hirawat",
"content": "Sure. Thank you, Matt, for the question. So for multiple myeloma, look, MRD endpoint is something that is new from the perspective of using as a registration trial endpoint. And that's why we have to continue to follow the patients and provide the durability in terms of not only an MRD, but also overall response rates, CR rate that we will see and these will be the points of discussion with the FDA as we get into those time points once the magnitude is known for this endpoint as well as the events occur in the Iberdomide trial. In terms of how we are thinking about use of this particular endpoint for other trials. We are continuing to evaluate the potential to leverage an earlier MRD endpoint readout to accelerate the development of our multiple myeloma assets across the board, but it will all depend on the timing, the population as well as how the event accrual is occurring. Successor studies target a little bit more of a difficult-to-treat patient population. So we'll see how the event occurrence happens and that may become as 1 of the studies that we may consider an endpoint as well in the future, but not at this time."
},
{
"speaker": "Adam Lenkowsky",
"content": "As it relates to Abema, we know multiple myeloma is going to remain a very crowded and competitive space, and there are multiple treatment options available. We remain committed to Abema, but we're going to see continued depending intensity and competitive pressures. So our focus is making sure that we're optimizing the value of bema and we're going to remain competitive in the space. As you heard earlier from Chris and David, we're very excited also about GPRC5D which we believe is going to play a critically important role in the treatment of post-BCMA CAR T with a single infusion and an improved safety profile."
},
{
"speaker": "Operator",
"content": "Next question will come from Steven Scale of TD Cowen."
},
{
"speaker": "Steve Scala",
"content": "I have 2 questions. First, Bristol's second-generation TYK2 completed Phase I in psoriasis in August of 2024, but hasn't progressed. So curious what the profile of this agent is, what are plans and is IBD within those plans? And secondly, Milvexian Phase III readouts in stroke and ACS are expected in 2026, but later in the year. Curious if events are tracking for that 2026 readout and is there any possibility at all for a 2025 readout for either trial?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Steve. Samit."
},
{
"speaker": "Samit Hirawat",
"content": "Thanks, Steve, for both the questions. So first of all, for the backup Tik2, we completed those studies. We have the data -- but as you know, we are continuing to progress our overall plans for Sotika this time. And as we spoke earlier, we have to decide within our pipeline where we are going to really focus and prioritize -- and at the current time, our focus is truly squarely on Sotto and maximizing that opportunity from a development and commercial perspective. So at this time, that ticket is not in the development as you already have stated. From the SSP and ACS readout, events are tracking as well as the enrollment is going really well. We do not expect that readout in 2025. We expect that readout as we have stated at the back end of 2026."
},
{
"speaker": "Operator",
"content": "The question will come from Kripa Devarakonda of Truist Securities."
},
{
"speaker": "Unknown Analyst",
"content": "I have a canvas question. Congrats on getting the label update in EU. I was wondering with the label change in EU and potentially a change in the U.S. as well. How do you see the peak opportunity now? And with ODYSSEY data upcoming this year, can you help set expectations for the readout? And then if I can week 1 in Senan for Kobani. One of the tails we recently spoke to said that there was an issue with drug availability at average pharmacies is what he said. I was wondering if this is just a one-off or just does it just take time to ramp up availability?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. So I can certainly take those thank you. So as it relates to the label for CAMZyOS. As I said, we expect to have a PDUFA date in April of this year. And our goal is to continue to ease the burden of the echo requirements for both patients and physicians, and it's going to open up additional capacity at the COEs. What we are seeing for Caxias, which is and steady growth. We have a very large revenue base that's building, and we continue to expect growth from the expansion of prescribers and high persistency. Patients are staying on treatment for a very long time because they're feeling better. And so that's going to help with the duration of therapy, and we're focused on continuing to add new patients each and every week. As it relates to the ODYSSEY readout, maybe Samit, if you want to talk a little bit about it, but just as I mentioned, we're looking forward to seeing top line data in Q2. This is going to add a positive around 1/3 of patients in HCM and have an opportunity to build upon the success of CMIOs with a strong first-mover advantage across both indications, and we're certainly looking forward to that data readout. And so I'll turn it to Samit to talk a little bit more about MCM and then I'll quickly answer your Coben question in the form."
},
{
"speaker": "Samit Hirawat",
"content": "Yes, I'll address the Odyssey question very quickly. The paper from a methodology perspective as well as the baseline characteristics of the patients who are just published in JACC heart failure. So you can certainly pick it up from there. And the primary endpoints of KCCQ and PVO2 are well described as well as what the statistical methodology is. So, of course, we are looking forward to the readout and it's just -- I think in the next quarter, we'll be able to see the results, and then we'll share that with you. ."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Just really quickly on that. We're not hearing that. Our teams are out both with positions, but they're also at the pharmacies as well. So I do think that is potentially a one-off. And we want to make sure that the Covent is available broadly across the U.S., so patients can get access to this really important product."
},
{
"speaker": "Operator",
"content": "Next question will come from Olivia Brayer of Cantor Fitzgerald."
},
{
"speaker": "Olivia Brayer",
"content": "What data did you submit to the FDA for the less restrictive camsiosrans? Did that include anything additional versus what was submitted to -- and are you asking the agency for the same 2 updates that were proposed in the December agenda? I think those are around monitoring frequency and the use of LVOT gradient -- and then, Adam, I just wanted to clarify 1 point you made earlier. You said the European label was updated to reduce frequency. I think you said from every 12 weeks to once every 6 months. I just wanted to clarify that I heard that correctly."
},
{
"speaker": "Samit Hirawat",
"content": "Maybe I can start off. Thanks for the question, Olivia. We will not be able to give you the specifics at this time in terms of the asks of the FDA. Certainly, there are several of them, and then we'll see which ones we are able to have a conversation and get from a relief for the patient perspective. And in terms of the data that were submitted, they come from both clinical trials as well as from the real-world evidence. So overall data package was very strong, and we continue to have the dialogue with the regulatory agencies."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. And Olivia, just to clarify, again, the label in Europe was updated to reduce the frequency of echo monitoring for patients taking Censis post week 12. So after week 12, as pace move into the maintenance phase instead of once a quarter, they're able to now have echos once every 6 months."
},
{
"speaker": "Operator",
"content": "Next question will come from James Shin of Deutsche Bank."
},
{
"speaker": "James Shin",
"content": "I just wanted to follow up on the Rise question. What are BMY's expectations for the PANscore benefit? And then -- any color on how ADP 2 will be disclosed? Will the MPIC be top line in the PR? And will this be followed by a full data set at a Medical Congress Tom?"
},
{
"speaker": "Samit Hirawat",
"content": "Thank you for the questions. Let me start with the second 1 for Adapt. As has been recently done and previously done, at the top line, if we it reads out, we will be putting out a press release. But generally, we do not disclose the data. Those will be presented at medical conference appropriately and for RISE again, the magnitude that we are going to be looking for is going to be the difference between the 2 arms rather there and as well as we look -- the difference that we observed from baseline to the time of readout. So both of those endpoints are going to be important, apart from the, of course, the secondary end points. Right now, we are not commenting on the overall magnitude. But here, even small differences in terms of the points would be very, very important and clinically meaningful, as you know, in the neuropsychiatric space. ."
},
{
"speaker": "Operator",
"content": "Our next question will come from Sean McCutcheon of Raymond James."
},
{
"speaker": "Sean McCutcheon",
"content": "Can you speak to the expectations for the cadence of data for the targeted radiotherapeutic portfolio and prioritization of further investment in BD and internal development. following that investment in the infrastructure in that segment.."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. From the raise portfolio perspective, of course, the Phase III is already ongoing in Gap NET. And this is in the patient population. -- that is already you see prior Lutathera. So it's -- and certainly, the Phase I data was very strong, and we'll continue to look for not only the response rate, but of course, progression-free survival is going to be important to continue to observe in this one as we look to the readout in 2026. As you know that we are also exploring the activity of this drug in patients with small cell lung cancer in a Phase I study, and we recently started the breast cancer program as well. And from the portfolio perspective, we have -- we're looking forward to initiation of our Phase I program for GPC3 as a new target. And then, of course, there's a pipeline behind it in the research space as well."
},
{
"speaker": "Christopher Boerner",
"content": "And the only thing I would add is that we continue to be looking for opportunities to enhance the acquisition of raise, we believe in this platform. And if it's appropriate and it makes sense for us, both financially and scientifically, we would consider business development as well."
},
{
"speaker": "Chuck Triano",
"content": "Great. Thanks, Chris. Operator, we'll take our last question, and then we'll turn it to Chris for some closing remarks. ."
},
{
"speaker": "Operator",
"content": "Next question will come from Alexandra Hammond of Wolfe Research."
},
{
"speaker": "Unknown Analyst",
"content": "Bristol's long-term growth potential. So the team has mentioned an under appreciation to the pipeline. Can you imply the key assets you expect to drive revenue looking at the back end of the decade, maybe your favorite child or 2?"
},
{
"speaker": "Christopher Boerner",
"content": "Well, listen, I'll take that one. We feel great about the pipeline. We have a number of really exciting assets that are coming -- we've spoken at length, obviously, about Cobin. Clearly, we also are very excited about our CELMoD programs. We have multiple CELMoDs that we've spoken about today, Ibara messy, but we haven't spoken about gocotomide. -- that's a potentially very meaningful product in in lymphoma. Melexionis important. So it's very difficult to pick a favorite child here whenever there's such a wealth of opportunity in the late-stage pipeline. And we haven't even talked about the next wave of assets, which include some really exciting opportunities, including products like CD19, XT, ARLDD in prostate cancer as well as others. And by the way, I forgot to mention in the first wave of assets, LPA1, which is also a very fighting opportunity. So a plethora of potential catalysts that will be playing out over the next 24 months, and we look forward to seeing them then play out and going from there. So I think with that, we'll close today's call. I appreciate everyone staying on. I know we went a bit long, but hopefully, we're able to get to virtually all of the questions. Let's take a step back and maybe summarize where we are. Our priorities as a company, hopefully, you've seen on this call are clear, we're focused on continuing to deliver very strong commercial execution and to deliver on the upcoming pipeline catalysts, some of which we just discussed. We're going to continue to have the ability to enhance value creation through business development and all the while maintaining strong financial flexibility. As I look at 2024, we made very good progress. and I want to recognize our colleagues for all the hard work that they had last year. We continue to take decisive action to further rightsize our cost structure and invest in future growth. We believe these are important next steps in continuing to execute on the multiyear journey that we're on. And of course, we remain committed to our overarching goal, which is to reshape BMS to deliver top-tier growth by the end of the decade and most importantly, generate attractive returns for shareholders. So thanks again for tuning in today. And as always, the team is available for follow-ups. And have a good rest of the week."
},
{
"speaker": "Operator",
"content": "Conference has now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] |
bmy | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Bristol-Myers Squibb Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Chuck Triano, Senior Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Chuck Triano",
"content": "Thank you, and good morning, everyone. I'm happy to be here at Bristol-Myers Squibb, and we appreciate you joining our third quarter 2024 earnings call. Joining me this morning with prepared remarks are Chris Boerner, our Board Chair and Chief Executive Officer; and David Elkins, our Chief Financial Officer. Also participating in today's call are Adam Lenkowsky, our Chief Commercialization Officer; and Samit Hirawat, our Chief Medical Officer and Head of Global Drug Development. Earlier this morning, we posted our quarterly slide presentation to bms.com that you can use to follow along with Chris and David's remarks. Before we get started, I'll remind everybody that during this call we will make statements about the company's future plans and prospects that constitute forward-looking statements. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in the company's SEC filings. These forward-looking statements represent our estimates as of today and should not be relied upon as representing our estimates as of any future date and we specifically disclaim any obligation to update forward-looking statements, even if our estimates change. We'll also focus our comments on our non-GAAP financial measures, which are adjusted to exclude certain specified items. Reconciliations of certain non-GAAP financial measures to the most comparable GAAP measures are available at bms.com. And with that, I'll hand it over to Chris."
},
{
"speaker": "Chris Boerner",
"content": "Thank you, Chuck, and thank you all for joining us this morning. Starting on Slide 4. Our third quarter results reflect our continued focus on near-term execution and building the foundation for long-term sustainable growth. During the quarter, we saw solid demand for key products across our growth and legacy portfolios. We remained disciplined in managing expenses, and we continue to advance important pipeline programs. Let me highlight a few achievements in the quarter. Growth portfolio revenues increased 20% in Q3 at constant currency and now account for approximately half of total revenues. These are primarily young assets that have exclusivity well into the next decade. Our legacy portfolio also performed well, generating cash flow that allows us to strategically invest in growth opportunities. During the quarter, we achieved several clinical and regulatory milestones. Notably, we reestablished our presence in neuroscience with the approval of Cobenfy, which I'll speak to in a moment. We also strengthened our leading oncology portfolio. And earlier this month, we received FDA approval for an Opdivo-based perioperative treatment regimen in non-small cell lung cancer. Additionally, we continue to advance our innovative pipeline. In oncology, we presented data at ESMO, highlighting 8 new registrational opportunities. We shared positive clinical data for our nivolumab plus relatlimab high-dose combination in first-line lung cancer, which is now advancing to Phase 3. And we talked about the progress we're making across other promising assets and modalities, including our bispecific ADC and our radiopharmaceutical pipeline. This past week, at ENA, we also presented promising Phase 1 data for our PRMT5 program across all the tumors. Turning to Slide 5. The acquisition of Karuna Therapeutics is a key example of how we are strengthening our long-term growth outlook. We're proud to highlight the recent FDA approval of Cobenfy, formerly known as KarXT with a strong label that reflects its efficacy and safety profile. This milestone marks significant progress in delivering value from the Karuna acquisition for patients. Cobenfy is the first truly novel mechanism approved for adults with schizophrenia in decades, and it addresses 1 of the most significant unmet needs in mental health. There are approximately 1.6 million people being for schizophrenia in the U.S. alone, many of whom have endured debilitating side effects from older treatments. Cobenfy delivers compelling efficacy without the notable side effects associated with atypicals. The BMS team has been laying the groundwork for a successful launch. We built an experienced sales and medical team engaged with payers to secure access and develop sophisticated patient support services. We have ongoing clinical programs in adjunctive schizophrenia with Phase 3 data expected in 2025. And we have expanded the ongoing ADEPT program in Alzheimer's disease psychosis with Phase 3 data expected in 2026. We remain on track to start registrational trials next year in Alzheimer's agitation, Alzheimer's cognition, bipolar disorder and autism spectrum disorder. Adam and Samit can speak more to our launch progress in schizophrenia and other potential indications, we are actively assessing for Cobenfy in Q&A. Turning to Slide 6. I'll spend a moment updating you on our progress against our key strategic priorities. First, we're focused on transformational medicines where we have a competitive advantage. We are advancing our mission to serve patients with first or best-in-class treatments across our therapeutic areas. This includes driving leadership in hematology, cardiology and oncology therapeutic areas with products like Reblozyl, Breyanzi, Camzyos and Opdualag. At the same time, we're strengthening our innovative pipeline by prioritizing key programs. 1 asset that continues to advance well as Milvexian. We continue to see considerable unmet need across indications, in particular, AF as well as a large commercial opportunity. Today, we want to share an encouraging update related to our atrial fibrillation Phase 3 trial, which continues to recruit very well. As you'll soon see on clinicaltrials.gov we and our partner, J&J, have approved an increase in patient enrollment side. This is because at this time, based on review of event rates, we are seeing a lower rate of strokes and systemic embolism than originally anticipated, and the increased enrollment supports maintaining the planned data readout in 2027. As a reminder, as described in our published study design paper, we indicated that the sample size may be adjusted based on review of event rates. We remain confident in the design and progress of the program. Beyond Milvexian, we continue to advance other programs where we have a right to win. This includes our CD19 NEX-T cell therapy, our radiopharmaceutical and protein degradation platforms as well as additional indications for Cobenfy. Our second priority is driving operational excellence. We are reviewing overall spending and prioritizing investments that will deliver the best long-term returns. We remain on track to deliver $1.5 billion in savings by the end of 2025. And -- these savings will be reinvested into high ROI opportunities that serve patients' needs and accelerate growth. We are becoming a more agile company with stronger commercial and pipeline execution. Our progress on this front was demonstrated by the performance of our growth portfolio in Q3, the approval of Cobenfy and acceleration of key programs. We see the drive for greater operational excellence as a continuous process. As such, -- we're exploring opportunities to further improve productivity and efficiency over the coming quarters. Our third priority is to strategically allocate capital for long-term growth and returns. We remain focused on our near-term goal of delevering our balance sheet. We made further progress during Q3 and are on track to pay down our target of $10 billion of debt by the first half of 2026. We're committed to the dividend, and we will continue to invest strategically in growth through our own pipeline as well as sourcing innovation externally. Now turning to upcoming milestones on Slide 7. At the American College of Rheumatology's Annual Meeting in November, we will present promising Phase 1 data for our CD19 NEX-T cell therapy. This is a next-generation immunology asset, leveraging the Breyanzi construct. We are optimistic about its potential to deliver benefits for patients across multiple immunology indications by resetting the immune system. In late December, we expect the FDA's decision on the subcutaneous formulation of nivolumab. We anticipate this launch in early 2025 will provide an important benefit for both patients and physicians while extending our leadership in immuno-oncology into the next decade. We're also on track to share top-line Phase 3 data from Sotyktu in psoriatic arthritis by year-end. This data should help strengthen the competitive profile for Sotyktu as roughly 1/3 of psoriasis patients also have psoriatic arthritis. Turning to our outlook on Slide 8. Given the strength of our results year-to-date, we are raising both our full year revenue target and our full year EPS guidance. David will discuss these updates in more detail shortly. Looking ahead, I'm confident in our ability to deliver long-term value for patients and our shareholders. To summarize on Slide 9, I'm pleased with our achievements in critical areas. Our overall business mix is beginning to transform as our growth portfolio is becoming a bigger component. The U.S. approval of Cobenfy adds another asset with multibillion-dollar potential to serve more patients and accelerate growth. Our pipeline continues to advance with additional near-term catalysts and we are maintaining a disciplined focus on expense management, driving initiatives across the company to lower cost. These actions underscore our focus on executing in the near term while laying the groundwork for long-term sustainable growth. We look forward to keeping you updated as we build momentum with important milestones in 2025 and significant data flow in 2026. Before I close, I want to thank our employees for their dedication and performance in the quarter. Together, we are building a strong future for BMS and the patients we serve. Now I'll turn it over to David."
},
{
"speaker": "David Elkins",
"content": "Thank you, Chris, and good morning, everyone. I'm pleased to share our quarterly financial performance. As a reminder, unless otherwise stated, all comparisons are made from the same period in 2023 and sales growth rates will be discussed on an underlying basis which excludes the impact of foreign exchange, all references to our P&L on a non-GAAP basis. Let's start on Slide 10 with some highlights from our third quarter sales. We demonstrated solid commercial performance in the third quarter with higher sales driven primarily by our growth brands. The growth portfolio delivered another quarter of double-digit growth, up 20% with continued progress across key brands, including Reblozyl, Breyanzi, and Our legacy portfolio also performed well with U.S. growth led by Eliquis, partially offset by lower sales of Sprycel. As a reminder, the LOE for Sprycel in the U.S. recently occurred on September 1, and the LOE for Pomalyst in Europe happened back in August. Our continued focus on commercial execution enabled us to deliver nearly half of our sales in the third quarter from the growth portfolio. And with the recent U.S. approval and launch of Cobenfy, our sales mix will continue to diversify and provide a stronger foundation for growth. Importantly, we will continue to optimize the strong cash flow generated from the legacy portfolio to invest in growth opportunities. Before going into key brand performance, it's important to note that third quarter sales were impacted by the reversal of an approximate $150 million inventory build from the second quarter. This tempered growth across several brands, primarily Opdivo, and as well as Opdualag, Camzyos and some immunology products. Let's start with our oncology business on Slide 11. Global sales of Opdivo were higher in the third quarter, reflecting solid demand growth outside the U.S. Looking ahead, we continue to expect global full year sales growth to be in the mid-single-digit range. We remain focused on the anticipated approval and launch of the subcutaneous formulation of nivolumab which, as Chris mentioned, is expected to receive FDA approval by year-end. With this anticipated approval, we will have the potential to extend the durability of our immuno-oncology portfolio into the next decade. Moving to Opdualag, we delivered strong double-digit growth in the third quarter, driven primarily by demand. Three years post launch, Opdualag has become a standard of care in first-line melanoma in the U.S. with 30% market share. Outside the U.S., third quarter sales benefited from the strong uptake in newly launched markets such as the U.K., Brazil and Australia. Moving to our cardiovascular portfolio on Slide 12. Eliquis is the leading anticoagulant worldwide and delivered double-digit sales growth in the third quarter. U.S. sales benefited from the higher demand and market share gains. Sequentially, as we've seen historically, U.S. sales included an unfavorable gross to net impact related to the Medicare coverage gap. Outside the U.S., sequential sales of Eliquis reflected higher demand across key markets and favorable inventory compared to the prior quarter. Turning to Camzyos. Third quarter sales more than doubled, driven by strong U.S. demand for new patient starts and an increasing number of patients on commercial drug. During the third quarter, we saw steady patient adoption with nearly 20% growth in patients on commercial drug, more than doubling the number from a year ago. Outside the U.S., sequential sales growth reflected higher demand in newly launched markets in Europe. Now let's turn to hematology on Slide 13. Sales of Reblozyl grew 81% in the third quarter, with strong double-digit growth, both in the U.S. and international markets. The U.S. sales were driven by continued demand in first-line setting, outside the U.S., recent first-line reimbursement in Europe and Japan contributed to the strong performance in the quarter. In cell therapy, sales of Breyanzi more than doubled versus prior year, driven by demand in new indications and improved manufacturing capacity and reliability. In the U.S., sales grew more 40% on a sequential basis driven primarily by pent-up demand in 2 of our newly approved indications, follicular lymphoma and mantle cell lymphoma. We expect more modest sequential growth from third quarter to fourth quarter as demand normalizes. Also in cell therapy, despite a competitive market, bema performed well in the third quarter with solid demand growth in both the U.S. and international markets. Now moving to immunology on Slide 14. Sales Sotyktu nearly doubled when compared to the impact of the $30 million clinical trial purchase in the third quarter of last year. Outside the U.S., sales grew year-over-year, benefiting from the launch in a number of international markets. Looking to the fourth quarter, we expect a step-up in gross to net discounts resulting from increased rebating associated with our approved access position. This would result in the fourth quarter sales being similar to this quarter. As we said previously, we expect that over time, demand growth will offset these pressures. Now turning to the P&L on Slide 15. In addition to solid commercial execution, our third quarter performance demonstrated our focus on financial discipline and steady progress against our $1.5 billion cost savings program. As a reminder, we initiated this program to offset incremental OpEx from the recent deals. Savings from across the organization include reductions in direct clinical trial expense, site rationalization, elimination of roles and a reduction in headcount. As we said previously, we expect the majority of the savings to come through this year. As we realize these savings, we are strategically reinvesting in high potential opportunities to fuel long-term growth and innovation in key areas. Moving to gross margin. We saw a decline in the quarter of about 130 basis points, driven primarily by product mix. Operating expenses, excluding in-process R&D were impacted by higher deal-related spend, partially offset by savings from our efficiency initiatives. Our effective tax rate in the quarter changed from 11.6% in the prior year to 18.5%, impacted by onetime adjustment in 2023 resulting from newly issued IRS guidance. Overall, third quarter earnings per share were $1.80. Now moving to the balance sheet and capital allocation highlights. We ended the quarter with approximately $8.4 billion in cash, cash equivalents and marketable debt securities on hand. During the third quarter, both our growth and legacy portfolios delivered solid revenue growth, contributing to robust operating cash flow of approximately $5.6 billion. In terms of capital allocation, we remain focused on strengthening our balance sheet. We are executing our plan to pay down approximately $10 billion of debt. And relative to our position at the end of the first quarter, we have reduced it by $5.9 billion. This includes roughly $3 billion of commercial paper and 2.9% of long-term debt. As we previously have said, we remain committed to our dividend. Our strong cash flow profile enables us to address these priorities while also strengthening our outlook. Turning to 2024 non-GAAP guidance. As is our practice, we provide revenue guidance on a reported basis as well as on an underlying basis, which assumes currency remains consistent with prior year. We now expect full year 2024 revenue to increase approximately 5% as reported and approximately 6% at constant currency, primarily due to higher-than-anticipated sales of Revlimid. We are pleased with the performance of both growth and legacy portfolios. And in legacy, we have updated our full year sales estimate of Revlimid to approximately $5.5 billion. As a reminder, for modeling purposes, in addition to Revlimid, other legacy brands should soften in the fourth quarter due to competition from generics for Sprycel and Abraxane in the U.S. and Pomalyst Europe. Turning to gross margin. We now expect a slightly tighter range to reflect the impact of our U.S. sales mix. Excluding acquired impresses R&D, we now expect total operating expenses for the year to increase approximately 4% to 5%. This increase reflects higher fourth quarter spending to support our product portfolio and pipeline and is in line with fourth quarter increases seen in previous years. These costs are partially offset by savings from our productivity initiatives. We remain confident in our ability to achieve our full year operating margin target of at least 37%. For OI&E, we have increased our estimate from approximately $50 million of expense to approximately $125 million of income due to better-than-expected royalty and interest income. As a reminder, our tax rate was impacted by the nondeductible charge for acquired in process R&D, primarily from the Karuna acquisition in the first quarter. Excluding the acquired in-process R&D, we continue to expect estimated underlying non-GAAP tax rate for the full year to be approximately 18%. Taking these updates into effect, we are raising our non-GAAP EPS guidance to a range of $0.75 to $0.95. In closing, our third quarter results were marked by significantly higher sales across key growth brands. Robust cash flow generation and continued financial discipline. As we reestablish our presence in neuroscience with the U.S. launch of we are excited about the long-term opportunity of this brand and its potential to serve more patients. We're looking forward to additional near-term catalysts as our pipeline continues to advance. Our solid performance year-to-date supports our raised full year guidance and our increased confidence in our ability to drive long-term sustainable growth. And with that, I'll now turn the call back over to Chuck for Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And your first question will come from Evan Seigerman with BMO Capital Markets."
},
{
"speaker": "Evan Seigerman",
"content": "Congrats on the progress this quarter. So 1 for Adam, now that you have approved. Can you walk us through what the next year looks like when it comes to access? I know there's a lot of puts and takes when it comes to Medicaid and commercial. But maybe give us some color as to how we should think about it?"
},
{
"speaker": "Chris Boerner",
"content": "Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Thanks, Evan, for the question. We're very excited about the approval of Cobenfy. As you heard from Chris, is the first innovative therapy approved in schizophrenia in decades. And we're very pleased with the label does not carry the atypical antipsychotic class warnings and precautions or a box warning. And so how we think about this addresses a large market. Remember, there are 1.6 million people treated for schizophrenia each year in the U.S. We do see this as a 2025 launch with the launch picking up after attaining broad access. We expect to see sales ramp in the second half of the year, and I'll describe those dynamics. First and foremost, we're really excited that product is available this week. Our field teams are out now selling. They're engaging with customers. And so we'll see stocking this year. Now access is a gating factor to sales uptake as over 80% of patients are either Medicare or Medicaid. And just remember, schizophrenia is a fundamentally different market than markets that are highly PBM driven. So we expect to take about a year to achieve 80% to 85% access. It could move a bit faster in Medicaid and we're certainly going to work to accelerate that. So the way to think about is really in a step-wise fashion. In Medicaid, recall roughly half of the states have 0 to 1 step access. And so deep Medicaid P&T meetings will take place over the course of the next several months. We've already seen a few states come online this week. Physicians can prescribe once P&T reviews are completed and we are working to expand access across the remaining states. Now in Medicare, recall, this is a protected class. So payers have 90 days to make a coverage decision, and we expect to see mandatory coverage determinations in Q1, but in the meantime, physicians can push through medical exemptions before any of these formulary reviews take place. Our asset teams have been meeting with payers for some time, and our team without immediately post approval with payers to review the approved label and the response has been very, very positive. So again, we know the work that we need to do to maximize this important launch, and we plan to make this a very big product for our company over time."
},
{
"speaker": "Operator",
"content": "Next question will come from Chris Shibutani with Goldman Sachs."
},
{
"speaker": "Chris Shibutani",
"content": "Certainly, you've been doing a lot to focus the operating expense profile here. And at the same time, you're seeing improving top line -- where are you in that trajectory in terms of what we should expect 2025? Any early commentary on the shape of 2025 top line dynamics as a function of operating expense would be helpful."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Chris. I'll ask David to take that one."
},
{
"speaker": "David Elkins",
"content": "Yes, Chris, thanks for the question. And look, we feel really good about the progress we're making on our $1.5 billion savings initiatives that we had in place. And you recall -- we're on track to achieve the majority of that this year. We also feel really good about the operating margin guidance that we provided of at least 37% both this year and for next year as well. So we're continuing to look for efficiencies in our cost base, and you'll continue to hear more about that. But as it relates to '25, we're going to give you full line guidance like we typically do on our fourth quarter earnings call."
},
{
"speaker": "Operator",
"content": "Your next question will come from Chris Schott with JPMorgan."
},
{
"speaker": "Chris Schott",
"content": "Just maybe a 2-parter on Just thank you for all the details on the reimbursement piece. Once reimbursement is in place, can you just talk about how you're thinking about the ramp of the drug from there? I guess, historically, I think we've seen more gradual launches in schizophrenia, but these are largely assets with similar mechanisms to existing products. I'm just wondering in this case, are you anticipating this could be a faster ramp than we've historically seen given the unmet need and your unique mechanism of action? And then just my second part on the same product is just when you think about the additional line extensions here, what's your confidence in the bipolar 1 opportunity? It's obviously a very large market and live data you've seen in schizophrenia, do you view that as a high probability of success study as you start to ramp that one?"
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Chris. Adam will take the first part, and then Samit can chime in as well."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes, Chris, thanks for the question. First thing I'd say is there's really no perfect analog here because unlike previous launches, where you've seen multiple success of approvals, for example, schizophrenia that MDD. That's not going to be the case with approval cadence is going to be in schizophrenia, first in monotherapy than adjunctive therapy. As I said, in terms of the -- as we see the launch an access coming online, really, this is going to be a second half ramp. That's how we see it. So physicians can prescribe today push through medical exemptions before formulary reviews, but we expect to see really full access 80 to 85 access within roughly 12 months post approval."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. And thanks for the question, Chris. If you think about bipolar, so if you think about mania in general, bipolar one, that includes symptoms that are excessive activity as well as the psychotic symptoms of delusion, hallucinations and thought disorders. Then xanomeline and especially as we think about has demonstrated reduction of these agitation symptoms in Alzheimer's disease as well as in schizophrenia, Alzheimer's data, of course, came from the 1997 study that was published for in the past. So these are all predictive of efficacy potential in bipolar mania. There is no evidence thus far in the studies that have been conducted in the emergent program that shows a worsening of the depressive symptoms. So taken together, we are looking forward to initiation of that program in bipolar mania in the middle of 2025. Just too also add to on top of that beyond bipolar in 2025, we are looking forward to the readout of the ARISE trial, which is the schizophrenia trial. And of course, 2 additional indications that we will be initiating in 2025 will be AD agitation as well as recognition."
},
{
"speaker": "Operator",
"content": "Next question will come from Luisa Hector with Berenberg."
},
{
"speaker": "Luisa Hector",
"content": "On Sotyktu, you mentioned the price impact in Q4, but could you add a little more color on the outlook for next year and the access and pricing as we roll into next year? And then perhaps just a reminder of the profile that you're looking for in the Psoriatic Arthritis Trial."
},
{
"speaker": "Chris Boerner",
"content": "Adam can take the first 1 and then, Samit."
},
{
"speaker": "Adam Lenkowsky",
"content": "Thanks, Louisa. As we said in the past, the Sotyktu performance has been slower than we'd like, and we are making progress on executing against our plan. And that's securing favorable access and ultimately improving performance and execution. Recall, we had 25% access in the first half of the year. We more than doubled that in Q3. We now have approximately 50% zero step edits in the market. And I could say we are having productive conversations with the remaining payers and expect to enable broader access and adoption in 2021. But this comes with significant rebating and gross net impact that will be compensated by increased volume over time. It's going to take a few quarters for that to wash out. In fact, in Q3, you saw some of this. We saw some of the pull-through delivered both versus prior year and sequentially when you exclude clinical trials. So this is a market that is going to remain highly competitive, and we're going to continue to work to increase more market share as well as paid prescriptions. But as we exit this year, we will be in a better position versus where we started the year, and we're going to work to be more competitive."
},
{
"speaker": "Samit Hirawat",
"content": "Thanks for the question, Louisa, for the arthritis part. Remember, we have been able to pull and accelerate the readout of the second study as well. So we are looking forward to the readout towards the end of this year for both POETYK-PsA-1 and POETYK-PsA-1 within 2024. Overall, as you can imagine, since a lot of data has now been generated from a safety and efficacy perspective for Sotyktu in psoriasis the readout of the program will put us in the right footing as we think about the competitor profile versus Otezla as well. So looking forward to that, we have no concerns from a safety perspective as we've said, so hopefully, the studies read out positive that will lead to a filing in 2025."
},
{
"speaker": "Operator",
"content": "The next question will come from Geoff Meacham with Citibank."
},
{
"speaker": "Geoff Meacham",
"content": "For Chris or Samit on the Milvexian program, I know you guys did talk about the use of -- the potential to upsize the trial previously. But -- what would you say is the cause for the lower event rate? Does this change the risk profile? We know that GLP-1s have an impact, for example, in cardiometabolic trials, you think changes there commercially could have changed the event rate in your study?"
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Geoff. I'll start, and then I'll turn it over to Samit. Let me just say at the outset, Geoff, that we're encouraged by what we're seeing with this program. Just a reminder, we're developing Milvexian because there remains high unmet need for patients in anti-coagulation. That's particularly true in atrial fibrillation, where as I think you know, this is an area where 40 million individuals worldwide have atrial fibrillation. And that despite the success of Factor Xa like Eliquis, about 40% of those patients remain on or undertreated due to the risk of bleeding. And we believe Milvexian has the potential to improve the outcome for these patients. The update that we provided today is really intended to give some context to the decision to increase the sample size given the encouraging blended event rates that we're seeing at this point in the study. This is a potentially important medicine. We want to do everything we can to ensure that the program continues to read out in 2027. But before I turn it over to Samit. I want to leave you with, we're encouraged by what we're seeing here, and we look forward to seeing this study come to its outcome in 2027. Samit?"
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thanks, Chris. And Geoff, just extending from where Chris left off from an encouraging point of view, remember where we started the program from. What we have seen from trial in AF, it was very clear that one of the key drivers of the outcome was the dose. . We started the Milvexian program with well-designed Phase 2 studies that led us to pick the right doses for our Phase 3 programs in AF as well as in combination with agents in ACS as well as SSP. Secondly, our event rate is lower compared to what we had designed the study for at the current time. And that gives us the reason to increase the sample size, which you will see the numbers when we update centrals.gov. Thirdly, as we think about why the study was started, the genic study was stopped because the DMC reviewed the data and saw almost more than -- almost 3x the event rate on the investigation arm in that study. Our study is periodically reviewed by the DMC. There are no indications from the DMC that we should go any other route and they are supportive of continuing the study at this time. We truly are encouraged by all of this. And as you know, ACS as well as the SSP programs are slated to read out in 2026, and we are on track for that."
},
{
"speaker": "Operator",
"content": "Next question will come from Carter Gould with Barclays."
},
{
"speaker": "Carter Gould",
"content": "Maybe I don't mean to hammer on it again, but just wanted to follow-up on the prior question for Samit there. With the increased patient enrollment, will there be any shift in the criteria or enrichment of patients away from the -- of our proximal segments. I mean, I appreciate your commentary on what happened to your competitor but at the same conversation at ESC, there was talk about the challenges in those populations given especially what seems to be going on here at the event rate. Any color would be appreciated."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you, Carter. There are no plans to change any of these criteria. We will continue to observe them and the study will continue as is, except for the change in the sample size."
},
{
"speaker": "Operator",
"content": "Next question will come from Mohit Bansal with Wells Fargo."
},
{
"speaker": "Unidentified Analyst",
"content": "This is Serena on for Mohit. We wanted to dig more into the KarXT development plans as it relates to cognition. Perhaps starting with the AD psychosis trial, I was wondering if it will still have the 3x in one day dosing and longer titration period. And then moving on to the cognition trial. Was wondering what this could look like, like would it need to be longer than the emergent studies? And do you plan to enrich for patients cognitively impaired at baseline."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you, Serena, for the question. So we're looking forward to, obviously, the initiation of 3 Phase 3 programs next year, 1 in AD agitation, second in bipolar mania. Third in the AD cognition program. The reason for belief of course, is the dual mechanism of action in terms of M1 and M4 direct agonism that is obviously associated with xanomeline as well as the available data from the old studies that were conducted with xanomeline that already showed the right trend in terms of the cognition improvement in those studies. Your question around the 3x a day dosing right now that is built into the AD psychosis program. We are working on the BID dosing for these patients, and there will be instituted in the new study that we will start in the 3 indications that I talked about as well as we are thinking about how we will institute a bridging program so that we can bring it back into the AD psychosis program as well. Overall, in a good track and certainly looking forward now to the readout of the ARISE study next year."
},
{
"speaker": "Operator",
"content": "Next question will come from Trung Huynh with UBS."
},
{
"speaker": "Trung Huynh",
"content": "Just one on the recent PMRT5 data. We saw an ORR of 21% across the -- a bunch of solid tumors. Can you perhaps talk about efficacy as regard to durability that you're seeing here with the product? And what tumor types are you going to be prioritizing?"
},
{
"speaker": "Samit Hirawat",
"content": "Thank you for the question. Really, actually, very encouraging data from our perspective. We look at it from a breakdown in terms of the tumor types that were enrolled and the 2 that stood out from that program thus far. Our non-small cell lung cancer, where you -- if you look at just the non-small cell lung cancer cohort, the overall response rate is about 31% with a very good durability. The 1 thing to note in that program is that responses do occur late -- so it's more of a long-term duration of control of these patients on the drug and most patients actually have disease control for a very long period. As you saw, the duration of response is already 10.5 months. Then if you take about -- talk about the stable diseases as well, that also constitutes about the similar trajectory from our non-small cell lung cancer population. The second thing that was very encouraging was looking at the pancreatic cancer patient population and at the right doses at the 400 and 600-milligram dose, we saw actually increased response rates, again, a very good durability. Some patients now going all the way almost up to a year. And so those 2 indications look very promising, and we are looking forward to giving you update on next year in terms of the later phase development for this program."
},
{
"speaker": "Operator",
"content": "Next question will come from Steve Scala with Cowen."
},
{
"speaker": "Steve Scala",
"content": "I have 2 points and there are really -- 2 questions. They're just really clarifications but 1 percentage point of Bristol revenue growth is about $500 million. And that's the amount that Bristol is increasing its guidance that's roughly equivalent to what Revlimid. So is the increase solely attributed to Revlimid? And then secondly, and I apologize for going back to asundexian -- but the AFib trial had a lower-than-expected event rate and failed. Why is a lower-than-expected event rate in the Milvexian trial encouraging? It as easily could be a risk, I would think. I understand the DSMB point. So any clarity would be appreciated."
},
{
"speaker": "Chris Boerner",
"content": "Thanks for the question, Steve. I'll ask David to start and then we'll flip over to Samit."
},
{
"speaker": "David Elkins",
"content": "Yes, Steve, thanks for the question. And look, we saw a strong performance in our growth portfolio as we talked about. And that's why we also saw good performance and raised the Revlimid guidance to $5.5 billion, and that caused us to raise the full year outlook 5% growth versus prior year on a reported 6% excluding currency. The other thing I would note, too, is as I said on the call, we have generic entry coming in on Sprycel Abraxane and Pomalyst. The already facing generic as is Pomalyst. So we just want to make sure that people update their models for the additional generic erosion in the fourth quarter. But net-net, when we put all that together, as we said, we raised our revenue guidance as a result."
},
{
"speaker": "Samit Hirawat",
"content": "And Steve, thank you. This is Samit. Great question. Just to recall, if you go back to [indiscernible] study and we look at the event rate for asundexian then we look at the rate for apixaban. Apixaban was 1.03. Asundexian was 2.33, if I remember, and even more so. And then if you think about what we have planned in the Milvexian study is 1.33. So overall, if you think about it, we are looking at a blended event rate as Chris mentioned, which is much lower than the planned event rate. So overall, we are encouraged by this and not necessarily thinking that it's an issue. As I said earlier, DMC continues to look at it, and they are okay with us continuing this study, and we are increasing the sample size."
},
{
"speaker": "Operator",
"content": "Next question will come from Courtney Breen with Bernstein."
},
{
"speaker": "Courtney Breen",
"content": "Another question just on the Covent launch. What I wanted to make sure we were able to understand is because some of the practicalities around kind of a patient receiving a script and kind of the doctor choosing that patient to prescribe to. Can you share some of the context on the warnings and precautions in the label, particularly around liver and how many patients you practically expect to be managed through these challenges? I do note that obviously, there isn't the box label warning, but there are some warnings that require extra physician attention. And so can you just speak to some of those challenges?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Courtney, thanks for the question. Just as you know, Cobenfy offers efficacy that at least as good or better than Zyprexa, without the significant adverse events that have plagued D2s. We keen dyslipidemia, EPS sedation, those are the ones where they lead to the greatest level of discontinuation and why you see patients stop treatment and physicians re-challenge with another agent. We're very pleased with the label, and we're just at the beginning, but the progress and the feedback that we're hearing have been very, very positive. When you look at some of the monitoring that's in the label, remember, the large majority of patients have had recent lab assessments. So we don't anticipate this to be a barrier. In the label, this is recommended. It's not a mandated and lab assessments are very common in this patient population. Most antipsychotics today recommend lab assessments. So we don't see it's an issue for adoption. And when you look at renal impairment in patients with schizophrenia, in the mid-single digits. So taken together, we are very pleased with the efficacy profile that is unique to Cobenfy, based on its mechanism of action and its best-in-category safety profile."
},
{
"speaker": "Samit Hirawat",
"content": "And just to add to what Adam is saying. You will also see the data on longer-term studies, EMERGENT-4 and EMERGENT-5, hundreds of patients who have been treated through those as well. And the safety profile continues to remain the same, but certainly efficacy maintained. So that, in addition, gives us a lot of confidence in the overall profile for Cobenfy as Adam said."
},
{
"speaker": "Operator",
"content": "Next question will come from Seamus Fernandez with Guggenheim Securities."
},
{
"speaker": "Seamus Fernandez",
"content": "Wanted to just get a sense for your enthusiasm for the upcoming data at ACR for your CD19 asset? And how you see the evolution of a potential market for intensive immunologic treatments like this versus the potential for whether it be T-cell engagers or bispecific products with a similar type target profile, but perhaps less efficacy. And then just the second question is on the 2025 dynamics. Just hoping to get maybe a little bit of a better sense of the sort of pushes and pulls on IRA. I know you've said that you expect it to be largely neutral, but it does seem like there are opportunities to potentially increase volume in that context. And I just wanted to clarify whether or not any volume benefits are incorporated into your assumptions around that neutral assumption?"
},
{
"speaker": "Chris Boerner",
"content": "Samit, maybe you can start and then turn it over to Adam."
},
{
"speaker": "Samit Hirawat",
"content": "Thanks, Seamus. Great question. And let me start -- there are 2 parts on the drug side of things. Let's start with our CAR T cell therapies, truly a transformational approach to treatment of autoimmune diseases as we've seen with the emerging data from others -- and now we will have a chance to present our own data. Just remember one thing. We just -- we started our study at the end of November last year. First patient was actually dosed in November of 2023. And so we are looking forward to presentation of that data at ACR, there are a few things that you may want to notice as we present that data. Number one, who are the patients who are enrolled in these studies and what is the severity of the disease that they have been enrolled with. And then secondly, after treatment, what happens to the B cell dynamics in terms of the loss of B cell or depletion of B cells as well as reemergence? And then what is the impact on their remission in terms of stopping the treatment that they were on for immunomodulators, immunosuppressants. And then, of course, what is the safety profile. Remember, many of these patients will have underlying organ damage. And so that will be important to keep in mind as you look at the data. These are small number of patients, but we will be able to update these data again at ASH with additional patients, longer follow-up and even additional indications. Second part of your question was around -- how do you see these as cost to T cell engagers bispecifics. I think that's an important element that we will need to consider and new publications have recently come out using BCMA-directed therapy, and there is a case report for CD19 directed T-cell engager as well in the past. And they look very promising, encouraging. We'll have to see which patients should go on to CAR T cell therapies in the future and which patients should go through with a T-cell engager and bispecifics because bispecifics will require repeated administration at a certain point in time, either weekly, by weekly or every 4 weeks. And we'll have to define then the duration of that treatment. So all of those questions are still to be answered for T cell engagers. You recall we have a BCMA T cell engager that we stopped develop in multiple myeloma. But next year, in 2025, you will see a study -- a couple of studies starting in a couple of indications that we will certainly test out the theory for application of BCMA-directed bispecific in those diseases. Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. So just the question around the changes to the benefit design as it relates to IRA. So with the elimination of the coverage gap, we expect favorability with Eliquis next year due to CAR T redesign with the elimination of the coverage gap. But that's going to be offset largely by products like Revlimid and Pomalyst in the catastrophic phase, where we're now responsible for 20%. So there are pushes and pulls with IRA opportunities, including patient affordability, also with changes in the CAR T benefit design. But taken together, we see this as essentially net neutral across our portfolio."
},
{
"speaker": "Operator",
"content": "The next question will come from Matt Phipps with William Blair."
},
{
"speaker": "Matt Phipps",
"content": "Just wondering how you all view the market opportunity for the GPRC5D CAR T maybe relative to Abecma, given you've now moved the 5D program into a second-line Phase 2 trial, do you think the profile is strong enough to really challenge a BCMA CAR T? Or would it be used after a BCMA CAR T. And Chris, what type of are you going with tonight?"
},
{
"speaker": "Chris Boerner",
"content": "So we'll start with Adam, and Samit, you can chime in as well."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. So, we started the study with our GPRC5D agent will be moving that quickly into Phase 3 registrational trials. We are very encouraged with what we've seen thus far. Remember, this is going to be an important asset that is going to be used after BCMA CAR T treatment is a competitive environment we know. But with a single dose -- and the toxicity profile that we are seeing thus far with GPRC5D we think we have a really great opportunity here with this asset to be another leading cell therapy asset for our company."
},
{
"speaker": "Operator",
"content": "Next question will come from David Risinger with Leerink Partners."
},
{
"speaker": "David Risinger",
"content": "So I'll just keep it to one high-level question, please. So Chris, I think you mentioned a few times on the call that you see Bristol-Myers as a sustainable growth company. Could you just provide some more context on that, your sustainable growth expectations in light of 2026 revenue pressures and the end of the diabetes royalty stream."
},
{
"speaker": "Chris Boerner",
"content": "Thanks for the question, David. Yes. Look, as we have said consistently, our North Star since I took over as CEO in November has been that we execute in the short term and stay focused on building a company that will deliver long-term sustained growth and shareholder value, particularly as we work our way through the middle of the decade exiting with a very strong growth profile towards the end of the decade. And as I think about the way that we continue to build confidence in that, I would say, I'd highlight 3 things. First, we have a young portfolio of growing assets. You've seen that in the quarterly results. And we're squarely focused on continuing to drive performance in this growth profile. We've got products like Cobenfy, which just launched very early in its life cycle. Clearly, schizophrenia is important. You're going to see additional indications, notably the adjunctive indication in 2025. Breyanzi continues to show very solid and strong growth in cell therapy. And remember, that's at the tip of a pipeline of assets we've discussed this morning in fact, that look promising, including CD19 and GPRC5D. We saw continued steady growth for Reblozyl and Camzyos. We would expect that to continue. Those 2 products have line extensions coming up in the next 12 months. And of course, we've talked considerably about Opdualag and nivo subcu providing a foundation for our I-O business through the end of this decade and into the next. And then when you step back from that, the second thing that's encouraging is we continue to see very good progress in our late-stage pipeline. We've talked about Milvexian and the encouraging progress of that program in AFib as well as the 2 other additional indications we're running in parallel. We're excited about LPA1. And remember, we have multiple Phase 2 programs that have demonstrated efficacy and safety for that program. So we're excited to see that play out. Iberdomide and mezigdomide give us opportunities in multiple myeloma. And these are products that have important readouts over the next 12 to 24 months. So we've got continued excitement in the late-stage pipeline. And then across all of our businesses, we've maintained financial discipline. That gives us the ability to have a solid balance sheet. Our P&L looks good, and that gives us strategic flexibility to continue to invest both in our internal program as well as source innovation externally as we did with the Karuna acquisition, for example, in December. So if I add it up, I think those are the core components of how we continue to build conviction in the sustainable growth that we're looking to drive for the company."
},
{
"speaker": "Operator",
"content": "Next question will come from Akash Tewari with Jefferies."
},
{
"speaker": "Akash Tewari",
"content": "Given that there's been reports of J&J shutting down their cardiometabolic division, is there any potential for your team to renegotiate your partnership with them around Milvexian and on subcu Opdivo, your team doesn't seem to be guiding for branded reps beyond the FDA regulatory protection which is a market contract to what Merck is communicating on subcu KEYTRUDA. Any color on why your team seems to be more conservative here?"
},
{
"speaker": "Chris Boerner",
"content": "So do you mind repeating the second question?"
},
{
"speaker": "Akash Tewari",
"content": "In terms of protections around subcu Opdivo in terms of the length of duration versus what Merck is communicating on subcu KEYTRUDA?"
},
{
"speaker": "Chris Boerner",
"content": "Got it. Sorry, we just missed that. So with respect to J&J, no change in our partnership with J&J. J&J has communicated, they continue to be squarely supportive and engaged on the Milvexian program. And in fact, their work on the ongoing Phase 3 programs continues to be very, very good, and we've got a very good relationship with J&J on that program. And then Adam, I'll ask you to take the second."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Regarding the subcu. First, we look forward to the PDUFA date for the nivolumab subcu in late December. Launch planning is progressing very well. And we talked about shifting at least 30% to 40% of the total U.S. Opdivo business, we can do that ahead of the LOE, which is in late 2028. As far as the extension of the I-O franchise. This is what excites us potentially about this product because not only does subcu address the treatment burden for patients and physicians with a 3- to 5-minute fusion time as well as in opposite injection what this is going to do based on the broad patent state for the subcu, it will allow us to extend our franchise into the next decade."
},
{
"speaker": "Operator",
"content": "Next question will come from James Shin with Deutsche Bank."
},
{
"speaker": "James Shin",
"content": "I just want to go back to Milvexian real quick. I really appreciate the update on the stroke and embolism event rates. But was there any separation between the arms? And perhaps even more importantly, do you have any color on bleed rates."
},
{
"speaker": "Samit Hirawat",
"content": "Thank you, James, for the question. Obviously, we can't look at those from a by-arm perspective. This is a blinded study. We don't get to see the data that way. It's a blended event rate that we can talk about and we don't get to the specifics of the general profile of the drug at this time."
},
{
"speaker": "Operator",
"content": "Next question will come from Olivia Brayer with Cantor."
},
{
"speaker": "Olivia Brayer",
"content": "Can you guys talk through what you're looking to see in that adjunctive schizophrenia data set next year? And when you think about uptake in that setting, are you getting any early feedback around potential off-label use from potential early adopters? I mean how big of a market do you think that could realistically be just given the focus on making monotherapy use a standard of care. Also, I just wanted to ask a quick clarification on Milvexian time lines. I know it's still 2027, but should we assume that it's later in the year considering today's update?"
},
{
"speaker": "Chris Boerner",
"content": "Thanks for the questions, Olivia. Maybe we'll ask Samit and Adam to get those questions between the 3 of them."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you. Remember, Olivia, how patients are treated today. With the antipsychotics that are available without even having an approval in the label, patients are being treated with combinations of D2 agonist in this space. So it was important from our perspective to generate the data to showcase efficacy as well as the safety profile of combining [indiscernible] with the background therapies that patients are on. And that's the intent of showing the -- from the ARISE program perspective as an adjunctive therapy, what Cobenfy can deliver on top of the background therapies. That will be important, and that study will read out in 2025. On Milvexian side, from a clarification perspective, the 2027 is an event-driven end point in the trial. So we can't give you a specific in terms of the timing within 2027. That's why we give you a general guidance for 2027 as before."
},
{
"speaker": "Adam Lenkowsky",
"content": "Olivia, thanks. As it relates to adjunctive commercially today, psychotics use to 2 D2s to get greater efficacy and around 20% to 30% of the patients, even though the D2s are not FDA approved for adjunctive treatment, we do believe that Cobenfy could be an important adjunctive treatment option. Samit talked about the ARISE study, and we're working to generate evidence on this. And pharmacologically, it makes sense adding an M1 and M4 on top of a D2 because, again, we think there could be synergistic effects there. So we're excited to see the study readout. Just to be clear, though, our teams are focused on driving on-label use in schizophrenia to make Cobenfy standard of care there. And we can't -- it's not going to be our choice, but patients may or may not choose to use Cobenfy off-label because of the safety profile of the product. But we're really excited for the data readout next year in Juno schizophrenia as well as some of the other data readout that Samit talked about how Alzheimer's psychosis, these are going to be important accelerators of growth for this product."
},
{
"speaker": "Chris Boerner",
"content": "And I would just remind you what Adam ended on is really important, which is that -- this is a product that, obviously, we're super excited about the initial indication in schizophrenia. We've got the adjunctive data coming, but this is a product that will continue to generate new line extensions with a very robust clinical development plan that we put in place for it."
},
{
"speaker": "Operator",
"content": "Next question will come from Sean McCutchen with Raymond James."
},
{
"speaker": "Sean McCutchen",
"content": "One more on Cobenfy. Can you speak to your view on the import of the M1 component for Cobenfy as it relates to potentially driving targeted improvements in schizophrenia in particular, what proportion of the population have cognitive deficits. Do you expect these patients to be kind of parsed out in the monotherapy setting or post atypical or in the setting? And what are your comments to those that are looking at the BID regimen and GI adverse effects as potential barriers on ease of use in this patient population where compliance or lack thereof is a significant variable when thinking about your competitors that are coming up behind you."
},
{
"speaker": "Chris Boerner",
"content": "Samit will take the first part and then Adam."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you. Remember, the differentiating feature for Cobenfy is that it's a dual direct agonist as opposed to some of the other therapies in development that target the M4 to indirect ways because they are allosteric modulators, which require a ligand such as [indiscernible] to be present in the brain. And M1 is a very important component because from a biological perspective, that is associated with cognition function in the brain. And so having a direct impact on M1 as well as M4 gives us that opportunity to really impact the cognition -- and during the overall life cycle, as we think about the Alzheimer's disease patients as they go through it, cognition does become important in terms of the impact on the patient and patient life and quality of life. So there's a large proportion of patients who will have cognitive impairment and will be eligible if the data reads out positive to be treated with the drug. So overall, that's why we've developed a program in all 3 parts of AD that impact from a psychosis perspective, agitation perspective as well as recognition perspective. Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. So it relates to the dosing regimen for that step back and just talk about the leading cause of discontinuation. Number 1 is efficacy and Cobenfy delivers unsurpassed efficacy, efficacy that's at least as good as a Zyprexa and the other areas of high-level discontinuation include areas like weight gain, include infections, dysfunction, trouble concentrating, excessive sedation. And so now physicians don't need to trade that off. People living with schizophrenia commonly managed multiple medications at significantly higher rates than the general population. In fact, when you look at patients with schizophrenia, they're on average 7 pills a day which includes our antipsychotic. It could include different psychotropic medications, including anti-depressants, anti-anxiety medications as well as medicines to combat the adverse events of their existing products. So yes, we're going to need to manage this, but we don't believe that this will impact uptake based on the unprecedented efficacy that has shown. Last thing I'd mention is we saw very low discontinuation rates in our clinical trial due to the fact that patients that robust efficacy that the product is well tolerated and we will provide support to both patients and caregivers to maximize compliance with --."
},
{
"speaker": "Chuck Triano",
"content": "I know you all have a busy morning in the space. So we'll take our last question, and then we'll turn it to Chris for some brief closing remarks."
},
{
"speaker": "Operator",
"content": "The last question will come from Srikripa Devarakonda with Truist Securities."
},
{
"speaker": "Srikripa Devarakonda",
"content": "Congrats on the quarter today. I'll switch gears and not ask a Cobenfy question. I want to ask a question about your [indiscernible] program. You've recently published data from a Phase 2 with mavacamten. Can you talk about how this translates to 2 to 4, which I think is the drug you've indicated as the HFpEF drug? And what percentage -- like how big of a market do you see? And can you remind us of the time lines for this program?"
},
{
"speaker": "Samit Hirawat",
"content": "Thank you, for the question. HFpEF is an important indication. We've always indicated that as we think about myosin cardiac inhibitors, with the impact that it does have on the cardiac function and remodeling in general, there is an important element that we wanted to test out, which we first tested out with mavacamten in a small number of patients, which gave us an inkling into the -- through the biomarker work that we did over there through NT-proBNP as well as [indiscernible] measurement, which gives us confidence to continue with that program. We switched over to MYK-224, which was the second program that was available to us, and that's the beauty of having 2 cardiac myosin inhibitors in the programs. And -- that trial is enrolling very well. We are now extending that trial in terms of the Phase 2a study to enroll more patients to generate the data. We anticipate that, that Phase 2 data readout in the next couple of years and then start the Phase 3 program based on the doses that we have identified in that Phase 2 program. And then in the early part of next decade is when we anticipate to really have the Phase 3s reading out. We don't have a time line specifically in terms of the year -- but really excited to see what we have seen thus far and looking forward to initiation."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. As far as the opportunity, this is a large opportunity where heat affects around 3 million people in the United States and that is expected to grow significantly over the course of the decade. In fact, the heart failure drugs, the category is valued at over $12 billion in 2022, and we expect this to almost double by 2032. So this is a significant opportunity, and we're really pleased with what we're seeing early on with MYK-224."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Adam. Well, thanks, everyone, for joining us for the call today and for the very thoughtful questions. Maybe I'll just leave you with a few thoughts on the performance for the quarter. First, as you hopefully have gotten from the discussion, we remain very focused on execution. The growth portfolio is now, as David mentioned, contributing nearly half of our total revenue -- and that profile continues to benefit from robust demand for key products, products like Reblozyl, Breyanzi, Camzyos and Opdualag. Second, the Cobenfy approval is a pivotal achievement. We've been working hard to deliver that since we closed the Karuna transaction. And this is an important medicine for patients, and it's an important growth driver for the portfolio. Third, we continue to advance our innovative pipeline across therapeutic areas. We've had several important readouts over the course of the year, and we have a few more coming between now and the end of the year as well as beginning of next year. And then finally, again, as you hopefully gathered, our commitment to operational excellence is yielding results, and we're going to remain focused on driving value across the organization. So thanks again for your time today. And as always, the team is available for follow-up questions, and have a great rest of the day."
},
{
"speaker": "Operator",
"content": "The conference is now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
bmy | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the Bristol Myers Squibb Second Quarter 2024 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, today's event is being recorded. I would now like to turn the conference over to Tim Power, Vice President, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Tim Power",
"content": "Thank you, and good morning, everyone. Thanks for joining us this morning for our second quarter 2024 earnings call. Joining me this morning with prepared remarks are Chris Boerner, our Board Chair and Chief Executive Officer; and David Elkins, our Chief Financial Officer. Also participating in today's call are Adam Lenkowsky, our Chief Commercialization Officer and Samit Hirawat, our Chief Medical Officer and Head of Global Drug Development. As you'll note, we've posted slides to bms.com that you can use to follow along with Chris and David's remarks. Before we get started, I'll read our forward-looking statement. During this call, we make statements about the company's future plans and prospects to constitute forward-looking statements. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in the company's SEC filings. These forward-looking statements represent our estimates as of today and should not be relied upon as representing our estimates as of any future date. We specifically disclaim any obligation to update forward-looking statements even if our estimates change. We'll also focus our comments on our non-GAAP financial measures, which are adjusted to exclude certain specified items. Reconciliations of certain non-GAAP financial measures to the most comparable GAAP measures are available at bms.com. And with that, I'll hand it over to Chris."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Tim, and thanks everyone for joining us this morning. Starting on Slide 4, our second quarter results reflect continued progress against our strategy to position BMS for long-term sustainable growth. In Q2, we continued to strengthen commercial performance with uptake accelerating across a number of our marketed products. Growth portfolio revenues increased 18% year-over-year or 21% excluding the impact of foreign exchange. This portfolio is on track to be a larger component of our overall mix moving forward. We also advanced our pipeline, demonstrating the strength of our portfolio and the development of our first or best-in-class assets. This includes US regulatory approvals for Breyanzi, Krazati and Augtyro. We also achieved a number of milestones this quarter for our I-O franchise, including European approval in first-line bladder cancer, presented data at ASCO in first-line liver cancer and are progressing to a more convenient subcutaneous formulation of nivolumab where we now have a PDUFA date from the US FDA of December 29th. The EMA is also reviewing our subcu application. Before we get into more details around quarterly performance, on Slide 5, I'd like to step-back and take stock of where we are as a company and where we are headed. As discussed previously, we are focusing on reshaping BMS to achieve sustained top-tier growth and maximize long-term value. We're doing this by focusing on three key objectives. First, we are focusing our portfolio on transformational medicines where we have a competitive advantage. This means advancing and, where possible, accelerating first or best-in-class treatments across our therapeutic areas, prioritizing pipeline assets with meaningful growth potential and discontinuing programs that no longer meet our threshold for return on investment. Through these actions, we are ensuring our R&D efforts are focused on programs where BMS has a right to win and where we can deliver compelling ROI to shareholders. Second, we are actively driving greater operational excellence throughout the organization. This includes streamlining our operations and focusing the organization on what matters most, becoming more efficient in how we operate, improving R&D productivity and driving a culture that emphasizes speed and accountability. We're executing on our cost-reduction efforts and are on track to achieve the $1.5 billion in cost savings we announced in Q1. Third, we are strategically allocating capital for long-term growth and returns. We remain focused on ensuring we are investing behind our growth portfolio and most critical pipeline assets. Business development and partnerships remain important for us and we continued to strengthen our balance sheet while maintaining our commitment to returning cash to shareholders. Taken together, these actions are ensuring we are focused on the highest-value activities across the organization, tightening our execution where needed and accelerating our ability to deliver important medicines to patients. On that note, turning to Slide 6. Our objective of generating top-tier growth requires us to deliver on the potential of our pipeline. In hematology-oncology, we are driving leadership by extending our IO business and broadening our focus to include cell therapies and protein degraders. We have also expanded into ADCs and radiopharmaceuticals. In cardiovascular, we are leveraging decades of expertise to deliver new treatment options in thrombosis, heart failure and cardiomyopathies. In immunology, we're focusing our R&D efforts on therapies that reset the immune system with a potentially transformational program in cell therapy. And finally, we are re-establishing our presence in neuroscience, starting with KarXT in neuropsychiatry, followed by an exciting pipeline in neurodegeneration, which continues to advance nicely. On Slide 7, let me update you on our progress with KarXT specifically. We have two main objectives, preparing for the upcoming launch and executing against a robust clinical program to expand this important therapy into multiple indications. We are rapidly building out the necessary infrastructure ahead of KarXT's anticipated FDA approval in late September. We're excited about the commercial potential for this product. Adam can speak more about our launch prep in Q&A. As previously discussed, we are also expanding KarXT to additional indications with data expected in adjunctive schizophrenia in 2025 and Alzheimer's disease psychosis in 2026. Our plans to start trials in both Alzheimer's agitation and bipolar disorder are on track. Finally, we have also initiated planning for two new indications for this product in autism spectrum disorders and Alzheimer's cognition. On Slide 8, I want to highlight a few important pipeline milestones across our therapeutic areas this year. In hematology-oncology, we're extending our I-O franchise with nivolumab subcu and lung data for Opdualag. With the anticipated launch of the subcutaneous formulation of nivolumab at the end of this year, we continue to estimate that at least 30% to 40% of US patients being treated with IV will convert to the more convenient subcutaneous administration across multiple indications. This ultimately allows patients to benefit from the standard-of-care cancer medicine into the next decade. With Opdualag, we plan to share Phase 2 proof-of-concept data soon. This supports initiation of a Phase 3 study in a subset of patients with first-line non-small cell lung cancer later this year. In immunology, we expect to see data this year for CD19 NEX-T. By resetting the immune system, we believe this therapy can deliver meaningful benefits for patients across multiple indications. We have also completed enrollment of our two Phase 3 trials for Sotyktu in psoriatic arthritis and now expect to see data later this year. Looking ahead, on Slide 9, we will begin to see important data readouts for our pipeline in the second half of this year with momentum building through 2026. A few to focus on include LPA1 in pulmonary fibrosis, our registrational multiple myeloma pipeline, including GPRC5D cell therapy and our CELMoDs, iberdomide and mezigdomide and, of course, Milvexian, which has the potential to be the only oral factor 11A inhibitor in atrial fibrillation. All have the potential to deliver significant benefits for patients and form a large commercial opportunity for the company. With increasing pipeline momentum, we are confident in our ability to further strengthen our growth profile. Let me close with our outlook on Slide 10. Given the strength of our Q2 results and the confidence we have in the remainder of the year, we now expect to deliver top-line growth at the upper end of our guidance range. We are also raising our guidance range for full-year EPS. David will discuss these updates in more detail shortly. Let me summarize by noting that in Q2, we took notable steps forward on our journey to drive sustained long-term growth. While there is more work to do, we are strengthening the foundation for that growth by progressing what is a catalyst-rich pipeline, growing our commercial portfolio and maintaining a strong balance sheet that provides strategic flexibility. I want to thank the employees of BMS for their contributions in the quarter and their commitment to delivering breakthrough medicines to more patients even faster. Let me now hand it over to David."
},
{
"speaker": "David Elkins",
"content": "Thank you, Chris, and good morning, everyone. I will begin with the highlights of our quarterly sales results on Slide 12. Let me start with a brief reminder that unless otherwise stated, all comparisons are made from the same period in 2023 and sales growth rates will be discussed on an underlying basis, which excludes the impact of foreign exchange. All references to our P&L are on a non-GAAP basis. Our performance during the second quarter reflects focused execution across the business, including a 21% increase in our growth portfolio and a 3% growth in our legacy portfolio. The growth portfolio continued to increase as a proportion of our total sales and now represents about 46% of the business. Expenses during the quarter came in more favorable than expected, reflecting our focus on driving operational excellence and timing of spend, resulting in a slightly higher operating margin of roughly 40%. These results support our positive outlook for 2024 and our updated financial guidance. Second quarter sales performance across our key therapeutic areas reflect continued momentum for several important growth brands, including Reblozyl, Camzyos, Breyanzi and Opdualag. While we saw growth across our immunology business, we recognize there's still more work to do, particularly with Sotyktu in this highly competitive category. There were also some inventory and gross-to-net favorability across several growth brands this quarter, which will be important to take into consideration when phasing sales in the second half of the year. Let's take a closer look at our key brand performance, starting with our oncology franchise on Slide 13. Opdivo remains an important product within our immuno-oncology business. Sequentially, global sales were up driven by demand and an estimated benefit of $65 million related to customer buying patterns in the US. We expect growth this year to be in the mid-single-digit range as core indications mature and we await additional regulatory actions, including FDA approval in the periadjuvant lung expected in October. And our I-O franchise is further strengthened with Opdualag, which delivered another quarter of double-digit growth, driven primarily by higher demand. Outside the US, we see encouraging trends across several newly-launched markets and remain focused on securing reimbursement. As we said previously, we are pursuing further development of Opdualag in a segment of first-line lung cancer and we remain on track to initiate our Phase 3 registrational program later this year. These expansion opportunities, coupled with the pending approval of nivolumab subcu further support extension of our I-O franchise into the next decade. In cardiovascular, on Slide 14, Eliquis remains the market leader anti-coagulant worldwide with global sales of more than $3 billion. In the US, sales were primarily driven by higher demand and market share gains. Sequentially, as is typical in the second quarter, US sales reflect an unfavorable gross-to-net impact as patients begin to enter Medicare Coverage Gap. As a reminder, these dynamics are more acute in the second half of the year, resulting in lower sales versus the first half. Turning to Camzyos, second quarter sales more than tripled compared to the prior year. Sequentially, US sales were driven mainly by demand. US demand in the second quarter was led by an increase of approximately 1,300 commercially dispensed patients since Q1, bringing the total to almost 6,900 patients on commercial drug. This growth demonstrates steady and consistent adoption. Outside the US, sales growth reflects the timing of reimbursement in approved markets and, globally, we see significant room for future growth. Let's turn to hematology on Slide 15. Sales of Reblozyl in the quarter grew 82% with growth in both US and international markets. In the US, sales benefited from higher demand, driven by first-line MDS associated anemia and some favorable inventory in gross-to-nets. Outside the US, the brand is approved in approximately 40 countries, including recent broad-label introductions in Europe and Japan. We look forward to seeing the first-line indication reimbursed across the globe. In cell therapy, we saw quarter-over-quarter sales growth with Abecma, driven largely by ex-US. We continue to work through the competitive dynamics in multiple myeloma by discussing our KarMMa-3 data with customers. Breyanzi grew 55% in the quarter, which was driven by growth across multiple indications and expanded manufacturing capacity. International sales growth reflected strong demand in markets such as Germany, France and Japan. Now moving to immunology on Slide 16. Performance of Sotyktu continued to be impacted by competitive environment and the quality of commercial access in the US. At the same time, during Q2, we achieved improved commercial access across multiple large PBMs with zero step edits. And starting earlier this month, we added another large PBM as we discussed last quarter. We now have greater than 60% of covered lives with favorable access. As a result, in the near term, we anticipate modest incremental gross-to-net pressure on revenue growth, which will be offset by demand growth over time. Now turning to Slide 17, I will highlight some components of the P&L. In addition to solid commercial execution, our second quarter performance reflects a focus on financial discipline and steady progress against our $1.5 billion cost savings program we discussed on last quarter's call. As a reminder, we plan to reinvest the cost savings into higher growth opportunities to drive greater patient impact and accelerate our sales growth in the second half of the decade. Gross margin came in favorable this quarter, driven primarily by product mix. Operating expenses, excluding in-process R&D were impacted by higher deal-related spend, partially offset by cost savings related to our efficiency initiatives and the timing of planned expenditures. On a sequential basis, expenses came in lower than anticipated due to timing of planned investment spend that shifted to the third quarter. Our tax rate in the quarter changed from 16.9% in the prior year to 14.1%, primarily due to a release of income tax reserve. Overall, earnings per share was $2.07 in the quarter. Now moving to the balance sheet and capital allocation highlights on Slide 18. Both our growth and legacy portfolios delivered solid revenue growth in the quarter. With legacy continuing to contribute to our robust operating cash flow of approximately $2.3 billion. And we closed the quarter on June 30th, we had approximately $7 billion in cash, cash equivalents and marketable debt securities on hand. During the second quarter, we reduced our total debt position by $3.1 billion, including roughly $2.7 billion of commercial paper and $400 million of long-term debt. These actions are consistent with our plan to pay down approximately $10 billion of debt over the next two years. In terms of capital allocation, we are prioritizing opportunities that will further strengthen our long-term growth outlook, while remaining committed to our dividend. Please turn to Slide 19 to walk through the details of our guidance. On Q2 performance, focused execution across the business generated top-line growth and driving operational excellence. These results provided support for updated full-year guidance. As is our practice, we provide revenue guidance on a reported basis as well as on an underlying basis, which assumes currency remains consistent with prior year. Our guidance for the full-year revenue is now low single-digit growth, which we now expect to come in at the upper end of the range. This is due to the continued performance of our growth portfolio and better-than-expected sales of Revlimid. With respect to gross margin, we are raising our guidance to reflect the impact of sales mix. Excluding acquired and process R&D, we continue to expect our total operating expenses to be at the upper end of low-single-digit percentage increase range. This reflects incremental costs associated with the recent acquisitions, partially offset by the realization of savings due to our productivity initiative. Given the delay in timing of anticipated expenses in Q2 , we now expect a step-up in Q3. Overall, our previous operating margin target of at least 37% for the full year remains unchanged. For OI&E, we now expect annual expenses of approximately $50 million due to higher-than-anticipated estimated royalties and favorable net interest expense. The annual tax rate will be affected by one-time nondeductible expenses of Karuna acquired in-process R&D charge, which impacted our non-GAAP net income in the first quarter. Excluding this impact, the estimated underlying tax rate for the full year is still expected to be about 18%. As a result of these changes, we are raising the range of our 2024 non-GAAP EPS guidance to between $0.60 and $0.90. Let's walk through the phasing of our sales for the full year. Year-to-date, our growth portfolio has grown approximately 16% and we anticipate a similar rate of growth in the second half. In relation to phasing of product sales in the back half of the year, keep in mind, the typical product seasonality we expect to see in the business in the third quarter. Also, we had roughly $150 million in stocking in the second quarter and we anticipate reversing in Q3. Normalization of these dynamics next quarter will likely temper sequential growth. However, as a result of these dynamics and the strength of our underlying business, we expect strong growth across the portfolio in the fourth quarter. And for Revlimid, while we continue to monitor variability from generics and other dynamics, we now expect full-year sales to be at the higher end of our $4.5 billion to $5 billion sales range. In closing, we have entered the second half of 2024 with sales momentum building in key brands and financial discipline driving a leaner and more agile organization. And as Chris said, we are excited about the long-term opportunity ahead of our emerging neuroscience platform, with the anticipated FDA approval of KarXT in September. We are committed to investing in high-growth areas where we have competitive advantages to meet the needs of our patients. And with that, I'll now turn the call over to Tim for Q&A."
},
{
"speaker": "Tim Power",
"content": "Thanks, David. Rocco, could we go to the first question, please?"
},
{
"speaker": "Operator",
"content": "Absolutely. [Operator Instructions] Today's first question comes from Chris Schott at JPMorgan. Please go ahead."
},
{
"speaker": "Chris Schott",
"content": "Great. Thanks so much. Just two quick questions here. Maybe the first one is, can you just talk about the immunology portfolio and how to think about pricing going forward? I know you mentioned that there's some modest incremental price pressure on Sotyktu, given the broader access. But once that rolls out, I guess, as we think about the second half of this year, is that a good run rate to think about price for immunology or when we consider further access competitive environment, is this a business that likely continues to see price erosion over time? The second question I had was just on IRA. I know we're all kind of waiting on the price disclosure on Eliquis, but is there any just directional color you can share of just in terms of how negotiations went, any surprises, just how you think about IRA price negotiations more broadly as you're thinking about the portfolio and kind of markets you're competing, et cetera, just anything you could share on that front or do we just have to wait till that disclosure, I guess, in a month or so, but I appreciate it. Thank you."
},
{
"speaker": "David Elkins",
"content": "Thanks, Chris. Maybe I'll start with your second question, then I'll flip it to Adam. So as expected, we've received the government's final MFP price for Eliquis. And as is consistent with what we've discussed previously, we anticipate CMS is going to publish the MFP price either on or before September 1st. And once that happens, we look forward to providing you more color on the impact of MFP on the shape of the Eliquis business. What I'll say today, now that we have seen the final price, we're increasingly confident in our ability to navigate the impact of IRA on Eliquis. Eliquis is an important drug for patients. It's going to continue to be an important drug for the company in the short-to-medium term. If we step back from Eliquis though, I want to continue to emphasize that we firmly oppose government price setting under IRA. We continue to believe that arbitrary price setting by the government on life-saving medicines is not good public policy. So irrespective of short-term dynamics, we remain very concerned about the long-term implications of IRA on innovation, but we'll be able to give you more color on Eliquis once we get that price published, which we anticipate in the coming weeks and certainly before September 1st. Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah, Chris, thanks for the question. Just more broadly in immunology, we know this is a highly competitive and highly rebated category and we're making good progress across a number of our key products as you heard from David and Chris in our growth portfolio as well as in immunology. Now, I have to acknowledge that Sotyktu performance has been slower than we'd like, but we're focused on improving that. We're executing our plan where a key focus has been on improving our access position. As David mentioned, we're continuing to make significant progress in that area. We came into the year with 25% unrestricted access and we had that through roughly the first half of the year. As we move into the back half of the year, essentially effective July 1st, we more than doubled that. We now have approximately 65% access, the majority of which is zero step edits. And so that's about over 100 million lives now and we expect further access improvements in January. So obviously, that's important because we'll see new patients move faster onto commercial product, we'll work to move patients quickly out of our bridge program and onto commercial product and we'll see much fewer patients attrit at the specialty pharmacy. We'll also see, as David mentioned, a modest increase in gross-to-net due to the rebates required for improved access, offset by increased volume. As a reminder, in Q2, we had a one-time negative impact of about $6 million due to a gross-to-net true-up. So as we exit the year with our expanded access, we're going to be in a much better position versus where we started this year, which will give us a lot of momentum as we move into 2025, and we're committed to making this a big product for the company."
},
{
"speaker": "Tim Power",
"content": "Thanks, Adam. Rocco, can we go to the next question, please?"
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question is from Luisa Hector with Berenberg. Please go ahead."
},
{
"speaker": "Luisa Hector",
"content": "Hello, thank you for taking my questions. I just wondered whether you could describe where the $150 million stocking benefit occurred across which products in Q2? And then perhaps a question on cendakimab. So good to see the positive readout there. Could you tell us how soon you might be able to file and perhaps how you can position this and some sort of color around the access and the launch ramp sort of piggybacking on your comments on Sotyktu. So how should we think about the potential launch there? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Luisa. I'll ask David to start and then Samit and Adam can address the question on cendakimab."
},
{
"speaker": "David Elkins",
"content": "Yeah, Luisa, thanks for the question. On the inventory, that's really in the I-O franchise across Opdivo and Yervoy, but as well there are some in our immunology franchise of Orencia and Zeposia."
},
{
"speaker": "Samit Hirawat",
"content": "Thanks, David, and thank you for the question. For cendakimab, we have a positive Phase 3 study that read out just recently. The trial met both its primary endpoints on dysphagia days as well as the eosinophilic count decrease, and it also met the secondary endpoints, but we've just received the data in our hands. So we are doing a deep-dive on that. And as we look at the data, we will, of course, take into account when the data will be presented at the medical conference as well as take into account what the landscape is in terms of how patients are treated today and as we plan for the next steps for cendakimab. From a commercial perspective, let me pass it on to Adam, who can then comment on that as well."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah. Luisa, thank you for the question. So we're obviously pleased with the positive Phase 3 study for cendakimab. It's early days and so we look forward to presenting the data. But just roughly when you look in the US, there are about 300,000 treated patients. Treatment rates in EOE are pretty low in the United States. In fact, first-line treatment rate is around 4% and that increases as you go down lines of therapy to third line, which about a third of patients are treated. And the majority of patients are on conventional therapies like PPIs, steroids and then they are treated with Dupixent. And so as Samit mentioned, dysphagia days are important for patients as also the potential for remodeling here. And this is a market where payers are managing about half of the lives in the US, so we expect in -- majority of lives to be positioned behind Dupixent. And again, we look forward to sharing the data with regulatory authorities and presenting at an upcoming meeting."
},
{
"speaker": "Tim Power",
"content": "Thanks, Adam. Let's go to the next question, please, Rocco."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question comes from Chris Shibutani with Goldman Sachs. Please go ahead."
},
{
"speaker": "Chris Shibutani",
"content": "Good morning. Thank you very much. Chris, you and the team have been much more aggressive on the business development front over the last six to nine months and you've had to make some really thoughtful decisions about prioritizing programs so that the costs don't overrun. What's your capacity now? And in particular, what's your appetite, noting that historically Bristol has been in cardiovascular disease, metabolic and just a requisite question about any interest in the obesity and obesity adjacent realms? Thank you so much."
},
{
"speaker": "Chris Boerner",
"content": "Sure. Thanks for the questions, Chris. Maybe I will start and then I'll turn it over to David who can speak to the capacity a bit. Well, as expected, we continue to prioritize business development. It's, as you point out, something that we've certainly had as a priority going back to when we did the deals at the end of last year. I would say our priority right now is to execute the deals that we completed seven months ago. Notable among that is we're actively preparing for the KarXT launch, hopefully in September, and certainly, Adam can speak to that. As David also mentioned, I would highlight that we're also focused on paying down the debt as a top priority. Beyond that though, business development and partnerships are going to be continue -- continue to be important to us in terms of the types of deals that we're interested in. Obviously, they have to make strategic and financial sense as a first order. We're going to continue to be disciplined there. As I mentioned in my prepared remarks, you saw the therapeutic areas and modalities that we're focused on and where we feel we have a right to win. So those would be primarily the areas of focus for business development. And then the requisite question on obesity, I'll get to in a second, but there's also a requisite question on size of deal. I would think about bolt-on deals and partnerships as being the priority for us in the immediate term. And look, we're going to continue to monitor the obesity market, but I would say with respect to business development for us right now, I would focus on those areas that I highlighted in my prepared remarks. David?"
},
{
"speaker": "David Elkins",
"content": "Chris, I think you covered it well. The only thing I'd emphasize as we think about capital allocation overall besides the debt paydown is we remain firmly committed to the dividend as evidenced by us paying a dividend for the past 92 years and increasing it the last 15 years. And as you know, we have one of the lowest payout ratios of our peer group. So overall, we remain very financially disciplined from a capital allocation perspective."
},
{
"speaker": "Tim Power",
"content": "Great. Thanks, David. Can we go to the next question, please, Rocco?"
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question today comes from Tim Anderson of Wolfe Research. Please go ahead."
},
{
"speaker": "Tim Anderson",
"content": "Thank you. Can I go back to the IRA stuff for a moment? There's no formal gag order preventing drug companies from talking about ongoing price negotiations. I'm told CMS has asked drug companies to keep quiet nonetheless and all the drug companies have been complying with that, including Bristol, and I'm trying to figure out why would drug companies comply with that request and really kind of keep it quiet ahead of the coming announcement. And then second, we might actually be getting that announcement much earlier than people are thinking possibly in the next week or so ahead of the congressional recess. If that update does come earlier, can we assume that you'll provide your update shortly thereafter, so meaning possibly in the next couple of weeks if the news were to come earlier?"
},
{
"speaker": "Chris Boerner",
"content": "Sure. Thanks for the questions, Tim. So first, we've been consistent that we're going to only speak to the specifics of MFD once we have the -- once we have CMS having published, which we anticipate being on or before September 1st. What I'll say is once that price is disclosed, we're going to be able to provide a very good picture of the shape of the business for Eliquis going forward, inclusive of the impact of IRA. And we very much look forward to being able to provide that clarity. And again, what I would emphasize is based on having seen the price, we're very confident in our ability to navigate the impact of IRA on Eliquis. And so again, we'll provide more details when that price becomes public. And one other point is, we will provide once that becomes public is we will announce earlier if CMS comes before September 1st and we'll put what we anticipate around IRA and its impact on our IR website, and so that's how we'll be communicating that."
},
{
"speaker": "Tim Power",
"content": "Great. Let's go to the next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question comes from Evan Seigerman with BMO Capital Markets. Please go ahead."
},
{
"speaker": "Evan Seigerman",
"content": "Hi, guys. Thank you so much for taking my question. Two for me. So Adam, can you walk me through some of the key launch preparations you're taking for the launch of KarXT that will help you capitalize on your competitive headstart? And then on the IRA/trough earnings, I'm not going to push on the price, but what else do you need to know or need to have in hand to really be able to help us understand kind of when these trough earnings that we've been talking about and when you'll be able to provide kind of when that happens? Thank you guys so much."
},
{
"speaker": "Chris Boerner",
"content": "Sure. So why don't I let Adam start on KarXT and then I'll take your second question."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah, Evan, thank you for the question. So we're excited about the launch of KarXT as this is a very important drug with significant commercial potential as we shared. Reminder, given a late September and Q4 launch, we effectively see this as a 2025 launch and KarXT is going to be the first innovative therapy in schizophrenia approved for decades. So let me talk a little bit about how we are preparing for the launch. And I'll focus on a few key areas. Number one, we're sourcing a very experienced field sales and strong medical organizations to prepare the market for this new mechanism. Secondly, the access team that we have, have been out there for months, reinforcing the profile with state Medicaid directors and Medicare payers. Just as a reminder, the schizophrenia market is very different in terms of access in markets that are highly PBM-driven. Government payers will be critical to building access for this product since the patient population is greater than 80% Medicaid and Medicare. We've received very positive feedback from thought leaders and payers in the space that KarXT fills a significant unmet need. And the third area that I'll highlight is we need to ensure that physicians and patients have a positive first experience. This is a new mechanism with a different profile and ensuring that patients stay on treatment. So overall, we're pleased to launch Readiness Efforts and we look forward to launching this important medicine later this year."
},
{
"speaker": "Samit Hirawat",
"content": "Yeah, thank you, Adam. I just want to add a couple of things, Evan. Samit here. In addition to looking forward to the approval in September, we are also executing on the overall development plan for KarXT, as you know, adjunctive schizophrenia study as well as the Alzheimer's disease associated psycho studies are ongoing and they're enrolling well. We look forward to data readouts in 2025 and 2026. We anticipate initiation of the Phase 3 trials in bipolar disorder as well as Alzheimer's agitation also in 2025 with a BID dosing and then also preparing to start the Phase 3 study, Alzheimer's disease cognition impairment also in 2025. In addition to that, we are now making the preparations for the autism studies, which will include children, so we need to do some work on that, but really a large program that is being initiated and executed right now."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Samit. Now Evan, going back to your question on trough. I'll redirect you back to the comments that I made at the beginning of the year. We've talked about navigating a period that starts in 2026. Now having said that, our focus continues to be on improving the shape of the business over time. And the good news is we have a lot of strategic levers to pull. We have a growing portfolio of young assets. We saw good growth in the first half and we expect good growth in the back half. We have new products launching, notably KarXT and nivo subcu this year. Those are going to be important in terms of describing the shape of our business longer-term. We have late-stage pipeline assets that are reading out starting this year and accelerating through next year and into 2026. And as we've discussed over time, these have considerable commercial potential. We have some very interesting early programs. We're going to start seeing proof-of-concept starting this year, notably CD19 NEX-T. And of course, as David has mentioned already today, we have a very good balance sheet and the capacity to do smart partnerships and business development. So those are a number of the things that are obviously going to shape how this business looks in the back half of the decade. And we're fixated on delivering across the business in the short-term as well as pulling the strategic levers I just mentioned that are going to be needed to accelerate the timing and pace of growth for the company in the back half of the decade."
},
{
"speaker": "Tim Power",
"content": "Let's go to the next question, please, Rocco."
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question today comes from Carter Gould with Barclays. Please go ahead."
},
{
"speaker": "Carter Gould",
"content": "Hi. Good morning. Thanks for taking the questions. Maybe one for Adam. You had a really nice quarter in Breyanzi, you highlighted some of the drivers there. Can you maybe, you know, compartmentalize that a bit and help us think about then the second half of the year as we think about both those new indications, but also the step-up in supply? Just again given sort of the reset in 2Q, additional color here would be pretty helpful."
},
{
"speaker": "Chris Boerner",
"content": "Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah, Carter, thank you for the question. We're pleased with Breyanzi performance in the quarter. Remember, in Q1, we said we expected significant improved manufacturing capacity and also a tailwind from our new indications. So in the second quarter, as David shared, sales increased over 50% versus prior year and we anticipate that to continue through the remainder of the year. We expect continued strong growth to be driven first by our lead indication in LBCL as Breyanzi is increasingly recognized as the best-in-class CD19 as well as by our expanded indications, which are off to a very good start. We're also pleased and I want to acknowledge and thank our GPS organization with our expanded manufacturing capacity. We're now in a much stronger position to meet demand in the market. And so taken together our recent approvals, our expanded manufacturing capacity and best-in-class will enable us to compete much more effectively to win in this market."
},
{
"speaker": "Carter Gould",
"content": "Thanks, Adam."
},
{
"speaker": "Tim Power",
"content": "Okay, let's go to the next question, please, Rocco."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question comes from Seamus Fernandez with Guggenheim Securities. Please go ahead ."
},
{
"speaker": "Seamus Fernandez",
"content": "Great. Thanks for the question. So a couple of quick ones. Samit, you have a number of clinical readouts coming in multiple myeloma with your CELMoD portfolio in 2026. Just hoping you could help us understand how you see those products potentially commercially or maybe not commercially, but clinically positioned relative to the very increasingly crowded landscape that we see today. And then the second question actually hearkens back a little bit to IRA, but more so to Part-D redesign. Can you guys help us understand how the Part-D redesign dynamics that are likely to materially impact the substantial payout that you make on Eliquis is likely to be offset negatively by the impact of the catastrophic cap that comes in, in 2025? And at what point will you seek to educate the market on those pushes and pulls in 2025? Will that fall with the IRA negotiation effects or will it fall, you know, simply with 2025 guidance? Thanks."
},
{
"speaker": "Chris Boerner",
"content": "Samit, then Adam."
},
{
"speaker": "Samit Hirawat",
"content": "Yeah. Thank you, Seamus, for the question. As we think about multiple myeloma, it is a disease which has really been benefiting from multiple therapies that have been approved over the years and certainly has had transformational outcomes for these patients, including small molecules as well as large molecules and now with cell therapies and bispecifics coming into the play. As we think about CELMoDs, as we think about Iberdomide and mezigdomide both in development across the four Phase 3 clinical trials with readouts coming in 2026. The way we think about it is multi-drug regimens will be required for these patients because ultimately right now we don't have a cure for the disease. And that's the way we have designed the studies with mezigdomide going head-to-head versus pomalidomide, whereas if we think about iberdomide, we're looking at combinations to really change the outcomes when you combine them with velcade and dexamethasone or moving into a maintenance setting after transplant going head-to-head versus Revlimid. So we believe that there are patients who are not going to be eligible to receive cell therapies where these therapies will play a role. Also, we need manageable toxicities, which don't have the same outcomes of CRS, et cetera, that are associated by specific therapies right now. So placement of these therapies will become important and we'll continue to generate more data through many other trials so that we ultimately give more our momentarium to physicians to prescribe to the right patients for better outcomes in multiple myeloma."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Samit. Seamus, before I turn it over to Adam to walk through the redesign of that specifically, I'll just say that when we give the color on MFP, that will be inclusive of all aspects of IRA, including the Part-D redesigns, get that whenever we talk about the final MFP price. But Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah, Seamus. As you alluded to, since products are impacted differently by the Medicare redesign, we carefully evaluate each of the individual dynamics both now as well as into the future to determine the potential impacts. We will see a favorability with Eliquis next year due to the Part-D redesign, notably with the elimination of the coverage gap. That'll partially be offset by Rev and Pomalyst having responsibility now in the catastrophic phase. So we're monitoring this very closely to understand what the impact is on out-of-pocket cap as well and other shifts that are happening in the landscape."
},
{
"speaker": "Chris Boerner",
"content": "Yeah. And just to close off on that, what I would say when we look at Part-D redesign across the entire portfolio, we actually think that it offsets and would be largely meaningful."
},
{
"speaker": "Tim Power",
"content": "Great. Thanks, Chris. Can we go to the next question, please?"
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question today comes from Terence Flynn at Morgan Stanley. Please go ahead."
},
{
"speaker": "Terence Flynn",
"content": "Great. Thanks so much for taking the question. David, I was just wondering if you can provide any early commentary on how we should think about 2025 operating margins, maybe just walking us through some of the puts and takes. And then separately, I was wondering if you guys can disclose the WINREVAIR royalty from Merck? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "David?"
},
{
"speaker": "David Elkins",
"content": "Yeah, thanks, Terence. And look, we remain committed to our greater than 37% operating margin. And as you saw, we saw strength in our gross margins with our mix of our business. And we feel really good about the operational efficiency programs that we're executing against now, which gives us a lot of flexibility in maintaining those operating margins above 37%. Thanks, Terence."
},
{
"speaker": "Terence Flynn",
"content": "And about WINREVAIR, David?"
},
{
"speaker": "David Elkins",
"content": "And WINREVAIR that, so we recognized 22% of global sales of WINREVAIR that comes through our other growth revenue that comes through there and you'll hear about those sales from Merck when they come through."
},
{
"speaker": "Terence Flynn",
"content": "Great."
},
{
"speaker": "David Elkins",
"content": "But obviously an important growth driver for us is that 22% royalty rate."
},
{
"speaker": "Tim Power",
"content": "Great. Thanks very much, David. Can we go to the next one, please, Rocco?"
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question today comes from Mohit Bansal with Wells Fargo. Please go ahead."
},
{
"speaker": "Mohit Bansal",
"content": "Great. Thank you very much for taking my question. And maybe one question I want to ask is like as with new launches, there are spaces you have done really well like oncology and cardiology now with Camzyos picking up, but immunology seems to be a challenge and even before Sotyktu there was Zeposia, so just want to understand, what are the excess dynamics that you are finding challenging versus your expectations going in? I'm asking because with some of those IL-23s and all, they have found better access than what we are seeing with Sotyktu. So could you please help us understand that? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Mohit. Good question. And Adam, you'll take it."
},
{
"speaker": "Adam Lenkowsky",
"content": "Sure, Mohit. Thanks for the question. So as we talked about, we are focused on continuing to accelerate our growth portfolio. As you saw in the quarter, we're making good progress there. We're delivering strong performance for products like Reblozyl, Camzyos, Breyanzi and Opdualag. As I talked about, Sotyktu performance is slower than we would like and we are focused on improving both performance and execution. But ultimately, it's the access there that has taken longer than we expected. Remember, in many of the immunology categories that we compete in, these are highly controlled, highly managed products by the large PBMs. And so it took longer for us to get into a preferred position based on entrenched contracts. And so as we're seeing uptake now, we're in a much better position with approximately 65% access with most of that is at zero step edit. And that's going to be really important. So we recognize this is a highly competitive market and we're continuing to make improvements and we expect further improvements in access in January. As it relates to Zeposia, Zeposia has really been a tale of two launches. We entered the market in multiple sclerosis and we've seen good uptake there over time and we're doing that in a market that continues to contract based on the kind of the increases in the products like Ocrevus and Kesimpta and we continue to grow our share in a competitive market. Now UC has been more challenging. It is more managed, it's more managed class. TNFs have preferred status across virtually all of the PBMs, but we're also focused on making progress there as well. So I think it's hard to paint immunology in general with a broad brush. Orencia continues to perform well, no biosimilar insight. And finally, as we talked about, we're ready for the launch of KarXT, which has very different access dynamics than what's in the immunology space today. So we are continuing to make progress in delivering strong performance and execution and we're confident in our ability to continue to grow our business in the near term and into the longer term."
},
{
"speaker": "Tim Power",
"content": "Thanks, Adam. Let's go to the next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question comes from David Risinger with Leerink Partners. Please go ahead."
},
{
"speaker": "David Risinger",
"content": "Yes, thanks very much, and congrats on the performance. So two questions, please. First is, with respect to IRA, many companies, including Bristol have suggested it's not too much of a problem. And so I'm just helping, I'm hoping that you could help us understand a little bit how you're thinking about drugs that aren't rebated today like Part B drugs such as Opdivo and their risk of price pressure when they're negotiated relative to drugs that are heavily rebated today like Eliquis. So if you could just comment on that, that would be helpful. And then second, with respect to some of your growth drivers, obviously, you've kind of commented a lot on Sotyktu and Opdualag, but there are competitors that have shown some pretty encouraging data and competitors claim and in some cases, i.e., with respect to Sotyktu, they're running head-to-head trials that their drugs are going to show much better efficacy cross-trial than Sotyktu and Opdualag and launch late decade. So if you could just comment on that and how you're thinking about the future competition? Thanks so much."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, David. I'll let Adam address certainly the first question and actually probably the second question as well. But let me just first say, we're not going to speculate on the impact of products that have not been or aren't planned to be negotiated. Adam can speak generally about how we manage the different books of business between Medicare and commercial. But Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah. I mean, I think we're a long way off to 2028. So I agree, I think it's premature to discuss if Opdivo would be eligible even for IRA negotiation. Remember, if Opdivo makes the list, there could be generics in the market or biosimilars in the market as well. But I think most importantly is what you heard from both David and Chris is that we announced a PDUFA date for our nivo subcu in late December. So our goal is to convert as much business as we can well prior to the LOE. And we expect to convert at least 30% to 40% of the total US business for Opdivo ahead of the LOE and we think this is a great opportunity for both physicians and patients and we look forward to launching this important formulation. Also, with a biosimilar in the market and we don't expect to see Opdivo completely fall off either. So we also expect to see the subcu and the IV continue into the next decade as well. As it relates to the competition in immunology or in PSO, I think, more specifically as you're asking, again, we are preparing for competition there. I think Sotyktu has set a high bar for new orals in the PSO space. This is a very competitive category today. It's only going to become more crowded and more competitive over time. We also plan to have several indications, including PSA by -- we'll see some data by the end of this year, which will help both PSO and help accelerate Sotyktu as well as SLE, both of which SLE and PSA will be approved and will read out at that time. So we're going to have to see the results of the study. The oral IL-23 Phase 3 data would need to be meaningfully different in order to move the needle, but we're continuing to make progress with Sotyktu and executing our plan and we focus on growing this important brand."
},
{
"speaker": "Chris Boerner",
"content": "And I think I'll just add because I think you also mentioned, David, Opdualag. And as far as Opdualag is concerned, once again, we are way ahead with melanoma indication already approved in the first line, anticipating the data for the adjuvant melanoma, anticipating also the presentation of the Phase 2 data soon and then initiation of the Phase 3 program in the subset of non-small cell lung cancer to continue the progress. Rest of the data that we've seen from the competition is just too small to really interpret anything out of that."
},
{
"speaker": "David Risinger",
"content": "Thanks."
},
{
"speaker": "Tim Power",
"content": "Thanks so much. Can we go to the next question, please, Rocco?"
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question comes from Steve Scala with TD Cowen. Please go ahead."
},
{
"speaker": "Steve Scala",
"content": "Thank you very much. Chris, I apologize for being picky, but you said two times on the call that Bristol would give visibility on the contour of Eliquis business around September 1st, but you didn't say floor guidance. And when you were specifically asked about floor guidance, you repeated something from earlier in the call. So is floor guidance no longer in the plans? And secondly, Samit on cendakimab in EoE. So Dupixent showed 60% of patients achieved histologic remission at 24 weeks. Is cendakimab fully competitive with that? You sound very confident. So it sounds like yes. And historically, your tone in saying things like this has been very predictive. So I'm just curious what to make of it. Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Steve. I'll start and then I'll turn it over to Samit. So look, we know there's a lot of interest in this topic around floor guidance. As I've said before, in general, we've moved away from providing long-term targets. This actually reflects us going back to what the company has done historically. That said, we continue to increase our confidence in the long-term growth profile of this business. We're going to continue to provide updates to you on that business as appropriate and we'll be transparent about how we see the business evolving. And as for how we do that and when we do that, as I think most of you are aware, our normal practice is to provide forward-looking guidance at the beginning of the year, normally when we report our Q4 results, and we're going to continue with that process. Samit?"
},
{
"speaker": "Samit Hirawat",
"content": "Thank you. And thanks for the question, Steve. As always, very pointed one. Look, we did do the study as it relates to comparison versus Dupixent. So it's very hard to start comparing the data. Also remember the way the dysphagia days, which is a more important and most important thing from a symptom relief for the patient. The way we measured it versus what Dupixent did in their study are very different ways. So we have to keep that in mind. Certainly will not comment on the specificity of the data because we would rather present it at a medical conference or to come on that. Certainly, as mentioned earlier by Adam as well, we look to the data deeply and put it into perspective as we go forward also in communications with the regulators."
},
{
"speaker": "Tim Power",
"content": "Let's go to the next question, please, Rocco."
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question today comes from Trung Huynh with UBS. Please go ahead."
},
{
"speaker": "Trung Huynh",
"content": "Good morning, guys. Trung Huynh from UBS. I have a few follow-ups on the subcu Opdivo. So today you highlighted again the 30% to 40% conversion. How quickly are you arriving at this 30% to 40% of patients? What's stopping it from being more as we've seen things like Darzalex have quite significant conversion? And then, when is the exclusivity expected to last for this subcu versus IV given the somewhat recent CMS drafts on IRA on subcu formulations? I think you mentioned in one of the questions the next decade, but do you have a year? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah, Trung, thanks for the question. So again, as I said, we are looking forward to the PDUFA date in late December and our launch planning is continuing to progress. So we said we have converted at least 30% to 40% of the total US Opdivo IV business. And we have -- the good news is we have time because the LOE is not until 2028. So we expect that conversion to come largely from patients who are in the adjuvant setting, use in combination with Yervoy where there is continuing Opdivo treatment, for example, indications in metastatic melanoma in first-line RCC as well as in Opdivo monotherapy. These indications represent approximately 70% of our overall business. And so we talked about the benefits of nivo subcu has the potential to benefit both patients with a less than five-minute infusion time and physicians who are able to free-up chairs, particularly in the community setting. And we do have the potential to benefit patients through the next decade with nivo subcu based on the fact that we've got a broad patent estate. So we expect to see both nivo subcu and Opdualag continue to persist our leading IO franchise into the early 2030s."
},
{
"speaker": "Tim Power",
"content": "Thanks, Adam. Let's go to the next question, please."
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question comes from Matthew Phipps with William Blair. Please go ahead."
},
{
"speaker": "Matthew Phipps",
"content": "Thanks for taking my questions. Two quick ones on Phase 3 trials. Wondered if recruitment has recommenced in the ACTION-1 trial with RZ101 and Actinium supply is secured there. And then on the successor trials with mezigdomide, it looks like the trials have advanced to Part 2 of the Phase 3. Wondering if you can give us any sense of the dose that was taken from Part 1 into Part 2? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Matt. Samit?"
},
{
"speaker": "Samit Hirawat",
"content": "Yeah. Thank you for both the questions. For the Actinium-225 study, as you know, we are the furthest along in terms of the Actinium-225 Phase 3 trial. GEP-NET is the first indication with very strong data supporting it. We have reinitiated the recruitment in the trial and we are still looking forward to the data readout in 2026, along with certainly looking forward to new indications starting with a small-cell lung cancer Phase 1 trial that is already ongoing. For mezigdomide trial, again, enrollment is continuing. We will not yet declare what the dose we've taken forward. But certainly, yes, both trials have moved to the Part 2 of the study and you will continue to hear about how the trial progresses and we're looking forward to the readout starting in 2026."
},
{
"speaker": "Tim Power",
"content": "Thanks, Samit. Let's go to the next question, please."
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question comes from Olivia Brayer with Cantor Fitzgerald. Please go ahead."
},
{
"speaker": "Olivia Brayer",
"content": "Hi, good morning, and thank you for the question. I wanted to ask a follow-up on Sotatercept. It looks like you guys changed your other income guidance by about $200 million for the year. So is that essentially entirely from the Sotatercept launch? Obviously, a big number there if you back it out based on a 22 -- or a 22% royalty rate. And then how are you thinking about Sotatercept's contribution to your P&L going forward just given the strong economics there? And one more, just can you also comment on level of enthusiasm around your PRMT5 program and what we'll see from the Phase-1 readout in the back half of the year? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "David and Samit."
},
{
"speaker": "David Elkins",
"content": "Yeah, Olivia, thanks for the question. The O&E increase was mainly driven by two things, as I said earlier in my prepared remarks, which is the diabetes royalties coming in better than we had anticipated as well as interest expense coming in better than anticipated. And what I was saying earlier related to WINREVAIR, since we still own the intellectual property of that, that 22% of global sales related to the product goes through our other growth revenue line. So it comes through sales."
},
{
"speaker": "Samit Hirawat",
"content": "And thank you, Olivia, for the question on PRMT5. Certainly, again, very much further along on that one. Phase 1 trial continues on. What we will be presenting data is the responses that have been seen across multiple different tumor types. So really looking forward to presenting that data as we plan to initiate the Phase 2 studies in a couple of indications, which we will talk about more as we get closer to the initiation of those trials in selected patients, of course, with MTAP deletions."
},
{
"speaker": "Tim Power",
"content": "Thanks. And let's go to the next one, please, Rocco."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question comes from Steve Chesney with Redburn Atlantic. Please go ahead."
},
{
"speaker": "Steve Chesney",
"content": "Yeah, great. Thank you. Maybe just a follow-up on radiopharma, please. With regard to the commercial opportunity for RYZ101 and GEP-NET, I wonder how competitor filings of an ANDA and a 505(b)(2) for Lutathera impacts your thinking on pricing for innovators in the space? And then also on KarXT, we've seen a couple of competitor data sets over the past month or two that showed relapses at a fairly early time point and somewhat lower-than-expected response rates. Just wondering how you guys have been thinking about that as it relates to KarXT, whether you have more confidence in your construct or are you doing something differently on dosing? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Adam, then Samit."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah, first, let me just talk about our enthusiasm about RayzeBio and the platform that we have here. We believe this is a really exciting platform, one that's going to grow significantly through the back end of the decade. And what particularly excites us about Rayze is the kind of robust IND engine that we'll see over the course of the next decade or plus as well as what we know is a state-of-the-art manufacturing facility that has been forward. Now the lead program in RYZ101 in GEP-NET is, I think, a fairly modest commercial opportunity. However, when you look at this technology, particularly the Actinium-based radiopharmaceutical platform, this has the potential to have efficacy and safety across a host of solid tumor treatments. So as we've talked about, we are looking at this in small-cell lung cancer and potentially many other tumor types. So we look forward to launching the GEP-NET indication that will be the lead asset and well -- as well as a number of new INDs coming in the back half of the decade and beyond."
},
{
"speaker": "Samit Hirawat",
"content": "Yeah. And thank you, Adam. And just to talk about CD19 NEX-T there are a couple of things to understand. Number one, we have two studies ongoing. The first study enrolls patients not only with far advanced systemic lupus erythematosus, but also systemic sclerosis as well as myositis. The second study is enrolling patients with multiple sclerosis. Now it's very important to understand the profile of the patients that are being enrolled. These are patients who have far advanced disease. They are on glucocorticoids, immunosuppressants, immunomodulators. And these patients may also have underlying organ dysfunction such as renal failure and kidney damage. So as we think about the impact of these single-infusion CAR-cell therapies, what are we trying to achieve? We're trying to achieve a remission in the sense that patients can go off of their treatments such as glucocorticoids and immunosuppressants. What one does not expect at this time at least that we can revert the damaged kidney to a normal state because kidney doesn't grow by itself. So I think we have to keep that in mind as we look at the data and we're looking forward to bring that data as we look to the presentation of these patients that we are treating today."
},
{
"speaker": "Tim Power",
"content": "Great. Thanks, Samit. Let's go to the next one, please."
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question today comes from James Shin with DB. Please go ahead."
},
{
"speaker": "James Shin",
"content": "Good morning, guys. Thanks for taking the questions. A couple more on the pipeline. Just to piggyback on PRMT5 readout later this year, can you shed some light on the data size, which data points to expect? And are you thinking this will be disclosed via conference setting? And then similar to that about CD19 NEX-T, how will that be read out? And then I think another question, our previous question talked about some of the negotiation dynamics in immunology. A lot of these CDMs are getting into biosimilars. Has that changed negotiation dynamics at all in your early interactions? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Samit and Adam."
},
{
"speaker": "Tim Power",
"content": "Yeah. And I think your question, you're breaking up a bit, James. I think you were asking about disclosure for?"
},
{
"speaker": "Samit Hirawat",
"content": "PRMT5 and CD19."
},
{
"speaker": "Tim Power",
"content": "Exactly."
},
{
"speaker": "Samit Hirawat",
"content": "Yeah. So both of these molecules, we are looking forward to presenting the data this year, certainly through a medical conference for both of them. For PRMT5, all the patients that have been enrolled, we are looking forward to bring the dose overall safety and where we've seen responses. And certainly, that will be the data that we will be presenting. For KarXT, we're looking forward to presentation of the data for certainly SLE at an upcoming conference as well and then grow from there. We are obviously preparing and planning to have conversations with regulatory authorities as well to plan for later stages of development of this molecule."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yeah. Just quickly on the biosimilar question, as I mentioned, in UC, yes, biosimilars do have a preferred position in first-line. However, in respect to the PSO market, we are continuing to work with payers to understand the dynamics there. But we have not heard or seen PBMs move to a biosimilar first approach. The reason for that largely is the fact in PSO, products like Humira and Stelara do not have a dominant position in that space. So we would not expect biosimilars, at least in the near term to take on a preferred position."
},
{
"speaker": "Tim Power",
"content": "Thanks, Adam. Let's go to the next one, please."
},
{
"speaker": "Operator",
"content": "Absolutely. Our next question today comes from Kripa Devarakonda with Truist Securities. Please go ahead."
},
{
"speaker": "Kripa Devarakonda",
"content": "Hey, guys, thank you so much for taking my question and congrats on the quarter performance. I have one question on Camzyos and maybe a question on IRA. Camzyos, in terms of patients added per quarter, it seems like we're starting to see a little bit of acceleration. I know last couple of quarters, you said you thought of reaching steady state. Do you think this is just noise or could this be a trend going forward? Are you seeing awareness and understanding of the drug increase uptake? And the other thing on IRA is actually a little bit more futuristic maybe. Do you see any potential impact on IRA implementation depending on result of the November election? Could there be any change? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "So Adam, and then I'll take your IRA question."
},
{
"speaker": "Adam Lenkowsky",
"content": "Kripa, yeah, thanks for the question. And we've seen steady and consistent growth from Camzyos. And as David mentioned, we saw approximately 1,300 patient increase on commercial drug quarter-over-quarter. We expect that to be steady and consistent growth over time. Physician and patient feedback continues to remain very positive. Our focus is increasing our user base, both in the large COEs, while also increasing breadth of prescribing in some of the smaller institutions and some of the larger community practices. In fact, we'll be deploying additional community representatives. These are Eliquis representatives into the community of cardiology account to drive treatment. So we're seeing good momentum with Camzyos and we're pleased with the performance of this very important product."
},
{
"speaker": "Tim Power",
"content": "And I know we're running over time maybe for two more here. So maybe go to the next one, please."
},
{
"speaker": "Operator",
"content": "And yes, sir. And our next question today comes from Sean McCutcheon with Raymond James. Please go ahead."
},
{
"speaker": "Sean McCutcheon",
"content": "Hey, guys. Thanks for taking over it -- thank you for taking my question. Maybe one for Samit. So we're going to get the Oceanic AF data at ESC in about a month. Obviously, Librexia AF is ongoing and time will tell if there are any distinctions from the rapid failure we saw for Asundexian. But and likely insufficient dose-finding in Pacific as noted, but what are the specifics you're looking for read through on the mechanism for those data? And do you see any risk to getting data that come in that clearly shows sufficient inhibition of Factor XIa activity, do you have a detriment on stroke prevention? Thanks."
},
{
"speaker": "Chris Boerner",
"content": "And before Samit answers, I just want to address the second part of Kripa's question just very quickly around patient. Obviously, we're going to continue to follow the election in the United States, it's difficult to speculate on how things will change from a policy standpoint with any given administration just simply because it's not just a Presidential Election, but it's also you have to look at the composition of Congress. So I think we're just going to have to continue to pay attention to this over time. But Samit, do you want to address?"
},
{
"speaker": "Samit Hirawat",
"content": "Yeah. Thank you. Thank you for the question as well. Look, I think let's start off with the first fact that when we started the Milvexian program, it was based on the prior learnings from the Phase 2 studies. That's why we chose the doses that we chose that for a single agent at a higher dose of 100 milligrams BID, whereas the 25 milligram BID where there was a background of antiplatelet agents. Second, independent investigators have now conducted preclinical work to show the differentiation between Asundexian versus Milvexian, showing the inhibition and the time it takes and the doses that are required for real inhibition of Factor XIa. And so that gives us a little bit more confidence in terms of how things are going -- are shaping up. Third, for AF, secondary stroke prevention as well as ACS, the enrollment continues very well in these three trials and we're looking forward to those readouts. Last thing I would say is when the data are presented, we certainly would like to see the number of events that happened, what time they happened and the impact of the dose that was used that will all be very helpful as we think about Milvexian."
},
{
"speaker": "Tim Power",
"content": "Great. Thanks. And let's go to the last one, please, Rocco."
},
{
"speaker": "Operator",
"content": "Absolutely. Our final question today comes from Alex Hammond of BofA. Please go ahead."
},
{
"speaker": "Alexandria Hammond",
"content": "Hey, guys. Thanks for squeezing me in. So following Camzyos' strong performance this quarter and the REMS registry data at ACC. Can you set expectations for potential REMS modification moving forward? And do you think having the results from the ODYSSEY study reading out early next year will provide a favorable time to reengage with the FDA? Thank you."
},
{
"speaker": "Chris Boerner",
"content": "Samit."
},
{
"speaker": "Samit Hirawat",
"content": "So I think as -- thank you for the question, as both David and Adam said earlier, thousands of patients have now been treated with Camzyos and certainly, we've learned a lot and we see the manageable profile here as well as the transformational outcomes that these patients have and stay on treatment for a very long time with 80% of the patients being treated with 2.5 and 5 milligram doses. We continue our conversations with the FDA. I will not get into the specifics. And certainly now that we have pulled in the readout of the non-obstructive hypertrophic cardiomyopathy study about six months in with a readout now expected in 2Q next year, we will certainly have multiple engagements with the FDA on that front as well."
},
{
"speaker": "Chris Boerner",
"content": "Thanks, Samit. So before we close the call, maybe I'll just leave you all with a few things. We are pleased with the performance of the business and in particular, the growth portfolio performance where revenues grew nicely in the first half and now represent, as David said earlier, 46% of the total business. At the same time, our pipeline continues to advance with new medicines and we look forward to important catalysts coming up like the KarXT launch and a number of data readouts in the coming months. So overall, I'd say we've executed well in the quarter. We feel good about the full year and are raising our outlook accordingly. It's certainly going to be a busy back half of the year and we're focused as a team and as a company on driving strong execution. So thank you all for your time today and the Investor Relations team is certainly available to answer any follow-up questions that you may have. Have a nice weekend."
},
{
"speaker": "Operator",
"content": "Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day."
}
] |
bmy | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Welcome to the Bristol-Myers Squibb First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note, today's event is being recorded."
},
{
"speaker": "",
"content": "I would now like to turn the conference over to Tim Power, Vice President and Head of Investor Relations. Please go ahead."
},
{
"speaker": "Timothy Power",
"content": "Thank you, and good morning, everyone. Thanks for joining us this morning for our first quarter 2024 earnings call. Joining me this morning with prepared remarks are Chris Boerner, our Board Chair and Chief Executive Officer; and David Elkins, our Chief Financial Officer. Also participating in today's call are Adam Lenkowsky, our Chief Commercialization Officer; and Samit Hirawat, our Chief Medical Officer and Head of Global Drug Development. As you'll note, we've posted slides to bms.com that you can use to follow along with for Chris and David's remarks."
},
{
"speaker": "",
"content": "Before we get started, I'll read our forward-looking statement. During this call, we'll make statements about the company's future plans and prospects that constitute forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the company's SEC filings."
},
{
"speaker": "",
"content": "These forward-looking statements represent our estimates as of today and should not be relied upon as representing our estimates as of any future date. We specifically disclaim any obligation to update forward-looking statements even if our estimates change. We'll also focus our comments on our non-GAAP financial measures, which are adjusted to exclude certain specified items. Reconciliations of certain non-GAAP financial measures to the most comparable GAAP measures are available at bms.com."
},
{
"speaker": "",
"content": "And with that, I'll hand it over to Chris."
},
{
"speaker": "Christopher Boerner",
"content": "Thank you, Tim, and good morning, everyone. Q1 was a busy quarter for us and a good start to 2024. Starting on Slide 4, and knowing what an active quarter we had, I wanted to start by telling you how we think about our performance across four dimensions."
},
{
"speaker": "",
"content": "First, the performance of our commercial portfolio was good and broadly in line with our expectations, even with some products impacted by inventory or gross to nets. Second, we made solid progress advancing our pipeline. Third, we closed four import transactions that strengthened our long-term growth profile during Q1. And fourth, we're taking decisive actions to improve productivity."
},
{
"speaker": "",
"content": "Taken together, Q1 performance was broadly aligned to our internal expectations. And importantly, there is no change to the underlying business outlook we provided in February. As you know, we've included the accounting impact of the recently closed transactions in our non-GAAP EPS guidance."
},
{
"speaker": "",
"content": "Let's turn to Slide 5 for some details. I'll start with some highlights on commercial performance. We've seen real strength across key brands, including Eliquis, Opdualag, Reblozyl, Yervoy and Breyanzi. And though the BCMA space remains competitive, our objective is to return Abecma to growth over time with the KarMMa-3 approval as we move into a larger patient population."
},
{
"speaker": "",
"content": "Turning to Opdivo, Camzyos and SOTYKTU. What's important about all three brands is that demand grew while revenue was impacted by other factors such as inventory and gross to nets. Today, we are seeing the inventory patterns for Opdivo and Camzyos normalizing. And for SOTYKTU, we're steadily building commercial script volume as access continues to improve this year. David will give you more details, but taken together, the commercial performance in Q1 is in line with our expectation and sets us up for the year."
},
{
"speaker": "",
"content": "Second, we made important progress advancing our pipeline. This includes two important cell therapy approvals, the initiation of new registration trials and important proof-of-concept data for Opdualag in lung cancer from a prespecified analysis of our Phase II during Q1. We're looking forward to starting a Phase III registrational trial versus standard of care in a segment consisting of about 20% to 30% of non-small cell lung cancer patients."
},
{
"speaker": "",
"content": "And not on this slide, but important for patients is milvexian, which has the potential to be the only oral Factor XIa medicine in AFib and ACS. The trials are continuing following the most recent DSMB review with enrollment accelerating."
},
{
"speaker": "",
"content": "Third, we closed four important deals during the quarter. Across all four, we have added assets, capabilities and expertise that strengthen our ability to drive long-term growth as we exit the 2020s. Our team is driving performance of Krazati, the Rayze radioligand plant in Indiana is now operational. We're in the process of filing an application to supply clinical product for RYZ101 from the site. SystImmune's first-in-class bispecific ADC is advancing into global clinical trials in tumors, including lung and over time, breast cancer. And we are very excited about the potential of KarXT from Karuna, which I will review on Slide 6."
},
{
"speaker": "The team is on track and focused on two objectives",
"content": "First, launch preparations are underway and on track for KarXT; second, we are executing against a robust clinical program for this important asset. On this slide, you can see the significant unmet need in schizophrenia and highlights of data recently presented for KarXT. These data demonstrate its compelling long-term efficacy as KarXT was associated with significant improvements in symptoms of schizophrenia across all efficacy measures without evidence of metabolic or movement disorder side effects."
},
{
"speaker": "",
"content": "This reinforces the very attractive profile for this medicine as an important advancement for patients and a significant commercial opportunity for the company. Underpinning our efforts to navigate this decade is an enhanced focus on driving operational productivity and efficiency, and we have made some notable progress already this year."
},
{
"speaker": "",
"content": "Let's go to Slide 7. At a company level, we have clearly identified brands and programs that are most critical to both near and latter half of the decade performance. Across the organization, we have initiated efforts to delayer and streamline decision-making. And within R&D, we are optimizing the portfolio to focus our internal efforts on higher ROI programs. These are programs with compelling science, significant commercial value and in therapeutic categories where BMS is positioned and resourced to win. As a result of these actions, we anticipate cost savings of approximately $1.5 billion by the end of 2025, which will allow us to reinvest in high priority growth brands and R&D programs."
},
{
"speaker": "",
"content": "With our heightened focus on improving productivity and efficiencies, we're strengthening the company's long-term growth profile. This is a snapshot of what has been a very busy start to the year. And while we clearly have more work to do this year, we're off to a good start."
},
{
"speaker": "",
"content": "Let me close on Slide 8. Overall, our business outlook remains unchanged. We remain confident that we will deliver top line growth for the year consistent with what we communicated in February. And our underlying non-GAAP EPS forecast has also remained unchanged."
},
{
"speaker": "",
"content": "We are taking important actions to effectively manage the decade. Our management team is focused on ensuring the disciplined execution required to deliver both this year and set us up for the longer term. I want to thank the employees of BMS, including new team members from our recent acquisitions for their contributions and commitment to delivering for patients."
},
{
"speaker": "",
"content": "Let me now hand it over to David. David?"
},
{
"speaker": "David Elkins",
"content": "Thank you, Chris, and good morning, everyone. As Chris highlighted, we're off to a good start to the year with top line growth as shown on Slide 10. As a reminder, unless otherwise stated, all comparisons are made from the same period in 2023 and sales growth rates will be discussed on an underlying basis, which excludes the impact of foreign exchange."
},
{
"speaker": "",
"content": "Building our momentum coming out of last year, we're executing against our plan to drive our growth portfolio, which delivered approximately 11% sales increase in the first quarter compared to the prior year and now represents approximately 40% of our total revenue. This growth was broad-based, with most growth brands recording significant increases in the quarter. Our legacy portfolio also contributed to overall sales growth in the quarter, with strong sales of Eliquis, which remains an important cash flow generator for the company."
},
{
"speaker": "",
"content": "Now turning to the first quarter performance of our key brands, and starting with oncology on Slide 11. On this slide, you can see the impact of our strategy and broadening our I-O franchise and expanding in new targeted solid tumor therapies. Global sales of Opdivo were impacted by inventory work down and timing of orders in the U.S., partially offset by demand growth. As we said in the past, we expect to see growth at a more modest pace than 2024."
},
{
"speaker": "",
"content": "And Opdualag, a standard of care treatment in first-line melanoma, generated strong quarterly sales with U.S. sales growth primarily driven by strong market share. We are very encouraged by the future expansion potential of Opdualag, not only in adjuvant melanoma, but also in our plans to develop it in first-line lung cancer. This, along with the anticipated launch of our Opdivo subcutaneous formulation next year, we will extend our I-O franchise well into the next date. Our targeted solid tumor therapies expanded with the addition of Krazati after the completion of Mirati acquisition in late January."
},
{
"speaker": "",
"content": "Our reported sales represent a partial quarter. And on a pro forma basis, Krazati global sales in Q1 were approximately $27 million, primarily in the U.S. With recent conditional marketing approval by the European Commission, we look forward to bringing Krazati to more patients towards the end of the year. Augtyro's first quarter performance reflects positive early sales trends. We remain focused on driving awareness and penetration based upon its potential best-in-class profile."
},
{
"speaker": "",
"content": "Now moving to Slide 12 and our cardiovascular franchise. Eliquis remains the market-leading oral anticoagulant worldwide. Q1 sales in the U.S. grew 12%, primarily due to strong demand, including increased market share. Internationally, sales were roughly in line with prior year. Camzyos generated strong sales in the quarter, nearly tripling its performance versus Q1 of last year."
},
{
"speaker": "",
"content": "In the U.S., sales were driven by demand growth including an almost 25% increase in commercial dispenses since Q4 of 2023. Sequentially, U.S. sales of Camzyos were impacted by the inventory dynamics of approximately $20 million and gross to net impacts from the typical copay reset at the start of the new year. We expect the momentum of Camzyos to continue, supported by the compelling real-world evidence in over 1,500 patients presented earlier this month at ACC."
},
{
"speaker": "",
"content": "Let's now turn to Slide 13 and discuss our hematology business. Our legacy brand, Revlimid, saw sales decline in the first quarter. Utilization of free drug program normalized in the quarter. We continue to anticipate variability in Revlimid sales quarter-to-quarter based upon historic dispensing patterns in specialty pharmacies. As anticipated, there is an increased volumes of U.S. generics starting in March."
},
{
"speaker": "",
"content": "Turning to Reblozyl, growth in the quarter was driven primarily by the strong U.S. launch of the broader commands label and first-line MDS. International sales growth benefited from the new market launches, and we look forward to bringing Reblozyl to more patients with the recent first-line approvals in the EU and Japan."
},
{
"speaker": "",
"content": "In cell therapy portfolio, global Breyanzi sales growth reflected the strength of the clinical profile and improved manufacturing capacity. Consistent with what we previously communicated, starting in Q2, we expect Breyanzi to benefit from the recent new indications and expanded manufacturing capacity."
},
{
"speaker": "",
"content": "With Abecma, U.S. performance in the quarter was impacted by ongoing competitive pressures. Future demand will benefit from the recent KarMMa-3 approval, which expands the addressable patient population. Internationally, Abecma demand growth was offset by unfavorable pricing pressures to secure access."
},
{
"speaker": "",
"content": "Now moving to immunology on Slide 14. Zeposia sales in the quarter were primarily due to demand of new patient starts in multiple sclerosis. SOTYKTU sales performed in line with our expectation. During the quarter, we delivered on our goal of achieving roughly 10,000 commercially paid prescriptions. Sales in the quarter reflected increased demand and expanded commercial access. In addition, we expect to add another large PBM later this year that will expand access coverage by approximately 30 million lives."
},
{
"speaker": "",
"content": "Now turning to Slide 15. I will walk you through the remainder of our P&L, and my comments will be on a non-GAAP basis. As expected, gross margin decreased compared to the prior year, primarily due to product mix. Excluding acquired in-process R&D, first quarter operating expenses increased mainly due to the impact of the recent acquisitions and higher cost to support the overall portfolio. We expect this growth to be mitigated later in the year through savings and productivity initiatives I will speak to shortly."
},
{
"speaker": "",
"content": "Other income and expense declined as expected in the first quarter, primarily due to lower PD-1 royalty rate and the financing costs associated with the recent transactions. Acquired in-process R&D in the quarter was $12.9 billion, primarily due to the previously disclosed onetime charge of $12.1 billion for the Karuna transaction and $800 million for SystImmune. Our tax rate in the quarter was impacted by the onetime nondeductible in-process R&D charge for Karuna."
},
{
"speaker": "",
"content": "Before the impact of acquired in-process R&D, our first quarter earnings would have been $1.89. Taking into account the impact from the recent transactions, including acquired in-process R&D, we reported an earnings per share loss of $4.40."
},
{
"speaker": "",
"content": "Now moving to the balance sheet and capital allocation on Slide 16. Cash flow from operations remained strong with approximately $2.8 billion generated in the quarter, resulting in approximately $10 billion in cash and cash equivalents and marketable debt securities on hand as of March 31."
},
{
"speaker": "",
"content": "Our strategic approach to capital allocation remains unchanged. We are committed to the dividend. And as we said previously, we plan to utilize our cash flow to repay approximately $10 billion of debt over the next 2 years. And we remain financially disciplined around business development to further strengthen the company's long-term growth profile."
},
{
"speaker": "",
"content": "Next, let's turn to Slide 17 to discuss our productivity initiative. As Chris described earlier, we have taken action to increase productivity and efficiency and focus our efforts on the assets and opportunities with the highest potential ROI and those most likely to drive our long-term growth. As part of this process, we are making deliberate choices to prioritize the assets that will have the greatest clinical benefit to impact areas of high unmet need and where we can deliver the most value for patients."
},
{
"speaker": "",
"content": "We will disproportionately invest in higher-return opportunities, which improves our portfolio ROI and strengthens our growth profile in the second half of the decade. After a thoughtful process, we have made the decision to discontinue and externalize several clinical assets. We anticipate cost savings from these actions of approximately $1.5 billion by the end of 2025, thereby absorbing the incremental OpEx expense from the recent deals. These cost savings will come from across the organization and include reductions in direct clinical expense, site rationalization and elimination of open roles and reduction in headcount. As we realize these savings, we will reinvest in the highest potential opportunities."
},
{
"speaker": "",
"content": "Now turning to Slide 18. I'll walk through the impact of our recently closed acquisition on our EPS guidance. As you can see on this slide, if you take our previously stated non-GAAP EPS guidance range of $7.10 to $7.40 from February and include the previously stated impact of deal dilution and the onetime impact of acquired in-process R&D, our revised range continues to reflect the strong outlook of the business as we told you in February."
},
{
"speaker": "",
"content": "Now let's walk through the details of our guidance on Slide 19, starting with revenue. As is our practice, we provide revenue guidance on a reported basis as well as on an underlying basis, which assumes currency remains consistent with prior year. We continue to expect 2024 total revenues to increase in the low single-digit range at reported rates as well as excluding foreign exchange. This reflects our confidence in the growing momentum of our growth portfolio, including products such as Opdivo, Reblozyl, Breyanzi, Camzyos and SOTYKTU. And as a reminder, the sotatercept royalty will be included in the other growth revenue line."
},
{
"speaker": "",
"content": "We continue to expect gross margin to be approximately 74%. And as we saw last year, we should see a sequential dip in Q2 related to our sales mix. Excluding acquired in-process R&D, we continue to expect our total operating expenses to increase in the low single-digit range, reflecting incremental costs associated with the recent acquisitions, partially offset by the realization of internal savings through the productivity initiatives I mentioned earlier."
},
{
"speaker": "",
"content": "Given the timing of the deal closures, we expect to come in at the upper end of our guidance range with an expected step-up in Q2 and the remaining OpEx to be more evenly spread across the back half of the year. We remain aligned with our previous operating margin to target at least 37% through next year."
},
{
"speaker": "",
"content": "For OI&E, we now expect approximately $250 million of expense primarily reflecting the debt financing costs from Karuna and RayzeBio. The tax rate was affected by onetime nondeductible expense of the Karuna acquired and processed R&D charge, which impacted our non-GAAP net income. Excluding this impact, the estimated underlying tax rate in the quarter was about 19.5%. And as a result, we now see full year underlying tax rate of about 18%."
},
{
"speaker": "",
"content": "Before we move to Q&A, let me take a minute to read some of the key highlights on our call today. We grew the top line, we advanced the pipeline, and we are executing our productivity initiative and our expectations for the underlying strength of the business remains unchanged from the beginning of the year. Finally, I'd like to recognize our BMS employees around the world for their unwavering hard work and commitment as we continue to make progress in strengthening the company's long-term growth profile and bringing truly transformational medicines to patients."
},
{
"speaker": "",
"content": "With that, I'll now turn the call over to Tim for Q&A."
},
{
"speaker": "Timothy Power",
"content": "Thanks, David. Can we go to the first question, please?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Geoff Meacham with Bank of America."
},
{
"speaker": "Geoffrey Meacham",
"content": "Just had one for Chris or maybe for David. On the cost savings, how much would you say was legacy Bristol, either workforce or facilities versus optimizing integration of all your recent deals? I guess I'm trying to get a sense for whether you think there's further optimization to come as you guys focus on the new launch portfolio."
},
{
"speaker": "Christopher Boerner",
"content": "Jeff, I'll let David answer that."
},
{
"speaker": "David Elkins",
"content": "Yes. Thanks, Jeff, for the question. The majority of the savings come from the historical BMS. As we talked about, the main drivers of the $1.5 billion savings really came into three buckets. First was really looking at the portfolio, obviously, with the Mirati, Karuna and with RayzeBio, we have really important portfolios that we're bringing into the overall portfolio. That gave us the opportunity to look at that and maximize the ROI of -- in totality of the portfolio as well as adjusting for some updates on new data and the competitiveness."
},
{
"speaker": "",
"content": "The second thing that we really looked at for legacy BMS is how do we become more agile, quicker decision-making and streamline the organization by removing layers of management so decisions can be more quickly. And there, we talked about the roughly 2,200 impacted employees as a result of those changes."
},
{
"speaker": "",
"content": "And then lastly, we went through all of our third-party relationships, continuing to look for efficiencies in third-party service providers, and that was the last category. And a lot of those activities are also legacy BMS. So the vast majority of the savings are coming from our in-house existing operations."
},
{
"speaker": "Operator",
"content": "Our next question comes from Chris Shibutani with Goldman Sachs."
},
{
"speaker": "Chris Shibutani",
"content": "Obviously, a lot of moving parts operationally, strategically. I think investors have been keen to get a sense for how you're thinking about potentially a trough level of earnings. I think the notion that there might be some visibility into where you could begin to see some growth, and I know in your vocabulary, you mused about exiting the decade and into the next. Help us with where you are with that thinking since we haven't had that clarity with all the moving parts. But how are you thinking about the potential to communicate that kind of timeline and model?"
},
{
"speaker": "Christopher Boerner",
"content": "Okay. Chris, I'll take that one. And I think there, embedded in that question, maybe two things. First is how we're thinking about how we're going to guide around this trough and then there's maybe a second question in there, which is when we think we'll see that trough and what's the timing of it."
},
{
"speaker": "",
"content": "With respect to the first question, look, we've been engaging with investors on this topic over the last number of months. A bit of context here, given the industry dynamics, we -- certainly, I believe companies in this industry need to be judicious with respect to providing long-term guidance. But we get why you are asking the question here, because it's something that we're going to need to continue to engage with investors on to strike the right balance in terms of how we think about providing guidance on this topic."
},
{
"speaker": "",
"content": "One uncertainty that we know that's related to this question, though, is the impact of IRA on Eliquis. And once that price is public, and remember, that's going to happen in the September time frame, we'll provide the impact of Eliquis both on the top line as well as on EPS."
},
{
"speaker": "",
"content": "In terms of how we think about the timing of the trough, based on our current plans, we start to see an impact in 2026. And then as we said earlier in the year, we anticipate to be returning to growth before the end of the decade. And then obviously, we're clearly focused on accelerating both the timing and the pace of growth in the back half of the decade, and that's going to influence timing as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from Chris Schott with JPMorgan."
},
{
"speaker": "Christopher Schott",
"content": "Just a two-parter, coming back to the restructuring. I guess the first part is, is the redeployment of savings going to be mostly focused on the R&D side or on SG&A? And just related to that, in terms of investment in the growth drivers, it seems like elements such as payer dynamics and competitive launches are impacting uptake of some of the new launch assets. So I'm just interested in which products do you see having the greatest potential for improvement with further investment, and how you, I guess, balanced SG&A versus either further R&D or just dropping some of those savings to the bottom line as you're considering kind of how to redeploy that $1.5 billion."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Chris. Let me just say a couple of words and then I'll turn it over to David for the first part of your question, then Adam can come in on the back end. First, as David mentioned, when we thought about these efficiencies, we were really thinking along three lines: the need to invest in the pipeline; ensuring that we had adequate investment for our growth products; and then needing to be more agile and focused as an organization. In terms of how we think about allocating those redeployment opportunities, I would say, generally speaking, they're in that order with the majority going back into R&D."
},
{
"speaker": "",
"content": "But David, do you want to start?"
},
{
"speaker": "David Elkins",
"content": "And yes, Chris, thanks for the question. The way to think about it, about 2/3 of the savings associated in the R&D area and about 1/3 is in MS&A. But importantly, if you really think about the acquisitions that we've just done, if you think about Mirati and Krazati, in particular, really important development programs in first-line lung, both the doublet as well as the triplet."
},
{
"speaker": "",
"content": "And then if you think about Karuna, and Adam can talk further about this, we see multiple indications -- billion-dollar indications in this space. We talked about schizophrenia, the adjuvant schizophrenia as well is moving into Alzheimer's with agitation and psychosis. So there's significant investments that you have to make there."
},
{
"speaker": "",
"content": "And then if you think about radioligand and RayzeBio, we see multiple INDs being able to come out of this. We're also -- we finished the manufacturing facility in Indianapolis. We're going to be able to supply our clinical studies out of that. So significant investments in those three areas, which through all of that as well as reprioritizing our existing BMS portfolio, what we've been able to do is increase the ROI of the portfolio. But just as importantly, we increased the growth profile of the company in the second half of the decade."
},
{
"speaker": "",
"content": "So there's a lot of work that's going under the surface in order to continue to maximize the value of the portfolio and strengthen the growth profile of the company. Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Chris, thanks for the question. So we're making good progress across the totality of our growth portfolio. As David shared, we saw strong year-on-year demand growth across the majority of our growth products. And we continue to be focused on accelerating our key brands. And we're doing what we said we would do as we continue to drive our growth portfolio."
},
{
"speaker": "",
"content": "So just a few of the products that I think is important to mention. Opdualag has become a new standard of care in first-line metastatic melanoma, grew 76%. Reblozyl continue to deliver strong performance post first-line. COMMANDS approval grew over 70% as well."
},
{
"speaker": "",
"content": "We have increased investment at the end of last year behind products like SOTYKTU, Breyanzi and Camzyos. Camzyos continues to demonstrate strong growth. We had 25% growth of new patients added on to commercial drug quarter-over-quarter. Breyanzi, we also increased our investment. We're a much stronger supply position today than we were last year and increasingly being recognized as a best-in-class CAR-T. And as David mentioned, we're readying for the launch of KarXT in September, which is a very significant multibillion-dollar opportunity."
},
{
"speaker": "",
"content": "I would say that a product like Abecma has been more challenging for us. But we have an opportunity now with the KarMMa-3 approval to work to return Abecma to growth over time as we move into a larger patient population. But adding it all up, we continue to make good progress in delivering strong commercial execution and performance."
},
{
"speaker": "Operator",
"content": "Our next question comes from Evan Seigerman with BMO."
},
{
"speaker": "Evan Seigerman",
"content": "Kind of a follow-up to what we've been talking about. So when you talk about the cost savings being reinvested, do you mean that you're going to manage your margins by titrating the reinvestment of the cost savings? Are you going to deploy the $1.5 billion kind of informed by the science or potential for growth?"
},
{
"speaker": "",
"content": "And then a follow-up, as you mentioned you're going to discontinue and externalize several clinical assets. Any commentary as to which ones you're thinking about? That would be great."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Evan. We'll have David start, and then Samit."
},
{
"speaker": "David Elkins",
"content": "Yes. Thank you, Evan. As I said in my prepared remarks, we're looking at our operating margins as we previously communicated in that 37% range. So that $1.5 billion of savings that we'll achieve by the end of next year, that's being reinvested both in the portfolio as I described earlier, particularly with the acquisitions that we did. But we've also had good progress like Opdualag lung where we're going to continue those clinical studies as well. And all of that put together, as I was saying, really strengthens not only the ROI, but the growth profile of the business in the second half of the decade. And I'll turn it over to Samit on the assets that we're looking at to externalize."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you, David. And just to build on what David said, from a pipeline perspective, we took a very thoughtful approach to see -- from our rich pipeline, what are the assets that we are not going to be continuing on our own. So first thing that we looked at is the evolving science from the ongoing exploration of our clinical assets. An example over there where we look at CTLA-4 in our pipeline that we were developing, we had set the bar with ipilimumab, which is already a high bar to then look at the data and then we decided that if the data are not going to be better than ipilimumab, we shouldn't be continuing that program, so we decided not to continue with that."
},
{
"speaker": "",
"content": "Similarly, when we looked at external and internal data for the SIRP alpha program, that did not meet the muster, and we wanted to look at the real return on that investment as well for patients. And so we are not going to continue that program."
},
{
"speaker": "",
"content": "The second way we looked at it is that the science may be really good. Data evolution is really good, but does it really make sense from -- for a company our size to continue a program if it's not going to be ultimately a growth driver. So from that perspective, if you think about BET 158, where the data are pretty good in myelofibrosis, but really, from our perspective, does not meet the threshold to be a driver for our growth potential. So that program, we are not going to be continuing."
},
{
"speaker": "",
"content": "And then, of course, we continue to look at our desire to be either first-in-class or best-in-class product profile. So from that perspective, we continue to focus on what we will continue versus not. Overall, I would say, Evan, that we have about -- discontinued about 12 programs at this time. But it's a continuum. And so throughout the year, we'll continue to look at these same principles and see what else we need to take out from our pipeline and either externalize it or not be able to develop it further."
},
{
"speaker": "Operator",
"content": "Our next question comes from Seamus Fernandez with Guggenheim Securities."
},
{
"speaker": "Seamus Fernandez",
"content": "So just wanted to check in on your thoughts around IRA and the impacts associated with that as we approach 2026 in particular. And if you might be able to provide us any color on progress or process in the \"negotiations\" or price fixing that may come from the U.S. government."
},
{
"speaker": "",
"content": "And then just the second question, hoping you might comment, help frame for us the Opdualag opportunity in lung cancer and when we might gain some incremental visibility on that. Is it going to be more from clinical trials hitting clinicaltrials.gov, and we'll get some information in that regard first? Or will we actually see the data in this potential subset?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the question, Seamus. Maybe I'll start, have Adam weigh in a little bit more on IRA. With respect to the ongoing discussions with CMS, we're not going to be commenting. As I said earlier, we will have the outcome of that public in September and we'll be able to provide more insight at that point. But Adam, you can speak to some of the other aspects of IRA and then Samit."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Thank you, Chris and Seamus, thanks for the question. As it relates to IRA, there are obviously multiple components to it. There's the negotiation. There's also the change in the Part D benefit design. So in 2024, we don't anticipate significant impact across our portfolio, across Eliquis, Revlimid or other brands. We do expect, though, more substantial changes to the Part D benefit next year since the products are impacted by the redesign. We are carefully evaluating each product individual dynamics now and we'll see into the future. And we're monitoring very closely to understand the impact of, for example, out-of-pocket caps and other shifts that are happening in the system."
},
{
"speaker": "",
"content": "So as we move from a $3,500 cap to a $2,000 cap, we would expect to see more patients' ability to fill their medicines and improve as it becomes lower at the pharmacy counter. But obviously, we'll need to do more -- see more data before we can provide additional details."
},
{
"speaker": "Samit Hirawat",
"content": "Thank you, Adam. And then thanks, Seamus, for the question. For Opdualag, let's just take a step back and understand what we were planning to do and try to do. So for Opdualag, we conducted a study of Opdualag plus chemotherapy in first-line non-small cell lung cancer. At first, we wanted to define the dose. So we tested a couple of doses in the first part of the study. And in the second part of the study, then we randomize the patient to receive Opdualag plus chemotherapy versus nivolumab plus chemotherapy."
},
{
"speaker": "",
"content": "And as we have said before, what we wanted to understand, is the drug applicable for all patients? Or are we going to find a differential activity in a subset of patients? And what we have said is we have found a subgroup of patients where the drug's activity is good and encourages us to now go into a Phase III trial. And so we are looking forward to presenting the data in the second half of this year as well as initiating the trial versus standard of care in the second half of this year. And we are planning that, we'll be executing that. As soon as we have that ready, you will be hearing about it."
},
{
"speaker": "",
"content": "In addition to that, Opdualag, is of course, other opportunities. As you know, we are already waiting for the data for the adjuvant melanoma trial and we're looking forward to the data evolution towards the back end of this year in first-line hepatocellular carcinoma as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from Terence Flynn with Morgan Stanley."
},
{
"speaker": "Terence Flynn",
"content": "Maybe a two-part for me on the CAR-T franchise. David, I think you mentioned something about Abecma ex-U.S. pricing dynamics, some change there to help boost access. Can you just provide a little bit more detail if that was a one-off in a specific country or what's going on there?"
},
{
"speaker": "",
"content": "And then on Breyanzi, Gilead has talked more recently about moving in the U.S. out to some of these secondary community hospitals as they think about expanding, particularly in the second-line label indication. And so is that something that you guys are considering as well? Or do you feel pretty good about your current footprint for Breyanzi at the primary academic hospitals?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Terence. I'll let Adam take both of those."
},
{
"speaker": "Adam Lenkowsky",
"content": "So as it relates to Breyanzi, what we saw in the quarter was we were able to stabilize the decline in the U.S. Sales were roughly flat versus last quarter. What you're referring to internationally is we did see strong demand growth, which we expect to continue, but that demand growth was offset by negative pricing skewing reimbursement, mainly in Germany. So that's where that took place."
},
{
"speaker": "",
"content": "And now with KarMMa-3, it gives us the opportunity to have a different conversation with our customers about our data in a larger patient population. And our objective is to return Abecma to growth over time as we move into this larger patient population."
},
{
"speaker": "",
"content": "Now for Breyanzi, we're very excited about this product. In Q1, we increased sales over 50% versus the prior year. We anticipate robust growth this year, because not only just in accelerated growth in DLBCL, as Breyanzi is increasingly recognized as the best-in-class CD19, we also expect to see expanded indications. We just received approval in the U.S. for CLL and with additional approvals anticipated next month in follicular lymphoma and mantle cell lymphoma. And this is going to roughly double the addressable market for Breyanzi."
},
{
"speaker": "",
"content": "We're also very encouraged by our expanded manufacturing capacity and now in a much stronger position to meet demand. We're seeing about 20% outpatient use today for Breyanzi, and we expect that to continue based on the differentiated safety profile. So taken together, we're very excited about the growth profile of Breyanzi."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tim Anderson at Wolfe Research."
},
{
"speaker": "Adam Jolly",
"content": "This is Adam on for Tim at Wolfe Research. So just on SOTYKTU, can you give us some updated market share metrics, things like new-to-brand share or versus Otezla in the oral category percent use in first-line versus later lines, that sort of thing? And also, any details on when the free drug program might begin to wind down?"
},
{
"speaker": "Christopher Boerner",
"content": "Sure. I'll take that, Adam. Thanks for the question. So we're continuing to make progress with SOTYKTU, and we're executing our plan. We delivered in the quarter what we said we would do, and that's reaching approximately 10,000 paid prescriptions. That's what we shared in January, and we expect to roughly double that to 20,000 paid prescriptions in Q4. So that's where we're focused on driving today."
},
{
"speaker": "",
"content": "Remember, we also said there would be an increase in gross to net due to broader rebating needed to secure improved access, and this impacted sales in Q1. But the volume that we'll see will more than offset that throughout the year. So we talked about improving our access position. And aside from the wins that we announced last year in CVS and Cigna and ESI, we saw access improvement with SOTYKTU, which was added to Optum. And as David mentioned, we do expect to announce additional improved formulary access including a large PBM with approximately 30 million lives."
},
{
"speaker": "",
"content": "So we remain focused on securing zero steps by 2025. And when you have that better access position, the need for a bridge becomes less and less important. And so basically, when you look at -- when you have better access, patients are moved faster into commercial product because they go directly to the specialty pharmacy."
},
{
"speaker": "",
"content": "As far as market share, look, this is a highly competitive market. We look at launch analogs at the top of the funnel or written prescriptions, and SOTYKTU performance is ahead of products like TREMFYA, COSENTYX at the same time ago launch. We are laser focused on share growth versus Otezla, which is a critical area of focus and becoming the oral standard of care in the market over time."
},
{
"speaker": "Operator",
"content": "Our next question comes from Dave Risinger with Leerink Partners."
},
{
"speaker": "David Risinger",
"content": "And thanks for all of the detailed perspectives that you're sharing. So I'm hoping that you can help with other income prospects in the future, including the look for AstraZeneca, other incomes, run rate and the anticipated step down in coming years."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Dave. David?"
},
{
"speaker": "David Elkins",
"content": "Yes. So this year was the big step down in the PD-1 rate. And then the other thing impacting that is the diabetes that will step down next year as well."
},
{
"speaker": "",
"content": "The other thing to keep in mind, as I said in the prepared remarks is on the interest for the additional debt that we just did. That was the big change in the guidance that we just provided for this year, going from $250 million of OI&E income down to $250 million of expense. And the bulk of that is related to the additional interest cost, which is around $13 billion with 5.3% interest rate. And that's slightly offset by the royalty income."
},
{
"speaker": "Operator",
"content": "And our next question comes from Mohit Bansal with Wells Fargo."
},
{
"speaker": "Mohit Bansal",
"content": "I actually want to probe the trough guidance comment a little bit further. It does seem like that you are considering it. But if that is the case, can you talk a little bit about the puts and takes there regarding timing of such guidance? I'm asking because it depends on when you think the trough is, if it is '26 or '28. Because, I mean, you might not want to provide if it is '28, but just now because it is still a little bit uncertain regarding the timing of it. So what are the puts and takes regarding the timing of it when you eventually decide to provide it?"
},
{
"speaker": "Christopher Boerner",
"content": "Yes. So maybe I'll start and then David can chime in if he has any additional -- anything else that he would like to provide. I think the way we're thinking about the trough guidance, and again, it's something that we have been engaged with investors for the last number of months. I think the way I would think about it is, first and foremost, probably the underlying question on guidance right now is what is the impact of IRA on Eliquis. We will, as I said earlier, be in a position in September when the price for Eliquis coming out of the IRA process is known and public, at that point, to talk about what that price is and the impact of -- on Eliquis on both the top line as well as on EPS."
},
{
"speaker": "",
"content": "And then in terms of how we're thinking about the timing of the trough, again, and we said this back at the beginning of the year, we see the impact starting in 2026 and our plan is to be growing by the end of this decade. David, anything else you would add?"
},
{
"speaker": "David Elkins",
"content": "I think you covered it, Chris."
},
{
"speaker": "Operator",
"content": "Our next question is from Carter Gould with Barclays."
},
{
"speaker": "Carter L. Gould",
"content": "I wanted to dig into Camzyos for a second. You did have data at ACC and sort of the current rate or the one with that seemed very positive. And just when you think about that REMS registry data and the potential to potentially get the REMS modified down the road, should we be reading into that data? Any level of confidence or anything on that front you want to message?"
},
{
"speaker": "",
"content": "And I guess along those lines as well just, I believe housekeeping on -- did I hear a $20 million inventory impact in the quarter? I know that something was called on the slides, but I'm not sure that was quantified. Any help there would be great, too."
},
{
"speaker": "Christopher Boerner",
"content": "Yes. Thanks, Carter. Maybe Samit can start and then Adam. ."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you, Carter, for the question. So for Camzyos, we remain obviously very confident in the overall profile of Camzyos. It has been a very transformational therapy for patients. And as you mentioned, the data at ACC clearly showed from the patients that have been treated in the real world that there is transformational outcome. And from a safety perspective, with 80% of the patients being treated, the 2.5- and the 5-milligram dose, the overall outcomes remain really, really positive as well as the impact on the ejection fraction is minimal at best."
},
{
"speaker": "",
"content": "So certainly, it gives us an opportunity to collate that data and find the conversations continuing with the FDA at appropriate times. Remember, we've also got the nonobstructive hypertrophic cardiomyopathy study that we'll be reading out early next year. So that will provide another opportunity for us to also engage deeper into conversations for the REMS program as a whole and how we can bring this therapy to more patients as well as decrease the burden on the patients."
},
{
"speaker": "",
"content": "With that, let me pass it on to Adam to comment more."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Thanks for the question. We're pleased with Camzyos' performance in the quarter. And we saw a nice acceleration in new patient starts. We saw about a 25% increase in patients added to commercial dispense, but that was offset as you mentioned, by approximately $25 million inventory work down from Q4 to Q1. And we saw a slight gross to net impact as well from copay restart that happened at the beginning of the year."
},
{
"speaker": "",
"content": "What we see from Camzyos is consistent positive feedback from physicians and patients. It's very positive. We're also making very good progress in the launch internationally as we work to secure reimbursement. So we're seeing good momentum for Camzyos and we feel good about the performance of this important product now until the end of the year, for sure."
},
{
"speaker": "Operator",
"content": "And our next question comes from Steve Scala with TD Cowen."
},
{
"speaker": "Steve Scala",
"content": "This is a different version of earlier questions, but there are a number of potential obstacles in Bristol's future, Eliquis IRA price and patent expiration, Opdivo patent expiration, other patent expirations, et cetera. But based on your replies to those earlier questions, it sounds like that Bristol views the IRA price of Eliquis as the single biggest obstacle to profits in the next decade. Is that the conclusion that you'd like us to draw?"
},
{
"speaker": "",
"content": "And then the second question is that it was noted, Revlimid free drug was lower in Q1. Just to confirm, is that consistent with prior Revlimid guidance? And what is the reason it is lower? Was there just fewer patients requesting free drug? Or did Bristol change the terms?"
},
{
"speaker": "Christopher Boerner",
"content": "So Steve, I'll start, and then I'll ask the last part of your question. We've highlighted the issue around the Eliquis price and the negotiations, because that is an important consideration in the midterm as we think about this sort of transition period that we're going through that we've talked about in the middle of the decade. And so we'll have greater insight into what that impact is later this year, and we'll be able to provide more of an estimate for the impact both on top line and on EPS as we get into the back half of the decade at that time."
},
{
"speaker": "",
"content": "What I would say, though, as I step back, I mean, clearly, you've articulated that -- the importance of Eliquis. And as we've discussed in the past, we have a number of LOEs that we faced during the course of the decade. But I think it's important to note as well that we've talked a lot about the importance of the growth portfolio that we had. We saw nice double-digit growth with that portfolio in the quarter."
},
{
"speaker": "",
"content": "We actually are now -- about 40% of the overall business is comprised by that portfolio of products. And remember, this is a diversified portfolio of assets across each of our therapeutic areas, and we feel good about the potential of that portfolio going not only through the end of this year, but to be a catalyst for growth in the back half of the decade. And then we saw very nice progress with the pipeline over the course of the quarter."
},
{
"speaker": "",
"content": "So I think it's important to recognize that while IRA has an impact in the middle of the decade, we feel very good about being able to more than compensate for that with a very young and attractive growth profile coming from our growth portfolio and the pipeline. David?"
},
{
"speaker": "David Elkins",
"content": "Steve, on your question around Revlimid, just a couple of comments I'll make on that. One is what I said is that the free drug programs come down to normal levels. So no change in the program there. Just throughout last year, those levels came down in the start of this year. Remember, every calendar year, it starts again, back at traditional levels. So that was in relation to that comment."
},
{
"speaker": "",
"content": "The other thing as it relates to Revlimid is, as we said, there's no change to our guidance this year. As previously said, it was $1.5 billion to $2 billion step down this year and the same next year. So for this year, if you remember, we exited last year at $6 billion. So we'll be in that $4 billion to $4.5 billion is our best view this year and then a further step down next year."
},
{
"speaker": "",
"content": "So we'll be through the LOE of Revlimid basically at the end of next year. And then as Chris talked about, we'll get insight to what's happening with Eliquis from an IRA perspective when that price becomes public here in September. And recall that the LOE for Eliquis is in 2008."
},
{
"speaker": "",
"content": "And then lastly, the thing I'd say about from an LOE perspective as it relates to Opdivo, is that LOE is in December of 2028. So '29 is when that LOE would start. And then three things I'd say about that as we think about that franchise. One is we're looking forward to launching the subcutaneous formulation of that early next year. And we believe that will help that franchise continue into the next decade. I think you've heard Samit talk about Opdualag and that combination. We're really excited, number one, with its performance and standard of care in first-line melanoma, but also with the data that we're seeing in lung, we're really excited about continuing that program into Phase III and bringing that. And also, there's other tumor types that Opdualag will come in."
},
{
"speaker": "",
"content": "So as we think about that franchise, there's multiple avenues for that franchise to continue into the next decade."
},
{
"speaker": "Christopher Boerner",
"content": "Just adding one thing, Steve. Around Revlimid, we had seen some volatility in generic dispensing in the quarter, including some generic supply shortages. And so Revlimid and our legacy portfolio continues to be a strong source of cash flow for the organization."
},
{
"speaker": "Operator",
"content": "And our next question today comes from Trung Huynh with UBS."
},
{
"speaker": "Trung Huynh",
"content": "Trung Huynh from UBS. Two from me, if that's okay. Just one on the cost saving program. How is that $1.5 billion split between this year and 2025? There's no change to your OpEx guide, but I think you noted savings were absorbed by the deals. Is 2024 the main year you'll see most of these costs realized?"
},
{
"speaker": "",
"content": "And then just on Abecma, you have KarMMa-3 on the label now. You noted it's going to be important for growth. How quickly can we start to see that helping? Is it realistic to see an inflection immediately?"
},
{
"speaker": "Christopher Boerner",
"content": "Thanks for the question, Trung. David, then Adam."
},
{
"speaker": "David Elkins",
"content": "Yes, the vast majority of the savings comes through this year. Because if you think through the actions that we're taking, whether it's positions, the portfolio actions, we made those actions immediately and the third-party spend, we'll receive that. And then you have it annualize fully next year. So that's really the difference between '24 and '25. But it's safe to say that most of all the actions we're taking, 90% of those are being done this quarter."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Trung, as it relates to Abecma, we're certainly pleased with the regulatory approvals of KarMMa-3 in a triple class-exposed setting in the U.S., in Europe and in Japan. This will remain a very competitive space with multiple products and modalities available. Our focus is on educating physicians on the KarMMa-3 data, Abecma's differentiated and predictable safety profile as well as the manufacturing reliability that we've had with Abecma."
},
{
"speaker": "",
"content": "We're also focused on expanding our site footprint in the U.S. and around the globe, making Abecma available to more patients. So we believe that there is a place for multiple assets in this market, and our objective is to return Abecma to growth over time as we move into a larger patient population."
},
{
"speaker": "Operator",
"content": "Our next question comes from Matthew Phipps with William Blair."
},
{
"speaker": "Matthew Phipps",
"content": "Adam, I was wondering if you can comment on -- is there any path to grow Opdualag in melanoma outside the United States? Or will additional data be needed?"
},
{
"speaker": "",
"content": "And then maybe for Samit. On KRYSTAL-12, I don't suppose you can give us any tidbits on trends and overall survival at this point. I know the study is ongoing there, but maybe, if not just confidence in that data set as it stands today being able to support full approval."
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. I'll start. Thanks for the question. First, I'd say we're pleased with our continued progress as Opdualag has become the standard of care in the United States in first-line metastatic melanoma. We saw over 70% growth versus prior year. And our market share now is above 25% in the U.S., and we still have further room to grow penetrating what's still around 15% monotherapy use."
},
{
"speaker": "",
"content": "It's exciting because we're also starting to launch internationally in markets like Australia, in Canada and Brazil as well as several European markets. We still have not had an opportunity to launch in Germany, but we are working on that negotiation. And we're hopeful that we have an opportunity to launch there sometime in the back end of this year and into next year."
},
{
"speaker": "",
"content": "Additionally, as spoken earlier, we're very pleased to have the proof-of-concept study with LAG-3 on top of PD-L1s and chemo in first-line lung cancer. And when you add that up, coupled with opportunities with lung and adjuvant melanoma, Opdualag truly has the potential to meaningfully extend our I-O franchise well into the next decade."
},
{
"speaker": "Samit Hirawat",
"content": "And thank you for the question. If I think about KRYSTAL-12, remember, this is a study with a primary end point in progression-free survival. And you will see the data being presented at ASCO. Overall survival data remains immature at this time, so I will not be able to comment on the specifics of that. But really excited for the confirmation of the single-arm study previously done now with the randomized study here."
},
{
"speaker": "Operator",
"content": "Our next question comes from Olivia Brayer with Cantor Fitzgerald."
},
{
"speaker": "Olivia Brayer",
"content": "What does the commercial rollout strategy look like for KarXT as we look past that September PDUFA? And any thoughts around Medicaid negotiations?"
},
{
"speaker": "",
"content": "And then when do you think we start to see some meaningful growth from that franchise, whether that's next year or more so in 2026?"
},
{
"speaker": "Christopher Boerner",
"content": "Adam?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes. Thanks for the question. So we're very excited about the opportunity to launch KarXT later this year. This is a very important drug with significant commercial potential. As we talked about, KarXT will be the first innovative therapy in schizophrenia approved for decades. And what we've shared is KarXT offers Zyprexa-like efficacy without the significant adverse event that's plagued the D2 such as weight gain, lipidemia, EPS. And we know how compelling this is for physicians. We are rapidly preparing for the launch and the plans are going well, and we will be ready to launch by the summer, well in advance of our PDUFA date."
},
{
"speaker": "",
"content": "We've been focused on prelaunch efforts and made very good progress preparing for the launch. So Karuna had made good progress in sourcing a very experienced commercial organization and our field medical and our access teams have already begun meaningful conversations with thought leaders and payers. Our prelaunch efforts today are focused on driving awareness of this new mechanism. We're currently building out a large neuroscience field sales organization. In fact, we've increased the investment across multiple fronts to maximize the opportunity that we have."
},
{
"speaker": "",
"content": "So we also need to ensure that physicians have a positive first experience. So we're focused on building our customer model to make sure that we have the optimal physician caregiver and patient support. And as you alluded to, we know that achieving rapid access is important. And so this is a largely Medicaid and Medicare opportunity, around 70%, and our access teams are ready today. We will leverage our large access organization to ensure rapid access for patients. Our teams have already been out and meeting with state Medicaid directors, and the feedback on the product profile has been very, very positive."
},
{
"speaker": "",
"content": "So over half of state Medicaid programs either have no step edits or a single step edit. So our goal is to improve the quality of access to only one step edit, which you know is going to take some time, but we're very confident in our ability to achieve quality access for this product. So given a September '26 PDUFA and some of the timelines to obtain broad Medicaid coverage, we effectively see this as a 2025 launch, but we're very excited about the potential of KarXT and we plan to make this a very big product for Bristol-Myers Squibb."
},
{
"speaker": "Timothy Power",
"content": "Thanks, Adam. We're starting to run a little short on time, maybe take 2 or 3 more. Can we go to the next one?"
},
{
"speaker": "Operator",
"content": "Our next question comes from James Shin with Deutsche Bank."
},
{
"speaker": "James Shin",
"content": "I had a question on Opdualag Phase II for frontline multiple cell lung. I know the full data set is for readout in the second half, but can you share if what you've seen is any different or comparable to the other LAG-3 non-small cell data sets such as [ TACD ]?"
},
{
"speaker": "Samit Hirawat",
"content": "Certainly, I can take that question. Look, obviously, I can't comment on what others have seen. All we know is they've seen six patients worth of data. Hard to compare six patients worth of data with more than 200 patients treated with Opdualag plus chemotherapy in the first-line setting."
},
{
"speaker": "",
"content": "What we have seen is overall review of our own data set, looking at the various endpoints that we looked at as well as the biomarkers we looked at in our [ profile ] and we remain confident in the profile of the drug to take it forward into the Phase III."
},
{
"speaker": "Operator",
"content": "Our next question comes from Kripa Devarakonda with Truist Securities."
},
{
"speaker": "Srikripa Devarakonda",
"content": "I had a question about your acquisition of RayzeBio and now that you've got enablement and we're seeing -- it's getting to be very competitive. Just wanted to see what the urgency and what this strategy is to build out the radiopharma pipeline. And also, when can we see more details on what the priorities are and also regarding actinium production going live?"
},
{
"speaker": "Christopher Boerner",
"content": "Well, let me start and then I'll ask Samit and Adam to speak. Let me just at a high level, though, say, that we continue to be incredibly excited about radiopharmaceuticals as a platform. It's one of the fastest-growing platform in solid tumor oncology. We believe we have a best-in-class asset that we've acquired with Rayze."
},
{
"speaker": "",
"content": "The integration of that team has gone very well. We continue to be very excited and happy with the bringing online of the facility in Indianapolis. So in terms of us getting that asset, incredible enthusiasm and the integration has gone well. But Samit, maybe you and Adam can speak to details."
},
{
"speaker": "Samit Hirawat",
"content": "Yes. Thank you for the question. For Rayze, as Chris just mentioned, the platform is absolutely exciting and very encouraging data that we have seen emerging from the first program that is already in Phase III for the SSTR directed radioligand therapy. And that Phase III program is right now enrolling in the GEP-NET indication as well as the small cell lung cancer Phase I studies ongoing, and we are looking to see a couple of other indications added over there, and we're designing those trials as we speak and conduct those. So it holds a huge amount of promise because of the specificity of the directed radiation to the tumor itself."
},
{
"speaker": "",
"content": "Thereafter, we're looking forward to additional IND filing later this year, and that might then be able to start our actually very specific tumor-directed indication within HCC at the back half of this year. And then thereafter, we are looking to see an IND generation coming from this platform as we go forward."
},
{
"speaker": "",
"content": "With the Indianapolis manufacturing facility now up and running, we're looking forward to supplying the actinium part of it as well as the drug product towards the back half -- or back end to early part of next year, and that will certainly help in terms of continuing to supply and taking it forward. We are learning lessons from the front runners and those lessons will be very helpful as we go into the commercial stages in a couple of years."
},
{
"speaker": "Christopher Boerner",
"content": "Adam, anything to add?"
},
{
"speaker": "Adam Lenkowsky",
"content": "Yes, I'll just add just a few things. RayzeBio was an important strategic acquisition that we believe continues to diversify our oncology portfolio. It's -- as Chris mentioned, we see this as a modality that's going to continue to grow over time. It will be a competitive space."
},
{
"speaker": "",
"content": "But what we liked about RayzeBio, this is going to be an IND engine. And the lead program RYZ101 is already in Phase III development, as you heard earlier, for GEP-NET. But we have opportunities in small cell lung cancer, in breast cancer and potentially many other tumor types. So this is tremendously complementary to our existing portfolio."
},
{
"speaker": "Timothy Power",
"content": "And maybe we could go to our last question, if you don't mind, Rocco?"
},
{
"speaker": "Operator",
"content": "Our final question comes from Akash Tewari with Jefferies."
},
{
"speaker": "Siyue Wang",
"content": "This is Ivy on for Akash. We just have two quick questions. The first one is a follow-up for KarXT. So do you think patients on the drug will develop tardive dyskinesia? If not, how will that help position KarXT in the schizophrenia market?"
},
{
"speaker": "",
"content": "And then our second question is for CAR-T. So why do you think CAR-T for autoimmune is more attractive than CD19 bispecifics? And also, would you consider approaches that don't require lymphodepletion?"
},
{
"speaker": "Christopher Boerner",
"content": "Samit?"
},
{
"speaker": "Samit Hirawat",
"content": "Sure. Thank you. First of all, great profile for KarXT that I think Adam has spoken about earlier from a safety profile perspective and the data has recently been presented also at the SIRS conference where we do not see the same toxicities that are seen with the atypical such as the tardive dyskinesia, the movement disorders as well as many of the other elements that have been spoken about, so I won't repeat. So that's why we are very confident on the profile and looking forward to bring it to the patients with schizophrenia. And then as David said earlier, with other indications as well for AD psychosis, agitation, bipolar disorders and others that we are exploring."
},
{
"speaker": "",
"content": "On the CAR-T side, certainly an advantage for a single infusion leading to good outcomes for patients, especially starting with SLE in the refractory setting, where patients have had multiple other treatments ongoing and organ dysfunction factors in these patients. That is the advantage, a single infusion, if that can cause tremendous transformational outcomes for these patients."
},
{
"speaker": "",
"content": "As you know, our program is quite large. So we are also looking at multiple sclerosis as well as systemic sclerosis as well as idiopathic myositis. So those programs as they enroll patients will generate the data, and we're hoping to be able to present some data from SLE this year and certainly, future approaches might include non-lymphodepletion therapies, but we're not ready for that right now."
},
{
"speaker": "Christopher Boerner",
"content": "Thanks, Samit. And maybe I'll just close by saying, first, thank you all for joining the call today. I know it is a very busy day for all of you. So maybe I'll just leave you with a few things. First, we're off to a very good start in 2024. Our performance this quarter reflects execution and actions that we've taken to strengthen the company's long-term growth profile. Our business out remains unchanged from the beginning of the year. And of course, we look forward to sharing our continued progress on future calls."
},
{
"speaker": "",
"content": "And with that, we'll close the call. And as always, the team is available to answer any questions you have following today's discussion, and I hope all of you have a very good day."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day."
}
] |
br | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day! Welcome to the Broadridge Financial Solutions Fourth Quarter and Fiscal Year 2024 Earnings Conference Call. All participants will be in a 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 hand the call to Edings Thibault, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Edings Thibault",
"content": "Thank you, Andrea. Good morning, everybody. And welcome to Broadridge's fourth quarter and fiscal year 2024 earnings call. Our earnings release and the slides that accompany this call may be found on the Investor Relations section of broadridge.com. Joining me on the call this morning are Tim Gokey, our CEO; and our Interim Chief Financial Officer, Ashima Ghei. Before I turn the call over to Tim, a few standard reminders. One, we'll be making forward-looking statements on today's call regarding Broadridge that involve risks. A summary of these risks can be found on the second page of the slides in a more complete description on our Annual Report on Form 10-K. Two, we'll also be referring to several non-GAAP measures, which we believe provide investors with a more complete understanding of Broadridge's underlying operating results. An explanation of these non-GAAP measures and reconciliations to their comparable GAAP measures can be found in the earnings release and presentation. Let me now turn the call over to Tim Gokey. Tim."
},
{
"speaker": "Tim Gokey",
"content": "Thank you, Edings, and good morning. It's great to be here to discuss our strong fiscal ‘24 financial and operating results. I'm also pleased to be joined by Interim CFO, Ashima Ghei. Ashima took over on July 1 from Edmund and we continued to wish good luck in his next endeavor. Importantly, I've had the opportunity to work closely with Ashima over the past two and a half years as she played a leading role in driving the strong results of her ICS business. Previously, she was in American Express for 18 years, and she has brought a strong combination of deep insight and experience to her role as CFO of ICS here at Broadridge. Ashima, welcome."
},
{
"speaker": "Ashima Ghei",
"content": "Thank you, Tim. Great to be here."
},
{
"speaker": "Tim Gokey",
"content": "I'll start my review this morning with a quick comment on what we're seeing in the market. Over the past six months, the market has been stable to improving. Our clients have been moving proactively to digitize communications, simplify and modernize their technology infrastructure, and enhance investor engagement. These trends played to Broadridge’s strengths, and they drove record closed sales for the quarter and for the year. This past week has seen much higher volatility, with questions about the pace of rate easing and sustainability of growth. It's too early to know if this represents a market turn, but if it does, these kinds of environments are where Broadridge's resilient recurring revenue business model really stands out. I'm confident that Broadridge is going into fiscal ‘25, poised to deliver another year of sustainable growth backed by a record backlog of sales already closed, a strong pipeline, and resilient volume trends. We're executing on our growth strategy and investing in our products and capabilities. So in any scenario, I feel very good about how we're positioned. With that as context, let's review our strong results and strategic progress. I'm happy to report that Broadridge is executing on our strategy to democratize and digitize Governance, to simplify and innovate in capital markets, and to modernize wealth management. Our clients look to us as trusted and transformative partner to help them adapt to regulatory change, reduce cost and complexity, and drive innovation. That trusted and transformative position, along with strong execution, is driving record closed sales. For the year, Broadridge reported 39% growth in closed sales to $342 million. That's both record sales and record sales growth. It's also enabling Broadridge to continue to deliver strong and sustainable growth. For the full year, adjusted EPS rose 10% on 6% organic growth in recurring revenues. As we've seen all year, that growth was accompanied by strong free cash flow conversion, ending the year at 102%. Higher cash flow and our strong balance sheet enabled us to fund tuck-in M&A investments, and we purchased $450 million in Broadridge shares. I'm also pleased to announce a 10% increase in our annual dividend, the 12th double digit increase in the last 13 years. Finally, the combination of strong execution and sales growth has Broadridge positioned to deliver another year of strong and sustainable growth in fiscal ‘25. Our guidance includes 5% to 7% organic recurring revenue growth, and 8% to 12% adjusted EPS growth, with $290 million to $330 million of closed sales. Now, let's dive into how we generated these strong results, starting on Slide 4 with our governance business. We continue to make strides in executing our strategy to drive the democratization and digitization of governance. For FY’24, our ICS business reported 5% recurring revenue growth, driven by data-driven fund solutions, issuer and digital communications. Part of driving democratization is enabling the continued growth in equity and fund investments by Mainstream investors. Full year equity position growth was 6%, including 7% in the fourth quarter, in line with mid-to-high single-digit trends of the past decade or more. That growth was driven by managed accounts, which continued to be a key area focus for Wealth Advisor, while self-directed position growth was flat. Mutual fund and ETF growth was 3% for the full year, driven by demand for passive funds. While growth picked up to 6% in the fourth quarter, demand trends remained mixed. Money market fund positions, which account for less than 5% of the total, grew by 17% in the quarter, suggesting that many investments remained content to be in cash. Recall that investors tend to have only one money market fund versus multiple equity or bond funds. So growth in money markets tends to lower overall position growth. Beyond position growth, Broadridge is driving democratization by helping our fund clients implement voting choice for their shareholders. We are now enabling more than 100 separate funds to offer their investors a greater say in governance, up from only eight a year ago. We're also seeing strong interest in Europe, where funds see voting choice as a competitive differentiator. Our virtual shareholder meeting capabilities are also making shareholder meetings more accessible. We recently hosted more than 6,500 investors and guests on our VSM platform for the meeting of a mega cap tech company. We're playing a role in enabling investors to weigh in on the governance in some of the largest and most widely held companies in our market, including Disney earlier this year and Tesla in the fourth quarter. I'm especially pleased with the success of our tailored shareholder report solution. As most of you know, beginning last month, tailored shareholder reports replaced the 100 plus page annual and semi-annual reports that fund shareholders previously received with a condensed and more digestible two to three page report. While, it's a big step forward in enabling funds to communicate more effectively with their shareholders. It doesn't come without added cost or complexity. Funds now need to manage a much greater number of individualized reports that first need to be digitally composed and then distributed to shareholders. To meet that demand, we created solutions to lower the print and distribution costs of these new communications and streamline the higher value digital composition and digital tagging work. Our ability to deliver compelling solutions in the face of a looming regulatory deadline was critical for our clients, and the sales of our TSR Solution contributed strongly to our overall sales growth this past year. It's a great example of how Broadridge is bringing innovation and value added services to do more for asset management clients. Finally, our printed digital strategy is driving digitization in our customer communications business. After crossing over the 100 million digital revenue threshold in fiscal ‘23, we delivered another year of double digit growth in ‘24 driven by continued on-boarding of new clients to a Wealth InFocus Digital Solution. In the fourth quarter, we reached agreement with a major financial services firm to bring its digital communications infrastructure onto our platform. This was an existing Broadridge print client who sees Broadridge’s digital capabilities as an opportunity to accelerate client engagement and drive additional savings. New sales like this give our BRCC business a clear runway for growth in ‘25. Now, let's move to our Capital Markets franchise. We continue to make strong progress against our goal of simplifying and innovating across the trade life cycle. Capital markets revenues crossed the $1 billion revenue milestone, rising 8% for the year, driven by strong growth in BTCS and by the onboarding of new global post-trade clients. In the front office, our bank clients face the pressure to drive ever-increasing trade volumes at lower spreads from a faster settlement across multiple asset classes and geography. We're meeting that need by delivering a state-of-the-art global SaaS platform that gives trading firms best-in-class order management, execution, scale, and reliability. We're now extending those capabilities to the derivatives market by developing new futures and options solutions. We also continue to help our clients reduce the cost and complexity of their back office operations for their global post-trade capabilities. In fiscal ‘24, we brought a leading global bank, the international operations of a major European bank, and a leading Nordic bank onto our global post-trade platform. By combining multiple existing platforms and dozens of markets, Broadridge is enabling these clients to simplify their operations, reduce complexity, and optimize capital. Only Broadridge can deliver that kind of global simplification at scale, and our success is driving a strong pipeline of additional post-trade engagements. Driving simplification also means helping our clients adapt to regulatory change, and the transition to T+1 at the end of May was a notable example. The move to a shortened settlement cycle across North American equities and corporate and municipal bonds was the culmination of initiative that began in 2020. The goal was to reduce systemic risk or lowering clearinghouse collateral requirements and enhancing operational efficiency. For Broadridge, it was another opportunity to showcase the benefits of metallization. For more than a year leading after the change, our teams focused on delivering rigorous testing, meticulous planning, and robust client communication. A year ago, we set up a T+1 test environment that enabled clients to thoroughly test their own preparedness, and we led and participated in industry-wide initiatives along with the DTCC and CDS. The results have been a seamless transition for our clients, marked by significant improvement in industry-trade date affirmation rates, a 30% reduction in certain collateral requirements, and increased liquidity. Finally, we're driving innovation across trading through the adoption of AI and distributed ledger technology. We're seeing growing interest in our AI solutions, including our now-patented BondGPT capability and our OpsGPT console. Our distributed ledger repo platform is delivering reduced external transaction fees, lower sales, and increased liquidity. We added two new clients onto our DLR platform in fiscal ‘24, increasing our monthly average trading volume to $1.5 trillion. Now let's turn to Wealth and Investment Management on Slide 6. In Wealth, we are helping our clients modernize and transform on their own terms with our modular suite of capabilities. Wealth and Investment Management revenues rose 7% in fiscal ‘24, driven in part by the go-live of our UBS contract at the beginning of the year. Partially offsetting this growth was the de-conversion of Morgan Stanley E-Trade. After a three-year journey, we helped Morgan Stanley complete the transition of the E-Trade platform last fall. More broadly, the sales of our Wealth and Investment Management solutions rose more than 40% in fiscal ‘24, including a strong contribution from our Wealth platform solutions. Our pipeline continues to grow, and we're seeing continued demand for tools that help increase advisor effectiveness, enhance client engagement, and drive operational efficiency. Last quarter, we announced the acquisition of Kyndryl SIS business in Canada. The SIS platform provides front, middle, and back-office technology for Canadian financial services firms. The addition of the SIS clients to our existing business in Canada will accelerate our ability to bring new capabilities, including our wealth solutions, to the Canadian market. That deal is now moving through the Canadian regulatory review process, and we expect it to close in the first half of fiscal ‘25. I'll close my review of our fiscal ‘24 execution with closed sales. Broadridge reported record closed sales of $342 million, including fourth quarter sales up more than 70% to $157 million. We benefited from strong demand for our tailored shareholder reports and digital capabilities in ICS, and from strong growth in both capital markets and wealth in GTO. It's a direct reflection of the steps we've taken to help our clients adapt to change and grow their business. It's gratifying to see our investments translate into growth. Our strong sales performance is a clear sign that as clients begin to reinvest themselves, they see Broadridge as a trusted, transformative partner to help them operate, innovate, and grow. And with a strong pipeline going into next year, we expect another year of strong sales in fiscal ‘25. I'll wrap up my review with some closing call-outs on Slide 7. First, Broadridge is executing on our growth strategy. We're driving the democratization of investing by ensuring that a growing number of Mainstream investors get the critical information they need to understand their investments and make their voice heard. We're powering important corporate elections and extending voting choice. As an upcoming change in regulatory fund reporting, we stepped up to develop innovative, tailored shareholder report solutions. In digital, we started a journey years ago to combine world-class digital solutions with our low-cost print network. And in GTO, we have acquired, built, and invested in our front and back office solutions to help our clients’ trade faster, engage with their clients, enhance adviser productivity, and reduce operational complexity. We're delivering new capital markets capabilities in derivatives and extending our global reach. We've enabled faster settlement times for dozens of clients and trillions of dollars of assets. We're driving innovation with AI-Enabled solutions and distributed ledger technology. We're live with our Wealth platform. We're driving the sales of our modular solutions and we're leveraging the technology more broadly, including as we extend and grower out business in Canada. Our execution on these strategies drove record-close sales, 6% recurring revenue growth, and double-digit adjusted EPS growth in fiscal ‘24. Looking ahead, we expect another year of strong and sustainable growth in fiscal ‘25, and we're on track to deliver on our three-year financial objectives. Most importantly, we continue to see a long runway for future growth. Technology trends are enabling more investors to participate in the market and giving them access to increasingly sophisticated investments. Digitization is transforming the way businesses engage with their clients. Trading continues to accelerate, and banks look to reduce the cost and complexity of their operations. Regulators around the world are constantly updating rules to modulate behavior and improve disclosure for all investors. And every one of those trends is shaped by the power of data and AI. We've positioned Broadridge to help our clients meet the opportunities and challenges these trends create. We're executing on a growth strategy to do even more as we attack our $60 billion and growing vented market opportunity. The power of mutualizing change to increase speed and reduce cost is true in almost all economic environments, and our resilient business model is particularly strong in periods of higher volatility. I've never been more optimistic about Broadridge's future. Before I hand over to Ashima, I want to thank our associates. As I've talked about today, Broadridge is executing on multiple fronts, and none of that would be possible without the hard work and client focus of everyone at our company. So, thank you for your work in serving our clients today and for helping to transform our industry for tomorrow. Ashima."
},
{
"speaker": "Ashima Ghei",
"content": "Thank you, Tim. It's great to join all of you to discuss the strong results and to review our guidance for fiscal ‘25. Broadridge has a long track record of delivering strong and sustainable top and bottom line growth with strong shareholder returns, and this year was no different. Fiscal ‘24 recurring revenue grew 6% constant currency, and adjusted EPS grew 10%. Before I go through the results, I want to call out the key items that give me confidence that we are on track to deliver on our fiscal ‘25 guidance and our three-year growth objectives. First; sales and backlog. Record closed sales of $342 million drove a 13% increase in revenue backlog, giving us strong visibility into our revenue growth in fiscal ‘25 and ‘26. Second, position growth. Equity position growth was 6% in ‘24, and fund position growth was 3%. Our current testing shows a modest improvement in those trends with continued mid-to-high single-digit growth in equities and mid-single-digit growth in funds. Third; expenses, investments and margins. We have a long history of driving operating leverage. This quarter, we completed a restructuring initiative that will position us to continue to fund long-term growth investments, grow core margin and deliver earnings growth. Fourth and last, capital allocation. In fiscal ‘24, we repurchased 2.3 million shares for $450 million and have recently announced three tuck-in M&A investments. That capital will contribute directly to our top and bottom line growth. These four areas position us well to deliver our three-year financial objectives and our fiscal ‘25 guidance which calls for 5% to 7% recurring revenue, constant currency growth, almost all organic and 8% to 12% adjusted EPS growth. With that let's go through the numbers on Slide 8. Fiscal ‘24 recurring revenues grew to $4.2 billion up 6% on an organic constant currency basis. Adjusted operating income grew 9%. Adjusted EPS grew 10% to $7.73 and we reported record closed sales of $342 million which drove our recurring revenue backlog to $450 million. Turning now to the fourth quarter headline numbers. Recurring revenue grew 5% on a constant currency basis to $1.3 billion. Adjusted operating income grew 5% and AOI margin was 28.8%. Adjusted EPS rose 9% to $3.50 and closed sales rose 74% to a fourth quarter record $157 million. Moving to Slide 9, fourth quarter recurring revenue rose 5% to $1.3 billion driven by a combination of converting revenue from sales and mid-single digit position growth. For the full year recurring revenue growth was 6% essentially all organic and in line with our three-year organic growth objective of 5% to 8%. Let's turn to the next slides to review the growth across our ICS and GTO segments. In Q4 ICS recurring revenue grew 6% powered by growth across all four product lines. We also saw the benefit of the timing delays we'd called out in our Q3 results which added 1 point to fourth quarter growth. For the full year ICS recurring revenues were up 5% to $2.6 billion. Regulatory revenue grew 7% in Q4 and 5% for the full year in line with position growth. Looking ahead we expect continued mid-single digit revenue growth in fiscal ‘25 in line with our position testing. Data-driven fund solutions revenue increased by 7% in the fourth quarter and for the full year driven by growth in retirement and workplace solutions and our data and analytics products. The acquisition of AdvisorTarget which closed on June 1st made a very modest contribution to growth. Issuer revenue grew 5% in Q4 and 7% for the full year led by growth in our registered shareholder solutions and disclosure products. Customer communications recurring revenue rose 3% in the fourth quarter and 2% for the full year as we continue to execute our print to digital strategy. Digital revenues grew double digits for both the quarter and the year. We expect customer communications growth to accelerate in fiscal ‘25 driven by a combination of digital growth and new client wins. Looking ahead to fiscal ‘25 we expect stronger ICS recurring revenue growth driven by revenue from strong fiscal ‘24 sales, continued mid-single digit position growth and strong growth in digital which will more than offset the loss of 33 revenues and lower float income. Turning to GTO on Slide 11, Q4 recurring revenue growth was 4%. For the full year GTO revenues grew 8% to $1.6 billion. At the high end of our three year 5% to 8% organic growth objective, driven by strong growth across both our capital markets and wealth businesses. Capital markets revenue grew 6% in the fourth quarter. Strong growth in revenue from sales and higher trading volumes more than offset lower license revenue. Full year revenues increased 8% powered by strong growth in BTCS and revenue from sales from new global post-trade clients. Wealth and investment management revenue increased 7% for the full year. Fourth quarter growth was flat, as revenue from new sales was offset by the E-Trade deconversion and lower license revenue. We expect the impact of E-Trade will continue to weigh on the wealth and investment management growth through the first half of fiscal ‘25, especially in the first quarter. Looking ahead to fiscal ‘25, we expect GTO revenue growth to be at the low end of our 5% to 7% recurring revenue guidance range, with stronger growth in capital markets and lower growth in wealth and investment management. Excluding the impact of E-Trade, wealth and investment management growth would be at the higher end of the 5% to 7% recurring revenue guidance. Now, let's turn to slide 12 to review volume trends. Position growth returned to mid to high single digits for both equities and funds in the fourth quarter. Equity position growth rose to 7% in the fourth quarter, in line with our testing. Full year growth was 6%, driven almost entirely by double digit growth in managed accounts. Our fiscal ‘25 first half testing continues to show healthy mid to high single digit growth. Fund position growth metric rebounded to 6% in the quarter. Full year fund position growth was 3%, driven by growth in passive funds and double digit growth in money market funds. Fund flows have strengthened in recent months and our current testing of underlying fund positions is indicating a modest pickup to between 4% to 5%. Turning to trade volumes, trade volumes grew 15% on a blended basis in Q4, driven by both higher fixed income and equity volumes. For the full year, trading volumes were up 13%. Let's now move to Slide 13 for the drivers of recurring revenue growth. For the quarter, recurring revenue growth was 5%, virtually all organic, and balanced between net new business and internal growth. Revenue from closed sales provided 5 points of growth. Our recurring revenue retention rate was 97% for the quarter and for the full year. Adjusting for the E-Trade deconversion, retention rates remained at 98%. And internal growth, primarily positions and trading volumes contributed 3 points. Lastly, we closed two small acquisitions in our ICS segment. Advisor target contributed less than 5 basis points to fourth quarter revenue growth and CompSci closed at the beginning of July. We expect these two acquisitions will contribute approximately 20 basis points to fiscal ‘25 recurring revenue growth. I'll finish the guidance on revenue on Slide 14. Total revenue grew 6% in Q4 to $1.9 billion, and recurring revenue was the largest contributor, with 4 points of growth. Event-driven revenue was $76 million and contributed 1 point to Q4 growth. Event-driven revenue benefited from higher levels of mutual fund proxy and equity contest activity versus the fourth quarter of last year. Low to no margin distribution revenue increased 4% and contributed 1 point to total revenue growth, driven by higher postal rates. Remember, these have a dilutive impact on our adjusted operating income margin. So let's turn to margins on Slide 15. Adjusted operating income margin for Q4 was 28.8%, as the positive impact from operating leverage was offset by the timing of annual expenses. On a full-year basis, adjusted operating income margin was 20%, up 20 basis points from fiscal ‘23. The combination of operating leverage and the benefits from our fiscal ‘23 restructuring enabled us to absorb the deconversion of E-Trade and higher amortization from our wealth platform, while increasing our investments in long-term growth and meeting our earnings objectives. The net impact of higher float revenue and distribution, which have little impact on earnings, increased margins by 30 basis points. During the fourth quarter, we completed the restructuring program we began last year to realign some of our businesses and streamline our management structure. We incurred $56 million in fourth quarter charges, which were not included in our calculation of adjusted operating income and adjusted EPS. We estimate that these actions will generate over $100 million in annualized cost savings, which will position us to fund investments, further scale our business, and deliver earnings growth. Rounding out the fourth quarter non-GAAP items, I would also note that we incurred $10 million in charges to settle various legal matters. Let's move ahead to closed sales on Slide 16. Broadridge had a very strong sales year. Fiscal ‘24 sales rose 39% to a record $342 million, driven by a very strong fourth quarter, where closed sales grew 74% to $157 million. As you heard from Tim, we benefited from strong sales of our tailored shareholder report solutions and digital, as well as strong growth across both our capital markets and wealth and investment management solutions. These strong sales lifted our revenue backlog to $450 million, equal to 11% of our fiscal ‘24 recurring revenue. I'll now turn to cash flow on Slide 17. Broadridge generated free cash flow of $943 million in fiscal ‘24, up 26% from fiscal ‘23. Free cash flow conversion increased to 102% from 90% in Fiscal ‘23 and 42% in ‘22, returning to a more historic levels after a period of higher investment. We expect free cash flow conversion of approximately 95% to 105% in fiscal ‘25. Let's move next to capital allocation on Slide 18. We continue to take a balanced approach to capital allocation. In Fiscal ‘24, we made platform investments of $41 million and deployed $113 million on capital expenditures and software spend. Fiscal ‘24 also marked a return to tuck-in M&A. In total, we enhanced our data and analytics solutions with the $35 million acquisition of Advisor Target and closed the smaller acquisition of CompSci on July 1 to augment our issuer capabilities. In May, we announced the proposed acquisition of SIS from Kyndryl for approximately $200 million. SIS is a leading Canadian wealth and capital markets technology platform with annual revenues of $80 million to $85 million. The acquisition is expected to close during the first half of our fiscal year and will not have a significant impact on our margins or adjusted EPS during the first year of operation. Given the inherent timing, uncertainty of regulatory review, we have not included it in our guidance. We will add SIS to our Fiscal ‘25 guidance after it closes. After internal and external investments, we return excess capital to shareholders. We returned $781 million to shareholders in Fiscal ‘24 through a combination of dividends and share repurchases. During the fourth quarter, we repurchased $300 million of shares, bringing our total gross repurchases in Fiscal ‘24 to $450 million. Finally, we repaid $60 million of debt, ending the year with a 2.2x leverage ratio, below our long-term target of 2.5x. Last night, our Board approved a 10% dividend increase to $352 per share. As Tim noted, this is our 12th double-digit increase in the last 13 years, which emphasizes both, our sustained earnings growth and our long-term commitment to balanced capital allocation. I'll close my prepared remarks this morning with some detail on our guidance on Slide 19. We expect another year of sustainable recurring revenue growth, core margin expansion, strong adjusted EPS growth, and very healthy closed sales in fiscal ‘25. Let me walk through each of those points, starting first with revenue. We expect recurring revenue growth constant currency of 5% to 7%, almost all organic, driven by new sales as we onboard our $450 million revenue backlog. We expect ICS recurring revenues to be at the higher end of that range, with GTO lower. We expect event-driven revenues to be at the high end of our historic range, driven by a proxy campaign at a major mutual fund complex in our second quarter. Distribution revenues are forecast to grow at low double-digit rate, powered by higher postage rates and stronger BRCC print volume. We expect these low-to-no margin revenues to have a dilutive impact on our reported margins. Second, let's move to margin. We expect adjusted operating income margin will be approximately 20%. We anticipate the combination of higher operating leverage and disciplined expense management will enable us to deliver over 50 basis points of underlying core margin expansion, in line with our three-year financial objectives. We expect this to be partially offset by the impact of higher distribution revenues and lower float income. Third, EPS. We expect adjusted EPS growth of 8% to 12%. Embedded in this outlook is an expected tax rate of 21%. Fourth, we expect another year of strong closed sales. Our guidance range of $290 million to $330 million reflects continued growth from our fiscal ‘24 results, excluding sales of tailored shareholder report solutions. And lastly, I will remind you that our guidance does not include the impact of SIS. Taken together, our Fiscal ‘25 guidance highlights the strength of the Broadridge business model. Now before I conclude, let me offer some insight on our first quarter. We expect our first quarter earnings will account for 10% to 11% of our full year adjusted EPS, at the low end of our historical range, driven in part by lower event-driven revenue versus Q1 of ‘24 and the E-Trade impact. So let's wrap up with a quick summary of the key takeaways from our strong fiscal ‘24 results. First, Broadridge delivered another year of strong and sustainable recurring revenue and adjusted EPS growth. Second, our record closed sales highlight the strong demand for our solutions and give us increased visibility into future growth. Third, we are putting our strong free cash flow to work for shareholders, with another double-digit dividend increase, strategic and value-creative acquisitions, and share repurchases. Finally, Broadridge is poised to deliver another strong year in Fiscal ‘25, keeping us well on track to achieve our three-year growth objectives for the fourth consecutive cycle. With that, let's move to Q&A."
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator Instructions]. And our first question will come from Dan Perlin of RBC Capital Markets. Please go ahead."
},
{
"speaker": "Dan Perlin",
"content": "Thanks. Good morning. Tim, I just wanted to ask you, and you touched on this a little bit in the prepared remarks, but we are seeing a pretty material uplift in volatility here, and I appreciate the recurring revenue model. The question is really, in times where we’ve seen this kind of volatility in the past. What have kind of the client behaviors been, and how has the business kind of performed, and are there things structurally different about the business today that you think if we look at other historical periods where we had this heightened volatility, we might have more stable hands, so to speak, this quarter around? Thank you."
},
{
"speaker": "Tim Gokey",
"content": "Yeah Dan, thank you. Thank you very much for that. And obviously, we have no special knowledge about whether what we're seeing is just a moment or is something more significant. But I do think, and I highlighted this in my prepared remarks, that one of the most attractive features of our business model is its resiliency. And when you look at our fee revenues, they are 94% recurring, and the highest driver there is revenue from sales, and we have a $450 million backlog of things that are already contracted. And, when you look at position growth, it's been pretty resilient through a variety of economic cycles. It has sometimes gone down. In global financial crisis, it went down, it didn't go below zero, but it still stayed positive. We're hedged on interest rates, and volatility benefits us on trading. So, I think if you compare where we are now to where we've been in past periods of volatility, it's really not a lot different. The fundamental components around resilient business model, high recurring revenue, revenue from sales, all of those really remain intact. High trading, that volatility debt is a little bit of a plus in the near term. Sometimes when it's volatile, that causes position growth to slow a little bit, but that's all very speculative at this point, and those things really don't move our broad numbers. So that's why we were pretty confident today around our guidance on 5% to 7% recurring revenue growth, 8% to 12% earnings."
},
{
"speaker": "Dan Perlin",
"content": "That's great. Thank you so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Darrin Peller of Wolf Research. Please go ahead."
},
{
"speaker": "Darrin Peller",
"content": "Guys, thanks. And Ashima, congrats, and welcome to the call. I just want to touch base on the strength in bookings trends. I think you hit $340 million in closed sales for fiscal ‘24, which was above the range. I think the midpoint you had said was $300 million for the year. So just, maybe just revisit what – if you take it a step back and revisit the key drivers and the strength, and then really where you are seeing in demand right now, going forward in terms of drivers and areas of real demand for the new bookings and new closed sales."
},
{
"speaker": "Tim Gokey",
"content": "Yeah Darrin, thank you. Thank you very much. Look, we are really proud of the ‘24 sales results with the $342 million. Really driven in ‘24 by four drivers, tailored shareholder reports, digital solutions, strong growth in both capital markets and wealth and investment management. And tailored shareholder reports were an important part of that story, but we like the other stories too. And if you pull out the one-time impact of tailored shareholder reports, sales were at record levels, and we expect that to grow off of those sales, excluding TSR. You know, what we really like is that the sales that we're seeing are aligned with the investments that we have been making, investments in regulatory, investments in digital, investments in capital markets, especially on the front office side, and in wealth. And each of those areas saw strong growth this year. Each of those areas has a nice pipeline for next year. So as we think about where we're seeing that demand that you mentioned, you know we've talked about the bigger themes of helping our clients grow their revenue or helping our clients reduce cost, and the sub-solutions in each of those areas really hit on those. So looking ahead, we're expecting these trends to continue to be very positive, excluding the impact of tailored shareholder reports. We expect to continue to grow our sales in FY ‘25, and we feel good about the 290 to 330 based on our strong pipeline."
},
{
"speaker": "Darrin Peller",
"content": "All right. Very good. Thanks guys."
},
{
"speaker": "Operator",
"content": "The next question comes from James Faucette of Morgan Stanley. Please go ahead."
},
{
"speaker": "James Faucette",
"content": "Great. Thank you very much. I wanted to ask on wealth. It seems like on the wealth front, you alluded to strong pipeline growth for some of the new wealth management solutions. Are you still on track to deliver the $20 million to $30 million of incremental module sales, and how should we be thinking about incremental opportunities down the road there?"
},
{
"speaker": "Tim Gokey",
"content": "Yeah James, thank you very much. We were really happy with how our wealth business continued to perform, obviously 7% up for the past year as we benefited from the onboarding of UBS, partially offset by E-Trade. We do see continued momentum in ‘25 with really being at the high end of that 5% to 7% if we pulled out the E-Trade impact. Remember, E-Trade happened sort of a little bit after the end of the first quarter last year, so the first quarter this year will be impacted. Look, it is strong sales, and it is with clients who want to, we always call it ‘transform on their own terms,’ which is to be able to use a modular approach as a way to long-term transformation. And obviously, the sales are up 40% year-on-year. That was right near that sort of $20 million goal, so not at the 30, but near the 20. We really like though the pipeline of opportunities, and our pipeline right now is 30% higher than it was 12 months ago. And if you remember, that pipeline was up quite a bit over the pipeline the year before. So I think we're continuing to see that nice build. Then really, as we get into SIS in Canada, that's going to really add to the long-term opportunity. We're looking forward to being able to bring our investment on the wealth platform with SIS to accelerate and bring that to the Canadian market as well."
},
{
"speaker": "James Faucette",
"content": "That's great. Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Puneet Jain of J.P. Morgan. Please go ahead."
},
{
"speaker": "Puneet Jain",
"content": "Yeah, hi. Thanks for taking my question. It seems like the advisor target and CompSci deals are different from your prior or typical deals. As you noted, they are both small tuck-in in nature, as well as both of them are in digital areas. Should we expect more deals like this as your M&A priority over the near term?"
},
{
"speaker": "Tim Gokey",
"content": "Yeah, thanks Puneet. It's a great question. Just stepping back, I like talking about M&A, but let's just remember we're an organic growth company. Our growth is primarily organic. There's a long runway given the $60 billion TAM. But that said, as you pointed out, M&A has been an attractive way for us to meet new needs for clients. Remember, for context, we're calling for sort of 1 to 2 points from M&A over the long term. When you look at advisor target and CompSci, they are perfect examples of a buy versus build philosophy. When we look at an area where there's a client need that we think we're the right person to meet, then we look, do we have a platform that's really one that we can build on? Or is there, a really good set of entrepreneurs in the market who've taken something and gotten it to a place where then combining it with us would help them accelerate and help us fill out our product line. It's faster to buy it than it is to build it. So, that's been very successful for us in the past. When you think about sort of the mix of M&A going forward, it's interesting this year because you had AdvisorTarget and CompSci, but you also had SAS, which is a real company with real revenue, nice margins, and it's that sort of portfolio mix, and you've seen that over time. So we've been – we were really proud of our track record over time with M&A. We've done 40-some transactions, but it's always been disciplined in terms of the financial returns. It's always been very strategic in terms of the areas and how – why we're the best owner and those are the things that won't change."
},
{
"speaker": "Puneet Jain",
"content": "Okay. Thank you. Then quickly if I can ask, like, is the duration of backlog, $450 million, any different from what it generally is and that has been in the past?"
},
{
"speaker": "Ashima Ghei",
"content": "Yeah. So Puneet, I'll take that. Our backlog includes a backlog in our ICS business and our GTO business. As you know, typically ICS sales convert a lot faster than on the GTO side. As we've looked at our revenue guidance for fiscal ‘25, we've taken some of that into account and the accounting on conversion from that sales backlog."
},
{
"speaker": "Tim Gokey",
"content": "And Puneet, I'd just add that when you look at the revenue, and this is part of the prepared remarks, but the backlog as a share of recurring revenue, it's 11% this year. If you look back last year, it was 10%. So it's not dramatically different but incrementally better."
},
{
"speaker": "Puneet Jain",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick O'Shaughnessy of Raymond James. Please go ahead."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "Hey, good morning. A question on margins. I'm just kind of curious about the lack of margin expansion embedded within the fiscal ‘25 guide, given that the $1 million savings from restructuring I think would boost margins by 1.5%, all else equal. So maybe can you talk about or quantify the margin headwinds from distribution revenues and float income in fiscal ‘25, and then maybe bigger picture, how confident are you still in your kind of three-year, 50 basis points per year margin outlook?"
},
{
"speaker": "Ashima Ghei",
"content": "Thanks Patrick. I'll take that one. So you know this, Broadridge has a long history of being able to fund long-term investments, while delivering on our earnings objectives, and margin expansion is a super important part of that story. We've delivered on average 80 basis points of annual margin expansion over the last 10 years. Having said that, we do see margin expansion as a means to an end. What we are really focused on, is on delivering sustainable double-digit earnings growth, while investing in our long-term growth opportunities, both of which we effectively achieved in fiscal ‘24 and is what we are guiding towards for fiscal ‘25. So as we think about fiscal ‘25, you are right in pointing out, we're guiding to 20%. We do expect to see the impact of float income coming in lower. We've factored in a couple of rate cuts into our estimate. We expect the impact of distribution. But we do expect the benefits from the restructuring program that we just did and core margin expansion to allow us to fund our long-term growth investments, still getting us right on track with the 8% to 12% sustainable earnings growth."
},
{
"speaker": "Tim Gokey",
"content": "And Patrick, I'll just add in that, and actually that was great. I think as you pointed out, we have overcome a number of, when you think about the three-year number of one-off impacts with VMAP [ph], with E-Trade, with rates coming down now. So there are a number of things. At the same time, we feel really good about the core margin expansion next year and no reason to see why that wouldn't continue to be the case in the future. I just step back to say we're an organic growth company. We think of every client as a 1990-year client, and part of that promise is always to be investing in what's next. That's a great formula for our clients, associates, and shareholders. So we are making investments in governance, in digital, voting choice, in the front office. We have the ability to flex those up and down. That's one of the ways we've been able to be really resilient over time."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "Perfect. Thank you. And then just a quick clarifying question. So the 5% to 7% recurring revenue growth outlook for the year, that embeds 0.2% contribution from the two smaller tuck-ins and nothing from the SIS deal. Do I have that correct?"
},
{
"speaker": "Ashima Ghei",
"content": "That's correct."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I'd like to turn the call over to management for any closing remarks."
},
{
"speaker": "Tim Gokey",
"content": "Yeah, thank you operator. As you can tell, we believe that the Broadridge business model is resilient. That resulted in strong fiscal ‘24 results with outlook for another strong year in fiscal ‘25 and for a three-year period. We believe we're executing on a growth strategy. We have long-term trends behind us that we're very well positioned in a $60 billion and growing market. Thank you very much for your interest in our company. We look forward to reporting our next set of results to you later this fall."
},
{
"speaker": "Operator",
"content": "The conference is now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
br | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Broadridge Financial Solutions Third Quarter and Fiscal Year 2024 Earnings Conference Call. All participants will be in a 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 hand the call over to Edings Thibault, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Edings Thibault",
"content": "Thank you, Andrea. Good morning, everybody, and welcome to Broadridge's third quarter fiscal year 2024 earnings conference call. Our earnings release and the slides that accompany this call may be found on the Investor Relations section of broadridge.com. Joining me on the call this morning are Tim Gokey, our Chief Executive Officer; and our Chief Financial Officer, Edmund Reese. Before I turn the call over to Tim, a few standard callouts. One, we'll be making forward-looking statements on today's call regarding Broadridge that involve risks. A summary of these risks can be found on the second page of the slides and a more complete description on our annual report on Form 10-K. Two, we'll also be referring to several non-GAAP measures, which we believe provide investors with a more complete understanding of Broadridge's underlying operating results. An explanation of these non-GAAP measures and reconciliations to their comparable GAAP measures can be found in the earnings release and presentation. Let me now turn the call over to Tim Gokey. Tim?"
},
{
"speaker": "Tim Gokey",
"content": "Thank you, Edings, and good morning. It's great to be here to review our third quarter results and update you on our full year outlook. Overall, I'm pleased with the performance of our business in a complex environment. We see a market in which the underlying fundamentals are solid, where capital markets and retail investor activity are beginning to strengthen, and where our clients are highlighting the need for continued technology investment. While all that is going on, those same clients are being careful with their spending as they weigh the new higher for longer scenario as well as other tail risks. These trends play to Broadridge's strength. Our testing is indicating that healthy markets are driving a pickup in investor participation and position growth, and are delivering innovative solutions across governance, capital markets and wealth. Sales continue to be strong, highlighting our clients' willingness to move ahead with solutions that address revenue, cost or regulatory needs. My conversations with clients make it clear that they see Broadridge as a partner in helping them grow their business and adapt to change. It's a strong position, and it will be further enhanced as we put our cash flow to work with a balance of capital returns and targeted M&A. So, let's dig into the quarter. First, Broadridge reported 4% recurring revenue growth and 9% adjusted EPS growth. Those results were modestly impacted by the timing of annual meetings, which pushed some governance revenues into the fourth quarter. Second, we continue to execute against our strategy to drive the democratization and digitization of investing, simplify and innovate trading, and modernize wealth management. Our strategy is supported by long-term trends, including position growth, which we continue to see in the mid to high single digit range. Third, that execution is coming through in our closed sales, which rose 29% in the quarter and are now up 19% year-to-date. We expect that positive momentum to continue in the fourth quarter. Fourth, we remain on track to achieve our objective for 100% free cash flow conversion for the full year. That positions us to use our capital to increase share repurchases and to fund strategic tuck-in M&A. Finally, as we move through our seasonally large fourth quarter, Broadridge is on track to deliver another year of steady and consistent growth, in line with our long-term financial objectives. We are reaffirming our outlook for fiscal '24, adjusted EPS at the middle of our 8% to 12% range, with recurring revenue growth at constant currency at the low end of our 6% to 9% range. With strong year-to-date sales, we also expect record closed sales of $280 million to $320 million. Now, let's turn from the headlines to slide four to review highlights of our execution, starting with our governance franchise. ICS recurring revenue rose 1% in the third quarter as the timing of regulatory communications impacted our quarterly growth. In regulatory communications, revenues were flat despite 5% equity position growth. As many of you know, the peak period for proxy communications falls right at the end of March, so any shift in the annual meeting schedule can have an impact on quarterly revenues. This year, with Easter in the last week of March instead of April last year, we saw a substantial number of companies push back to date for their annual meeting. That change led to a shift of regulatory revenue from March to April, or from the third to fourth quarter. This timing shift will have no impact on our full year results. Outside of timing, position growth trends were mixed. As I noted, equity position growth was 5%, in line with our testing, driven by double-digit growth in managed accounts. Fund and ETF record growth declined to negative 1% for the quarter. Quarterly fund position growth can vary more widely than the full year number, because it is impacted by the timing and types of communications that are distributed during any particular quarter. More broadly, the cumulative impact of lower fund flows and the shift to money market funds that began over a year ago has weighed on growth, especially for active funds. Year-to-date fund record growth was 2%. Looking ahead, fund flows are improving and our testing indicates a modest pickup in the fourth quarter. As Edmund will outline, for the year, we expect stock record growth of 6% and fund record growth of 3%. Driving and enabling the democratization of investing is a key part of our long-term growth strategy. There's no better opportunity to demonstrate that -- what that means than in a large and very visible proxy fight. As part of the Disney contest, Broadridge processed and distributed multiple rounds of communications to millions of registered and beneficial shareholders holding almost 2 billion shares on behalf of hundreds of our broker/dealer clients. Each vote was subject to multiple reviews and a process verified by an independent accounting firm so that all sides could be highly confident in the accuracy of the Broadridge votes. Vote tallies were available daily to all participants. The process culminated with an annual meeting posted on Broadridge's virtual shareholder meeting platform and the outcome was known immediately when the meeting closed. Contests like Disney are a great showcase for issuers, investors, our broker/dealer clients and regulators of how Broadridge's significant investments in technology and digital communications, combined with our commitment to accuracy, enhance investor confidence in our markets. Outside of highly visible contests, we continue to enhance investor engagement by supporting the growth and voting choice across funds. In recent months, we've gone live with five of the largest asset managers across a mix of both retail and institutional focused funds and ETFs. This, in turn, is leading to strong interest to extend this service from more asset managers and for a wider set of fund categories. We're also continuing the rollout of our tailored shareholder report solution as we help the funds industry navigate regulatory change. We're in production testing now and we go fully live beginning in July. Turning to capital markets. Revenues rose 8% to $266 million, driven by strong growth in BTCS, which continues to deliver on the pillars of our original acquisition case. During the quarter, we signed a leading U.S. and global bank as the first client for global futures and options SaaS platform. This new capability will build on our existing products and significantly expand our derivatives trading solutions. It also represents another step forward in our goal of expanding BTCS' capabilities across asset classes and to our U.S. client base, which was a key part of our long-term growth plan at the time of the acquisition. On the post-trade side, we completed the implementation of our global post-trade platform for a leading Nordic bank. Our platform consolidates the bank's legacy in-house systems, streamlining its operations across 25 European markets and 10 custodians across both equities and fixed income. This particular bank was a long-term BTCS client. So, it's also another example of leveraging our front office relationship to extend our solutions across the trade life cycle. We also continue to see nice traction with our digital ledger repo and in AI with our BondGPT and OpsGPT solutions. Turning now to Wealth and Investment Management. Revenues rose 11% to $159 million as strong growth from UBS and the license revenue was partially offset by the E-Trade transition. In the first full year since the rollout of our wealth platform, we are seeing significant interest in our broad suite of wealth capabilities, and that's driving strong sales momentum with year-to-date Wealth Investment Management sales up 75%. I'm especially pleased to see strong interest in Canada for wealth component capabilities. Canada accounts for approximately a third of our Wealth and Investment Management revenues, and we see a long-term opportunity to adapt our wealth tools for Canadian firms. Moving to sales. Closed sales rose 29% in the third quarter and are up 19% year-to-date. We benefited from strong sales of our digital and print solutions for the new tailored shareholder reports, and we continue to see significant print and digital opportunities in customer communications. Our pipeline remains at record levels as clients focus on solutions that drive revenue growth, like our front office trading tools, and meet their regulatory requirements like tailored shareholder reports. That combination of strong sales and a record pipeline is giving us increased confidence in our ability to achieve record closed sales in line of $280 million to $320 million full year guidance. Let's move to slide five for some additional thoughts on our quarter and outlook. First, we are poised to deliver another year of mid single digit organic recurring revenue growth and double-digit earnings growth, right in line with the long-term growth goals we laid out at our Investor Day in December. In a quarter impacted by the timing of annual meetings, we reported 9% adjusted EPS growth. Now one month into the fourth quarter, we have high visibility into our remaining volumes. For the full year, we're tracking to recurring revenue growth of 6%, adjusted EPS growth of approximately 10% and record closed sales. Second, our growth continues to be driven by long-term trends, increasing investor engagement, the demand for digitization, accelerating trading, regulatory change, leveraging data and AI, and the need to modernize wealth management have all combined to drive strong sales over the first three quarters. As a result, we're going into our largest sales quarter with a strong pipeline and increasing visibility. Position growth has moved from pandemic highs and overall trends remain in line with the mid to high single digit growth rate of the past decade. Looking beyond the fourth quarter, the outlook for financial services firms appears to be improving. Capital markets activity is picking up and innovation is driving sales growth as our clients increase their level of investment. At the same time, strong equity markets are driving investor engagement and fund investors are beginning to rotate out of money market funds, both of which bode well for future position growth. Third, we're executing on our growth strategy. We are driving shareholder engagement and governance, enhancing our digital capabilities and customer communications, delivering innovative new capabilities in capital markets and are expanding our ability to drive growth and wealth across North America. We're also investing to strengthen our product teams, sales capabilities and technology capabilities including of course AI. Fourth, we're on track to achieve our 100% free cash flow conversion objective and the combination of strong free cash flow and our investment-grade balance sheet positions us to return additional capital to shareholders. We're also seeing a growing number of attractive M&A opportunities to further complement our organic growth. Finally, Broadridge remains well-positioned to drive long-term growth. We remain on track to deliver on our three-year growth objectives of 7% to 9% recurring revenue growth constant currency, 5% to 8% organic, and 8% to 12% adjusted EPS growth with fiscal '24 right in line with those goals. And with continued execution supported by long-term demand trends, we are well-positioned to continue to grow beyond FY '26 as we attack our $60 billion and growing market opportunity. I want to close by thanking our associates around the world. The market for what we do continues to evolve and Broadridge will be evolving as well. We're seizing the opportunities in front of us. And your focus on serving our clients, as shown by our strong accomplishments this quarter and over a long period, continues to set us apart. Thank you. And with that, let me turn it over to Edmund."
},
{
"speaker": "Edmund Reese",
"content": "Thank you, Tim, and good morning, everyone. Let me start by saying that I'm pleased with the third quarter results relative to our full year guidance. While third quarter recurring revenue growth was impacted by the timing of annual meetings, we are entering the seasonally larger fourth quarter in a strong position. Through three quarters, we reported 6% recurring revenue growth, 11% adjusted EPS growth, and have received 98% of proxy records through April. That gives us a high confidence interval in our ability to deliver 6% recurring revenue growth, approximately 20% adjusted operating income margin and adjusted EPS growth of approximately 10%. Of equal importance is our cash flow performance for the year. We are on track for 100% free cash flow conversion, which will allow us to return a total of $700 million to $800 million to shareholders through the dividend and with share repurchases of $350 million to $450 million. So, with clarity on fiscal 2024, in my view, what matters most to achieving our three-year financial objectives are the wins that we have at our back, which are driving positive momentum in the business. First, closed sales through the first three quarters are up 19% over last year. And our healthy pipeline reinforces our conviction that we will achieve 15% to 30% sales growth in our full year '24 guidance. Second, while our testing shows 6% equity and 3% fund and ETF position growth for full year '24, the early testing for Q1 '25 is consistent with more recent increased retail market activity and our long-term outlook of mid to high single digit growth. Third, we continue to focus on actively managing our expenses and finalizing our restructuring effort in the fourth quarter to create investment capacity for organic growth in fiscal '25 and '26, while delivering continued earnings growth. Finally, our free cash flow conversion is definitively back at historical levels, positioning us to supplement our organic growth with accretive tuck-in M&A or return capital to shareholders. As a result, when I look ahead, I see strong momentum in the Broadridge business. Strong closed sales, driving five to eight points of growth from new sales, position growth supporting two to three points from internal growth, M&A investment contributing additional growth, and active expense discipline that will enable Broadridge to continue to invest in organic growth and deliver continued earnings growth. We continue to execute the Broadridge financial model and that gives me confidence that we remain on track to deliver again on our three-year financial objectives and on mid- to high teens ROIC. So, now turning to the financial summary on slide six. You see the performance for the third quarter. Recurring revenue rose to $1.1 billion, up 4% on a constant currency basis, all organic. Adjusted operating income increased 7%. And AOI margins of 21.4% expanded 40 basis points. And adjusted EPS rose 9% to $2.23. Finally, as Tim noted, we delivered third quarter closed sales of $80 million, up 29% over Q3 '23. On slide seven, you see that recurring revenue grew 4% to $1.1 billion in Q3 '24. Recurring revenue growth driven by converting our backlog to revenue and growth in GTO was impacted by proxy communications that were delayed into our fiscal Q4. So, for more context on this point, March is typically a heavy month for proxy communications, accounting for almost a quarter of our full year positions. As Tim mentioned, in 2024, we saw a modest delay in the timing of annual meetings, which pushed volumes from March into April. While that lowered our Q3 revenue, we have since processed virtually all of those delayed positions, and that will benefit regulatory revenue in the fourth quarter. On slide eight, we can see recurring revenue growth across our ICS and GTO segments. In Q3, ICS recurring revenue grew 1% largely impacted by the quarterly noise that I just mentioned. Regulatory revenue was flat as mid single digit equity position growth in revenue from sales were partially offset by the timing of the annual meetings. As I explained earlier, while these timing variances have no real impact on full year revenues, they can result in quarters that vary from our reported position growth. We continue to expect full year regulatory revenues to be in line with mid single digit position growth. Data driven fund solutions revenue increased by 4% due to higher float revenue in our retirement and workplace products as well as growth in our data and analytics products. Issuer revenue was up 3% driven by strong sales of our disclosure solutions and higher float income in our registered shareholder solutions. Our Q3 registered shareholder solutions were also impacted by the timing of the annual meeting cycle. So, I will note that the issuer business has grown 10% year-to-date and we still expect high single digit full year revenue growth. Customer communications revenue rose 1% as growth in higher margin digital revenue was offset by the lower growth of lower margin print. We expect volumes to increase in the fourth quarter as we onboard new clients. For the full year, we expect low single digit top line growth driven by double-digit growth of higher margin digital revenue and low single digit print growth. This is in line with our print-to-digital strategy, which should yield expanding margins and continued low double-digit earnings growth. Looking ahead to Q4, we expect ICS at the high-end of our organic growth objectives, with recurring revenue growth of 7% to 9%, driven in part by the benefit of timing differences. Turning to GTO. Recurring revenue grew 9% to $425 million. Capital markets revenue increased 8%, led by new sales in higher equity and fixed income trading volumes. I will also note that we continued to see strong performance in our front office BTCS solutions, which again had double-digit recurring revenue growth in the third quarter. Wealth and Investment Management revenue grew 11%, powered by the UBS contract and higher license revenue, partially offset by the E-Trade transition, which began late in the fiscal first quarter. Looking ahead, we continue to expect capital markets growth in the fourth quarter to be impacted by growing over high Q4 '23 license revenue. And we will also have another full quarter impact from the E-Trade transition in our wealth business. That said, GTO recurring revenue growth is 9% year-to-date, giving us high confidence that full year growth will be well within our 5% to 8% organic growth objectives for both businesses. Turning to slide nine for a discussion of volume trends. Equity position growth was 5% in the quarter, in line with our testing. Growth was driven by continued double-digit growth in managed accounts. We are now in the peak period for annual meetings and proxies. And through the end of April, we've received record data for 98% of proxies that are expected for the year. This data gives us high confidence in our outlook for position growth. For the full year, we expect equity position growth of approximately 6%. And while still early, our testing data is extending in the Q1 '25 and is showing mid single digit growth, continuing to support our outlook for mid to high single digit equity position growth. We continue to be encouraged by expanding investor participation in financial markets serving as a long-term tailwind that drives growth in our business. Fund and ETF positions declined by 1%. For the full year, we expect position growth of 3% with slower growth in passive funds and declines in active funds. Turning now to trade volumes on the bottom of the slide. Trade volumes grew 11% on a blended basis in Q3. Once again, we saw a difference in asset classes with increased volatility driving double-digit fixed income volume growth, now 11 consecutive quarters, and more modest equity volume growth. Let's now move to slide 10 for the drivers of recurring revenue growth. Recurring revenue grew 4% constant currency. Revenue from net new business contributed three points of growth. Internal growth, primarily trading volumes, expanding client relationships and float income, offset by the timing of proxy communications, contributed one point. Foreign exchange had a non-material 20 basis point positive impact on recurring revenue growth and based on current rates, we expect a similar benefit in full year recurring revenue growth, relative to fiscal year '23. I'll wrap up the revenue discussion with a view of total revenue on slide 11. Total revenue grew 5% in Q3 to $1.7 billion, with recurring revenue being the largest contributor, delivering three points of growth. Low to no margin distribution revenues contributed one point to total revenue growth. Distribution revenue grew 4% due to postal rate increases, which are a headwind to our adjusted operating income margin. We continue to expect distribution revenue to grow in the high single digit range, driven by the continued impact of postal rate increases. Event driven revenue was $67 million, up 29% over last year and adding one point to revenue growth. As anticipated, we saw more normalized levels of mutual fund proxy activity and elevated contest activity, including our work with Disney in Q3. With the combination of increased mutual fund proxy activity and higher contest activity, we now expect $260 million to $280 million in full year event driven revenue. In our Q2 call, we mentioned that we expected event driven revenue to trend above our historical levels for the full year. We modestly increased growth investments in Q2 based on the above trend event driven revenue. We continue to make investments in Q3 as we are committed to investing in long-term growth, while still delivering on our short-term fiscal '24 adjusted EPS guidance. Turning now to margins on slide 12; adjusted operating income margin was up 40 basis points from prior year to 21.4%. The net impact of higher distribution revenue and higher float income, which have an immaterial impact on earnings growth as I detailed at Investor Day, increased margins by 20 basis points in the quarter. Adjusted operating income margin continued to benefit from the operating leverage on our higher recurring and event revenue and the benefit from our restructuring initiative that we began in Q4 '23 to realign some of our businesses and streamline our management structure. As part of the initiative, we exited a small non-core GTO business in Q3 '24 and we remain on track to complete the restructuring initiative and have the remaining restructuring charge by the end of the fiscal year. The restructuring charges are excluded from our calculation of adjusted operating income and adjusted EPS. We have a long track record of disciplined expense management. This discipline, along with the operating leverage inherent in our business model, allows us to invest in long-term growth investments and meet our earnings growth objectives. Looking ahead, we continue to expect adjusted operating income margin to increase year-over-year to approximately 20%. Let's move ahead to closed sales on slide 13. Third quarter closed sales were $80 million, up 29% from $62 million in Q3 2023, and bringing our year-to-date total to $185 million, 19% above Q3 year-to-date '23. Our strong performance on closed sales has been in product areas where we've been investing and innovating, such as tailored shareholder reports, BTCS, and wealth. We continue to see clients willing to invest in areas that either drive revenue, lower cost or address regulatory requirements. With the performance through three quarters and our five-year history of closing on average 40% of full year sales in the fourth quarter, we continue to have high confidence in meeting our full year guidance of $280 million to $320 million, again, strengthening our revenue backlog and providing strong momentum entering fiscal year '25. I'll turn now to free cash flow on slide 14. Q3 '24 free cash flow was $167 million, $5 million better than last year. Through three quarters, free cash flow is a positive $259 million, relative to $47 million in the first nine months of 2023. These results are being driven by our continued strong earnings growth and lower client platform spend. Free cash flow conversion was 108% in Q3 '24, up from 63% last year. This is consistent with our expectations and has us on track for free cash flow conversion of 100% for fiscal year '24. On slide 15, you can see that over the first nine months of the year, we invested $109 million on our technology platforms and converting clients to our platforms. Additionally, before option proceeds, we returned $424 million in capital to shareholders due to dividend and share repurchases year-to-date. And given our expectations for 100% free cash flow conversion, we are positioned to return additional capital to shareholders in fiscal year '24. We continue to estimate $350 million to $450 million in total share repurchases for the full year, which includes an additional $200 million to $300 million in the fourth quarter. And let me put this into context for you. While we are still early in this current fiscal '24 to fiscal '26 three-year cycle, our capital allocation is unfolding right in line with our expectations. As I said at Investor Day, we are in a strong capital position, on track to generate approximately $3 billion of free cash flow, with another $1 billion available at our 2.5 times leverage objective. After the dividend, we are off to a strong start, balancing investment for growth with capital return to shareholders, which we expect to reach $700 million to $800 million this year and we remain well-positioned to execute accretive tuck-in M&A. We expect that this balanced capital allocation will increase ROIC to mid to high-teens level over the next three years. Turning to guidance on slide 16. We continue to execute the Broadridge financial model in fiscal '24. With two months left and high visibility in the fiscal '24 position growth, we expect recurring revenue growth constant currency to be approximately 6% for the full year, at the low end of our guidance range. We continue to expect AOI margin expansion to approximately 20%. Adjusted EPS growth at the middle of our 8% to 12% range, and closed sales of $280 million to $320 million and I'll also note that we remain on track to drive 100% free cash flow conversion and have capital return of $700 million to $800 million through dividends and share repurchases in fiscal 2024. To bring all of this together and highlight what it means to our financial objectives, I will conclude by emphasizing what I said earlier. First, the results through the third quarter and the visibility into the fourth quarter, give us confidence in delivering a fiscal 2024 in line with our guidance, marking a strong start to the fiscal '24 to fiscal '26 three-year cycle. Second, we have positive momentum in our business, including strong sales demand, growing investor participation, the actions we are taking to create investment capacity and sustain our steady and consistent growth, additionally, we have the capital capacity for accretive tuck-in M&A to supplement our organic growth. Finally, those two items, fiscal year '24 performance and positive forward momentum, position us to deliver on our three-year financial objective. And with that, let's take your questions. Andrea?"
},
{
"speaker": "Q - David Togut",
"content": "Thank you. Good morning. I'll ask my question and the follow-up both upfront. So first, given the solid early demand for OpsGPT and BondGPT, where do you see the biggest opportunity to increase Gen AI-related product development? And then the follow-up, since you've deleveraged the balance sheet, now we're a few years post the Itiviti acquisition, where do you see the greatest white space for your acquisition opportunities?"
},
{
"speaker": "Tim Gokey",
"content": "David, thank you very much. It's Tim and thank you for the question on AI. It's an area that we're pretty excited about, as you know and we have talked about being a leader in AI in our space. We've talked about how we're bringing that to -- really into all of our products. We think in the future, every product will be part -- will have AI as part of it and then to introduce commercial products as well and use it for internal efficiency, and do all that in a safe way. We are really pleased by the progress of OpsGPT and BondGPT. With OpsGPT, we're in production with our first client and we're actively engaged with another five. BondGPT, we have three proofs-of-concepts underway, eight additional discussions. So there's lots of good activity around those. We're also doing things in the asset management side with our global demand model, where we have six of the largest 50 asset managers already signed up and an additional 10 of the largest 100 in contracting. So, I think people are really attracted to these use cases. When we see sort of the biggest areas going forward, I think it's really deepening in these sort of unique areas that -- where it really makes sense for us to be the one to invest. It doesn't make sense for others to invest in the sort of depth of capital markets or in some of these marketing areas in asset management and we think there's real opportunity for us there. We're excited about how it's going to drive things in the fixed income world. When you think about this in the future, it's really there will be a commodity part of it where it's part of just having a good product, and then there will be a more exclusive part of it where, if you have proprietary data, you can really leverage something and create something unique and we think there are definitely areas where we have proprietary data. So we continue to be excited about AI. It will be a while for it to sort of begin to show in the economics, but we begin to be excited about it. I think on the M&A side, let me just turn to that, I think that's a really important question and David, as you know, our growth is primarily organic and we have a long runway for that with the $60 billion market opportunity and as you know, our three-year objective for M&A is sort of one point to two points and we've been on this sort of pause post our BTCS acquisition, but now as you point out, having reached our leverage and our free cash flow conversion goals, we do have flexibility to invest. And I think in past calls, I have been cautious about buyers and sellers coming together on price and I do think now, looking at the market that, that logjam is beginning to break up. We are beginning to see more tuck-in opportunities that have the potential to meet both our strategic and financial criteria and as you know, we always look for opportunities that tightly align with our strategy where we're the right owner and that's IRR sort of in the really attractive mid-to-high teens well in excess of our cost of capital. So we do think that there will be opportunities this year. We think there'll be opportunities when you look across the areas that we do. Wealth management has some very interesting things going on. Data and analytics have some very interesting things going on and we're beginning to see all the PE firms really polishing up their properties to make them look attractive to strategics like ourselves and so we think there will be a stream of opportunities. We'll be very, very selective. If you see us do something, you'll know that we're doing it because it's very attractive and will -- and enough opportunities out there that we can be very disciplined in doing things that we think will have very good returns for shareholders."
},
{
"speaker": "Edmund Reese",
"content": "And I'll just add, Tim, the opportunities are out there. David, we have two months left in this fiscal year, which is why I highlight the fact that the majority of our capital will be allocated towards share repurchases in this fiscal year, but as I said a number of times in my prepared remarks, we're in a really, really strong position because of the point that you made on being at the right leverage ratio and the capital we're generating through our free cash flow. So as Tim said, there are very attractive opportunities out there as we go into our next fiscal year and I think we'll be in a great capital position to be able to supplement our organic growth with M&A."
},
{
"speaker": "David Togut",
"content": "Understood. Thanks so much, Tim and Edmund."
},
{
"speaker": "Operator",
"content": "The next question comes from Will Vu of Wolfe Research. Please go ahead."
},
{
"speaker": "William Vu",
"content": "Hey guys. Thanks for taking my questions. This is Will on for Darrin here. I had two related to some of the bookings trends. First and foremost, you guys in the past have talked about some of the underlying bookings being more -- or being less transformative. And I was curious as to if you guys can comment on some of the more recent characteristics within your pipeline. Are you seeing any deal sizes expanding or any of that. And then my second question being, as we look on the wealth management side, kind of curious how -- what opportunities are really resonating with some of your prospective customers that you're seeing on this end? Thanks."
},
{
"speaker": "Tim Gokey",
"content": "Will, thanks. It's Tim. I'll take those. I think on the booking trends, we are -- I do think that the main thrust continues to be lots of, I don't want to say exactly bite-sized opportunities, but very manageably-sized opportunities. And so we do have some that are, call it, more than $5 million, but we don't have any of these sort of mega things that will take many years to influence. So we really feel good about sort of that flow that we're seeing. We are seeing in areas of demand, and I mentioned this a little bit in the script, but we're seeing it around things that will drive revenue, certainly on the BTCS side, certainly around adviser tools, securities class action, other things that really drive revenue nicely. We're seeing things that drive costs, lots of activity around print to digital and of course, regulatory with tailored shareholder report. So all areas that really align with the investments that we've been making and so that really makes us feel good about the return on the investments that we're going to see. And I think that, that really -- your sort of second part of the question was about wealth management and I think that is just emblematic of getting return on areas where we've made significant investments. As you know, a very attractive market, we've talked about the $16 billion market, how it's growing, and we're getting really good traction with a whole series of component sales. Our sales were up 75% for the year. Our current pipeline is over $200 million. And when you say sort of what opportunities are people looking for, I think that it's a combination of each has sort of a different specific pain point and want to address it, but at the same time, they're looking to sort of say, how do I begin to put in place a digital road map and sort of a North Star that they can build to over time? So, I think the open API framework, the enterprise integration service layer, all of those things in terms of how we can bring things together, they really like that as a vision. Meanwhile, they tend to say, let me start with an existing pain point like tax, like client onboarding, like corporate actions, some things that are very tangible. And so we have great conversations going on both here in the US, but also lots of good conversations in Canada. So we feel really good about the outlook there."
},
{
"speaker": "William Vu",
"content": "That's great. Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick O'Shaughnessy of Raymond James. Please go ahead."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "Hey. Good morning, guys. When you kind of think about the factors that are driving 6% recurring revenue growth this fiscal year as compared to the high end of your range of 9%, what are the factors that are kind of resulting in revenue coming towards the lower end of the range and then how does that inform your outlook point for next year?"
},
{
"speaker": "Edmund Reese",
"content": "Good morning, Patrick. Thanks for that question. I did want an opportunity to dive deeper into that. So, thanks for the question. We are tracking, to your point, 6% at the low end of what I would highlight is a strong organic recurring revenue range and there are two items that are really impacting that. First, I would say, is position growth. You know that our outlook was mid to high single digit position growth, and you just heard both Tim and I talk about 6% equity position growth and fund growth at about 3% for the full year. So that's one thing relative to the outlook that we had. The second, as you know, a strong component of our recurring revenue growth is converting sales to revenue and there I'd highlight lower revenue in our customer communications business. But again, you heard me talk about starting to see that tick up in the fourth quarter as we onboard new clients. So, I think the key point for me is that we do have positive momentum going into fiscal '25 and '26 with sales, which impacts next year revenue, estimated to be up 15% to 30%, and position growth starting to tick up. I was very deliberate about mentioning Q1 '25 testing data showing mid single digit at this point. I think that's a good trend, because as we know, it normally ticks up. So, look, delivering 6% in fiscal '24 and momentum going into fiscal '25, I think has us in a pretty good place relative to the three-year objectives. The second part of your question is like would it -- it's all focused on the go forward and what it means for the outlook. And for me, as you know, I like to put that in terms of our three-year objectives. And as I just mentioned, we have great line of sight into fiscal year '24. And I would say that's a strong start on the three-year cycle. And I'll just remind you, we're coming off a year of 7% recurring revenue growth and 9% adjusted EPS growth, and now sort of on track to deliver approximately 6% and 10%, respectively. And so, those numbers are right in line with our guidance, right in line with the growth algorithm as we think about the long-term objective. And I just talked about the drivers of growth being stable and the momentum that we have moving forward. So, we feel good about where we are relative to the three-year objectives. And as our usual practice, we'll come back and talk more specifically about '25 in a more robust way on our Q4 call."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "Yeah. I appreciate that. A quick follow-up. Just to make sure I'm understanding your commentary on timing and shareholder meetings getting pushed into April from March. So that would show up in the regulatory revenues line and the issuer revenues line, but no impact to data driven fund solutions or customer communications. Am I understanding that correctly?"
},
{
"speaker": "Edmund Reese",
"content": "That's primarily right. You're very astute in picking it up. Those are the two areas that we called out. So, you'll see it in both of those businesses in the registered shareholder solutions and issuer, and then obviously, the regulatory business."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "All right. terrific. Thank you."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] There are no further questions at this time. I'd like to turn the call over to management for any closing remarks."
},
{
"speaker": "End of Q&A",
"content": ""
},
{
"speaker": "Tim Gokey",
"content": "Thank you very much, Andrea. Thank you to everyone on the call. Thank you for your interest in Broadridge. As I said earlier, we're now well into our seasonally largest quarter. We're looking to delivering full year results, as Edmund just said, of 6% recurring revenue growth, double-digit EPS growth. That's going to mark a strong start to our three-year objectives. And we will look forward to seeing you in August."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation and you may now disconnect."
}
] |
br | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Broadridge Second Quarter and Fiscal Year 2024 Earnings Conference Call. [Operator Instructions]. Also note, today's event is being recorded. At this time, I'd like to turn the floor over to Edings Thibault, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Edings Thibault",
"content": "Thank you, Jamie, and good morning, everybody, and welcome to Broadridge's second quarter fiscal year 2024 earnings conference call. Our earnings release and the slides that accompany this call may be found on the Investor Relations section of broadridge.com. Joining me on the call this morning are Tim Gokey, our CEO; and our Chief Financial Officer, Edmund Reese. Before I turn the call over to Tim, a few standard call-outs. One, we will be making forward-looking statements on today's call regarding Broadridge that involve risks. A summary of these risks can be found on the second page of the slides and a more complete description on our annual report on Form 10-K. Two, we'll also be referring to several non-GAAP measures, which we believe provide investors with a more complete understanding of Broadridge's underlying operating results. An explanation of these non-GAAP measures and reconciliations to the comparable GAAP measures can be found in the earnings release and presentation. With that, let me now turn the call over to Tim Gokey. Tim?"
},
{
"speaker": "Tim Gokey",
"content": "Thank you, Edings. Good morning, and it was great reconnecting with so many of you at our Investor Day in December. As you heard, we are more optimistic than ever about the near- and long-term growth opportunity that lies ahead. You'll hear many of those same themes today as I discuss our positive second quarter results and fiscal year outlook. Before I do, let me comment on the unique and complex moment in which we find ourselves. At Davos 2 weeks ago, it was energizing to talk with our senior clients about the opportunities and challenges they see ahead. A lot of the discussion was on the promise of AI and how we move our industry forward. Broadridge's recent announcement of OpsGPT to leverage generative AI to transform Capital Markets operations was particularly timely. At the same time, the geopolitical challenges and uncertainties in the environment are clear which makes our highly recurring and resilient business model, all the more attractive. Against this backdrop, it was rewarding to hear our clients continues to think of Broadridge as an important partner for innovation and growth as well as for efficiency and resilience. And with that, let me turn to the quarter. First, Broadridge's second quarter results marked another step toward our growth plans for both fiscal '24 and the next 3 years with healthy organic growth across both segments that was in line with our long-term goals. Second, physician growth trends remained positive, with stronger fund position growth and mid-single-digit equity position growth. Third, we are executing against the growth plan we shared last month at our Investor Day by driving the democratization and digitization of investing, simplifying and innovating trading and modernizing wealth management. Fourth, we generated strong free cash flow in the quarter, keeping us on track to achieve our 100% FY '24 conversion objective and Edmund will discuss return more capital to shareholders. Finally, as we enter the seasonally larger second half of our fiscal year, we expect to deliver another strong set of results. We are reaffirming our guidance for 6% to 9% recurring revenue growth, 8% to 12% adjusted EPS growth, and importantly, strong closed sales. Now let's turn from the headlines to Slide 4 to review our results, starting with our governance franchise. ICS recurring revenue rose 6% in the second quarter. New sales were the biggest driver of growth, a direct result of our focus on delivering innovation across our governance business. We are seeing growth from adding new broker-dealer clients and from sales of our global insights data to asset managers. We're seeing continued momentum in our regulatory composition and disclosure business, and we're benefiting from a strong growth in our digital solutions and customer communications. Increasing investor participation remains an important driver for our regulatory revenues, which rose 8% in the second quarter with mid-single-digit position growth across both equities and funds. In a seasonally small quarter, equity position growth was 6%. The biggest driver continues to be managed accounts, which represent just under 50% of physicians and which continues to grow at double digits compared to low single-digit growth for self-directed accounts. Fund and ETF physician growth increased from last quarter to 5%, and the slowdown in the growth of passive funds was offset by a pickup in the number of active fund positions. Looking ahead, as Edmund will outline, we expect mid-single-digit physician growth in the second half in both equities and funds as investor participation remains healthy. In December, you also heard us discuss the growth opportunities in our other ICS product lines. In Q2, we saw strong growth across issuer and data-driven fund solutions. In customer communications, strong growth in high-margin digital revenue offset lower print. I was particularly pleased with the continued digital transition as you all recall, is a key part of our strategy. In Q2, a significant proportion of this transition was driven by the successful onboarding of one of the largest U.S. wealth managers to our wealth and focused platform. This is a platform we highlighted at our Investor Day, and it was great to see our printed digital strategy playing out. Four months then, wealth and focus is delivering lower costs and increased investor engagement for our client with industry-leading open rates and click-throughs. Capital markets revenues rose 10% to $262 million. Our focus on optimizing trading and connectivity in the front office continues to pay dividends in the form of strong growth in BTCS. On the post-trade side, we were helping to simplify our clients' back-office technology. I was pleased to see a new win at a regional bank who will be using multiple Broadridge products to drive their transition to self-clearing. We also continue to drive innovation in capital markets with distributed ledger and AI capabilities. Early this month, we launched our OpsGPT AI solution. OpsGPT uses generative AI to synthesize complex transactions, settlements and physicians data to enhance clients' sales resolution. As clients focus on reducing the cost and complexity of their operations, especially in the accelerated world of T+1, they see Broadridge as a natural partner given our deep subject matter expertise and early investment to leverage AI. This progress in innovation, combined with strong BTCS sales in the front office and wins in the back office reinforces how we are successfully helping our clients simplify and innovate in trading. Turning now to wealth and investment management. Revenues rose 4% to $143 million as strong growth from UBS was partially offset by the E-Trade transition. In early January, we onboarded the first client for alternatives workflow module. As you know, alternatives are one of the fastest-growing asset classes. Wealth managers are offering these products to a rapidly growing set of investors. But many of the back-office processes remain antiquated. We are seeing strong interest in alternatives workflow as wealth firms seek to address this growing opportunity and challenge. Moving to closed sales. Closed sales rose 12% for the first half. As you know, the second half of the year typically accounts for the bulk of our closed sales. And I'm pleased to note that our current pipeline sits at record levels. As important, we're starting to see more movement within the pipeline, increasing our confidence in the second half. While our clients remain cautious, we are seeing them invest in products that drive revenue, improve productivity and meet regulatory requirements, which plays to the strength of our solutions. In governance, we have built a strong pipeline around our digital and print solutions for the new tailored shareholder reports. We're also experiencing increasing demand for our global insight data products from asset managers and we continue to see significant print and digital opportunities in customer communications. Capital markets clients are beginning to look to a world beyond the implementation of T+1, which is driving growing interest in our post-trade capabilities. And in wealth, we saw significant sales in the first half as we begin to convert our strong pipeline. The net result is that we remain on track to deliver strong closed sales for the year, in line with our guidance of $280 million to $320 million. Let's move to Slide 5 for some final thoughts on our quarter and outlook. First, I'll reiterate that Broadridge delivered second quarter results that keep us on track for continued growth with more than 6% recurring revenue growth constant currency and strong free cash flow. Second, those of you who attended our Investor Day last month, heard me talk about how we have made investments over the years to align our business with clear long-term growth trends, including the democratization of investing, the digitization of communications, the acceleration of trading, the growing importance of data in AI and an evolving regulatory environment. Being aligned with those drivers enables us to help our clients operate, innovate and grow. And in so doing, deliver steady and consistent growth for our investors. This quarter again illustrated how we are executing against those priorities in governance, capital markets and wealth and investment management. Among these drivers, AI, in particular, has the potential to drive step changes in client outcomes. We have committed to be a leader in AI within our space. In the not-distant future, AI will be incorporated into all products, and we are at work doing that across Broadridge. More fundamentally, companies with unique data will be in a differentiated position. And we believe that our position at the center of financial services gives us a unique opportunity to provide industry solutions that will make a difference. That's a win-win formula for our clients and our shareholders. The products we've already introduced, including BondGPT, OpsGPT and distribution AI are a first step in that direction. Third, based on all that progress, we are reiterating our guidance for both recurring revenue and adjusted EPS growth as well as our outlook for closed sales for the full fiscal year. Fourth, we remain on track to deliver free cash flow conversion of 100% this year, while funding the internal investment we need to continue to deliver innovation to our clients. That's an approach that will enable us to retain our investment-grade rating, fund internal investment and deliver a strong and growing dividend, while we execute strategic tuck-in M&A and as Edmund will discuss return additional capital to shareholders. And that brings me to my last point, which is that Broadridge is well positioned to deliver on the 3-year financial objectives we laid out in December, including 79% recurring revenue growth, constant currency, 5% to 8% of which are organic, 8% to 12% adjusted EPS growth as well as to continue to grow beyond FY '26 as we attack our $60 billion and growing market opportunity. Before I close, I want to thank our 15,000 talented, knowledgeable and hard-working associates. Yesterday, Broadridge was recognized as one of Fortune's most admired companies. This is the tenth time we've been recognized and that's a direct result of our associates' commitment delivering great service, resiliency and innovation that makes our clients and our industry stronger, and that enables better financial lives for millions of investors every day. Thank you. And with that, let me turn it over to Edmund."
},
{
"speaker": "Edmund Reese",
"content": "Thank you, Tim, and good morning, everyone. I'm really pleased to be here to discuss the results for the second quarter. But before moving into the detailed review, it's important to highlight with the first half signals. For the seasonally larger second half and full year fiscal '24. First, we continue to execute the Broadridge Financial model in the second quarter results have us right on track to deliver another strong year of recurring revenue growth, margin expansion and adjusted EPS growth, right in line with our guidance. Second, strong free cash flow of positive $91 million through 2 quarters highlights the capital-light nature of our business and increases our confidence and our 100% free cash flow conversion objective in fiscal '24. Third, the combination of strong free cash flow and modest M&A in fiscal '24, means that we expect higher capital return to shareholders through increased share repurchases in the second half of fiscal '24. And finally, the demand for our products is strong. First half sales were up 12% over last year, and our pipeline and current client discussions reinforce our conviction that we will meet our full year objectives. Additionally, our equity position testing shows mid-single-digit growth for the full year. So we continue to be encouraged by expanding investor participation in the financial markets, serving as a long-term tailwind for our business. These 4 items are the meaningful and significant signals from our results and the performance through the first half. So now turning to the financial summary on Slide 6, you see the performance for the second quarter. Recurring revenues rose to $899 million, up 6% on a constant currency basis, all organic. Adjusted operating income increased 1% as we modestly increased growth investments given above-trend event-driven revenue. AOI margin declined 100 basis points to 12.4%. Adjusted EPS was up 1% to $0.92. And finally, we delivered closed sales of $58 million in the quarter, bringing our first half total to $106 million up 12% over the first half of fiscal '23. Let's get into the details of these results, starting with recurring revenue on Slide 7. Recurring revenue was within our full year guidance range and grew 6% to $899 million in Q2 '24. Our recurring revenue growth was driven by a combination of converting our backlog to revenue, fund position growth in ICS and double-digit trade volume growth in GTO. And on Slide 8, we can see recurring revenue growth across our ICS and GTO segments. ICS recurring revenue grew 6% to $493 million, driven by new sales, position growth and float income. Regulatory revenue grew 8%, led by healthy fund and equity position growth and revenue from new sales. Data-driven Fund Solutions' revenue increased by 9% due to higher float revenue in our retirement and workplace products as well as growth in our data and analytics products. Issuer revenue was up 15%, driven by higher float income in our registered shareholder solutions and revenue from strong sales of our disclosure solutions. Customer Communications revenue was flat, with strong growth in higher-margin digital business was offset by a decline in lower margin print revenues. We expect print volumes to increase in the second half of fiscal '24 as we onboard new clients. And I will again pause here to note that customer communications continues to execute on its print to digital strategy, replacing declining print volumes with higher-margin digital revenues. Over the long term, we expect the combination to result in low single-digit top line growth with expanding margins and continued low double-digit earnings growth. Turning to GTO. Recurring revenue grew 8% to $405 million. Capital markets revenue increased 10%, led by new sales in equity and fixed income trading volume growth. I'll also note the continued strong performance in our front office BTCS solutions, which again had double-digit recurring revenue growth. Wealth and investment management revenue grew 4% as revenue from the UBS contract was partially offset by the successful transition of E-Trade to the Morgan Stanley platform. which occurred late in the fiscal first quarter. Looking ahead, we continue to have high confidence in both businesses and full year GTO growth being in line with our 5% to 8% organic growth objective. With second half growth in both capital markets and wealth more weighted to the third quarter, driven by the timing of license revenues relative to last year. Turning to Slide 9 for a discussion of volume trends. Position growth for both equity and funds remained at healthy levels in the second quarter. The long-term trends that we highlighted at Investor Day, more investor participation in financial markets and more positions per investor underpin that growth. Equity position growth was 6%, driven primarily by double-digit managed account growth and more modest growth in self-directed accounts. As we approach the spring proxy season, which typically generates over 80% of our equity communications, our testing is now extending into the second half of the year, giving us insight on the full year relative to our mid- to high single-digit range. Equity position testing shows mid-single-digit growth for the second half of the year. As a result, we now expect mid-single-digit position growth for the full year of fiscal '24 keeping us on track to deliver our guidance of 6% to 9% recurring revenue growth. Mutual fund and ETF position growth improved from Q1 '23 to 5%, again driven by passive funds. We expect to see continued mid-single-digit growth for the second half of the year. And turning now to trade volumes on the bottom of the slide. Trade volumes rose 12% on a blended basis with strong growth in fixed income trading volumes, which benefited our capital markets revenue. And let's now move to Slide 10 for the recurring revenue growth drivers. Recurring revenue growth of 6% constant currency was all organic and in line with our 5% to 8% 3-year organic growth objective. As I mentioned during Investor Day, we have a decade-long history of delivering 6 points or better of revenue from closed sales each year. In Q2 '24 had 8 points of contribution with 6 points in ICS and 10 points in GTO, including a boost from wealth management. With continued high retention from existing customers, revenue from net new business contributed 4 points of growth. Internal growth contributed 2 points to recurring revenue growth, including 1 point from position growth. Foreign exchange had a 0.5 point benefit on recurring revenue growth. So I'll wrap up the revenue discussion with a view of total revenue on Slide 11. Total revenues grew 9% in Q2 to $1.4 billion, with recurring revenue being the largest contributor powering 4 points of growth. Low to no margin distribution revenues contributed 3 points to total revenue growth. Distribution revenue grew 9%, primarily due to postal rate increases which are a headwind to our adjusted operating income margin. We continue to expect distribution revenue to grow in the high single to low double-digit range, driven by further postal rate increases. Event-driven revenue was $55 million and added 1 point to growth. As anticipated, we saw more normalized levels of mutual fund proxy activity compared to lower levels in Q2 '23, driving a 47% increase in event-driven revenue over last year. I will also note that while contest activity is immaterial through the first half of the year, we expect the combination of increased mutual fund proxy activity and higher contest activity will now have us trending modestly above our historical $230 million to $250 million level for the full year. As I mentioned earlier, we have the flexibility to ramp up or ramp down investments based on performance, and we modestly increased growth investments in Q2 based on the above trend event-driven revenue. We are well positioned to stay committed to investing in long-term growth while still delivering our short-term fiscal '24 adjusted EPS guidance. Turning now to margins on Slide 12. Adjusted operating income margin was down 100 basis points from prior year to 12.4%. Adjusted operating income margin continued to benefit from the operating leverage on our higher recurring in event revenue and the benefit from the Q4 '23 restructuring initiative to realign some of our businesses, and streamline our management structure. The net impact of higher distribution revenue and higher float income, which have an immaterial impact on earnings growth as I detailed at the Investor Day, contributed the positive impact of 45 basis points in the quarter. Those benefits were offset by the timing of other expense items and the impact of our growth investments as our outlook on the full year gave us the confidence to invest in product enhancements in our digital technology platforms. Looking ahead, we continue to expect adjusted operating income margin to increase year-over-year to approximately 20%. And I'll remind you that we remain focused on disciplined expense management and creating investment capacity. So we continue to expect to complete the restructuring initiative that began in Q4 '23 and have the remaining restructuring charge by the end of the fiscal year. This restructuring charge will be excluded from our calculation of adjusted operating income and adjusted EPS. Let's move ahead to close sales on Slide 13. Closed sales were $58 million in the quarter, bringing the first half total to $106 million, up 12% from the first half of 2023. I was also pleased to see a strong start to the second half with continued sales growth in January. More importantly, the pipeline momentum that Tim mentioned gives us increased confidence in meeting our full year objective. And I'll turn now to free cash flow on Slide 14. Q2 '24 free cash flow was $168 million, $64 million better than last year. For the first half, free cash flow is a positive $91 million relative to the negative $115 million in the first half of 2023. These results are being driven by our continued strong earnings growth and lower client platform spend. Free cash flow conversion, calculated this trailing 12-month free cash flow over adjusted net earnings was 110% in Q2 '24 up from 51% last year. This is consistent with our expectations and has us on track for free cash flow conversion of 100% for fiscal year '24. On Slide 15, you can see that we remain committed to a balanced capital allocation policy. For the first half of the year, we invested $66 million on our technology platforms in converting clients to our platforms. Additionally, through the first 6 months, before option proceeds, we returned $330 million in capital to shareholders due to dividend and share repurchases. Given our expectations for 100% free cash flow conversion, we are positioned to return additional capital to shareholders. Based on our current outlook for limited M&A in fiscal 2024, we estimate $350 million to $450 million in total share repurchases, which includes an additional $200 million to $300 million in the second half. So moving to guidance on Slide 16, along with some concluding thoughts. We are successfully executing the Broadridge financial model in fiscal '24 and therefore, reaffirming our full year guidance on all of our key financial metrics. We continue to expect 6% to 9% recurring revenue growth, constant currency, adjusted operating income margin of approximately 20%, adjusted EPS growth of 8% to 12% and closed sales of between $280 million to $320 million. And I'll note that embedded in that full year guidance is high single-digit year-over-year adjusted EPS growth for both Q3 and Q4. In addition to the guidance for fiscal '24, it's important that I highlight our high free cash flow business model. We are investing for the long term beyond 2024. And after 6 months in our fiscal year of strong free cash flow conversion, we are confident in our ability to consistently generate 100% free cash flow conversion. That free cash flow conversion, combined with our current outlook for limited M&A in the next 2 quarters, positions our capital return through dividends and share repurchases to reach a total of $700 million to $800 million in fiscal 2024. And finally, the drivers of growth, both strong demand and investor participation, combined with the investments that I mentioned earlier, give us confidence in meeting our 2024 to 2026 objectives in driving sustainable long-term growth. So with that, let's take your questions. Operator?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. Our first question today comes from James Faucette from Morgan Stanley."
},
{
"speaker": "James Faucette",
"content": "Great. I just want to check some quick math on the Wealth segment. It looks like client losses were about a 3-point drag to constant currency recurring revenue growth. And if I presume that those losses were concentrated in the wealth business, without them that business probably would have grown about 6% to 7%. Are we kind of looking at that arithmetic about right?"
},
{
"speaker": "Edmund Reese",
"content": "So James, first, and thanks for the question on wealth. I think there's a couple of points to make in your question there. First, just generally for Broadridge. As I talked about during Investor Day, and as you see here, we just have a long history of retaining 97% to 98% of our existing recurring revenue. And when I set aside transitioning E-Trade to Morgan Stanley, I think we're right in line with that. And even with it, we're 3 points of contribution. So that's sort of the first point. I think that you can do the math on the wealth segment, we gave a good sense about exactly what the incremental wealth revenue would be for the year, just over $75 million. We said that would largely be offset by transitioning E-Trade. And so it gives you some sense about what the losses would be with -- knowing those 2 components."
},
{
"speaker": "James Faucette",
"content": "Got it. Got it. Okay. That's helpful. And then more broadly, I guess, obviously, constructive to see the year-to-date closed sales number. And I think you had previously spoken about some of that being adversely impacted by European tech discretionary weakness. But you've now reiterated the closed sales outlook. Your tone seems particularly bullish on that. So can you give a little more insight into maybe if there is an improvement in the overall demand environment, what you think is motivating that? And how Broadridge is -- are there incremental opportunities for Broadridge to take advantage of?"
},
{
"speaker": "Tim Gokey",
"content": "Yes, James, it's Tim. I'll take that one. And first of all, thanks for the question because I think we do feel really good about where we are on this. And as a reminder, obviously, closed sales don't have much impact on this year. This year is really supported by the conversion of our strong backlog, the $400 million we talked about at the beginning of the year. So this is all a question about future growth. And we saw a strong first half. January was strong. The -- and the one thing I just want to point out for you and our listeners is that, that growth that we've seen so far really came from the areas that we've been investing in, like the front office and like wealth management, which is really nice to see. And as we look at the second half, we're having really good conversations around tailored shareholder reports, around digital communications, continued front-office discussions, continued wealth discussions. And it's true that we've heard caution from other tech companies and that we have been seeing weakness in Europe previously and that sales cycles remain extended. I think partly what we're seeing now is, as we said, those conversations were extended, but they didn't go away and some of those are now coming through. And we're seeing that clients really are willing to spend on areas that drive revenue, that lower costs, that have specific regulatory needs, all of those really fit very well. So we are seeing that conversion of that strong pipeline improving. And you should have heard in the tone, and we do feel a lot -- some very good confidence in achieving our sales guidance of $280 million to $320 million, which is obviously a nice uptick on last year and really returns us to the long-term growth trend there."
},
{
"speaker": "Operator",
"content": "Our next question comes from David Togut from Evercore ISI."
},
{
"speaker": "David Togut",
"content": "Tim and Edmund. I'll combine my 2 questions upfront. The first is really on headwinds and tailwinds. The first part is really on revenue. Edmund, you talked about event-driven revenue likely coming in above the historical trend line average of $230 million to $250 million. So that seems like a nice tailwind and then the other, you seem to be guiding more toward the bottom half of your range on record growth mid-single digit versus the 6% to 9%. So maybe you could just walk through those walk through those 2 dynamics and how they might balance out in the guide? And then the second is really on expenses. SG&A, as you called out in your remarks, was up more than revenue in support of the ramp in event driven. Can you talk about the evolution of operating expenses in the back half of the year?"
},
{
"speaker": "Edmund Reese",
"content": "Yes, thanks for the question. I think it's an important one and gives us an opportunity to emphasize our confidence in being in line with the full year guidance that we have. Your first question is really on headwinds and tailwinds relative to the overall guidance and how we think about event as part of that. Let me first maybe make a comment on the event and then talk about the overall recurring revenue guidance itself and the headwinds and the tailwinds. On event, thus far, as we talked about in the prepared remarks, through the first half of the year, we have seen strong event. And while headlines might suggest sort of higher contest activity, it was really driven by a recovery in the mutual fund proxy activity given the low levels that we saw in Q4 '23, we expect that to continue in the back half of the year. And there could likely be some more contest activity. But I did mention that we started increasing investments in Q2 in this current quarter because of the outlook on the full year, including the outlook on the event-driven revenue. And it's good when we have these types of transparency earlier in the year, because, as you know, we have a number of unfunded investments that when we are performing above our expectations. We go deeper in that list and increase those investments. We're able to do that because it drives long-term growth and still allows us to be within our overall guidance of 8% to 12%. And so I think as we think about strength and event being above those levels, we'll continue to look for opportunities to invest while we have the opportunity to do it. Overall, on the recurring revenue guidance, as I've said before, I think it really comes down to 3 items in those 3 items are our ability to be able to convert our revenue backlog to revenue and as you know, we've had a long history of being able to do that, driving over 6 points of growth from that, and we had a very, very strong quarter. So I continue to feel very confident that we will be right in line with our expectations there. We had included in our guidance, mid- to high single-digit position growth. The testing is now showing mid-single-digit growth. So that allows us to stay right in line with the guidance. And I think the third item that I'll mention here has been float income, which really is a first half event and no change to that thinking. So I think halfway through the year, we're still very comfortable about where we are and still being within that 6% to 9% range. On expenses, look, I am really, really pleased about not just the long history of being able to drive margin expansion here. I know you know very well, 50 basis points over the last 10 years, including 77 basis points in our last 3-year objectives. But we have been able to execute based on the operating leverage that we have in the business based on our move to digital, based on the initiatives that we have been taking to realign our businesses and not only deliver margin expansion but create investment capacity. I do not get hung up in any particular quarter when it comes to margin expansion. As I think about the full year, it is playing out just as we expected. We still expect to be approximately at 20% AOI margin. But more importantly, we're creating that capacity to be able to invest in the items that Tim mentioned in his prepared remarks. So we'll be right there as the year completes."
},
{
"speaker": "Operator",
"content": "Our next question comes from Dan Perlin from RBC Capital."
},
{
"speaker": "Dan Perlin",
"content": "I just wanted to maybe revisit the wealth expectation as we just go into kind of the third and fourth quarters here. So you said that E-Trade kind of came off, I think you said late in the quarter. And so I don't want to get over our skis kind of jumping into the March quarter. So the expectation is that the 143 that you printed, it could step down from there despite the fact that new sales look pretty robust in that area? Is that a fair assumption? As we think about modeling that second half?"
},
{
"speaker": "Tim Gokey",
"content": "Yes. Dan, it's Tim. No, we don't see it stepping down. It is -- E-Trade was off for pretty much the entire quarter. And so I think the balance you saw in this quarter will be similar going forward. There may be some other factors up and down, but the net of those 2 is positive."
},
{
"speaker": "Dan Perlin",
"content": "Okay. Got it. That's super helpful."
},
{
"speaker": "Edmund Reese",
"content": "And I'll just add to Tim's point, then you heard me mention that we do expect both the capital markets and the wealth management for the full year to be within that 5% to 8% sort of longer-term 3-year objectives. We feel good about that. And I think that will be more weighted for both of those businesses, again, to the third quarter relative to the fourth quarter."
},
{
"speaker": "Dan Perlin",
"content": "Got it. That's super helpful. Tim, this is kind of a bigger picture question. You alluded to it a little bit, but you said you talked to a bunch of clients at Davos, we turned the page on the calendar here. So just the operating environment, the expectations, the pace of commitment from clients. I'm just trying to figure out where the pockets of, I guess, incremental demand in your view, will come from? And then maybe the speed with which you think clients are willing to put capital back into their business."
},
{
"speaker": "Tim Gokey",
"content": "Yes. Thanks, Dan. And I -- these days, it's a little bit embarrassing to talk about Davos, I guess, but it is a great opportunity to connect with a bunch of clients all at the same time. So it was a really useful set of discussions. And I think the nice demand that we're seeing for the second half, it really is those 2 factors I talked about before, which is it's a little bit of catch-up of discussions that were already taking place. And then it is -- then is new discussions. And we are seeing -- and it is -- people are being cautious. So they're really looking at areas where they see very tangible returns or they have very specific needs that they need to address. And many of our products fit into that arena. But we're -- as we look at incremental demand going forward, there is a big industry change around tailored shareholder reports. We have a great solution for that, that really saves our clients' money over any other way they could implement it. That is not only going to be a nice driver of sales in the second half, but it's really improving our whole relationship with the fund industry as being part of the solution. The digital communications, those conversations continue to be very robust really across all of our wealth management firms as they are looking to how do they better engage their clients and do so at lower cost. And with the conversion of one of the large wealth management players and the success of that, that I think is a great proof point on that. The -- and while we're just talking about communications, I don't want to actually skip over the fact that the -- when you look at our omnichannel communication strategy, it had the 2 parts that had the long-term conversion to digital, but had a pretty extended midterm period of that market is still 50% unvended. And there are a lot of in-house players that are basically losing scale as the world goes more digital and are, therefore, choosing to outsource. And we have some of those conversations going as well. So I think all sides of the communications will have some nice sales in the second half. Continued strength in front office. A lot of discussions there. As you know, we're sort of but number three, but numbers one and numbers two are really not investing in their business, and our clients are looking for long-term partners and so having a lot of great discussions there. And then the wealth side, double sales in the first half, and I said a really good discussions around the components that we have -- that we've talked about with clients having those components in their hands to trial them in a sandbox environment, seeing how they play out. And so we see really some really nice strength across multiple dimensions of the strategy."
},
{
"speaker": "Operator",
"content": "Our next question comes from Darrin Peller from Wolfe Research."
},
{
"speaker": "Darrin Peller",
"content": "Just maybe a quick follow-up on the wealth side. When you think about the cross-selling opportunities and what you -- what kind of progress you've been making that either is embedded in the closed sales now or obviously could be embedded in the year ahead. Maybe just comment again on how that's been progressing after UBS is now more --"
},
{
"speaker": "Tim Gokey",
"content": "Darrin, it's Tim. Thank you because it's a -- we think it's a great topic for us. We talked at our Investor Day about how the pipeline has really accelerated over the past year is now at over $200 million. And so then the question has really been about how to begin to convert that pipeline into sales. And what I just talked about is as we have live software and it makes a huge difference for our clients to be able to demo, hands-on keys, have a sandbox, see the software with their own data inside. And so I think that is one of the things that has really led to the strong first half and why we feel like we have a good traction in the second half. And it is across a pretty broad set of components. Remember that for UBS, there were 29 different components that we invested in and modernized and brought to the cloud. And so whether that's tax or it's client onboarding or its corporate actions, many clients see a little bit different path in terms of what their immediate need is and sort of their -- on their transition to sort of a north star. And so we're having just lots of good conversations both in the U.S. and in Canada. So it's -- we feel good about where we are."
},
{
"speaker": "Edmund Reese",
"content": "And just one point to add to Tim. We quantified what we expect in terms of incrementality from wealth at $28 million to $30 million in incremental sales, and we still, as Tim just said, we feel very good about that number."
},
{
"speaker": "Darrin Peller",
"content": "And then just one quick follow-up. Just to revisit the BRCC, the customer communications business. I know you talked about the obvious digital transformation from print. I mean, maybe just help us understand how to think about the growth profile of that business. I know it's -- it had been challenged a little bit after you first closed the deal and then it went to pretty strong positive growth rates pretty consistently. I think it was flat right now. Just remind us again what your expectations are for that?"
},
{
"speaker": "Tim Gokey",
"content": "Yes.And I just have to put in one more time in plug that we really think this quarter was a great demonstration of how our broader omnichannel communication strategy is working. And the growth rates will be ticked up and down, as you just said, Darrin, in any particular quarter. But longer term, what we are -- that strategy is really the one we talked about from before, which is to leverage our scale, our synergies and technology to be the low-cost provider in the industry. To consolidate print, which is still 50% unvended as in-house operations lose scale and then to drive print to high digital footprint -- drive from print to high-margin digital. So that remains the strategy. As we think about how all that plays into sort of long-term growth expectations, we continue to see not any given quarter, but over many quarters, we expect sort of low single-digit top line growth with expanding margins and low double-digit earnings growth. So that's really sort of the profile you should expect from that business."
},
{
"speaker": "Operator",
"content": "Our next question comes from Peter Heckmann from D.A. Davidson."
},
{
"speaker": "Peter Heckmann",
"content": "Going back to tailored shareholder reports and some of the compliance market there. Can you talk about how you're thinking about the opportunity around tailored shareholder reports for Broadridge? I'm sure it's dependent upon the wins, but I guess, how do you feel your position there?"
},
{
"speaker": "Tim Gokey",
"content": "Yes. Peter, thank you. And remember that when the industry moved to 30e-3, we got a sort of an uptick. We argued against it, but we got a sort of a $30 million uptick. And we had commented that when the -- when the world moved away from 30e-3 that we would have a headwind of about $30 million in revenue. And what I'm really pleased about is as we look at the -- now is the help our clients solve the issues that tailored shareholders, and I'll come back to this in a second, the issues that it creates. I think we're going to see that revenue more than replaced, which is very nice. The challenge that clients face with tailored shareholder reports, just to remind people what it is. It's taking the 150-page or so annual and semiannual reports that people receive and it is saying, what are the key data points that are inside there that people really care about and creating a condensed, much more readable sort of 2- to 3-page summary that is much more digestible for investors. So that's good. The challenge it creates for our clients is that those reports, the new regulation has them the wires tailored. It has to be specific to the share class that, that client has. So in the past, you would have gotten a report and you have a table and you said, we'll have to look up your share class and try to figure out for you what it means now has to be specific to you. That dramatically increases the number of SKUs. We talked in an earlier call about a fund we talked to you that had something like 120 to 150 different reports and now that's going to be 1,200 different reports. That makes it very hard to print the reports in advance and inventory level. So the solution that we have is because we've invested in digitizing all of this and a digital database of all the latest regulatory reports, we can -- for that percent of things that is print, which is -- a lot of this is digital, it's 80% digital, but there's still a lot of print. We can print that in line right in our facility and put multiple things in the same envelope significantly savings on creating significant savings on all the inventory but also all the postage and the envelopes and all of that. And so that ability to consolidate multiple reports into a single envelope all digitally in line, it creates a very significant savings for our clients over any other way of doing it. So we're having a really -- a high percent of funds are coming to us for that. And in fact, many funds that used to do this themselves on the registered side are also coming to us for that. So that's the whole sort of output and mailing side of things. The other thing I'm really pleased, though, about is moving upstream into the composition side of things. And historically, that work has been done by others, by Donnelley Financial and by Confluence. And one of the other unique things in the regulation is that the reports need to be tagged with XBRL and -- which is great for digital delivery and extraction of data points. That can be a very laborious process. And the composition engine that we have is pretty unique in that it's -- first of all, it's built in a way that makes it very easy to have many versions, same thing. And is also built with the XBRL tagging sort of natively embedded in it so that you don't have to come back as a second process. So it's a much better solution on the composition side. We're a newer player there, but we've seen a lot of client interest and that's really enabling us to move upstream to have a much deeper relationship with the asset managers."
},
{
"speaker": "Operator",
"content": "And our next question comes from Patrick O'Shaughnessy from Raymond James."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "So for GTO, in past quarters, I seem to recall you guys speaking to a 5% to 7% growth outlook for that business both in, I think, fiscal '24 as well as the medium term. And today, I heard you speak to 5% to 8% growth. So I'm curious if anything has changed in terms of your outlook for that business? And then I think specific to this year, is faster or higher trading volumes may be a bigger contributor to growth than you had previously anticipated?"
},
{
"speaker": "Edmund Reese",
"content": "Patrick, thanks for that question. We did. I'll emphasize that we did come out at an Investor Day and one of the big changes and an important change for us is moving our growth objectives, our 3-year growth objectives for organic growth from 5% to 7% to 5% to 8%. Now the strong growth that we expected in fiscal '24 has a lot to do with that. But the investments that we've been making in the strength that we've been saying, Tim said earlier, our front office capital markets business and even the strength in wealth management, given the incremental sales that we have, we think that GTO will be a contributor there as well. Those are our objectives of 5% to 8% over the next 3 years. And I think you're going to see each of the GTO businesses playing -- performing right in line with that, both capital markets and wealth management here."
},
{
"speaker": "Patrick O'Shaughnessy",
"content": "All right. And as you guys are to being able to modulate your investment spend due to higher event-driven revenue. Can you maybe give a little bit more detail on kind of the type of spending that represents? Are you bringing on more consultants? Are there other kind of very short-term expenditures that you're able to ramp up?"
},
{
"speaker": "Tim Gokey",
"content": "Yes, Patrick, it's a great question. It is one of the things that we're very clear with all of our businesses on is that the investments we're making are our onetime investment. So we have -- we, as do many firms have a whole set of relationships with external providers for building technology consulting, other kinds of things. And so when we have the ability to incrementally invest, it is not adding associates that are going to be here for the long run, but it is really going deeper into projects that may be already underway and accelerating those, but leveraging largely third parties for things that are already in motion that we can accelerate."
},
{
"speaker": "Operator",
"content": "And our next question comes from Brendan Miles from JP Morgan."
},
{
"speaker": "Q – Unidentified Analyst",
"content": "I'm on for Puneet. Jane, by the way, of course, from JP Morgan. So can for all the updates on wealth, it's been really cool, I've been following the stock to wash so like the J curve on your investments in the platform unfold on the free cash flow generation. So that's exciting to see. Quickly on cap markets kind of bouncing off this last question. It seems like it was a great quarter in capital markets. Could you just give us a quick update on the state of the market in that business? And then maybe like a technical question quickly on AI, I -- can I ask a question. For the OpsGPT and BondGPT's are products that you guys are rolling out, I understand you have access to like tons of incredible data. Is that data just kind of data that's in your custody? Or is it data that you own?"
},
{
"speaker": "Tim Gokey",
"content": "Yes. So let me just start with the last one and then come back to the broader capital market because I'm pleased to be able to talk about AI. It is an area that we're investing in, as I talked about earlier, we expect to be a leader in our space, and it is a real natural place for mutualization where -- because we're doing this for many clients, a particular activity and because really getting value out of this often depends on the nuances of a specific activity. we can invest more than it makes sense for any one client to invest, and we can have better data than any one client would have. So it's a really nice opportunity for a mutualized benefit and to -- and for the benefit of our clients. Now in terms specifically of the data, we obviously -- we do house lots of data across clients. We are being very careful on this in terms of how we leverage our models that we are at this point, doing that client by client. It is -- we are -- it is -- that data is owned by our clients and we're extremely careful about that. Could there be a longer opportunity with client permission to have across those pools, that could be possible in the future, but it is would be specifically with our clients' permission. When we look at things like OpsGPT, today, when there's, say, a fail, there's a whole research process that it kicks off and you have knowledgeable and fairly expensive ops people looking up in this database and then that database and then cross referencing it. And by working out what's the reason for the fail and then contacting the other party about it? That sort of research process can be easily automated here. And it is not that sort of looking at the Internet of things like that, it's using AI to write SQL queries to real databases to get real data to put that together and join it and be able to present an answer to an ops professional who can quickly validate it and really cut out tons of time. And this is just -- we're just scratching the surface in terms of what will be possible. But I think our clients are very excited about it and very excited about the idea that we'd be taking on this investment really on behalf of the industry to really help drive a lot of efficiency. And remember, we're a technology company, not so much a people company. So as we make things more efficient, that's not coming out of our personnel that's really helping our clients save money. So that's AI, and I'm sure we'll be talking about it a lot more. The other part was just the state of the market on capital markets?"
},
{
"speaker": "Edmund Reese",
"content": "For the drivers of growth in capital markets, and I'd probably hit 3 things, and thanks for asking the question, Brendan, because it does allow me to come back to an item that Patrick mentioned. But there are probably 3 things that I'd point out there. One is the continued double-digit growth in our front office capabilities as we brought on BTCS, we just continue, as Tim talked about earlier, to see strength in that business. Two, and this is the case across each of our different business units is our ability to be able to convert the revenue backlog into revenue, particularly given the investments that we have been making in our post-trade solutions. We continue to see strength in our capital markets post-trade solutions converting new clients into revenue. That is a strong boost for that business. And the third, and this is a point that Patrick mentioned, we did see strength in some of the trading volumes in the quarter. We go into our planning cycles not expecting significant growth from trading volumes almost assuming flat. But as I mentioned, the fixed income trading, in particular, has continued to have strong growth over the past couple of quarters, and that is also driving a boost in capital markets. And again, most importantly, having us very confident that, that business, along with wealth will be within our 5% to 8% objective here."
},
{
"speaker": "Tim Gokey",
"content": "And I'm sorry, I have to just add one other thing, which is -- when you take our capital markets -- capital margin is a very esoteric business. You take our capital markets team put in front of any even very top tier client. And it is a very impressive team. And the -- you see that in the innovation with digital ledger repo, with LTX, with AI across all those areas that are at the leading edge of where capital markets are going, front to back, we are showing real thought leadership and having great conversations with clients."
},
{
"speaker": "Operator",
"content": "And ladies and gentlemen, with that, we'll be concluding today's question-and-answer session. I'd like to turn the floor back over to management for any closing remarks."
},
{
"speaker": "Tim Gokey",
"content": "Jamie, thank you very much, and thank all of you for joining us this morning. As I hope you heard, we see a long runway for growth ahead. And as we enter our seasonally larger second half, we are on track to deliver another strong year and to continue to make a difference for investors everywhere and for our clients, our associates and our shareholders. Thank you very much for your interest this morning."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines."
}
] |
br | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Broadridge Financial Solutions First Quarter and Fiscal Year 2024 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 Edings Thibault, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Edings Thibault",
"content": "Thank you, Kate, and good morning, everybody, and welcome to Broadridge's first quarter fiscal year 2024 earnings call. Our earnings release and the slides that accompany this call may be found on the Investor Relations section of broadridge.com. Joining me on the call this morning are Tim Gokey, our CEO; and our CFO, Edmund Reese. Before I turn the call over to Tim, a few standard reminders. One, we will be making forward-looking statements on today's call regarding Broadridge that involve risks. A summary of these risks can be found on the second page of the slides and a more complete description on our annual report on Form 10-K. Two, we'll also be referring to several non-GAAP measures, which we believe provide investors with a more complete understanding of Broadridge's underlying operating results. An explanation of these non-GAAP measures and reconciliations to the comparable GAAP measures can be found in the earnings release and presentation. Let me now turn the call over to Tim Gokey. Tim?"
},
{
"speaker": "Tim Gokey",
"content": "Thank you, Edings, and good morning. I'm pleased to be here to discuss our strong start to fiscal 2024. Clearly, the economy and our world remain in a volatile and difficult place. Despite the uncertain economic environment, our business continued to perform well in the first quarter, which speaks to the long-term trends and needs driving our growth as well as the strength of our business model and the execution of our team. I'll start with the headlines. First, Broadridge reported strong financial results. Recurring revenue grew 8%, all organic, with strong growth across governance, capital markets and wealth. Adjusted EPS rose 30% driven by strong recurring revenue growth, timing of event-driven fees and continued expense discipline. After a slower finish to last fiscal year, closed sales rose $19 million to a first quarter record of $48 million. Second, while markets have remained uneven. Continued growth in investor participation drove equity and fund position growth of 8% and 3%, respectively. Third, we continue to execute our strategy to enable our clients to democratize investing, simplify and innovate trading and modernize wealth management. That execution is driving our results in the form of strong sales in our Government Solutions and strong performance of BTCS, and a growing pipeline in our Wealth Management business among many examples. Fourth, our commitment to balance capital allocation has always been a key part of our value creation strategy. In recent years, we've invested heavily to build out our wealth and capital markets platform capabilities. That investment is moderating. And in fiscal 2023, we repaid a portion of the debt from our BTCS acquisition and ended the year at our target leverage. Now we're returning to our more historical mix of investment and capital allocation. Type-4 investments declined significantly from last year's level, and we repurchased $150 million of our shares in Q1, our first share repurchase since fiscal 2020. Finally, with a strong start to the year, we are reaffirming our full year fiscal 2024 guidance. We expect recurring revenue growth of 6% to 9%, continued margin expansion, and another year of 8% to 12% adjusted EPS growth and closed sales of $280 million to $320 million. Those are the headlines for the quarter. Now let's turn to Slide 4 to review how we drove these strong results, starting with our governance franchise. Our ICS recurring revenue grew 6%, driven by a combination of revenue from sales, increased investor participation and higher interest income. Looking across our product lines, solid growth in our regulatory solutions was complemented by strong results in data-driven fund and issuer solutions. In Customer Communications, double-digit growth in our digital communications revenues more than offset a temporary slowing in print growth. The biggest driver of our growth remained revenue from new sales as we develop new solutions like our digital products and enhance our existing products. We're winning with both new clients and expanding our relationships with existing clients. Increasing investor participation also remains a positive driver for our regulatory business despite headwinds from a choppy market and rising interest rates. In what is the smallest quarter of the year, equity record growth remained strong at 8%. Growth within managed accounts remained in the mid-teens, more than offsetting low single-digit growth in self-directed accounts. Fund and ETF position growth was 3%, the underlying trends remain solid with double-digit growth in passive fund positions, offsetting weaker trends in actively managed vehicles. Our forward testing continues to indicate a mid to high single-digit outlook for equity positions and mid single-digit growth for fund positions. Equity driven activity also picked up in the quarter, event-driven activity also picked up in the quarter. I'm especially proud of the work done by our issuer business as part of the recent large cap spin-off. Not only did we seamlessly process critical communications for more than five million beneficial and employee shareholders. We also provided the digital composition and print work for the required filings. It's a great example how Broadridge can bring the full power of this network together to help public companies execute critical transactions. We also appointed new leadership for our ICS business, elevating Doug DeSchutter and Mike Tae to the role of co-presidents, as part of a long-planned transition. Mike and Doug are proven leaders, and they bring a long track record of execution to their new roles. Our governance business is in strong hands. Turning to capital markets. Our sell-side clients are seeking to expand their agency and principal trading capabilities and they're turning to Broadridge for our help. Capital Markets revenues rose 9% to $249 million, driven by strong growth in BTCS, and higher trading volumes. We also help our clients simplify their back-office operations. And during the quarter, we completed the rollout of our global post-trade platform for a large global bank. Step by step, we've worked with that client over the past few years to transition away from seven different disparate platforms covering 75 separate markets around the world, each of its own operational support and settlement structure, into a single unified Broadridge platform. This is a strong example of how we are helping our clients simplify their operations, reduce expenses and optimize capital utilization by modernizing their infrastructure. Wealth Management revenues grew 14% to $154 million. As we highlighted on our last call, we began recognizing revenue from UBS at the beginning of the first quarter. For some time, we've been discussing our move to a component-based approach, which we are calling transformation on your terms. I'm pleased that we are seeing success with this approach. Our pipeline continues to grow, and we have now sold one or more components to seven additional clients beyond UBS and RBC. These component sales give us confidence in our progress and the opportunity to expand these clients over time. Finally, we reported strong closed sales in the first quarter, driven by a combination of underlying demand and sales that moved from fiscal 2023. I was especially pleased to see sales growth across all of our franchise, including higher wealth sales and strong growth in BTCS. In an uncertain market, clients remain willing to invest in new capabilities, especially those that can deliver near-term benefits or to enhance the go-to-market strategies, including governance tools, enhance trading capabilities and adviser productivity tools. As a result, while time to close is sometimes longer, our conversations with clients remain strong, and our pipeline continues to grow. Let's move to Slide 5 for some closing thoughts on the quarter. First, Broadridge is off to a strong start to fiscal 2024. We reported strong first quarter results, including 8% recurring revenue growth and 30% adjusted EPS growth. We're executing against our strategy to enable the democratization of investing, simplify and innovate trading and modernize wealth management. Second, our growth is being driven by long-term trends and strong execution, continue to benefit from increasing investor participation and clients investing in new regulatory solutions, faster and more efficient trading and the modernization of wealth management. We have invested to ensure that we can help our clients benefit from these trends. That combination of long-term drivers matched with a clear investment and growth strategy is driving real value for clients and strong results for our shareholders. Third, we remain committed to balanced capital allocation, with our core priorities of retaining our investment-grade credit rating, funding, internal investment, growing our dividend, in line with earnings, completing tuck-in M&A and returning excess capital to shareholders. With our wealth platform investment now complete and target leverage achieved, we are confident that we will be able to return additional capital to shareholders going forward, and return to mid to high-teens ROIC. The $150 million share buyback we completed in the first quarter highlights that confidence. Fourth and last, we are reaffirming our guidance for fiscal 2024, and we remain well positioned for long-term growth. Our business has a long track record of delivering consistent top and bottom line growth and strong shareholder returns. Today, we are better positioned than ever to continue delivering even more value to our clients, and we're looking forward to sharing a newer set of three-year objectives at our upcoming Investor Day this December, in New York. Normally, I close my remarks with a thank you to Broadridge associates around the world. It's an acknowledgment of their work and focus on driving positive client outcomes. But today, I first want to thank and remember one associate in particular. Bob Schifellite passed away in September after a brief illness, while in the process of a long-planned transition away from his role, as President of our ICS business. He joined our governance business almost 40 years ago, and he was a principal architect in building the strong governance franchise, we know today. He was a passionate advocate for our clients, a champion of our culture, and most of all, a good friend and mentor to me and so many others at Broadridge. So I want to thank and remember, Bob, for his work in building our company. And I want to thank all of our associates for the work they do every day to serve our clients drive the transformation of our industry and enable better financial lives for millions. Edmund, over to you."
},
{
"speaker": "Edmund Reese",
"content": "Thank you, Tim. And thank you, in particular, for those comments on Bob. There is no doubt that he will be missed. Good morning, everyone. I’m really pleased to be here to discuss the results from another strong quarter and a strong start to fiscal 2024. Before reviewing this quarter’s results, let me share a few key points. First, Broadridge delivered strong top line growth, led by strong recurring revenue in line with our expectations and higher event driven revenue. Second, and as a result, we expect to generate approximately 25% of adjusted EPS in the first half of fiscal 2024. Third, we are reaffirming our fiscal 2024 guidance. And finally, we resumed share repurchases in Q1 as we are confident in our ability to drive 100% free cash flow conversion and return more capital to shareholders. As you can see from the financial summary on Slide 6, recurring revenues rose to $871 million, up 8% on a constant currency basis, all organic. Adjusted operating income increased 33% and AOI margin expanded 220 basis points to 13.9%. Adjusted EPS was up 30% to $1.09. And I’ll remind you that while higher interest expense partially offsets operating income growth, the interest rate impact at the Broadridge level is fully offset by higher float income in our ICS segment. Continuing with the results. We delivered closed sales of $48 million, up $19 million over Q1 2023. And finally, I will note again that we repurchased $150 million of Broadridge shares as part of our balanced capital allocation model. Let’s get into the details of these results, starting with recurring revenue on Slide 7. Recurring revenues grew 8% to $871 million in Q1 2024 and was at the higher end of our full year guidance range of 6% to 9%. Our recurring revenue growth was driven by a combination of converting our backlog to revenue and double digit trade volume growth. Let’s turn now to Slide 8 to look at the growth across our ICS and GTO segments. We continued to see growth in both ICS and GTO. ICS recurring revenue grew 6% to $469 million. Regulatory revenue grew 5% and was led by fund and equity position growth. More importantly, position growth remains in line with our expectations, as I’ll detail in a moment. Data-driven fund solutions revenue increased by 9%, primarily due to higher float revenue in our mutual fund trade processing unit, which we have rebranded to be Broadridge Retirement and Workplace. Issuer revenue was up 19%, driven by growth in our registered shareholder solutions and customer communications recurring revenue was up 2%, propelled by continued double-digit growth in our higher margin digital business, which more than offset lower growth in our lower margin print revenues. And while we do expect print volumes to pick up over the balance of fiscal 2024, we continue to expect print revenues to decline over time and be replaced with higher margin digital revenue. As a result, over the long-term, we expect our customer communications business to have low-single-digit top line growth with expanding margins and continued low-double-digit earnings growth as it execute on its print to digital strategy. Turning to GTO. Recurring revenues grew 11% to $402 million. Capital markets revenue increased 9%, led by continued strong performance in BTCS and elevated equity and fixed income trading volume growth. Wealth and investment management revenue grew 14%, powered by the onset of revenue recognition related to the UBS contract, partially offset by the successful transition of E-Trade to the Morgan Stanley platform, which occurred at the beginning of September. Looking ahead, we continue to have high confidence in full year GTO growth being in line with our historical 5% to 7% growth objective. Now let’s turn to Slide 9 for a closer look at volume trends. As you can see by our results, investor participation in financial markets has continued to increase despite the market volatility. Equity position growth was 8%, driven by continued double digit growth in managed accounts. Our testing of position growth continues to prove reliable as Q1 was in line with our expectations. We have now extended our testing into Q2 and Q3, and those results support our outlook for mid to high-single-digit growth for the full year. Mutual fund position growth moderated from Q4 2023, but grew 3%, driven by strong growth in passive funds. Based on our testing, we continue to expect mid-single-digit growth for the full year. Turning now to trade volumes on the bottom of the slide. Trade volumes rose 15% on a blended basis, led by double-digit volume growth in both equities and fixed income, which benefited our capital markets business. Let’s now move to Slide 10 for the drivers of recurring revenue growth. Recurring revenue growth of 8% was all organic and grew above our 5% to 7% growth objective for a six consecutive quarter. Revenue from net new business contributed 5 points of growth. Internal growth, primarily trading volumes, expanding client relationships and float income contributed 3 points. Foreign exchange had a non-material 15 basis point positive impact on recurring revenue growth. And based on current rates, we expect a similar benefit in full year recurring revenue growth relative to fiscal 2023. I’ll finish the discussion on revenue on Slide 11. Total revenue grew 12% to $1.4 billion, of which recurring revenue was the largest contributor with 5 points of growth. Event driven revenue was $87 million and added 2 points to growth. As expected, event driven revenue increased sequentially and was above our seven year average. Event driven activity in the quarter was particularly strong and benefited from the timing of mutual fund proxy activity and significant corporate actions. We continue to expect more normalized event driven revenue for the remainder of the year and for the full year to be $230 million, $250 million in line with recent years. Low to no margin distribution revenues contributed 5 points to total revenue growth. Distribution revenue was elevated and reached 14%, with half of that growth coming from postal rate increases, which have a dilutive impact on our adjusted operating income margin. We continue to expect distribution revenue to grow in the high-single to low-double-digit range, driven by further postal rate increases. Turning now to margins on Slide 12. Adjusted operating income margin was 13.9%, a 220 basis point improvement over the prior year period powered by a combination of operating leverage on our higher recurring and event driven revenue, higher float income and continued discipline expense management. Excluding the net impact of higher distribution revenue and higher float income, which was accretive to margins in Q1, we delivered over 100 basis points of margin expansion after absorbing the amortization from our wealth platform. This performance gives us confidence in our ability to both fund long-term growth investments and still meet our earnings growth objectives. We continue to expect adjusted operating income margin to increase year-over-year to approximately 20% as we overcome the dilutive impact of higher distribution revenue. Let’s move ahead to closed sales on Slide 13. Closed sales were $48 million, $19 million higher than Q1 2023. We were encouraged by our strong start to the year with higher sales across all three of our franchises. We saw strong BTCS sales in GTO and strong customer communications and regulatory sales in ICS. As Tim noted, our pipeline remains strong as we continue to see strong interest from clients in our technology solutions. I’ll turn now to cash flow on Slide 14. I’ll start with a reminder that Broadridge’s cash flow generation is typically negative in the fiscal first quarter and strengthens throughout the year. Q1 2024 free cash flow was negative $76 million, a $142 million better than last year, driven by a reduction in client platform spend, which I’ll discuss in a moment. Free cash flow conversion, calculated as trailing 12 month free cash flow over adjusted net earnings, was 103% in Q1 2024. This is consistent with our expectations of free cash flow conversion of approximately 100% for full year 2024. On Slide 15, you’ll see that we remain committed to a balanced capital allocation policy that prioritizes our investment grade credit rating, internal investment, a strong and growing dividend and strategic tuck-in M&A that meets our financial criteria with excess capital being returned to shareholders through share repurchases. Our total capital investment for Q1 2024 was $34 million, including platform investment of $20 million, down significantly from the prior year’s $163 million. We returned $86 million to shareholders through the dividend, and with no M&A activity in the quarter. We returned an additional $150 million to shareholders through share repurchases, our first share repurchase activity since fiscal year 2020. Turning the Guidance on Page 16. As I said in the beginning of my remarks, the strong start to fiscal 2024 gives us the confidence to reaffirm our full year guidance on all of our key financial metrics. We continue to expect 6% to 9% recurring revenue growth, constant currency, adjusted operating income margin of 20%, adjusted EPS growth of 8% to 12%, and closed sales of between $280 million to $320 million. Additionally, we expect approximately 75% of our earnings to be generated in the second half of the year with 25% in the first half in line with our performance over the last 10 years. Finally, let me summarize my key messages. Broadridge delivered strong Q1 financial results. The demand and secular trends driving our growth remain strong, and our testing is showing continued equity and fund position growth into the second half of the fiscal year. We expect free cash flow conversion of approximately 100% in fiscal 2024, allowing us to invest for growth and return capital to shareholders in line with our balanced capital allocation model. We are reaffirming our fiscal year 2024 guidance, highlighting the strength of our business and financial model. And with that, let’s take your questions. Operator, back to you."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question is from David Togut of Evercore ISI. Please go ahead."
},
{
"speaker": "David Togut",
"content": "Thank you. Good morning. Good to see the strong start to fiscal 2024. Looks like you’re running at about 3x the EPS growth targeted for the year as a whole, 30% versus 8% to 12%. Granted, 1Q is your smallest quarter of the year, and fourth quarter is the most important. Can you unpack the drivers of outperformance between recurring elements, which seem to be expense discipline, recurring revenue growth and some that are non-recurring, like event driven fees and obviously E-Trade was on your system perhaps a little longer than anticipated. But it looks like you’re on track to outperform versus your annual guide. What’s keeping you a little more conservative?"
},
{
"speaker": "Edmund Reese",
"content": "David, good morning to you. Thanks for joining. You asked the question and answered it within your own question. You did a very good job of that. And you said it exactly. I’ll start with one of the points you made, that Q1 is really a small quarter for us. And you know well that our focus is on driving medium to long-term growth and in the short-term meeting our commitments. In the short-term we’re focused on annual growth, and we run the company as an annual growth company. And over the last 10 years, you’ve seen, as I said in my remarks that roughly about 25% of our earnings happened in the first half of the year that’s given the strong proxy season in the back half of the year. And I think 2024 will be no different. And to the question that you ask, it is some of the non-recurring items that’s driving that type of performance. Specifically, in Q2, you’ll see more normalized event driven revenue as we talked about. We said in Q4 that we expected some of the pent-up demand from 2023 coming into 2024, and that’s exactly what we saw. It will be more normalized as we go through the rest of the year. You’ll see the full impact another non-recurring item of converting E-Trade over to the Morgan Stanley platform. And within your question you made the final point that I think is important to point out here is that the more recurring drivers of growth are stable, both for this year and both for the long-term. And I’ll call those out as converting our backlog to revenue. That’s very stable. That drove, as you saw in my remarks, over 5 points of growth here. The position growth and our testing for that remains in line with our expectations both for equities and funds. And to your – another point you made the continued discipline on expense management to be able to get the operating leverage from the scale in our business, to be able to execute on the actions that we’ve taken as we evaluate our cost basis. Those things continue to help us have the kind of growth. I would not get too hung up, the final point you made on the growth in this particular quarter. But on a full year basis, we continue – nothing’s unusual here and we continue to feel very strong and confident about the full year guidance."
},
{
"speaker": "David Togut",
"content": "Appreciate that. Just as a quick follow-up. Good to see the improved bookings performance in Q1 after a somewhat soft second half of FY2023, despite the pipelines being strong last year. Was there anything that changed in particular in the first quarter that gives you a better line of sight to your full year bookings target? Or is it just some of these sales cycles just got over the goal line?"
},
{
"speaker": "Tim Gokey",
"content": "Yes, Dave, it’s Tim. And thank you for that question. Look, we were really pleased with record sales in Q1. I think as you have heard from others, sales cycles are lengthening, which did drive some slippage from Q4 into Q1. But I think as we look forward, one of the advantages that we feel is really the breadth of our product set, which enables us from a mixed perspective to benefit from a wide range of market conditions. And so we have many chances to ensure that we’re sort of part of the solution to the problems that our clients are facing at any given time. So right now we’re seeing more demand for components and solutions that are addressing cost or are driving near-term revenue less for transformational solutions at this time. But we’re seeing good demand across all three of our franchises. Our pipeline has never been higher. And so that’s why we confirmed the $280 million to $320 million for this year."
},
{
"speaker": "David Togut",
"content": "Understood. Thanks so much. And condolences on Bob’s passing. I remember him well from your Investor and Analyst Day’s."
},
{
"speaker": "Tim Gokey",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "The next question is from Peter Heckmann of D.A. Davidson. Please go ahead."
},
{
"speaker": "Peter Heckmann",
"content": "Hey, just to follow-up, Tim and you addressed this in your answer to the last question. You’re talking about some of the components of the wealth management system. At least I think you’re referring to that when you said that the components that are more designed for cost efficiencies or cost savings are proving a little bit more popular. But could you just dig into that a little bit in more detail. Talk about some of the components in terms of relative demand and then the implementation cycles? Can some of the components go live fairly quickly? And then lastly, I didn’t hear you say it, but I think in the last quarter call you talked about perhaps $20 million to $30 million of new closed sales related to wealth management components. Do you think that’s still a good estimate?"
},
{
"speaker": "Tim Gokey",
"content": "Yes. Good. Peter, good morning. I would say, and we can talk about components across all of our franchises, but I think you were specifically asking a little bit more on the wealth side. And we really remain quite pleased with our progress on wealth. And obviously we began recognizing revenue from UBS in July. And on the components, we really started that marketing the components last spring with a really significant kick-off at the Securities Industry Conference, the CIFFA Conference in May, demoing live software, really being able to show clients working components. And so we’re sort of fully into selling mode on that. Our pipeline has built nicely and is quite a bit where it was a year ago. And we’re seeing – I think in the near-term, we’re seeing demand around things that can help drive advisor productivity. We’re seeing demand in corporate and class actions. We’re seeing demand around helping people process alternatives. So lots of things that are meeting some important needs that our clients have. So as I said, we now have clients – multiple clients live with at least one component and others in implementation. I think that shows that component approach is working. As you said, we are targeting $20 million to $30 million in incremental sales, and I think we’re on track to achieve that over time. So I think when you look at how we’re looking about our wealth strategy, we’re really assuming mostly these component sales within every few years, something a little bit larger that will boost sales in that year. But I think right now we’re focused on the component side."
},
{
"speaker": "Peter Heckmann",
"content": "Okay. Okay, that makes sense. And then just I didn’t hear you reference it. And certainly historically, Broadridge has been pretty active on M&A. But now with leverage back down below 2.5%, how do you view the M&A pipeline? And do you think we could still see a deal or two happen in fiscal 2024?"
},
{
"speaker": "Tim Gokey",
"content": "Yes, it is. I think if you look at the market there’s still a disconnect between buyers and sellers in terms of what the values are. So the landscape in terms of what is available is a little light, I would say. There are some interesting things that we are looking at. So I wouldn’t be surprised if we’re able to transact something in 2024. But the degree of pipeline and activity is definitely way below where it was a few years ago. I think one of the things, Peter, is that with the investments that we’ve made, we’re feeling really good about our ability to drive organic growth through organic investment. And so that balance between organic growth and M&A that may be a little bit different over the next few years than it was in past. But we will continue to look for the right opportunities that meet our criteria."
},
{
"speaker": "Peter Heckmann",
"content": "All right. That’s helpful, Tim. I appreciate it."
},
{
"speaker": "Operator",
"content": "The next question is from Darrin Peller of Wolfe Research. Please go ahead."
},
{
"speaker": "Darrin Peller",
"content": "Hey, guys. Thanks. Maybe we could jump in a little more to the components of the business, maybe just touching first on the communication side. I just want to make sure we understand. I know we saw strong growth in digital offset by slowing print. If you could just give us a little bit of an update on some of the additional color on print trends, sustainability of it and just broadly speaking, that’s a segment that is one that’s shown us some element of improvement obviously, since you – really, since you closed the deal, but it took a little while at first. So just give us a little more color on what you’re seeing there first, please."
},
{
"speaker": "Tim Gokey",
"content": "Sure. Darrin, thank you very much. Thank you for that question. We really liked this quarter because we’re now beginning to see that conversion of print to digital that we’ve been talking about. So this quarter we had a significant client that went live on our next-generation digital solution and moved a lot of communications from print to digital. So they saved a ton of money, and their end clients and advisors are really happy with the new solution and are very engaged with it and seeing real upticks in satisfaction. So on the base of that, we saw lower print volumes on that client, but overall, we saw a double digit increase in our digital revenues and a double digit increase in profitability. So that really shows how this transition can work for us. So I do think – just stepping back a little bit, our main story is that continued flow towards digital. But I do have to put an asterisk on it, which is that we are continuing to see a lot of demand from companies that are seeking to rationalize their print facilities. And so there still is an opportunity sort of in that midterm to be the consolidation point for print, which we'll do and are happy to do as long as the digital comes with it so we get the transition over time. So longer term, we expect to see lower growth in print, with strong growth in digital and strong profitability growth, which is exactly what we saw in the first quarter. But there will be some bumps along the way where we have stronger print volume."
},
{
"speaker": "Edmund Reese",
"content": "And then in the mean – and I'll just add, Darrin, you made a point in your question is worth highlighting that since the acquisition, we've continued to see margins expanding and low double-digit earnings growth as we execute on this strategy for print to digital that Tim just talked about. So we feel very good about that."
},
{
"speaker": "Darrin Peller",
"content": "Quick follow-up just on the positional growth side, specifically on mutual fund, but maybe more – first more, just more broadly what you're seeing and what you're expecting on trends. You guys tend to have a lot of really good data as you always say, in terms of at least the next six months. So just remind us your conviction on what you're seeing now on that front broadly. But then specifically mutual funds, I think, were 3%, I think you said driven by passive – and so – if you could just add color on active mutual fund position trends here broadly and just couple that into the first question on overall position growth."
},
{
"speaker": "Tim Gokey",
"content": "Yes, Darrin. Look, I think that the underlying trends on both numbers, both the equity side and the fund side are positive. And as we've talked about, that includes growth in managed accounts and then over time, things like direct indexing and pass-through voting. And we were certainly happy with the 8% record growth, which I know wasn't your question about what it was, but I have to repeat it. And that was really driven by the managed account side. On the fund side, where it was 3%, we have seen that be a little bit noisier quarter-to-quarter based on timing, and that is really what we think was going on this quarter. Sort of looking inside that, it's – there's good growth in money market funds, not surprisingly given sort of the volatility that is out there. And – but then as we look forward, I think the thing that really is giving us the confidence is the forward testing, which again, is showing the mid-high for equities and the mid single for funds. But really, the long-term trends we haven't really seen any change in those. So we're – that's why we're confirming where we are."
},
{
"speaker": "Darrin Peller",
"content": "Okay, thanks a lot."
},
{
"speaker": "Operator",
"content": "The next question is from Matthew Roswell of RBC Capital Markets. Please go ahead. Matthew, is your line muted?"
},
{
"speaker": "Matthew Roswell",
"content": "Hopefully you can hear me now."
},
{
"speaker": "Tim Gokey",
"content": "Yes."
},
{
"speaker": "Matthew Roswell",
"content": "Excellent, sorry about that. It's Matt Roswell on for Dan Perlin. Congratulations on a nice quarter. Just a couple of quick questions, hopefully. What was the FX impact in the quarter? And how should we think about it for the rest of the year?"
},
{
"speaker": "Edmund Reese",
"content": "Yes. Matt, that's – I'll just be quick on that one. In the quarter, on our recurring – it was not material on our recurring revenue, 15 basis points benefit to us. What we said when we gave guidance in Q4 is that we expected a modest 0.5 point benefit to earnings, and that's not us trying to do our own estimates of FX, but just looking at what current rates sit at today. And I think we're still largely in that range. If you look at our 10-K, and you'll see that a change in the U.S. dollar of 10% against the currencies that matter to our economics, primarily the pound, the Canadian dollar and increasingly with BTCS, the euro and the Swedish corona, there is about a $15 million impact on earnings. So that gives you some sense about what the overall impact can be, but we've been specific about what we think for fiscal 2024."
},
{
"speaker": "Matthew Roswell",
"content": "Okay. And then on the margin expansion for the remainder of the year, is there anything we should look out for in terms of either seasonality or grow over compared to last year?"
},
{
"speaker": "Edmund Reese",
"content": "And that's a great one to point out, Matt, because I think looking at the margins in any particular quarter is not – you should certainly be looking at that on a full year basis, given the timing of our investments and the timing of some things that are recurring versus nonrecurring? The short answer of what you should expect is that approximately 20%, which is margin expansion. And there's a couple of things going on there, right. There is setting aside the float income that we see in our ICS business, which is a benefit to the overall reported margin expansion but has no impact to our earnings because we have the interest expense that offsets that. The second component that you see impacting the reported rate is the distribution revenue, particularly with no margin postal rate increases in it that has no impact to our earnings. The impact of those two things together for the full year, we estimate to be dilutive by about 50 basis points and what we said is we'd be able to overcome that and continue to deliver margin expansion in the 50 basis points range absorbing the amortization associated with the Wealth management platform. So you put those two things together, to dilutive impact from the items that I mentioned, our ability to be able to drive margin expansion after absorbing the wealth management platform and you get to this approximately 20%. And I think the first quarter is a strong testament to that. I put those two things aside, we drove 100 basis points with the amortization in our overall results. So we continue to feel very good about that guidance. And finally, I think it's just important – it's important for us to drive that margin expansion because it allows us to both hit the earnings objectives that we have and fund."
},
{
"speaker": "Matthew Roswell",
"content": "Hello?"
},
{
"speaker": "Edmund Reese",
"content": "We're still here, Matt."
},
{
"speaker": "Matthew Roswell",
"content": "Okay, all right. Just lost you for a second there. And then I guess the final question I have is just what's the repurchase assumptions in the guidance?"
},
{
"speaker": "Edmund Reese",
"content": "Well, look, I think you have seen over the – as Tim said in his earlier remarks, our focus has been on paying down the debt and building out the wealth management in our capital markets platforms now that we are past that elevated investment phase and with the expectation of approximately 100% of free cash flow conversion. When you think about that, we have a dividend that we pay $3.20 a share at our share, as you can expect, just under $400 million of that going towards the dividend. The rest of that capacity will either be devoted to M&A, if we find the right opportunities, as Tim just said, that meet our strategic and financial criteria or return back to investors in the form of share repurchases. So I think those are the components you need to think about what that range of share repurchases is – approximately 100% free cash flow conversion the dividend and the rest of that capacity towards M&A and share repurchases."
},
{
"speaker": "Tim Gokey",
"content": "And I think the only thing I would add to that is we tend to wait on that until we really have high confidence on how the year is coming out. So that from a – it's really almost more of a 2025 question because any share repurchase we do would tend to be later in the year and not affect our weighted average share count for this year."
},
{
"speaker": "Matthew Roswell",
"content": "Excellent, thank you. Thank you for all the color."
},
{
"speaker": "Tim Gokey",
"content": "Yes."
},
{
"speaker": "Operator",
"content": "The next question is from James Faucette of Morgan Stanley. Please go ahead."
},
{
"speaker": "James Faucette",
"content": "Great. Thank you. I wanted to ask a couple of questions here. First, on the announcement of the UBS go live on the DLP platform, is that incremental to the $75 million of contribution outlined previously? Or is that project already contemplated in that number?"
},
{
"speaker": "Tim Gokey",
"content": "Great to clarify that is – that's part of the $75 million."
},
{
"speaker": "James Faucette",
"content": "Okay, thank you for that. And then I wanted to ask a more broad-reaching question around competition. I think we all know about the competitive dynamics at play within the proxy space. But there were – have been one or two announcements of more AI-focused players that seem to be pretty well funded that are looking to get into the space. Anything to call out in terms of changes in competitive dynamics or where there may be some incremental investment needed from your perspective?"
},
{
"speaker": "Tim Gokey",
"content": "Dave, I don't think there's anything significant that is incremental to what has been out there. I think that we always say that competition has always been significant in this area. And even though people like to talk about us as a market utility, the – we've always had in-house – competition from in-house and from other players. And we think that we win that on the merits by being safer for our clients, more resilient, less cyber risk, smarter in terms of better all-in economics when you take into account all the things we can provide our clients based on our unique network. So we don't really see a change, and we are certainly – we've already talked about on the AI side that we are going to be a leader in AI in our spaces. And we have products in market – AI different products in market, BondGPT on the Bond side, which is one of the earliest products we've got quite a bit of attention and reviews on that. And we're certainly investing to apply AI also on the governance side. So I think to the extent there's something interesting in applying AI in the governance space, we'll be a leader in that."
},
{
"speaker": "Edmund Reese",
"content": "And I also – James, I just want to comment back to your first question, overall across both UBS and across the success that we've been seeing with DLR with our Digital Ledger Repo system. Right now, the economics to Broadridge are not material at all for any of our clients. We've had great success really signing that up, but the economics are still not having a significant material impact on our guidance for fiscal 2024."
},
{
"speaker": "James Faucette",
"content": "Great, really appreciate the color on both those things."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks."
},
{
"speaker": "Tim Gokey",
"content": "Thank you very much for joining us today to talk about our strong first quarter results. We look forward to seeing you and talking to you at our Investor Day in New York on December 7, when we'll be talking about our outlook over the next three years, which we think will be a pretty productive day. And we have – we're pretty excited to share our forward view. Thank you."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
bro | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for standing by, and welcome to the Brown & Brown Fourth Quarter Earnings Conference Call. Today's call is being recorded. Please note that certain information discussed during this call, including information contained in the slide presentation posted in connection with this call, and including answers given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature. Such statements reflect our current views with respect to future events, including those relating to the company's anticipated financial results for the fourth quarter, and are intended to fall within the Safe Harbor provisions of the securities laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated, or desired, or referenced in any forward-looking statements made as a result of a number of factors. Such factors include the company's determination as it finalizes its financial results for the fourth quarter that its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday, other factors that the company may not have currently identified or quantified and those risks and uncertainties identified from time-to-time in the company's reports filed with the Securities and Exchange Commission. Additional discussion of these and other factors affecting the company's business and prospects, as well as additional information regarding forward-looking statements is contained in the slide presentation posted in connection with this call, and in the company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, there are certain non-GAAP financial measures used in this conference call. A reconciliation of any non-GAAP financial measures to the most comparable GAAP financial measure can be found in the company's earnings press release or in the investor presentation for this call on the company's website at www.bbinsurance.com by clicking on Investor Relations and then Calendar of Events. With that said, I will now turn the call over to Powell Brown, President and Chief Executive Officer. You may begin."
},
{
"speaker": "Powell Brown",
"content": "Thank you, Michelle. Good morning, everyone, and welcome to our fourth quarter earnings call. First, we'd like to express our deepest condolences to the many individuals impacted by the California wildfires. The magnitude of the devastation caused by these events is horrific. We're committed to assisting those impacted by these terrible fires. Now transitioning to our results. Our fourth quarter performance was just outstanding and capped-off another incredible year, where our team delivered nearly $5 billion of revenue, which included double-digit organic and double-digit earnings per share growth, as well as strong margin expansion. These results are only possible through the dedication of our 17,000 plus teammates delivering for our customers every day. Over the years, we've worked diligently to build a highly diversified business that consistently generates best-in-class financial results. The reason we can deliver these results is due to our unique operating culture. Now let's get into the results for the fourth quarter. I'm on Slide number 4. For the fourth quarter, we delivered revenues of $1.4 billion growing 15% in total and 14% organically over Q4 of 2023. Our adjusted EBITDAC margin improved by almost 200 basis points to 33% and our adjusted earnings per share grew 24.5% to $0.86. On the M&A front, we completed 10 acquisitions with estimated annual revenues of $137 million. Across the board, it was a very strong quarter. I'm on Slide 5. For the full year of 2024, we delivered revenues of $4.8 billion growing 13% in total and over 10% organically. Our adjusted EBITDAC margin was over 35%, increasing more than 100 basis points. On an adjusted basis, our diluted net income per share grew over 18% to $3.84, and we generated nearly $1.2 billion of cash from operations. We had another good year of M&A completing acquisitions with approximately $174 million of annual revenue with the largest being Quintes in the Netherlands. We'd like to extend a warm welcome to all the new teammates that joined us during 2024 and we're pleased with the quality of the organization and our new capabilities. I'm on Slide 6. From an economic standpoint, there were no major changes for the markets in which we operate as compared to the last few quarters. Many business leaders have shifted from being cautious to cautiously optimistic. In addition, we did not see companies materially change their levels of investment, as they're still hiring and growing their revenues generally at levels similar to the second and third quarters of 2024. Overall, the economies in which we operate are relatively stable, which we view as a good backdrop for our growth opportunities in 2025 and beyond. From an insurance pricing standpoint, rate increases for most lines continued. However, they're moderating downward as compared to last quarter and last year, except for ongoing upward pressure on auto and casualty. The line that had the largest change for the quarter as compared to last year was CAT property, which we'll discuss in more detail. Pricing for employee benefits was similar to prior quarters as medical and pharmacy costs continue to be up 7% to 9%. This ongoing upward pressure and the complexity of healthcare are driving strong demand for our employee benefits consulting businesses. With the investments we've made and continue to make, we are well positioned to help companies of any size navigate these market challenges. Rates in the admitted P&C market moderated slightly as compared to last quarter and were up 2% to 7% for most lines versus the prior year. The downward trend for workers' compensation rates remained and they were flat to down 5% in most states. For the fourth quarter, rate increases for non-CAT property were still in the range of flat to up 5. For casualty, we continue to see rate increases for primary layers, mainly due to the ongoing size of legal judgments in the U.S. Consistent with the last few quarters, rates for excess casualty increased in the range of 1% to 10%. For professional liability, we saw rates flat to up 5% as compared to last year. Now shifting to the E&S markets. First, in reference to CAT property, at the beginning of fourth quarter, there was speculation that the impact of Hurricane Helene and Milton would slow the recent declines of CAT property rates or even reverse the trend entirely. Based on insured losses and the fact that both storms were heavy flooding events versus wind, CAT property rates continue to decrease throughout the fourth quarter. On average, rates were down 10% to 20%, similar to the end of third quarter with more customers seeing decreases closer to or in excess of 20%. From a buyer's perspective, some leverage the lower rates to increase their limits or modify deductibles, while others realize the savings. As a result of our broad diversification, rate changes for individual lines of business generally will not materially impact the total results for our company. The major drivers of our organic growth are the economy and our ability to win net new business. This quarter was another good example. We had some lines that were up and some lines that were down, while still delivering strong results. On the M&A front, we had a good quarter. We acquired 10 great companies of $137 million of annual revenue and our largest acquisition was Quintes. We're very excited about our Dutch market position and our ability to grow over the coming years. From an overall market perspective, competition remains fierce for high-quality businesses, and we're starting to see more activity from financial sponsors for the smaller and mid-size deals as interest rates are beginning to decrease. I'm now on Slide 7. Let's transition to the performance of our three segments for the fourth quarter. Retail delivered 4.4% organic growth driven by good performance in most lines of business. We're pleased with the level of net new business as it was consistent with our strong performance over the last few quarters. Organic growth was partially impacted by the timing of our new business and certain non-recurring revenue. For the full year, we delivered strong organic growth of 5.8% as our team is performing well and we feel good about our prospects for 2025. Programs delivered another outstanding quarter with organic growth of 38.6%. This performance was driven by a number of our programs with strong new business and exposure unit expansion as well as claims revenue associated with the Q3 and Q4 hurricanes. Our lender-placed business and captives performed very well and our CAT property business continued to grow even with CAT property rates decreasing. For the full year, we grew 22.4% organically, an amazing result. As one of the largest, if not the largest global operator of MGAs and MGUs, we've made thoughtful and strategic investments creating meaningful differentiation and resiliency in the marketplace. Wholesale Brokerage delivered another good quarter with organic revenue growth of 7.1%. This performance was driven by growth across all lines through a combination of net new business and exposure unit increases. That was somewhat muted by the downward pressure of CAT property. For the full year, wholesale delivered strong organic growth of 9.1% and we have good momentum heading into 2025. Now I'll turn it over to Andy to get into more details regarding our financial results."
},
{
"speaker": "Andy Watts",
"content": "Great. Thank you, Powell. Good morning, everyone. I'll review our financial results in additional detail. When we refer to EBITDAC, EBITDAC margin, income before income taxes or diluted net income per share, we're referring to those measures on an adjusted basis. The reconciliations of our GAAP to non-GAAP financial measures can be found either in the appendix of this presentation or in the press release we issued yesterday. We're over on Slide number 8. We delivered total revenues of $1.184 billion growing 15.4% as compared to the fourth quarter of 2023. Income before income taxes increased by 27.2% and EBITDAC grew by 22.6%. Our EBITDAC margin was 32.9%, expanding by 190 basis points over the fourth quarter of the prior year. Our effective tax rate for the quarter increased slightly to 24.7% versus 24.1% in the fourth quarter of the prior year. Diluted net income per share increased 24.6% to $0.86. Our weighted average shares outstanding increased slightly compared to last year as we continue to prioritize paying down our floating rate debt. Lastly, our dividends paid per share increased by 15.4% as compared to the fourth quarter of 2023. Overall, it was a very strong quarter. We’re on Slide number 9. The Retail segment grew total revenues by 9.5%, with organic growth of 4.4%. The difference between total revenues and organic revenue was driven substantially by acquisition activity over the past year and higher contingent commissions. EBITDAC margin expanded by 100 basis points to 27.8%, driven by higher contingent commissions, finalization of full year performance incentives, and leveraging of our expense base. This growth was partially offset by higher non-cash stock-based compensation. We're over on Slide number 10. Programs had an excellent quarter with total revenues increasing 28.7% and organic growth of 38.6%. Keep in mind that a portion of this growth was associated with the $19 million charge recorded in 2023 for the change in reinsurance related to one of our captives. Growth in total revenues benefited from higher contingent commissions, but was lower than organic due to net disposition activity in the prior year. Our EBITDAC margin expanded by 660 basis points to 47.9%, primarily driven by leveraging our expense base and to a lesser extent, the sale of certain businesses in the fourth quarter of 2023. As we discussed in our third quarter earnings call, we anticipated recording $12 million to $15 million of flood claims processing revenue in the fourth quarter associated with Hurricanes Helene and Milton. As a result of faster than anticipated adjudication and increased average severity, we recorded approximately $28 million. With increased visibility into the timing of adjudicating claims and severity, we now anticipate recognizing revenues of approximately $14 million to $18 million in the first half of 2025, with the majority being recorded in the first quarter of this year. We’re on Slide number 11. Our Wholesale Brokerage segment had another good quarter with total revenues increasing 11.6% and organic growth of 7.1%. The incremental expansion in total revenues in excess of organic was driven substantially by higher contingent commissions. Our EBITDAC margin decreased by 140 basis points to 25.7% due to the finalization of full year performance incentives along with certain one-time cost. We're over on Slide number 12. This slide presents our results for both years. Our EBITDAC grew by 17% with the margin increasing 130 basis points to 35.2% with net income before income taxes growing 19.6% and net income per share was $3.84 growing by 18.2%. These compare to total revenue growth of 12.9%. Overall, we are extremely pleased with the results for 2024. We have a few other comments regarding our capital structure, cash generation, and outlook. From a cash perspective, we generated $1.174 billion of cash flow from operations, growing 16.2% over the prior year. Our full year ratio of cash flow from operations as a percentage of total revenues remained strong at 24.4%. As a reminder, we have also deferred the payment of approximately $90 million of federal income taxes for the third and fourth quarters of 2024 related to the IRS tax relief associated with the 2024 hurricanes. These taxes are due to be paid in the second quarter of 2025. During the quarter, we also drew down $250 million on our revolving credit facility in connection with the closing of the Quintes acquisition. For the full year, we continue to delever and finish 2024 in a conservative position as our gross debt to EBITDA ratio is in line with our 10 year average. We have a few comments regarding outlook for 2025. As it relates to contingent commissions, based on what we know now, we anticipate contingents for the full year of 2025 will be down slightly compared to 2024. The unknown variables are the potential impact of the California wildfires and the outcome of the 2025 Atlantic hurricane season. For the Retail division, we have two items. The first relates to the phasing of revenues between quarters. Based on the forecasted timing of net new business, organic revenue growth for the first quarter is anticipated to be approximately 100 basis points lower than the organic growth for the other three quarters. The second item relates to our recent acquisition of Quintes and the phasing of its revenues and profit. In the Netherlands, a substantial number of policies are placed in the first quarter of the year. As a result, we will record approximately 60% of Quintes’ annual revenues in the first quarter with the remaining revenues recognized fairly evenly over the following three quarters. From a margin perspective, this will improve Q1 margins and will unfavorably impact the margins in the other quarters. From a full year perspective, we anticipate revenue and EBITDAC to be within the ranges outlined during our August 2024 call. As it pertains to taxes, we expect our effective tax rate to be relatively consistent with 2024 and should be in the range of 24% to 25%. Based on the current outlook regarding interest rate cuts in 2025, we anticipate interest expense to be in the range of $170 million to $180 million for the full year. In regard to interest income, we anticipate this to be in the range of $65 million to $70 million, given recent reductions in the benchmark rate in certain territories. Finally, taking into consideration that net income and contingents will more than likely be down in 2025. We're expecting our adjusted EBITDAC margins for 2025 to be relatively flat. With that, let me turn it back over to Powell for closing comments."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Andy. Great report. From an economic standpoint, we expect the economies in which we operate to continue to be stable and grow at levels similar to the second half of ‘24. We believe this is a good backdrop for companies to grow and invest at moderate levels. From a U.S. perspective, the main topics that most business leaders are watching include policy changes from the new presidential administration, the outcomes of potential tariffs, the timing and trajectory of interest rates, inflation and finally, geopolitical matters. Depending on the outcome of each, it will influence the pace and intensity of investments in business growth. For insurance pricing, we'll provide our thoughts on rates for the first half of 2025 as too many things can change during the year. Specifically, timely extinguishment of the California wildfires will be critical, and we're hopeful there will not be another large -- there will not be other large wildfires as the estimated losses are significant. Then depending on the magnitude of insured losses, there could be impacts on California pricing for both admitted and non-admitted property. Subject to this outcome, we anticipate rates for admitted lines to be relatively similar or maybe moderate downward slightly versus their pricing in the second half of 2024 across the country. There will be similar outliers that we talked about earlier. For the E&S markets, the discussion will really be split between CAT property and all other lines. We expect rates for casualty and professional liability should be similar to what they were in the second half of '24. CAT property, we expect there will be additional downward pressure in rates as compared to pricing in the fourth quarter. Based on what we're seeing, early indications in Q1 would lead us to believe that property rates could be down more than 20% based on construction quality and loss experience. On the M&A front, we feel good as we have a robust pipeline both domestically and internationally and are building relationships with lots of good companies. As a result of some of the larger transactions last year, we're starting to see a moderation in multiples in the larger PE backed businesses. From our perspective, we finished the year in a strong cash and balance sheet position and have access to capital to deploy for companies that fit culturally and make sense financially. We're looking forward to another successful year in 2025. Our businesses are performing well as we're leveraging our collective capabilities to win more new business and help our existing customers achieve better results. Our market position is great, as we will continue to leverage our solution selling model to win and retain more customers across our three segments. With that, I'll turn it back over to Michelle to open for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our first question is from Gregory Peters with Raymond James. Your line is now open."
},
{
"speaker": "Gregory Peters",
"content": "Thank you, and good morning, everyone. In your comments, you spoke about net new business and the success you had last year. I was wondering, if you could and certainly, you're seeing it in retail and programs. I was wondering, if you could give us some perspective on to some of the drivers there? And how your outlook is for ‘25 on net new business and how it compares with the industry? And maybe inside that, sort of, map out for us what California might do, or how that might affect new business for you in next year?"
},
{
"speaker": "Powell Brown",
"content": "All right. Good morning, Greg. A couple of things that I would just say broadly across the business in ‘24. We wrote more new business than we ever have in all three of our divisions. So we're really pleased with that, number one. Number two, we anticipate our ability to continue to do that because of the capabilities that we have and we've invested in both built and purchased. And we are working really well together, as you know, as a collaborative company to leverage the capabilities to the benefit of all of our customers. As it relates to California, and I think that's a whole kettle of fish onto itself, I think there's a lot of variables there. And so number one, the impact to the fare plan and in the event, the losses are in excess of all monies accessible both surplus and reinsurance, how do the assessments work? That's a big question. Number two, the number of admitted carriers in the state today doing business and the number of non-admitted carriers will be impacted probably by the actions on a go-forward basis. And so the Governor and the Insurance Commissioner there are dealing with a difficult scenario where they're trying to provide an acceptable market, so availability of product with competitive pricing of that product. And so, at a very high level, I would tell you that we believe that there is, it would seem to us that it would be a massive expansion in the E&S market in that area. Having said that, many people not in our industry don't fully understand the impact of demand surge and the need for quality contractors to rebuild. And I can't stress the importance of those two things because that drives pricing and the ability to respond, that is independent of any regulatory or permitting actions."
},
{
"speaker": "Andy Watts",
"content": "Gregory, are you still there?"
},
{
"speaker": "Operator",
"content": "Yes. I'm sorry."
},
{
"speaker": "Powell Brown",
"content": "Go ahead, Michelle."
},
{
"speaker": "Operator",
"content": "Our next question comes from Robert Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"content": "Hey, thanks for taking my question. Yeah. Curious just to maybe start-off with Retail. Last quarter, I think you all mentioned that the run rate going into the fourth quarter was about 5%. Is that still the run rate as we think about heading into next year or into 1Q '25? And could you sort of size the impact to the retail organic this quarter from the non-recurring item?"
},
{
"speaker": "Andy Watts",
"content": "Good morning, Rob. It's Andy here. On the comment that we made in our prepared remarks regarding kind of timing is, as you know, we've got a number of businesses that we can have comparables by quarters, timing when kind of things come in. Some of our employee benefits businesses as well as bonds businesses such as those. Those can move around by quarters and then there's always just kind of timing of net new business. We think that probably impacted the organic by 40 basis points to 60 basis points in the quarter. We'll see that. That will just come back over the coming quarters. It can move around by quarters, but nothing that gave us any underlying pause in there. But we feel really good about momentum heading into 2025 and just how well the business is collaborating and winning the net new business as Powell talked about earlier."
},
{
"speaker": "Robert Cox",
"content": "Okay. Thank you. And just on my follow-up, for the Program segment, seems like a lot of moving pieces. I was just hoping you could talk about sort of the sustainability of the underlying organic growth in that segment into 2025. And also, what does a normal run rate year of contingent commissions look like in programs?"
},
{
"speaker": "Powell Brown",
"content": "Do you want to answer the contingent?"
},
{
"speaker": "Andy Watts",
"content": "Yeah, Rob. Let me take contingents first on it is, we've had a really good year as well as fourth quarter on contingents in the Programs businesses, as well as -- obviously, across all of our segments. I think the one that had downward pressure during the year was in Retail, primarily in personal lines. But I think as we head into 2025, we know we had some adjustments to calculations this year related to finalization of the contingents on 2023. And so, we think at least going into next year that we'll have probably some downward pressure on contingents in that space. And I think the other area is just kind of exactly how the losses play out in California and how that may impact a couple of our programs. It's hard to tell right now."
},
{
"speaker": "Powell Brown",
"content": "So Robert, on your other question, if you think about two of the components of the growth in programs this quarter, you had the increase -- well, you had the total flood revenue and you had the $19 million reinsurance component. And so, if you think about in our program space, a lot of growth in the last several years has been driven from wind and quake, and some of our other larger programs. And in those particular areas today, we're starting to see more rate pressure. And so that does not mean we don't think we can grow. I'm not trying to give you that impression, but I think that you're seeing not only in programs, but kind of across the industry kind of a moderating of growth rates. And so, we don't give guidance, as you know, on organic growth in that area. But what I would say is, we feel really good about our programs business. Part of that is really driven by the results we delivered for our carrier partners and their willingness to work with us in adjusting prices downward to remain competitive in the marketplace. It's not easy, but we feel good about ‘25 and beyond for programs."
},
{
"speaker": "Andy Watts",
"content": "And then Rob, also keep in mind our captive, right? And we write a specific amount of premium inside of there, and we're kind of hitting that, we'll call it, that run rate now. So we won't see that same amount of lift going into ‘25 as we've seen over kind of ‘23 and ‘24. It's performing very well, but we capitate that in order to limit the exposure."
},
{
"speaker": "Robert Cox",
"content": "Thanks for all the color."
},
{
"speaker": "Powell Brown",
"content": "Yeah. Thanks."
},
{
"speaker": "Operator",
"content": "And our next question will come from Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi. Thanks. My first question is on Retail. So it sounds like with some of the timing stuff, it gets you right closer to the 5, which was the adjusted Q3 number as well. Andy, I know you pointed out, right, Q1, 1% better than the other three quarters of the year. And I know you guys typically don't want to give forward guidance on that segment. But can you just help us think about triangulating that 5, maybe even just to the Q1 given this 1% headwind, that you're pointing to is the right way to think that it's 5 less 1 just given the noise we saw in the back half of 2024?"
},
{
"speaker": "Powell Brown",
"content": "I'd like to answer that, Elyse. So I know this frustrates you, but at the end of the day, we've said that our retail business is a low to mid-single digit organic growth business. So we're not going to give you the number. But whatever the number is that you think, as you said, we've articulated that we foresee a 100 bp headwind in Q1. That does not impact our overall outlook for the year. We just are giving you that guidance relative to Q1."
},
{
"speaker": "Andy Watts",
"content": "So Elyse, the easiest way to think that whatever number you have on it, so if it's a 4, 5, 6, whatever your number is, you want to keep your full year number correct or keep it in line with where you are, just adjust down the first quarter and then push up to the second, third and fourth, okay?"
},
{
"speaker": "Elyse Greenspan",
"content": "And then with the margin guide, right, obviously, programs, right, there's some headwind, right, from, you obviously had greater flood related revenue in ‘24 than you expect in ‘25. So I'm assuming that could be a margin headwind in that segment depending upon organic. Do the other segments, I guess, feel clean from just thinking about organic relative to margin expectations? And then one just random one, the corporate segment had like $11 million of negative EBITDA in the quarter. I just wasn't sure what was flowing through there?"
},
{
"speaker": "Andy Watts",
"content": "Okay. So I think the color that we gave on full year guidance, Elyse, was on total company. We don't break it down by the individual segments. And you're right, and I think two areas that we think will represent headwinds will be investment income and contingents. Depending upon what happens with storm claim activity this year, we do have the storm claim revenues in the first quarter for -- primarily first quarter and some over into the second quarter for last year. We think at least with the headwinds that we know about on the contingents and investment income that the remainder of the business should perform pretty well next year. Again, there's always moving parts back and forth, that should get total company relatively flat on adjusted EBITDAC margins."
},
{
"speaker": "Elyse Greenspan",
"content": "And then just the corporate in the Q4?"
},
{
"speaker": "Andy Watts",
"content": "We just had some one-off costs in there in the fourth quarter, nothing real unusual in nature. So those can always kind of move around by quarters and by years, but nothing unusual."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. Thank you."
},
{
"speaker": "Andy Watts",
"content": "Yeah. Thank you."
},
{
"speaker": "Operator",
"content": "And the next question will come from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"content": "Hi. First one I had for you is just to see if you could expand on some of the commentary provided on the M&A environment. Just looking at what some of your peers have done, it seems like maybe the environment is more ripe for larger scale M&A of some of these private equity-backed companies that have gotten maybe too big for the private markets. Are you seeing more of those types of opportunities? And any way we could think about your appetite in terms of how big it you would go?"
},
{
"speaker": "Powell Brown",
"content": "So good morning, Alex. So as you know, we talk mostly about cultural fit, first and foremost and then would it make sense financially. What's occurring in the market not only last year, but this year and what we anticipate in years to come is exactly what we thought for some time. Two plus years ago, we started and I started talking about internally the potential for great consolidation in our industry in the next three to five to seven years. And what you've seen is, you're seeing parts of that. The firms that were acquired last year were -- the larger ones were all private equity backed. And there are other private equity-backed firms out there that are seeking to buy other large private equity backed firms. There are other strategics that are thinking about or looking to buy the right firm. What we would tell you is, we look at every individual opportunity on its own merits. And so what we have done, and we're very proud of, is that, we have been very conservative financially and paid down our debt when we make larger acquisitions to prepare us to make an investment of pretty much any size business that we might want to buy. It doesn't mean we're going to buy anything big or -- but we want the ability to do it, if we find the right one. And so we feel really good about our positioning not only from the core business that we have and the opportunity to do very good acquisitions on a stand-alone basis. And if a larger acquisition came along that fit culturally and made sense financially, we'd absolutely look at it. But we feel really good about the business and where we're going. And the most important thing is, we want to have, which we do, the ability to invest, how we want to invest, when we want to invest in our business."
},
{
"speaker": "Alex Scott",
"content": "That's really helpful. Thanks. Next one I had is, just on lender-placed. I wanted to get a sense for, is that business operate more in sort of the Southeast Florida or do you have exposure to California? I'm just trying to understand where we are in sort of the cycle of non-renewals and how that may impact lender-placed. I think Florida maybe were hopefully getting closer to the end of a challenging environment where there were a lot of non-renewals. But in California, it seems. like, we're probably going into one, right? So I'm just trying to understand tailwinds and tougher cost and that sort of thing."
},
{
"speaker": "Powell Brown",
"content": "We'll make it simple, Alex, the entire United States."
},
{
"speaker": "Alex Scott",
"content": "That's clear. All right."
},
{
"speaker": "Powell Brown",
"content": "I'm not trying to be funny. I'm just telling you we have exposure everywhere."
},
{
"speaker": "Alex Scott",
"content": "Understood. That is what I wanted to get at, so thank you."
},
{
"speaker": "Powell Brown",
"content": "Yeah."
},
{
"speaker": "Operator",
"content": "And our next question will come from Mark Hughes with Truist Securities. Your line is open."
},
{
"speaker": "Mark Hughes",
"content": "Yeah. Thank you. Good morning."
},
{
"speaker": "Powell Brown",
"content": "Good morning."
},
{
"speaker": "Mark Hughes",
"content": "Andy, I want to just make sure I'm thinking about the $19 million change to reinsurance items. Are we to think the impact on organic growth is the fact that you didn't have that item this year is a $19 million good guide to organic, and that's the way to calculate it."
},
{
"speaker": "Andy Watts",
"content": "Yeah. I think that would be fine, Mark. I mean remember, we -- last year in the fourth quarter, so this fourth quarter of '23, right? We took that adjustment for the change in the treatment, so that was a negative impact to our organic in fourth quarter of last year. And now we're on a comparative basis. So it's not like you're going to see next year that it's a difficult comp that's already in there. So we'll be comparable to comparable Q4 '24 to Q4 '25."
},
{
"speaker": "Mark Hughes",
"content": "Understood. Then Powell, you had mentioned, I guess, in Florida, you've got the -- lot more experience with the need for quality contractors to rebuild. Do you have any observations about the supply of quality contractors in California?"
},
{
"speaker": "Powell Brown",
"content": "Well, this would be purely speculative, Mark. But the answer is, based on the magnitude of the losses, there cannot humanly possible be enough contractors. I'm not trying to be funny, but I'm just saying the demand will be so massive. And one of the things that I've been told, please don't quote me on this, but is that getting a permit to build a home can take up to 1.5 years. So I believe that the Governor and the rest of the elected officials there will need to do something that will be more thoughtful in terms of expediting the rebuild. So think of something on a much larger scale, which would allow them to expedite construction. So let me lead you down the path of something like the Marshall plan."
},
{
"speaker": "Mark Hughes",
"content": "Very good. Thank you."
},
{
"speaker": "Operator",
"content": "And our next question will come from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Charles Lederer",
"content": "Hey, thanks. This is Charlie (ph) on for Mike. Maybe just going back to the flattish margin expectations. Can you just provide some color on what the drivers of margin expansion, ex-contingents and ex-flood revenue since that will likely be lower. Is it more operating expense or comp and bend (ph)? And is it just operating leverage driving that or is there anything more you can touch on? Thanks."
},
{
"speaker": "Andy Watts",
"content": "Yeah. Hey. Good morning, Charlie. It's really around operating leverage. Again, remember, we run hundreds of businesses across the platform. So we're always looking to try to make sure we grow profitably. But also, we invest in our businesses at different times. So it's not like each one of them grows the exact same percentage and delivers the exact same profit. There's a lot of move parts inside the organization. So we're just trying to kind of make it relatively simple for the outside world as to how we see all the moving parts. And we'll get some benefits of investments we made in previous years, and we'll make some more investments in the current year in different areas."
},
{
"speaker": "Charles Lederer",
"content": "Got it. Thank you. And then I guess for my follow-up, we've seen some data showing relatively significant deep population out of citizens into the private market in Florida. Do you guys, is that materially expecting or impacting your guidance? Or do you see that having an impact just based on the different commission structures there?"
},
{
"speaker": "Powell Brown",
"content": "No."
},
{
"speaker": "Charles Lederer",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "And the next question will come from Dean Criscitiello with KBW. Your line is open."
},
{
"speaker": "Dean Criscitiello",
"content": "Hi. I was wondering, if the decelerating pricing in property implies less customer shopping or in other words, are you seeing less property accounts migrate for the wholesale markets."
},
{
"speaker": "Powell Brown",
"content": "Absolutely not. So let me just, Dean, explain the dynamics there in an extreme example, but a real one. Dean, you are an owner of cold storage warehouses in Florida, their $50 million total insured values, and you have one in Miami, you have one in Naples. You have one in Tampa and you got one in Jacksonville. And for the last five years or more, but for the last five years, your insurance premium has gone up every year and in some instances substantially. And so you are -- you're not feeling so good about insurance, unfortunately. And so one of two things happens, you want to make sure that your broker is doing the right thing and either we will bring you what the market will bear. And in this case, the market will bear typically downward pressure on rates. But I would tell you that any way a property owner or manager can save money, particularly in light of five years of upward pressure they are looking to try to capture that because they're a little bit kind of, it's like a really -- they're just worn out with it. And so -- and I believe that people understand that at an intellectual level, but I don't think people understand it at an emotional level. And so having said that, everybody is different, but I'm just saying there is a lot in there. And so we write a lot of business that way. And we have to face competition in many instances, that way. We have to earn the respect and trust of our customers every day. But please, Dean, don't think that, that this is an ultra-competitive market where there is angst and there is more emotion around that buying decision than you can imagine."
},
{
"speaker": "Dean Criscitiello",
"content": "Got it. Yes. That makes sense. Sort of staying on the topic of submissions, but moving to casualty, sort of, given that trajectory of like rate increases there. Like, can you to just talk about the impact that's having on casualty line submission growth into the wholesale line?"
},
{
"speaker": "Powell Brown",
"content": "Depends on what lines that you're talking about. Here's what I would say. There is still a net inflow into the E&S market today in aggregate, okay? So there are more accounts flowing in today than there have been. And we think that, that in the near to intermediate term will continue to occur. That said, the -- when we say casualty, casualty could be automobile, that's an admitted line up. And we continue to see rate increases Dean, on automobile on a regular and recurring basis. So I know -- I think what you're trying to do is trying to figure out is it going into wholesale versus the retail or both or whatever the case may be, the answer is, we're seeing more submissions into wholesale than we have. So increasing submissions, increasing written business in the non-admitted market, and that is exacerbated by events, some of which you read about and some maybe you don't read about, but it's areas that people become more and more uncomfortable with that could be hypothetically convective storms in places like Oklahoma and Nebraska and Kansas and things where they might have been in the admitted property market for a long-time and/or the admitted property market wants massive deductibles or it goes into the E&S market. So I know that I'm talking property, but the same concept applies with casualty. So -- but the wholesale market continues to expand."
},
{
"speaker": "Andy Watts",
"content": "And Dean we talked about this on a couple of calls. The thing to keep in mind, you always have to look about how the buyer thinks about it. While they are focused on rate online, what they're really focused on is their premium. And they're trying to figure out how to balance the premium because ultimately, they got to cut a check for that amount. And so they're trying to figure out what's the right balance with their retention that they want to keep through deductibles, etc. What limits do they want to buy. They're going to move or other exclusions, etc., they're going to move all of that around in order to figure out the premium. So you're not going to see that if rates go up 5% or down 5%, there's going to be a direct correlation in our commissions or potentially even direct correlation into the premium that the customer pays, okay?"
},
{
"speaker": "Dean Criscitiello",
"content": "Okay. Thank you."
},
{
"speaker": "Andy Watts",
"content": "Okay."
},
{
"speaker": "Operator",
"content": "And our next question comes from Scott Heleniak with RBC Capital Markets. Your line is open."
},
{
"speaker": "Scott Heleniak",
"content": "All right. Yeah. Good morning. Just wondering if you could talk about some of the organic hiring you've done in 2024 and the past few years, kind of, how that's stacked up? Anything you can share on that and has that been a big driver behind the organic growth? Just curious what's going on behind the scenes there in terms of that part outside of M&A?"
},
{
"speaker": "Powell Brown",
"content": "So it's Scott, we don't discuss in detail how we hire teammates. However, I would tell you that we have been actively hiring for the last several years and through COVID in that regard. And that's teammates in all positions, service teammates, marketing teammates, production teammates, claims adjusting teammates, all types of teammates. And so, we look at it as we want the best athletes on the team. And so we're -- it's the best athlete routine. We hire people from other industries that have made very, very successful transitions into our industry. We hire people with insurance background that could be carrier background or from other firms, and we obviously get a lot of very talented people through our acquisitions. But yes, we're very pleased with the acquisition, I mean, the hiring of new teammates that we've made in addition to the acquisitions we made last year."
},
{
"speaker": "Scott Heleniak",
"content": "Okay. That's helpful. And then, just on the captive business. I know you guys had guided to last quarter, $5 million to $10 million of claims cost. What did that come in for the quarter? Was it within that range or how -- what was the -- do you have that number?"
},
{
"speaker": "Andy Watts",
"content": "Yeah, it was in that range."
},
{
"speaker": "Scott Heleniak",
"content": "Okay. And then, I guess, the only question just on the captives was just to clarify. So you're saying you still see growth for 2025 and cap’s just not at the same rate as before. Was that the comment that you had made before?"
},
{
"speaker": "Andy Watts",
"content": "Correct. Yes. Because remember, we will -- we write a target amount of premium in there. Again, there's more complexity behind, but that will -- we're just about at a run rate there."
},
{
"speaker": "Scott Heleniak",
"content": "Yeah. Okay. Thanks."
},
{
"speaker": "Operator",
"content": "And the next question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Charles Lederer",
"content": "Hey, thanks. Just one quick follow-up. Just curious, sorry if I missed it, where the -- if you can touch on where the contingents kind of landed for Helene and Milton, if there are any adjustments in the quarter or adjustments you expect in the first quarter on that?"
},
{
"speaker": "Andy Watts",
"content": "Okay. Hi, Mike. Charlie, that’s right. We got Charlie, you’re stepping in there for Mike. We had some adjustments back in the third quarter for Helene and then, we had some adjustments in the fourth quarter for Milton. Nothing significant that we called out. And ultimately, we've got to see how loss development plays out there and what that might mean for '25. And I think that's why we just have a little bit of cautionary outlook on those as well as what happens in California."
},
{
"speaker": "Charles Lederer",
"content": "Thanks, guys."
},
{
"speaker": "Andy Watts",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "This does conclude the Q&A session. I would now like to turn it back over to Powell Brown for closing remarks."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Michelle. I wanted to thank everybody for your time today. We are really pleased with the performance of our business last year and equally excited about 2025. There are a lot of cool things going on at Brown & Brown, as you can tell. And I've said this before, but I am pumped on our performance last year and equally feel the same way about 2025 and beyond. Hope you all have a nice day, and we look forward to talking to you next quarter. Bye."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
bro | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Brown & Brown Inc. Third Quarter Earnings Call. Today's call is being recorded. Please note that certain information discussed during this call, including information contained in the slide presentation posted in connection with this call, and including answers given in response to your questions may relate to future results and events or otherwise be forward-looking in nature. Such statements reflects our current views with respect to future events, including those relating to the company's anticipated financial results for the third quarter, and are intended to fall within the Safe Harbor provisions of the securities laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated, or desired, or referenced in any forward-looking statements made as a result of a number of factors. Such factors include the company's determination as it finalizes its financial results for the third quarter that its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday, other factors that the company may not have currently identified or quantified and those risks and uncertainties identified from time to time in the company's reports filed with the Securities and Exchange Commission. Additional discussion of these and other factors affecting the company's business and prospects, as well as, additional information regarding forward-looking statements is contained in the slide presentation posted in connection with this call, and in the company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, there are certain non-GAAP financial measures used in this conference call. A reconciliation of non-GAAP financial measures to the most comparable GAAP financial measure can be found in the company's earnings press release or in the investor presentation for this call on the company's website at www.bbinsurance.com by clicking on the Investor Relations and then Calendar of Events. With that said, I’ll now turn the call over to Powell Brown, President and Chief Executive Officer. You may begin."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Kevin. Good morning, everybody, and welcome to our Q3 earnings call. First, we'd like to state that our hearts go out to all those impacted by Hurricanes Helene and Milton. These back-to-back storms were unprecedented in many ways and resulted in significant death and destruction throughout the Southeastern United States. We're committed to helping communities impacted by these events recovery and return to normalcy over the coming weeks, months, and years. With that, let’s transition to our performance for the quarter. We had an outstanding top and bottom-line results. Our team continues to deliver for our customers resulting in strong net new business, organic growth and margin expansion. I'll provide some high level comments regarding our performance, along with the updates on the insurance market and the M&A landscape. Andy will then discuss our financial performance in more detail. And lastly, I'll wrap up with some closing thoughts before we go to Q&A. Now, let's discuss our results. I'm on Slide 4. We delivered nearly $1.2 billion of revenue, growing 11% in total and 9.5% organically over the third quarter of 2023. Our EBITDAC margin improved by 30 basis points to $34.9 million and our adjusted earnings share grew 12.3% to $0.91. On the M&A front, we completed four acquisitions with estimated annual revenues of $8 million. Overall, it was another great quarter, as our team is focused on delivering the best solutions for our customers and strong results. I'm on Slide number 5. In the countries where we primarily operate, there were no major changes in the economic conditions versus the first half of this year. Consumers are still spending and driving demand. As a result, businesses are continuing to hire and invest albeit at a more moderate pace as compared to the last few years. Here in the US, we are seeing a bit more caution due to the uncertainty around the Presidential Election. From insurance pricing standpoint, rates for many lines continue to increase, but at a slightly slower pace, versus what we experienced in the first half of this year and the third quarter of last year. The line that had the largest change for the quarter was E&A property, which we'll talk about in more detail in just a moment. Pricing for employee benefits was similar to prior quarters with Medical and primary costs trends up 7% and 9%, for commission-based accounts. The continual upward rate pressure and the complexity of healthcare are driving strong demand for our employee benefits consulting businesses. Based on historical and ongoing investments to expand our capabilities, we are well-positioned to help companies of any size navigate this challenging market. Rates in the admitted P&C markets were up 2% to 7% for most lines. Downward trend for workers compensation remained, but there was moderation as we realize decreases of down 1% to 5% in most states. With the high level of employment, we expect this range to continue over the coming quarters. For the third quarter, rate increases for non-CAT property moderated and were in the range of flat to up 5. For properties in convective storm zones, we did not see the same rate increases that we experienced in the first half of the year. For Casualty, we continue to see rate increases for primary layers due to ongoing size of legal judgments in the US and to a lesser extent, higher levels of inflation. Consistent with the last few quarters, rate for excess casualty continue to increase between 1% and 10% or even more in some instances, professional liability we saw rates flat to up 5, Shifting to the E&S markets, as you know, this, this year some carriers and facilities have been willing to put up incremental limits on existing insureds and new business. While CAT property rates continue to increase slightly in the first quarter of this year, we started to see decreases later in the second quarter and into the third quarter. On average, rates decreased between 10% and 20%, as compared to the third quarter of last year. As a result, some customers increased their limits or modified adjustables and some just captured the savings. As we mentioned, before, moderate rate increases or decreases for one line of business will generally not have a material impact on the results of our company in total. In order to deliver consistently strong and industry-leading financial performance, we focus on diversification across lines of coverage, geography, industry and customer segments. On the M&A front, competition for high-quality businesses remained consistent with the first half of the year. While the number of acquisitions by private equity backers decreased as interest rates rose, we are now starting to see a higher levels of activity, as interest rates are beginning to decrease. For the quarter, we continue to build relationships with many companies and remain focused on our disciplined M&A approach to notify great organizations which align culturally and make sense financially. I am on Slide. Let’s transition to the performance of our three segments. Retail delivered 3.9% organic growth for the quarter with most lines of business performing well. We had another strong quarter for net new business, but realized the impact of moderating rates for most lines, as well as slightly lower growth in exposure units. In addition, our organic growth was negatively impacted by over a 100 BPS, resulting from the year-to-date true-up of certain incentive commissions as well as, quarterly volatility in bond or non-recurring revenue. Our team is performing really well and has good momentum going into Q4. Programs delivered an outstanding results with organic growth of 22.8%. This growth was driven by a number of programs resulting from new business and expansion of existing customers. Our lender-placed business and captives performed very well, and our CAT programs continue to grow. It was another great quarter due to the diversity of our programs, also brokerage delivered another good quarter with organic revenue growth of 8.4%. This performance was driven by a combination of net new business and rate increases. Our Open Brokerage business continue to grow nicely but at a slower pace due to the decline in CAT property rates. Our Delegated Authority business performed well again this quarter. Personal lines grew nicely driven by California and Texas. We're very pleased that our balanced mix between brokerage and Delegated Authority continues to drive strong and stable performance. Now, I will turn it over to Andy to get into more results – our financial results."
},
{
"speaker": "Andy Watts",
"content": "Thank you, Powell. Good morning, everyone. I'm going to review our financial results and some additional detail. When we refer to EBITDAC, EBITDAC margin income before income taxes or diluted net income per share, we are referring to those measures on an adjusted basis. The reconciliation of our GAAP to non-GAAP financial measures can be found either in the appendix of this presentation on the press release we issued yesterday. We are over on Slide number 7. We delivered total revenues of $1,186 million growing 11% as compared to the third quarter of 2023. Income before income taxes increased by 13.1%, and EBITDAC grew by 11.9%. Our EBITDAC margin was 34.9%, expanding by 30 basis points over the third quarter of the prior year. Effective tax rate for the quarter decreased to 24.6% versus the third quarter of the prior year, which was 25.6%. The decrease was driven primarily by certain one-time items in the prior year and the impact of changes in the market value of our company-owned life insurance. Diluted net income per share increased to $0.91 or 12.3%. Our weighted average shares outstanding increased slightly, as compared to last year as we continued to prioritize hanging down our floating rate debt. Our dividends paid per share, increased by 13%, as compared to the third quarter of 2023. Last week, our Board of Directors approved a 15% increase to our projected dividend payment for the fourth quarter of 2024. This represents our 31st consecutive annual increase. Overall, we are very pleased with our performance for the quarter and the strong results our team delivered. We are over on Slide number 8. The Retail segment grew total revenues by 6.5% with organic growth at 3.9%. The difference between total revenues and organic revenue was driven substantially by acquisition activity over the past year. EBITDAC decreased due to lower contingent and incentive commissions, higher non-cash stock-based compensation, as well as investments in teammates to drive and support our current and future growth. We are on Slide number 9. Programs had another excellent quarter with total revenues increasing 15.7% and organic growth of 22.8%. Our organic growth was benefited by approximately $15 million associated with onboarding of new customers within our lender-placed business. This revenue will be recognized more evenly throughout 2025. Growth in total revenues was lower than organic due to net acquisition and disposition activity, as well as lower contingent commissions. Our EBITDAC margin expanded by 360 basis points to 48.2%, driven by leveraging of our expense base and the sale of certain claims administration, and adjusting services businesses in the fourth quarter of 2023. While drawing the impact of the hurricanes, there is still lot of unknowns primarily associated with Hurricane Milton. Our best estimate is that we anticipate recording flood claims processing revenue associated with the recent hurricanes of approximately $12 million to $15 million in the fourth quarter and an $18 million to $22 million in the first half of 2025 with the majority of that revenue being recorded in the first quarter. As of now, we're anticipating claims cost of $5 million to $10 million within our captives associated with Hurricane Milton. We're over on to Slide number 10. Our Wholesale Brokerage segment delivered another great quarter with total revenues increasing 14% and organic growth of 8.4%. The incremental expansion in total revenues and excess of organic was driven by acquisitions completed over the last 12 months and higher contingent commissions associated with finalizing the estimates recorded in the prior year. Our EBITDAC margin increased by 130 basis points to 38.6%, primarily due to higher contingent commissions and leveraging our expense base. We have a few comments regarding our capital structure, cash generation and outlook. In the third quarter, we paid off $500 million of our Inaugural 10-year bonds with the proceeds from our issuance completed in the second quarter of this year. With our continued deleveraging, our balance sheet is in a great position as our gross debt-to-EBITDA ratio on a trailing 12 month basis is in line with our 10 year average. For the first nine months of this year, we had strong cash generation of over $810 million, increasing our ratio of cash flow from operations as a percentage of revenue to 22.4%. As it pertains to full year cash generation, we feel really good. We want to highlight that there is US Federal Tax relief associated with the recent hurricanes. As a result, payments for the third, and fourth quarters of this year are permissible to be deferred into the second quarter of next year. Therefore our full year ratio of cash flow from operations as a percentage of total revenue for 2024 should be in the range of 24% to 26%. Based on our strong year-to-date performance and taking into consideration the potential impacts from Hurricanes Helene and Milton, we anticipate our full year EBITDAC margin will be up at least 100 basis points for 2024 as compared to 2023. With that, let me turn it back over to Powell for closing comments."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Andy and a great report. From an economic standpoint, we do not anticipate material changes from what we experienced in the first nine months of this year. The biggest questions that seemed to be on the minds of business leaders here in the States, which may impact their level of investment or the outcome of the US Presidential Election, geopolitical matters and the timing and magnitude of future interest rate reductions and inflation. From an admitted lines rate perspective, we anticipate rates in the fourth quarter and early ’25 to be relatively similar or moderate downward slightly versus the third quarter of this year. For the E&S market, Casualty and Professional Liability should be similar with what we’ve experienced during the third quarter of 2024. For CAT property, it will come down to ultimate paid losses associated with Helene and Milton. We anticipate rate decreases from flat to down 10% going into the fourth quarter. On the M&A front, we continue to feel good about our pipeline both domestically and internationally. We're always building relationships with a lot of companies and we have a strong capital position. We will continue our disciplined approach as it's worked very well to help us acquire great companies and enhance our capabilities and drive profitable growth. Lastly, we're excited to have the Qantas team join Brown & Brown anticipate a closing in the fourth quarter. As we head into the fourth quarter, our team continues to be well-positioned and is leveraging the power of - we to win more net new business. We have great momentum across the company and feel good about our prospects for the fourth quarter and finishing the year strong. With that, we'll turn it back over to Kevin and open it up for Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Gregory Peters with Raymond James. Your line is open."
},
{
"speaker": "Gregory Peters",
"content": "Well, good morning, everyone. I guess the instructions said I should strongly ask one question. So, I guess I'm going to focus my only question on the Retail segment. Powell and Andy ran through some variables that affected the organic in the third quarter. I'm wondering if you could provide some more detail on that. And if there's any read through we should be thinking about as we look forward?"
},
{
"speaker": "Powell Brown",
"content": "Greg, good morning and we appreciate your one question. Actually we're not going to break it down into specific details. But what I would say is as we said in the organic growth, there is really incentives, the incentive commissions that are down and we talked a little bit about non-recurring one-time revenue that didn’t occur like bonds and other related matters. So, from a standpoint of – we feel good about our Retail business. I think that's the important thing. I do not believe that one quarter creates a trend. And so, I think you should take from that what you want. But we feel really good about our Retail business."
},
{
"speaker": "Andy Watts",
"content": "And then, Greg, the other thing just, I guess for everybody else, keep in mind, remember we've said in the past that normally our business will grow faster – the Retail business will grow faster in the first half of the year than the second half of the year. Last year it was a little bit different just because of timing of some bonds and some surety work inside – if you look kind of back historically, it normally grows faster in the first half than second primarily due to the amount of Employment Benefits business that is recorded in the first quarter."
},
{
"speaker": "Gregory Peters",
"content": "Got it. Thanks for the answer."
},
{
"speaker": "Powell Brown",
"content": "Great. Thanks, Greg."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Rob Cox with Goldman Sachs. Your line is open."
},
{
"speaker": "Rob Cox",
"content": "Hey, thanks. Appreciate the flat to down 10 guide for Property CAT rates. I was just curious if the products mix in wholesale is built to sustain nice growth in that type of environment? Or are we going to start seeing that show up a little bit more in the organic?"
},
{
"speaker": "Powell Brown",
"content": "All right, so, good morning, Rob and let me make one other clarifying comment on what I said. I believe that there is a great interest by the risk bearers particularly domestically to hold rates more closer to flat. Having said that, there are new participants. There are other markets, specifically, London, which is very aggressive and that's going to put additional pressure on that. So, having said that, interestingly enough, our Q3 is not an inordinately heavy property quarter. The property is typically in Q1 and Q2 out of hurricane seasons. So, again, it depends on the mix, but we have quite balanced brokerage and binding authority businesses and what we're talking about is in brokerage not necessarily in binding. So, what I would say is, anytime you have rate decreases it can, but from a standpoint of we're going to see what kind of discipline the markets will it’s here to in Q4. And what I'm about to say is purely speculative. Remember, prior to the storms, we were seeing down 20% and 30%. And so, we don't anticipate that but anything is possible. I think it’s a much higher probability is zero to 10."
},
{
"speaker": "Rob Cox",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. My question is going back to the Retail segment. So I guess, that incentive comp, it sounds like a supplemental commission, which I think you guys started leaving inorganic but like a couple years ago, so I just want to confirm that. And then given that the one-off with the 100 basis points, I know you guys don't typically like to guide, but how you did say right one quarter doesn't make a trend. Is the right way to think about it that some growth of around 5% is kind of like the baseline for the Q4 and beyond?"
},
{
"speaker": "Powell Brown",
"content": "Andy, do you want to take that?"
},
{
"speaker": "Andy Watts",
"content": "Yeah. So let me hit the first one, because that's pretty easy. Yeah, so, on the so GSCs, so the Guaranteed Supplement Commissions and then incentive commissions are in out of organic growth. And as you know those can move up and down by quarters just like the contingent commissions can adjust themselves inside of their. As you know, we don't give guidance for organic growth for the business. But I think as we look into, at least the fourth quarter is we would at least think that, one , we feel really good about our business and the net performance and how we're bringing in new business. One of us going to come down to what happens to rates and then exposure units for the economy. So, unless something goes unusual there, we would expect those two would be fairly similar to the third quarter."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. Our next question comes from Yaron Kinar with Jefferies. Your line is open."
},
{
"speaker": "Yaron Kinar",
"content": "Thank you. Good morning, everybody. So, my question is in the Programs business. So I think you sold a portion of the Captives to a third-party and that's how coming back into consolidated through a non-controlling to NCI? Could you maybe walk us through the impacts to the Programs segment itself where that NCI in the Programs business, namely what would the adjusted margin be? And what the organic growth be for that segment?"
},
{
"speaker": "Powell Brown",
"content": "Well, morning Yaron. It has no impact on the organic growth or the margins. Remember, the non-controlling interest is only on a pre-tax basis allocation over. So we record all the growth up above and then back up minority interest below."
},
{
"speaker": "Yaron Kinar",
"content": "Right, so my question would be what would the impact to the segment B, had we adjusted that NCI at the segment level?"
},
{
"speaker": "Powell Brown",
"content": "I guess, I would say, it’s going to be relevant because the kind of rule don't allow you to do it anyway. We're following what the rules are. You have to bring it in on a gross basis."
},
{
"speaker": "Yaron Kinar",
"content": "Okay. Thank you."
},
{
"speaker": "Powell Brown",
"content": "Yeah."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Michael Zaremski",
"content": "Morning. Hey, I guess for my one question. I want to focus on the Program segment, its growth has been exceptional for years now in the segment. And I think, you gave some color to that, maybe this quarter’s outsized growth was coming from catastrophe programs. But maybe just curious, is there, when we think of like the wholesale marketplace, we think about that marketplace over a long period of time typically growing a bit faster than the standard market due to some underlying kind of secular factors. Just curious in your Programs business, is there anything structural or secular you think this is just – should grow at a multiple of the standard markets over time?"
},
{
"speaker": "Powell Brown",
"content": "All right. So, good morning, Mike. So let's think about that most of our Programs, many, I shouldn't say most are admitted, okay? So, think of that as an extension of the Specialty admitted market as opposed to the traditional wholesale or non-admitted market. I think that's an important distinction upfront. That’s number one. Number two, I believe there will continue to be interest an emphasis on the Programs business going forward, depending on what you read and what you believe the Programs space is somewhere between $85 billion and 100 billion of premium in the United States. And so, we do continue to see that growing nicely into the future. And there are a number of very talented underwriters that want to join us either from a risk-bearer or sometimes from other Programs, because there is a dynamic environment here where we have fostered great relationships with our carrier partners. And remember, we are underwriting on behalf of, we are, as we understand it, the largest delegated underwriting authority entity in the United States. And so, they place - carriers place enormous authority in our hands, of which we take very seriously. So, is the growth going to continue in the 20% range, that that's over a long period of time that’s quite high, all right? Let's call it what it is. But what I would say is we believe that the Program space is a very nice, consistent grower over a long period of time and our results would indicate as such. And it's interesting because, and I know this isn't the case with you Mike, but there are some people out there that really don't, I don't think fully understand or give us credit for the others than retail part of our business, which is 40% of revenue, and as you know, it is performing very nicely. So, if you want to look at it on a slightly different perspective, and I know, you’ve already thought about this. But if you look at the performance of Wholesale and Programs together, that 40% grew at 17.7% in Q3. Pretty impressive."
},
{
"speaker": "Michael Zaremski",
"content": "I mean, I do think people when they look at, Programs and Wholesale if we look at arriving is a comp. But can I – since I fixed my one question, but a follow-up on your answer on the same topic. Would it be a fair assumption to say that underwriters that come to Brown> Or just a broker-owned Programs business can be compensated more highly than what a carrier can pay given valuation dynamics?"
},
{
"speaker": "Powell Brown",
"content": "Do you mean through the individual?"
},
{
"speaker": "Michael Zaremski",
"content": "Correct, correct."
},
{
"speaker": "Powell Brown",
"content": "The compensation. Well, I think the compensation is typically different because it can be cash, base plus a bonus in many instances, plus equity. So, generally it's, I think that as a broad statement you could probably say, yes."
},
{
"speaker": "Michael Zaremski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Mark Hughes with Truist Securities. Your line is open."
},
{
"speaker": "Mark Hughes",
"content": "Yeah, thanks. Good morning."
},
{
"speaker": "Powell Brown",
"content": "Morning"
},
{
"speaker": "Mark Hughes",
"content": "Andy, you had mentioned that you generated $15 million in revenue from onboarding new customers in Programs and that would be spread more evenly throughout 2025. Was any of that $15 million non-recurring and can you give us a sense of when you say, spread more evenly are there any kind of bumps or tough comps as we think about 2025 in that lender-placed business?"
},
{
"speaker": "Andy Watts",
"content": "Yeah, good morning, Mark. So, how that works is when we pick up a new account or we have a customer that buys a portfolio, normally, there is a lag of anywhere from 90 to 180 days from the previous servicer of actually sending out notifications and next so what happens is you generally will get two to three quarters of revenue in kind of the first quarter that we onboard them. Then when it comes around to renewal or the exit date, then that revenue will fall according and that's really what we're saying is next year in the third quarter, we would not anticipate seeing that $15 million. But that will be spread out during ’25 with most of it in kind of the first half of the year. Does that help kind of explain how that works?"
},
{
"speaker": "Mark Hughes",
"content": "Ii does, yeah. The second half of my one question is, anything on the advocacy business, if you’ve seen the first security administration be a little more active on adjudicating claims?"
},
{
"speaker": "Andy Watts",
"content": "No, everything is pretty similar to what we’ve been seeing over the last few years. We’ve got good inflow into our business, but only so much comes out of the back of the funnel."
},
{
"speaker": "Mark Hughes",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"content": "Hi, I wanted to ask you to provide more color on the M&A pipeline in particular the comments around interest rates beginning to come down and more interest from private equity players? Could you talk about the potential size of those opportunities and where you're focused on growing inorganically?"
},
{
"speaker": "Powell Brown",
"content": "Sure. So, as it relates to the first part of the comment, as interest rates - prior to interest rates going up, there were typically lots of private equity firms that expressed interest. And obviously, they think of it in a little different manner in terms of the way they account for it. And look at those investments. Then, that - and so there might have been ten firms that were involved initially just as an example. And then, as the interest rates ticked up, that number being involved, might have slowed to three firms. These are very hypothetical situations. And then, today there might be six or seven firms. So, what I'm trying to give you in a sense of is that, as interest rates go down, there are more interested parties that are short-term in nature in terms of the way they view it, i.e. private equity. As it relates to us, we continue to look both here domestically, which we think there are some very good opportunities for us here in the future. And in the international market that we currently operate in and as evidenced by the fact that we anticipate closing Qantas in The Netherlands this quarter, that’s another market that we are excited about participating in on a go-forward basis. So there is not one over another. We stress the importance of cultural fit. We think about capabilities, we think about either enhancing existing capabilities, adding new capabilities or maybe new geography as long as it's consistent with the core, which is one, we want it to fit culturally and make sense financially. And two, we like to operate in countries that we understand their governments. There is typically a rule of law. There is generally a stable economy and we are very pleased with the environments that we are currently operating in."
},
{
"speaker": "Alex Scott",
"content": "Got it. Thanks for the clarification on the private equity piece."
},
{
"speaker": "Powell Brown",
"content": "Sure. Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"content": "Great. Thanks so much., I just want to go back to the lender-placed insurance in Programs. Should we think that $15 million I think you said that there was a 92 to 120 day lag. So is the $15 million the equivalent of like three quarters of revenue or is that a full year? And did that impact margins in the segment?"
},
{
"speaker": "Powell Brown",
"content": "So let's see. The - it is - it represents over about six months of revenue or just a little bit more on that Meyer. Again, primarily in the first half of 2025. Some of it will reach into the fourth quarter as it kind of comes around just normal lag in processing and over from the previous processor. And then, from a full year margin no, it doesn't impact full year margins. It's just between the quarters."
},
{
"speaker": "Meyer Shields",
"content": "Okay, perfect. Thank you so much."
},
{
"speaker": "Powell Brown",
"content": "Yeah, no. Thanks."
},
{
"speaker": "Operator",
"content": "One moment for our next question. The next question comes from Grace Carter with Bank of America. Your line is open."
},
{
"speaker": "Grace Carter",
"content": "Hi, everyone. Good morning. Just you mentioned some pressure on contingents in the Retail from higher loss ratio to carrier partners. I think that this is the second quarter in a row that we've seen that. Could you elaborate on which lines caused the pressure in 3Q? And how those compares to 2Q? And just kind of any thoughts on whether do you think that this will be an issue that recurs moving forward for the next few quarters?"
},
{
"speaker": "Powell Brown",
"content": "Good morning, Grace. Yeah, we've been talking about this over, probably the last few quarters, at least. We saw this starting, back in in ’23. It's primarily on auto side, both on personal, as well as on commercial. I think as you know well carriers have been pushing for rate in that space, just because of frequency and severity of the claims that are out there, which is putting pressure on overall profitability. And that’s so that's the main driver. I guess, we would say right now, we don't see anything in the marketplace yet that is changing that trend at this stage. So, we would continue to expect some pressure on those."
},
{
"speaker": "Grace Carter",
"content": "Thank you."
},
{
"speaker": "Powell Brown",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. The next question comes from Scott Heleniak with RBC Capital Markets. Your line is open."
},
{
"speaker": "Scott Heleniak",
"content": "Yeah. Thanks. Good morning. Just wondering if you could expand on the Employee Benefits business I know you gave some commentary on that. It sounds like you're seeing some positive trends on healthcare. So just wondering if you can just talk about the trends in Q3 versus the first half and just the opportunity for 2025 just organically and through M&A, and what you're seeing in that business?"
},
{
"speaker": "Powell Brown",
"content": "So Scott, what I would say is, remember, in the last - I'm taking you back a little while, but in the last 10 years, we have consciously invested in additional capabilities, which has enabled us as an organization to basically handle any size customer and employee benefits. And so, what that means is, we can write a startup and if they grow one day to a 100,000 employees, we can actually handle them at 100,000 employees. And so, remember, our core business is middle market and upper middle market and the capabilities that we bring to the table we see lots of opportunities today and in the future and are very excited about the growth opportunities for us. And so, it's something that healthcare every CFO wants to talk about their cost of healthcare. And there are lots of things that we are able to bring to our customers and prospects that will enable them to think differently and potentially realize different and in some instances outsized positive performance versus what they have been experiencing. So, we are actively looking for additional firms to join the team. But even in light of if we did not do an acquisition with employee benefits capabilities in them in the next 12 months, I don’t think that in any way shape or form changes our opinion on existing business and employee benefits. Andy and I and the entire operating team are very, very pleased and quite honestly, very excited about our ability to write and service customers of all sizes."
},
{
"speaker": "Scott Heleniak",
"content": "Great. Appreciate the detail."
},
{
"speaker": "Powell Brown",
"content": "Yep."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"content": "Yeah, thank you. Just a quick one for me. Do you anticipate any impact on contingent commissions from Milton and Helene in the fourth quarter?"
},
{
"speaker": "Powell Brown",
"content": "Hi, good morning, Brian. I think still kind of to be determined. In our earlier comments we said there's still a lot of moving parts on Milton. We did have some adjustments in the third quarter for Helene not dissimilar to what we're back in ‘22 with Ian. We take the extent that we can based on what we know what that at the time. So would it - would we expect some adjustments in the fourth quarter? Yeah, that probably will occur. Now, again, keep in mind that we had - we did have adjustments positively in Q4 of last year because of low claim activity. So and that's primarily in the Program space. So you will see probably some meaningful year-over-year change in there. I don't know the magnitude of it right now, just we need some claims development to occur."
},
{
"speaker": "Andy Watts",
"content": "Hey, Brian. I'd like to just point out two things that might not be as immediately comes to mind. Number one, we saw and had continued to see a lot of auto losses in the storms, particularly Helene, but Milton, as well. So you’ve got a car in a garage and flood waters come up and the car dies. Okay, so it doesn't work anymore and I'm not even talking about electric vehicles, I am just saying that. That’s number one. Number two, depending on where you are, there is a very, very distinct correlation between structures, commercial and residential, that are built after 2005 and the amount of loss. So, there are new codes, as that were put in place quite honestly, if you go back 1992 with Hurricane Andrew, and then every couple years, it seems that they kind of up them. But if you talk to people in the market about losses on properties, those losses are typically on structures that are, - they're in the ‘90s and the ‘80s and the ‘70s and the’60s, beginning to older homes, in the ‘30s and the ‘40s, they're not, the ones having losses. They're actually very, solid structures. But it's that kind of middle stuff where the building codes may be weren't as stringent. So just a little aside, just to kind of give you a little color around your question. Thank you.."
},
{
"speaker": "Brian Meredith",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from Gregory Peters with Raymond James. Your line is open."
},
{
"speaker": "Gregory Peters",
"content": "Okay. I get my follow-up question. In your commentary on free cash flow, you talked about some deferred tax payments that will help the free cash flow result for ‘24. Should we anticipate that because you're going to have additional tax payments from ’24 and ’25 on top of just the ’25, the conversion rate on the ’25 free cash flow will be lower?"
},
{
"speaker": "Powell Brown",
"content": "Yes, Greg. That would be correct. And as of right now, the rules by the IRS is those need to be paid in the second quarter. So, when you're working out your projections, and you can get a pretty good idea of our taxes later on somewhere between $90 million and $100 million per quarter in there. So just make sure you put those in the second quarter. So that'll pull down our conversion for ‘25 is why we made the comment that we raised the conversion ratio for ’24 up because of that deferral."
},
{
"speaker": "Gregory Peters",
"content": "And the conversion rate for ‘24 is raised from to, can you just remind me?"
},
{
"speaker": "Powell Brown",
"content": "Yeah, we said ‘22 to ‘24, previously. So this will take it up by a percentage point. But when we look at the business and if you recall a while back, when we were talking about conversion ratio and we talked about 2025 is, we said we saw kind of a very clear path back to the ‘24 to ‘26 range. That was prior to this storm coming through. But when we look at the overall business itself, and how we're growing the business, the margins that we generate and our free cash flow conversion, we feel really, really good about the business and the trajectory it's just you have this timing of items back and forth sometimes between years. But underlying business continues to be very, very strong."
},
{
"speaker": "Gregory Peters",
"content": "Great. Thanks for answering the question."
},
{
"speaker": "Powell Brown",
"content": "Yeah, thanks."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. My follow-up is actually on investment income. That went up by a good amount in the quarter. Andy, what drove that? And then, is that level, like as rates move, how should we think about, I guess the level of NII that you're expecting in the Q4 and going forward?"
},
{
"speaker": "Andy Watts",
"content": "So one thing to keep in mind, remember the $600 million of bonds that we issued back in the second quarter, so, we were holding that money until we had paid off the September bonds. So that drove somewhere an incremental $6 million to $7 million dollars of interest income for the quarter. So, don't use the $31 million or so that we had in the quarter as a runrate. It'll definitely come back down in the second quarter. And then – or excuse me, in the fourth quarter for us."
},
{
"speaker": "Powell Brown",
"content": "I’d like to clarify something at least I would like to clarify something you asked earlier. And you are correct in saying that we do not give organic growth guidance, as you know. However, what we said was, you would ask about a number in Q4 and what Andy. And I were implying or trying to say was if you look at the performance in Q3, and you note the adjustments that we made, we believe that that is a good starting place for Q4. I wanted to make sure that was clear for you, does that make sense?"
},
{
"speaker": "Elyse Greenspan",
"content": "Yeah, so the 3.9 plus the 100 basis points, so around 5 is the Q4 starting point for Retail."
},
{
"speaker": "Powell Brown",
"content": "I was going to allow you to do the math and we don't give guidance, but I Just wanted to clarify."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay, got it. Thank you. Powell."
},
{
"speaker": "Andy Watts",
"content": "And then, hey Elyse, just kind of rounding out on the net investment income, because that is also important we talk about kind of the other side of that. And you can kind of get a feel for in modeling with rates drop by 1% an idea as to what it could mean on the net investment income. Now again, keep in mind that as we continue to grow as an organization, there is more fiduciary cash. So you're not going to see it on an exact ratio if you do that, right if you got to assume that fiduciary assets will continue to grow, but then also keep in mind on the other side of that is our floating rate debt. So as an organization, we build our capital structure to have somewhere around 25% of our debt to be floating rate been extremely, extremely beneficial for creating shareholder value over many years. And so when we, at the end of 9/30 we had just under $800 million on floating rate debt. So just make sure you grab down the other side of the equation if you're doing your ups and downs on interest, okay?"
},
{
"speaker": "Elyse Greenspan",
"content": "Okay, thank you both."
},
{
"speaker": "Powell Brown",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. The next question comes from Mark Hughes with Truist Securities. Your line is open."
},
{
"speaker": "Mark Hughes",
"content": "Yeah, thank you. You mentioned margin impact from the investment in Teammates, given that the M&A market has been, at least in Q3, your activity was a little bit lower. Is that a deliberate plan to spend more money on Teammates or was that more opportunistic?"
},
{
"speaker": "Powell Brown",
"content": "I look at it as more opportunistic, Mark. And the reason I say that is, is when we find the right people, we're going to invest in them. And so, that's why I always try to say that one quarter or does it make a trend? And when we make those investments, we fully anticipate that we will grow into those investments in the coming quarters and years ahead. And so, if it were something very significant in terms of a number, we would call it out and talk to you about it. But, from this standpoint, we - this is what I call normal opportunistic investing. Like we're not going to be some drama and say we got some programming. It's not like that. We're always looking for good people. We believe that culturally, we will attract a certain group of people that would like to work for a competitive, collaborative, high performing sales and service organization. But there's not something, there is not some secret initiative going on. That I want to give you that impression."
},
{
"speaker": "Mark Hughes",
"content": "Yeah, I appreciate that. Thank you."
},
{
"speaker": "Powell Brown",
"content": "Thank you.."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our last question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Michael Zaremski",
"content": "Hey. Great. Just a follow-up on kind of a teasing out what you all are seeing or projecting on the Casualty side in terms of pricing power trends? I know that, I think last quarter, you all is maybe many other stuff pricing would move up a bit. Has that changed at all? And I don't know if you want to bifurcate between E&S or admitted versus non-admitted? Thanks."
},
{
"speaker": "Powell Brown",
"content": "Sure. All right. So Mike, number one, if you remember, in the past, I have sort of said in my career, which is only back to 1990 in the insurance business. There’s always been an underlying tone that Casualty has been underpriced, but I don’t think that there has been a discipline around pricing it by the carriers. Today, that seems to be different. So there seems to be a discipline around that. And so, I believe it’s both in the primary in the excess, I believe it’s also in admitted and non-admitted. So it’s not something that we are bifurcating that you are seeing more so in one versus the other that’s not the case. And so, I think that we are going to continue to see rate pressure on Casualty. So, general liability, excess liability, and as Andy said earlier, in automobile, both commercial and personal auto. For the time being, I don't see that changing, depending on the carrier they are going to tell you different trends they're seeing in their books. But yes, there continues to be pressure on all of those segments."
},
{
"speaker": "Michael Zaremski",
"content": "Helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this does conclude the Q&A portion of today's call. I’d like to turn the conference back over to Powell for any closing remarks."
},
{
"speaker": "Powell Brown",
"content": "Sure, thanks, Kevin. We really appreciate everybody's time today. We are very pleased with the performance in Q3. We are excited about Q4, ending the year strong and going into 2025. You all have a wonderful day. Thank you for your time."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this does concludes today’s presentation, you may now disconnect and have a wonderful day."
}
] |
bro | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Brown & Brown Inc. Second Quarter Earnings Call. Today's call is being recorded. Please note that certain information discussed during this call, including information contained in the slide presentation posted in connection with this call, and including answers given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature. Such statements reflect our current views with respect to future events, including those relating to the company's anticipated financial results for the second quarter, and are intended to fall within the Safe Harbor provisions of the securities laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated, or desired, or referenced in any forward-looking statements made as a result of a number of factors. Such factors include the company's determination as it finalizes its financial results for the second quarter that its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday, other factors that the company may not have currently identified or quantified and those risks and uncertainties identified from time to time in the company's reports filed with the Securities and Exchange Commission. Additional discussion of these and other factors affecting the company's business and prospects, as well as, additional information regarding forward-looking statements is contained in the slide presentation posted in connection with this call, and in the company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, there are certain non-GAAP financial measures used in this conference call. A reconciliation of any non-GAAP financial measures to the most comparable GAAP financial measure can be found in the company's earnings press release or in the investor presentation for this call on the company's website at www.bbinsurance.com by clicking on the Investor Relations and then Calendar of Events. With that said, I will now turn the call over to Powell Brown, President and Chief Executive Officer. You may begin."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Shannon. Good morning, everyone, and welcome to our earnings call. The second quarter was another outstanding one for Brown & Brown. Our team continued to deliver strong net-new business across all segments by leveraging our collective capabilities or as we say, the Power of WE. I'll provide some high-level comments regarding our performance along with updates on the insurance market and the M&A landscape. Andy will then discuss our financial performance in more detail. Lastly, I'll wrap up with some closing thoughts before we open it up to Q&A. Now let's get into the results for the quarter. I'm on Slide 4. We delivered nearly $1.2 billion of revenue, growing 12.5% in total and 10% organically over the second quarter of 2023. This is now our third quarter of double-digit organic growth out of the last six quarters. Our adjusted EBITDAC margin improved 150 basis points to 35.7% and our adjusted earnings per share grew 17.7% to $0.93. On the M&A front, we completed 10 acquisitions with estimated annual revenues of $13 million. Overall, it was another great quarter of strong top and bottom line growth. I'm now on Slide 5. From an economic standpoint, inflation remained elevated but did moderate during the quarter. Consumers continue to spend, driving demand for products and services. However, we continue to see a bifurcation in spending patterns based on income levels of the consumer. In addition, business leaders are making investments in their companies and new construction projects are starting now that interest rates seem to have plateaued. As a result, many of our customers continue to hire employees, but at a slower pace as compared to 12 to 24 months ago. From an insurance pricing standpoint, the overall changes in rates for most lines were relatively consistent, with the last few quarters and - with the exception of the E&S property market. Pricing for employee benefits was similar to prior quarters with medical and pharmacy costs up 7% to 9%. These ongoing upward pressures and the complexity of healthcare are driving strong demand for our employee benefits consulting businesses. We believe we're very well positioned to help companies of any size navigate this very challenging landscape. Rates in the admitted P&C market continue to be up 5% to 10% for most lines. The downward trend for workers' compensation rates remained with decreases of 5% to 10% in most states. With a low level of unemployment, we expect this trend to continue. For the quarter, rate increases for non-CAT property moderated. We continue to see upward pressure on rates and deductibles for properties located in convective storm zones. As we mentioned last quarter, rate increases for primary casualty layers remain elevated due to the ongoing size of legal judgments in the U.S. and to a lesser extent, higher levels of inflation. For professional liability, we saw rates flat-to-down 10%. Shifting to the E&S market, CAT property rates moderated throughout the quarter as compared to the first quarter of this year and the second quarter of last year. This is not surprising to us as we expected CAT property rate to further moderate until the effects of the storm season are known. In Q1, we placed properties with rates down 10, to maybe up 10. And it was relatively balanced. This shifted in the second quarter where many renewals were flat-to-down and generally only lost prone or poor construction accounts realized rate increases. This continued to be driven by some carriers or facilities willing to put up additional limits combined with some new capital entering the marketplace. We saw some customers increase their limits based on their savings, while others captured the savings as a partial offset to the increases they've absorbed over the past few years. While CAT property rates moderated during the quarter, the rates for primary and excess casualty continued to increase between 1% and 10% with our highly diversified business, moderate rate increases or decreases for one line of business will generally not have a material impact on our consolidated results. That's why we focus on diversification across lines of coverage, geography, industry, and customer segment as these drive our consistently strong and industry-leading financial performance. Lastly, the M&A marketplace remained competitive for high-quality businesses. While the number of acquisitions by private equity backers has decreased, they are still active. For the quarter, we acquired 10 great businesses and continued to build relationships with many other companies. I'm now on Slide 6. Let's transition to the performance of our three segments. Retail delivered another great quarter with organic growth of 7.3%, with all lines of business performing well as a result of winning a lot of new customers along with good retention. Insurers are frustrated and exhausted with the level of rate increases over the last few years, which is driving many companies to shop their coverage. Most of the time this plays to our advantage and has been demonstrated by the growth of our net-new business. This strong and consistent performance is a reflection of our talented team and the breadth of our capabilities. The program segment had another outstanding quarter delivering organic growth of 15.4%. This growth is driven substantially by new business and the expansion of existing customers across many of our programs. The strong performance in the majority of our diverse portfolio of businesses continue to drive impressive growth. Wholesale brokerage delivered another strong quarter with organic revenue growth of 11%. This performance was primarily driven by riding more net-new business within our binding and personalized businesses. Our open brokerage business performed well, but did not grow at the pace of the last several quarters due to rate decreases in property. As we've mentioned before, we have strategically built our wholesale business to be well-balanced between brokerage and binding authority as this diversification helps us deliver consistently strong financial performance. Now I'll turn it over to Andy to get into more details with our financial results."
},
{
"speaker": "Andy Watts",
"content": "Thank you, Powell. Good morning, everyone. We're over on Slide 7. I'll review our financial results in additional detail. When we refer to EBITDAC, EBITDAC margin, income before income taxes or diluted net income per share, we are referring to those measures on an adjusted basis. The reconciliations of our GAAP to non-GAAP financial measures can be found either in the appendix of this presentation or in the press release we issued yesterday. We delivered total revenues of $1,178 million, growing 12.5% as compared to the second quarter in the prior year. Income before income taxes increased by 20% and EBITDAC grew by 17.3%. Our EBITDAC margin was 35.7%, expanding by an impressive 150 basis points over the second quarter of 2023. The effective tax rate for the quarter was consistent with the prior year and diluted net income per share increased by 17.7% to $0.93. Our weighted-average shares outstanding increased slightly as compared to the last year, as we continue to prioritize paying down our floating rate debt. Lastly, our dividends per share paid increased by 13% as compared to the second quarter of last year. Overall, it was a very strong quarter. We're moving over to Slide 8. The retail segment grew total revenues 9.3% with organic growth of 7.3%. The difference between total revenues and organic revenue was driven by acquisition activity over the past year, with a partial offset due to lower contingent commissions of approximately $7 million in the second quarter of this year. EBITDAC grew slightly slower than total revenues, due to lower contingent commissions and to a lesser extent, higher non-cash stock-based compensation. Excluding the impact of lower contingent commissions, the margins expanded nicely due to the leveraging of our expense base. We're on Slide 9. Programs had another strong quarter with total revenues increasing 15.8%, organic growth of 15.4%. Organic growth was positively impacted by approximately $5 million due to the finalization of a non-recurring growth bonus for one of our programs. The incremental growth in total revenues in excess of organic was driven primarily by increased contingent commissions, which resulted from our strong underwriting performance and a quiet hurricane season in 2023. For the quarter, we also recognized approximately $3 million related to the finalization of a contingent commission calculation for 2023. Our EBITDAC margin expanded by 220 basis points to 49.6%, driven by higher contingents and the leveraging of our expense base as well as the sale of certain claims processing businesses in the fourth quarter of 2023. We're over on Slide 10. Our wholesale brokerage segment delivered another great quarter with total revenues increasing 14.4% and organic growth of 11%. The incremental expansion in total revenues in excess of organic was driven by acquisitions completed over the last 12 months. Our EBITDAC margin increased by 240 basis points to 33.3%, primarily due to certain non-recurring costs in the prior year and leveraging our expense base. We've got a few other comments regarding our capital structure, cash generation, and outlook. In the second quarter, we issued $600 million of 10 year senior notes in preparation for the $500 million of notes that will mature in September of this year. We had excellent execution and the market responded well to our credit profile, and longer-term bias towards lower leverage. These new senior notes have a coupon rate of 5.65%. The remaining proceeds of $100 million were used to pay down a portion of an outstanding floating-rate term loan. Additionally, we paid down over $260 million of floating rate debt in the quarter. For the first six months of this year, we had strong cash generation of over $370 million, even when taking into consideration the previously mentioned timing of paying federal taxes in the first quarter of this year related to 2023. Lastly, regarding margins for the full year, we had previously provided guidance indicating that we expected margins to be up slightly for the full year. With our strong financial performance for the first half of the year, we are now expecting 50 to 100 basis of adjusted EBITDAC margin improvement for 2024. This guidance is dependent on the outcome of storm season and as a result, this range may adjust up or down. With that, let me turn it back over to Powell for closing comments."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Andy, for a great report. Let's start with the economy. Based on everything we're seeing, we think the economy will continue to grow in the second half of the year at the rate that is fairly similar to the first half. Additionally, we think inflation will further moderate as the year progresses and our customers will continue to invest and hire new employees. Overall, we see this environment as a positive backdrop to our growth. From a rate perspective, it's worth splitting the conversation into admitted and E&S markets. For the admitted markets, we do not anticipate material changes from the first half of the year. The outliers will continue to be auto, work comp, casualty, any really, really large premium accounts, things like that. But for the E&S market, we expect continued pricing pressure or moderation in CAT property rates unless there is meaningful storm activity this summer. Casualty pricing will more than likely continue to move higher. On the M&A front, we feel good. We're talking with lots of companies. Our pipeline continues to be robust and we're in a strong capital position. For Brown & Brown, our historical success has been rooted in our disciplined approach to building relationships, ensuring cultural alignment, and then delivering strong financial returns. I am very pleased at how our team is executing. We've spent significant effort to build great capabilities and develop an outstanding team. I'm also very proud that we developed the capabilities to serve customers of all sizes, both domestically and internationally. It's the Power of WE that is enabling us to win more net-new business. We're excited about the second half of the year and delivering another year of industry-leading financial metrics. Now with that, I'll turn it back over to Shannon to open it up for Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Mark Hughes with Truist Securities. Your line is now open."
},
{
"speaker": "Mark Hughes",
"content": "Yes, thank you. Good morning."
},
{
"speaker": "Powell Brown",
"content": "Good morning."
},
{
"speaker": "Mark Hughes",
"content": "Any way you could break out the impact of property on organic growth this quarter? These issues of pricing as well as capacity and then policyholder retention, a lot of moving parts. And I'm just sort of curious how property played out from your perspective."
},
{
"speaker": "Powell Brown",
"content": "So good morning, Mark. And unfortunately, the answer is no. We don't do that, but I will give you a color around what you're talking about, and I appreciate your goal to get us to open up on that. But the way we look at it is this. Property in Q2 was under pressure, particularly as we got towards the 7/1 date. And so pretty much, I'm not going to say all, but most accounts were seeing rate decreases except if you had really bad losses and even poor construction, we're getting some rate decreases. But - so if you've got a lot of losses, it might be flat or it might be up a little bit. So what I would tell you is this. This, what we're seeing today, is not surprising to us. We thought or at least I can say I thought, and I think Andy and I agree on this, we thought this was going to happen last year. And so there was - last year was again another tough rate year for customers. And so the rates in property are some of the highest they've been and forever. And so people like the return payoffs or the projected return payoffs. So they're coming in. And so depending on what the storm season does, that will dictate on what continues to happen in pricing in Q3 and beyond."
},
{
"speaker": "Andy Watts",
"content": "Hi, Mark, good morning. It's Andy here. One of the things we mentioned during our prepared comments was just the impact of diversification and we just suggest, think about our comment there, because property is pretty balanced in our overall book. And again, the second quarter is larger for the CAT property placements that's out there. But we've got more than just CAT property inside of our book from customer sizes, locations, industries, et cetera. So it's pretty balanced. And even, again, as we mentioned in the comments, if it goes up or down a little bit by an individual line, quite often there's something else that might be moving the other direction inside there."
},
{
"speaker": "Mark Hughes",
"content": "Understood. And, Powell, you said casualty pricing you expect to continue to move higher. Is there anything you're seeing in the marketplace? There have been some reserve issues, anything that suggests real meaningful distress across the industry and therefore a change in underwriting approach or is this more of a continuation of the prior trend gradual move higher?"
},
{
"speaker": "Powell Brown",
"content": "Well, I don't think there's one thing, Mark, to point to that says this is what triggered it to go up more. But let me just make a couple observations. Number one, the ability to get significant limits on an umbrella from one carrier is it's very low. So you might have gotten $25 million from a carrier before and now you might get $5 million. So you got to build up if you wanted $25 million with several carriers to get there. That's number one. Number two, please note, there are certain classes of business that are tougher than others. So if you ask me, which you haven't, what are two or three really tough classes of business from a casualty standpoint, I would point to habitational, so apartments. Two, I'd put anything with lots of liquor distribution, not distribution, but consumption. So like a restaurant that 70% of its revenue is alcohol or a nightclub. And habitation - residential construction. Those would be three areas that continue to be under - but that does not mean that all casualty is not under pressure. A products manufacturer might be up 10%, 8%, 7%, 5%, whatever the case may be, but you may have a hab account that's up multiples of that. So it depends on where you are in the country, the class of business, a lot of stuff. And so I do think that what you're hearing from the carriers and from other brokers is coming through, which is, there continues to be seemingly more discipline around pricing pressure on casualty more so than any time in my career."
},
{
"speaker": "Mark Hughes",
"content": "Very good. Thank you."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Mark."
},
{
"speaker": "Andy Watts",
"content": "Thanks, Mark."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Michael Zaremski with BMO. Your line is now open."
},
{
"speaker": "Michael Zaremski",
"content": "Hi, great. Good morning."
},
{
"speaker": "Powell Brown",
"content": "Good morning."
},
{
"speaker": "Michael Zaremski",
"content": "I guess three quarters double-digit last six, it's pretty impressive, but it kind of does make a trend. So I guess just along the lines of the marketplace discussion we've had so far. If there's upwards pressure on levels of casualty, which are material, I would assume, within your portfolio and then you gave us good color on property might decel if depending on CAT season. But is there anything else you want to call out that's kind of just unusual in the very near-term that's really driving your excellent organic versus kind of the marketplace? And then you also mentioned that there's more shopping, so maybe more new business wins, which might not be sustainable. Anything else you want to call out that we should be thinking about the back of our heads about that just might not be sustainable in the near-term?"
},
{
"speaker": "Powell Brown",
"content": "Well, I don't know about - I'm not going to say it is or is not. We feel good about the amount of new business that we're writing and the net-new how that translates through into our business. I think the only other thing which is kind of the counter to that and you didn't mention this, but I do believe in pockets of the country on larger accounts in the admitted market, there is pressure. And so that could be very dependent what's happening in the Pacific Northwest in the United States might be very different than in the Southeast or in the Northeast or the Midwest. So I just think, Mike, remember, we're not a sexy business. We just execute well. And we try to deliver for our customers each and every day and we have a good rhythm. We are talking with lots of people and when buyers of insurance, there is a fatigue level that's out there. So if you've got an increase for five years on your condo or your whatever auto fleet or whatever the case may be, sometimes you just say, listen, I need to talk to somebody else and more times than not, hopefully, that means we're in the mix and we're able to write a lot of new business as a result of that. That can work against you too. I mean, I'm not trying to say we're immune to that. We're not. But we just feel good about what - there's nothing, like there's no secret other than we think our culture is different. We talk a lot about it. We have teammates, we don't have employees. We have leaders, we don't have managers. And we have an ownership culture as you know. And when 22% of the company is owned by teammates, we run the business differently. So we don't think quarter-to-quarter, we think one year, three years, five years, 10 years out, and it has served us really well. And so we're just executing really well."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. Just obviously clearly great results, just seeing if I can get any other color. Now I guess lastly, I'm looking at the transcript. I think you said you're seeing more rate decline in open brokerage versus binding authority within the wholesale segment, if I understood that correctly. And if I am right, any further color there that's worth sharing?"
},
{
"speaker": "Powell Brown",
"content": "Yes, remember, and let's just use open brokerage for a minute. Think of that as property. So we already talked about property. Casualty has got upward pressure and professional liabilities got downward pressure. So two of the three in there have - that doesn't mean you can't grow, it just means that the benefits of a tailwind have shifted in two of the three to a headwind."
},
{
"speaker": "Andy Watts",
"content": "And then, Mike, keep in perspective that generally the second quarter is one of the heavier ones for property."
},
{
"speaker": "Powell Brown",
"content": "Yes."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. Thank you very much."
},
{
"speaker": "Andy Watts",
"content": "CAT property."
},
{
"speaker": "Powell Brown",
"content": "CAT property. Let me clarify CAT property."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Elyse Greenspan with Wells Fargo. Your line is now open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. My first question is on the guidance, the 50 to 100 basis points of margin expansion. Does where you fall within that range just depend on if the wind blows or not and whether you see losses under your captive?"
},
{
"speaker": "Andy Watts",
"content": "No, I think it's got a bunch of factors in it, Elyse, that drives in there. I think it depends upon outlook for contingents, how do they move during the year, mix of businesses, how much each of them grow back and forth. And so I'm just trying to give a range as to kind of where things play out. To our comment depending upon what happens with storm season, because depending upon what occurs and the severity of it, that impacts the flood business. It impacts our captives inside of there. So if when one goes up, the other one probably goes down and vice versa. So there's balancing inside of all of it. It's just always hard to determine exactly where a storm may hit or not hit in insured properties."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. But then I guess, right, so the 50 to 100 basis points, I mean, you guys were at 130 for the first half of the year. So that does imply contraction in the back half. Is it - another way of asking this, is it just captive losses as well as some conservatism around contingents that kind of - and then I know you had that one-off, right, some of that - you do get the - you had one-off revenue, right, within the captive from the reinsurance last year. I'm just trying to understand the moving pieces and what that implies for the margin in the back half of the year."
},
{
"speaker": "Andy Watts",
"content": "Yes. Keep in mind, which I think we've talked to pretty much everybody about this is, obviously, last year was a - there as calm storm season. And so our captives performed extremely well. When we go into each year, we think about our flood business as well as our captives and we have no idea what's going to happen during the year. So we use a lot of estimates going into it, and we'll look at averages over years. We do budget for storms, just it makes sense to do that. So that way if it doesn't happen, it's all upside, inside of there. So if you think about the third quarter and that's probably the higher likelihood in there is, yes, we would plan for storm claim activity. I guess, if it doesn't happen, that would be upside. And I think most everybody at least Elyse including yourself has that in the models for the third quarter on the margins coming backwards."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay, thanks. And then on programs, you guys have seen pretty consistent strong double-digit growth in that business. And I know you called off - you called out one growth initiative that modestly benefited the segment in the quarter. But as we think going forward, I know you guys don't like to guide on a segment level. So I'm not going to ask for a specific number, but how do you think about just overall just growth prospects of that business organically going forward?"
},
{
"speaker": "Powell Brown",
"content": "So I think of that business kind of several ways. Number one, remember, you have CAT businesses in there, which are property-driven. So you could have rate pressure on those, you have those that are casualty-driven or professional liability-driven, which they could have a little rate pressure, but they could also basically it comes down to writing more new customers. So from a standpoint of what I think is and what we've tried to do and I think we're very consistent on this is historically up to this point, in the CAT businesses, there's been a discussion about availability of capacity. And right now, I don't think you're going to hear as much about availability of capacity, you're going to hear about pricing of that capacity. And so that's the only hesitancy that I would give to you, Elyse. I was expecting you to feel really good about our results and because we do, but I wanted to clarify that."
},
{
"speaker": "Elyse Greenspan",
"content": "Yes. No, I mean, yes, I was pointing out the double-digit. That's helpful. That's helpful, Powell. Thanks for the color."
},
{
"speaker": "Operator",
"content": "Thank you."
},
{
"speaker": "Powell Brown",
"content": "Thank you, Elyse."
},
{
"speaker": "Andy Watts",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Yaron Kinar with Jefferies. Your line is now open."
},
{
"speaker": "Yaron Kinar",
"content": "Thank you. Good morning. Maybe one clarification after the last set of questions. So in the guidance range for margins, even in the kind of best-case scenario that you're looking at here with, I guess, a more benign storm season, you're still modeling some storms into that, right?"
},
{
"speaker": "Powell Brown",
"content": "Correct."
},
{
"speaker": "Andy Watts",
"content": "We are, yes."
},
{
"speaker": "Yaron Kinar",
"content": "Okay. And then, Powell, I am curious, I want to circle back to your comment about pricing pressure in casualty being kind of the worst in your career. I was just - I guess that caught me off-guard a little bit and not that I don't recognize that there is pricing pressure mounting in casualty, but just looking back to, say, the 2018 through '20 years or even going back a bit further to maybe the early 2000s, late 1990s, you're seeing the current environment as even worse than that from a pricing perspective."
},
{
"speaker": "Powell Brown",
"content": "Yes. So let me go back, give you a - I started in the industry in 1990 at an insurance company. And I did that for several years and then worked for a short period of time at a - in graduate school at a wholesale broker in New York. And so when I started seeing big casualty of all sizes and shapes and not just big in the early 90s to today, it has historically been under pressure. I'm making a broad statement. And there were classes of business that have struggled during that period of time, I think of habitational and I think of residential construction in particular, but I'm talking about broadly speaking in casualty. So what I want - what I mean by that is, not so much the upward pressure on rates. I'm more specifically thinking about the discipline of the industry to basically continue to hold the line because usually somebody is willing to flinch. And so I don't want to give you the impression that if you go out on a new, new piece of business that you can't keep rates flat in some instances. That is possible. But what I'm saying is, in my career, this is the broadest impact of pricing discipline in casualty that I recall. So I only have back to 1990."
},
{
"speaker": "Yaron Kinar",
"content": "Got it. No, that's a helpful clarification. If I could sneak one in - one last one in. In programs, are the programs that are leading the growth in the segment, are those the same or pretty consistent largely or have you seen a shift in where the growth - the leaders of growth are coming from?"
},
{
"speaker": "Powell Brown",
"content": "What I would say is that, in any business, many times, you're going to have a handful, two handfuls, three handfuls depending on the number of businesses you have that are going to be leaders. And so I would say as a general statement, those which have been growing over an extended period of time, and I'm not talking about one, two, three years. I'm talking about over a long period of time, tend to be those that are driving growth. And I think that would be very consistent within other firms as well. But, yes, that's how we've seen it."
},
{
"speaker": "Yaron Kinar",
"content": "Great. Thank you very much."
},
{
"speaker": "Powell Brown",
"content": "Thank you."
},
{
"speaker": "Andy Watts",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Rob Cox with Goldman Sachs. Your line is now open."
},
{
"speaker": "Rob Cox",
"content": "Hi, thanks. Hi. So I think maybe last year you guys had highlighted taking or just giving up some commission on the property business to kind of offset some of the rapid price increases your clients were seeing maybe particularly in the Southeast. So I'm curious, did that sort of flip back the other way this year with Brown maybe seeing a larger commission percentage and improved retention now that we're on the other side of those large increases?"
},
{
"speaker": "Powell Brown",
"content": "Yes. I don't remember, I'm looking at Andy. I don't remember exactly saying that, but let me clarify the point. I want you to know that it is very competitive in property. And so what I mean by that is, we are always looking for what's in the best interest of the customer because if we don't, somebody else will. So what I mean by that is, there are instances in any market where we may have to give up some commission to get an account or something and maybe over time, we're able to build it back. But having said that, I would tell you that pricing is of paramount importance either on the way up or on the way down. And so I would lead you more towards, it's more about what is the absolute price as opposed to how we're compensated on it. And I believe that we're being compensated fairly. And I don't believe that there are - I don't feel like there's a compression that's going on in that from the downward pressure, but that's how I'd answer that, Rob."
},
{
"speaker": "Andy Watts",
"content": "Yes, Rob, in this market, I guess, with your comment, don't take it like we're out of the woods and like we're in a completely different level of the cycle. I mean, rates have been going up for five or six years. This is kind of the first part of the year when you start to see some declines, but you're not seeing 25s or 40s or anything like that. And it's not like we've been doing this for a few years. So customers right now are saying, in many cases, excellent, I can either get some more limits or great, I'll take it to my P&L just because they've taken so much pain over the last few years that, so we're very early in a cycle, which we'll see what happens with storm season."
},
{
"speaker": "Rob Cox",
"content": "Okay, got it. I appreciate that. And maybe just as a follow-up on contingent commissions, are you already starting to see kind of some of this upward pressure on casualty loss trend in your contingent commissions? And would you expect that to potentially impact the remainder of 2024 or 2025?"
},
{
"speaker": "Powell Brown",
"content": "I think we just continue to see loss activity. I'm not even talking just solely about casualty, but we see loss activity impacting profit-sharing and contingencies. So I think that it is a kind of a universal kind of across-the-board phenomenon, it's not one line of business."
},
{
"speaker": "Andy Watts",
"content": "Yes. I mean, Rob, the areas that have been under pressure for a while, which we've talked about in retail is auto. I don't think that takes anybody by surprise with the level of pricing that has been pushed through most auto books that are out there. So we don't see that abating anytime soon."
},
{
"speaker": "Rob Cox",
"content": "Okay. Thank you."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Rob."
},
{
"speaker": "Andy Watts",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Gregory Peters with Raymond James. Your line is now open."
},
{
"speaker": "Sidney Schultz",
"content": "Yes. Hi, good morning. This is Sid on for Greg. Just staying with the contingent commissions, I understand it's a smaller number, but just looking at the retail segment, they were down by over 50% year-over-year. So can you just remind us if there was some sort of one-time benefit to last year's number or anything that could bleed in the third or fourth quarter from that decline?"
},
{
"speaker": "Andy Watts",
"content": "Yes, good morning, Sid. Andy here. We had some - a small amount of troops with the accruals that we made last year, but this is just as we talked about before, primary impacts around auto as well as some of the other lines inside of there."
},
{
"speaker": "Sidney Schultz",
"content": "Okay. And then just as a follow-up on the investment income line item, should we just think of that as being interest rate dependent moving forward? And is there any seasonality we should consider there moving forward?"
},
{
"speaker": "Andy Watts",
"content": "Yes. No real seasonality to it. It's more driven-off of rates and then what's the available balances outstanding that have the ability to earn interest on those. You probably saw in there, we've got a higher level of cash at the end of June, Rob. That is where we've got about $500 million we're sitting on, which we'll use for paying down the notes that come up in September for maturity. So that drove some - a little bit of incremental interest income in the quarter."
},
{
"speaker": "Sidney Schultz",
"content": "All right. Thank you."
},
{
"speaker": "Andy Watts",
"content": "Yes, thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Grace Carter with Bank of America. Your line is now open."
},
{
"speaker": "Grace Carter",
"content": "Hi, good morning."
},
{
"speaker": "Powell Brown",
"content": "Good morning."
},
{
"speaker": "Grace Carter",
"content": "I guess one quick follow-up on the contingents. Just given the dynamics across your different segments, would you expect any of the claims activity that impacted retail contingents in the quarter to bleed into the other segments going forward? Or do you think that just kind of the loss ratio impact there is pretty isolated to the retail segment?"
},
{
"speaker": "Andy Watts",
"content": "Good morning, Grace. I guess from what we can see right now, we don't see a significant bleed over. Obviously, anything is possible at this stage, but feel like it's probably more isolated in retail at this stage."
},
{
"speaker": "Grace Carter",
"content": "Thank you. And I guess over time, you all talked about thinking about organic growth kind of in the mid-single-digit range over the long-term. Clearly, it's been quite above that here lately. I guess if you could just help us think about how internally you all are thinking about maybe the glide path back towards sort of historical levels and just how long do you think that it can sustain at these elevated levels that we've seen over the past several quarters and just sort of any sort of puts and takes that you're thinking about from that perspective? Thank you."
},
{
"speaker": "Powell Brown",
"content": "So good morning, Grace. And we don't give technically organic growth guidance. And, yes, you are correct in the range that we have stated and we are not modifying over a long period of time our statements. I think that we continue to execute our plan really well right now. That's number one. Number two, from a standpoint of organic growth, the growth that we are seeing here domestically in our businesses is very similar the growth that we're seeing in our international businesses. So we're pleased with that as well. So what I would say is this. We're not changing our statements on those commentaries. I think that we're executing really well right now. We feel really good about our business. I will acknowledge that we get a little lift on some of that rate pressure, which was, let's say, property for a period of time. But I think that the future relative to organic growth is positive, very positive."
},
{
"speaker": "Grace Carter",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Meyer Shields with Keefe, Bruyette & Woods. Your line is now open."
},
{
"speaker": "Meyer Shields",
"content": "Thanks, and good morning. Powell, from a big-picture perspective, can you contrast maybe Brown & Brown's ability to win market share now with, I don't know, five years ago because you've been highlighting that as a driver of growth that's been really, really impressive. I'm wondering if this represents sort of a permanent change in growth prospects."
},
{
"speaker": "Powell Brown",
"content": "Yes, sure. Good morning, Meyer. This is how I would - let me sort of take you back slightly farther than that, let's go back 10 years. And in 10 years ago, we would - generally speaking, we were in a - we were a small and middle-market insurance broker and we still have a lot of that business. But today and we consciously, some of that consciously, some of it, it's better to be lucky than good, we have bought and built capabilities that enable us to be very successful in the upper-middle market and large accounts area. But let's just say upper-middle market for a moment, and specifically in employee benefit. So 10 years ago, were we going after a 5,000 and 10,000 life group? The answer is very limited. Today, we're going after those groups all the time. And so - and that is not just exclusive employee benefits. It could be on casualty, it could be a big property schedule, it could be D&O, it could be cyber, it could be surety, it could be any of these things. So - and then if you want to go back to your time frame, specifically, in the last five years, we have further enhanced and embellished those capabilities, but we're working better together as an organization. So you put increased capabilities with better collaboration, knowing that our teammates are the most important thing at Brown & Brown to be able to deliver that custom - those custom solutions for our customers, it's pretty powerful. And we're having a lot of fun, we're working hard, but we're having a lot of fun too."
},
{
"speaker": "Meyer Shields",
"content": "Okay, perfect. That's very helpful. And then a much smaller question, and I know we're all talking about contingent commissions. I guess my question is that commercial auto seems like it's been a terrible line of business forever. So I'm wondering why it's manifesting itself now in terms of contingent pressure as opposed to a year ago."
},
{
"speaker": "Powell Brown",
"content": "I don't think it's manifesting itself now as opposed to a year ago. I think it was embedded in a year ago, which I think Andy was just acknowledging that it's not just casualty. And again, the more unusual verdicts that you see out there that get headlines that is - it is terrible, but it highlights some of that as it rolls through into the carrier's results, but it's not - that was going on last year and it was going on four years ago. So don't - let's not - let's be clear on that."
},
{
"speaker": "Meyer Shields",
"content": "Okay, got it. Thank you very much."
},
{
"speaker": "Powell Brown",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Ward with Citi. Your line is now open."
},
{
"speaker": "Mike Ward",
"content": "Thanks. Good morning. I was just wondering, following-up on some of the other questions, are you able to quantify at all the - just how much premium in programs is actually exposed to casualty or social inflation and how the underwriting margins have been trending?"
},
{
"speaker": "Powell Brown",
"content": "No, we don't break that out, Mike, sorry."
},
{
"speaker": "Mike Ward",
"content": "Okay. And then on - maybe just on the captives. I was hoping you could refresh off on some of the economics with some of the changes with the quota-share captive recently. We were just - we were looking at the Q, I think you sold a stake in 1Q and then the written and earned premium spiked in 2Q. So just kind of curious if you have an outlook for that in the back half in terms of premiums and commissions or fee tailwinds."
},
{
"speaker": "Powell Brown",
"content": "So, Mike, I want to - we want to bring this in sort of for a landing. And here is the bottom line. We are very pleased in the performance of our captives. And we do not in any of our other businesses give individual guidance on the performance of an individual office or business. So what I would say in a broad-reaching statement would be the following. We like the business, we're not going to be giving guidance or talking about that particular business individually on a go-forward basis. We will continue to consider investments in that area. We may, may not do anymore. I don't like the terms never or always, but they will move up and down based on the marketplace. And so we're not going to get into the specifics about X or Y or whatever. And then they - whatever evaluation you do, that will be up to you. And we're not trying to be elusive, but what I'm saying is, we don't talk about the performance of one of our offices. And relative to the size of the business, this is just part of our company and we feel really good about it. And it's in our programs area and Chris and the team have done a great job with it. So it's a long-winded answer of saying no, but it's more of a clarification on how we want to approach it going forward. It's just part of the business, just like all the other businesses that we have, and maybe 500 plus locations. So that's how we'd answer it."
},
{
"speaker": "Mike Ward",
"content": "Got it. Understood. Maybe can I squeeze just a backward looking non-guidance one, just give you opportunity to talk about the U.K. for a sec. I think you've said you - that has a similar growth profile as the U.S., but it looks like revenue accelerated in U.K. Just curious if you have been seeing any difference in the organic growth between the two."
},
{
"speaker": "Powell Brown",
"content": "So let me back up. Remember, we have had a lot of opportunities to acquire businesses there. And some of those businesses are standalone and some of those are going into existing offices. That's one. Number two, as you know, we've bought the - most notably, the one I'm thinking of is Kentro Nexus, which is a program business. So we have more program business based in England today than before. Also, I would tell you that we have acquired in some of the instances, capabilities that are in slightly larger account capabilities as well, not large account, but slightly larger than the SME. And so we feel really good about the opportunities there. Our story and I said this earlier for a reason, anticipating if someone would ask that. But our story is one that is appealing to firms in England because we've been doing it one for 85 years. We're consistent with what we say and we do. And people like the idea that we have teammates. So that's a - I talk about it - we are like a bunch of competitive athletic teams. And if you live in England, you either like football, which is soccer in America, but English football or Rugby. And so most everybody likes one or the other or both. And they like the ownership culture, they like the idea about leaders versus managers, and they like the idea that it's 85 years in business, and we're doing this forever. So what I would say is, there continues to be a lot of consolidation in that market, and we will have - play a role in that. But we feel good and the organic growth opportunities there, I would say, are on par with our business, equivalent businesses here in the States. That's exactly how I'd say it."
},
{
"speaker": "Mike Ward",
"content": "Thank you so much, Powell."
},
{
"speaker": "Powell Brown",
"content": "Yes, Mike, thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our last question is from the line of Scott Heleniak with RBC Capital Markets. Your line is now open."
},
{
"speaker": "Scott Heleniak",
"content": "Yes, thanks. Good morning. Just wanted to talk - touch base on the employee benefits. Powell, I know you mentioned that just kind of high-level a minute ago, but anything you can talk about in terms of what you're seeing in terms of new business trends there versus the past few quarters or just anything you can share in terms of how that business is trending, anything you're seeing there to call out?"
},
{
"speaker": "Powell Brown",
"content": "Well, remember, just as a clarification, Scott, we don't give specific line guidance. So I have to - I want to be careful on how I say this. So I am very pleased with our property and casualty and our employee benefits capabilities at all sizes and shapes, both domestically and overseas. So let's start with that. Number two, my comment earlier was directed at our capabilities to go upmarket and the amount of new business that we are writing. I don't want to give you the impression that new business is more limited towards just employee benefits because it's not. We're writing those same size accounts in property and casualty every day as well. But what I'm saying is, our capabilities there have probably grown more because we were further ahead in property-casualty before we started, if that makes sense. And so we're - we - if you had asked me seven, eight years ago, you have a friend that has a manufacturing operation and it's got 12,000 employees, we may or may not have had all the capabilities to do that. Today, we are very, very capable, whether it's 200 employees, 2,000 employees, 20,000 employees or more. And so it's a great expanded capability and the people, a lot of the people that we are hiring like the way our system is built. So they might be leaving a firm where they've done large accounts, but it's more on a - this is how we do it. We sell one solution and you're coming to a business where it's a customized solution based on any and every customer. So we're excited about that opportunity, but it's not limited to, it is in addition to what we're already doing in P&C, because we got the same thing going on in P&C."
},
{
"speaker": "Scott Heleniak",
"content": "Yes, got it. Makes sense. And just the only other question I had was just on the wholesale units that was strong again, organic up double-digits. Can you just talk about the flow and the trends you're seeing there in terms of any - is there any kind of newer lines you're seeing that are coming in that you weren't before? And is any of that property business going back to the admitted markets? Or is it just different E&S players that are kind of competing for that?"
},
{
"speaker": "Powell Brown",
"content": "Yes. So first of all, we are seeing a lot of flow into the business. So not that we didn't before, but there's just a lot of activity, okay, that's the first thing. The second thing is the question you asked is absolutely the right question. And, yes, in limited instances, we are seeing that. And so what I mean by that is when the standard market comes back in, many times they are not riding the full limit of wind, they're writing a sub-limit, but it could be a big number. So for example, you could have a hotel, I'll make this up, in Texas, where it was - it's a superior construction, the whole deal and it's $500 million or $600 million of value and it used to be in the E&S market and a standard market could conceivably come in and write that ground-up, but would provide a $100 million wind limit. That would be an example of when you start - and that is not happening all over the place and is only happening when the construction is really good. So far more accounts are moving out of the E&S market - I'm sorry, out of standard into E&S than from E&S back to standard. But there are instances that I'm aware of that we saw this quarter that would be very similar to that maybe in different geographies, but the same concept. And so I think that there will be carriers that will be very strategic in the use of their CAT capacity. But remember, if you put up $100 million on a building, even if it's fire resistive, that's still hitting against your CAT. So it's a lot different than it was framed, but I'm just saying, it's still - that's a big number to come out of. So they may have written the account three years ago or two years ago, and it went into E&S and it's come back. That's how I see it."
},
{
"speaker": "Scott Heleniak",
"content": "Yes. Okay. Makes sense. Appreciate it. Thanks for all the answers."
},
{
"speaker": "Powell Brown",
"content": "Yes, absolutely."
},
{
"speaker": "Operator",
"content": "Thank you. I would now like to turn the call back over to Powell Brown for closing remarks."
},
{
"speaker": "Powell Brown",
"content": "Yes. Thank you very much, Shannon. Thank you all for joining us today. We're very pleased, as I said, about how we did for the quarter and the prospects going forward. Obviously, we watch very closely because there's a lot of really warm water in the Atlantic and the Gulf. So in the event a storm gets in there, it will probably supercharge it. But we don't know how that will play out until we talk to you again. But as it relates to, and kind of summarizing what Andy and I sort of said today, we feel really good about the business. We feel really good about the prospects and the opportunities we're talking to in the M&A space. We think that the market is changing as we've outlined today. I don't think the property market is going to crater in terms of pricing, but we could have continued downward pressure if there are no storms. And if there are storms, we could have all kinds of scenarios. We could have flattening, we could have upward pressure, we could have any of this stuff. So thank you all very much and we look forward to talking to you next quarter. Good day."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for your participation. You may now disconnect."
}
] |
bro | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to Brown & Brown Inc.'s First Quarter Earnings Conference Call. Today's call is being recorded. Please note that certain information discussed during this call including information contained in the slide presentation posted in connection with this call and including answers in response to your questions, may relate to future results and events or otherwise be forward-looking in nature. Such statements reflect their current views and with respect to future events, including those relating to the Company's anticipated financial results for the first quarter and are intended to fall within the safe harbor provisions of the securities laws. Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors. Such factors include the Company's determination as it finalizes its financial results for the first quarter and its financial results differ from the current preliminary unaudited numbers set forth in the press release issued yesterday. Other factors that the Company may not have currently identified or quantified and those risks and uncertainties identified from time to time in the Company's reports filed in the Securities and Exchange Commission. Additional discussions of these and other factors affecting the Company's business and prospects as well as additional information regarding forward-looking statements is contained in the slide presentation posted in connection with this call and the Company's filings with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future results or otherwise. In addition, these certain non-GAAP financial measures used in this conference call, a reconciliation of non-GAAP financial measures to the most comparable GAAP financial measures can be found in the Company's earnings press release or in the investor presentation for this call on the Company's website at www.bbinsurance.com by clicking on Investor Relations and then Calendar of Events. With that said, I would now like to turn the call over to Powell Brown, President and Chief Executive Officer. You may begin, sir."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Norma. Good morning, everyone, and welcome to our earnings call. Q1 proved to be another strong quarter where we delivered excellent top- and bottom-line growth. Our team did an outstanding job of winning more net new business again this quarter. I'll provide some high-level comments on our performance along with updates on the insurance market and the M&A landscape. Then Andy will discuss our financials in more detail. Lastly, I'll wrap up with some comments, some closing thoughts and comments before we open it up to Q&A. Now let's get into our results for the quarter. I'm on Slide 4. We delivered over $1.25 billion of revenue, growing 12.7% in total and 8.6% organically over the first quarter of 2023. Our adjusted EBITDAC margin improved by 130 basis points to 37% and our adjusted earnings per share grew 18.8% to $1.14. On the M&A front, we completed six acquisitions with estimated annual revenue of $16 million. I'm on Slide 5. Growth in markets we operate in has not materially changed compared to the fourth quarter of last year as consumer spending remained resilient. Levels of hiring and investment were similar to what we experienced in the second half of '23. However, there continues to be a shortage of workers for many industries, which has also driven elevated levels of inflation. From an insurance pricing standpoint, the overall changes in rates for most lines were relatively consistent with the fourth quarter of last year. Pricing for employee benefits was similar to prior quarters with medical and pharmacy costs up 7% to 9%. These pressures are driving strong demand for our EV consulting businesses. Rates in the admitted P&C markets were up 5% to 10% for most lines, while we continue to see decreases of 5% to 10% for workers' compensation in most states. However, we're starting to see some changes in rates for casualty, professional lines and CAT property as compared to prior quarters. Due to ongoing levels of inflation and the size of legal judgments, pricing for excess casualty lines continues to increase, and we're seeing upward pressure for primary limits. Over the majority of my career, primary liability rates seem to have been under downward pressure. As you've seen, the excess market has been up substantially in the past few years. And with the continued deterioration in the general liability market, the primary rate seems to be moving up in certain lines of business. Now, it seems there's an upward pressure on both primary and excess rates. For professional liability, we saw a slight improvement in pricing as compared to last quarter, but rates are still flat to down 10%. CAT property rates moderated during the quarter as compared to 2023. We saw many accounts that had low or no losses with rates down 10% or more. And accounts with losses or poor construction or a combination of both increased slightly to up 15%. This was driven by some carriers or facilities willing to put up additional limits combined with some new capital entering the marketplace. As we've seen some downward rate pressure on certain properties, this may have a slight impact on those offices in CAT areas. However, their new business activity remains strong, and they're performing well. As we've always said, our organic growth in a steady state economy is generally driven two-thirds by exposure units and one-third by rate. In CAT prone areas, the rate impact might be slightly higher. Keep in mind, we've built a highly diversified company in geography, lines of coverage and customer size as these enable our consistently strong financial performance. Lastly, in the M&A marketplace, it continued to be competitive for high-quality businesses. The quarter, we remained active building relationships with lending companies and acquiring another six. I'm on Slide 6. Let's transition to the performance of our three segments. Retail delivered another great quarter with organic growth of 7.2%, winning a lot of new customers along with good retention. In addition, all lines performed -- business performed well. We're very pleased how the team is leveraging our collective capabilities in order to create unique solutions for our customers. Our goal has always been to have the tools and capabilities to serve our customers as they grow and become more complex. We have strategically built our employee benefits and property and casualty businesses to serve customers of all sizes, those with less than 50 to over 50,000 lives as well as start-ups to multibillion-dollar revenue company. The program segment had an outstanding quarter, delivering organic growth of 11.8%. This is even with the headwinds of $8 million of flood claims processing revenue we recognized in the first quarter of last year. Our highly diversified global portfolio of over 60 programs performed very well for the quarter as we continue to provide market differentiated solutions that enable us to bind more accounts. Wholesale Brokerage delivered another strong quarter with organic revenue growth of 10.8%. This growth was primarily driven by binding more net new business and rate increases. Our highly diversified lines of business, including open brokerage, delegated authority and personal lines grew very well during the quarter. Now, I'll turn it over to Andy to get into more details regarding our financial results."
},
{
"speaker": "Andy Watts",
"content": "Great. Thank you, Powell. Good morning, everybody. We're over on Slide number 7. I'll review our financial results in additional detail. When we refer to EBITDAC, EBITDAC margin, income before income taxes or diluted net income per share, we are referring to those measures on an adjusted basis, which now reflect the previously announced exclusion of intangible asset amortization. The reconciliations of our GAAP to non-GAAP financial measures can be found either in the appendix of this presentation or in the press release we issued yesterday. We delivered total revenues of $1,258 million, growing 12.7% as compared to the first quarter in the prior year. Income before income taxes increased by 19.4% and EBITDAC grew by 17.1%. Our EBITDAC margin was 37%, expanding by an impressive 130 basis points over the first quarter of 2023. The effective tax rate for the quarter was down slightly from the prior year, with diluted net income per share increasing 18.8% from last year to $1.14. Our weighted average shares outstanding increased a little over 1% as we continue to prioritize paying down debt on a full year basis as this has a higher contribution to earnings per share, cash flow and shareholder value. Lastly, our dividends per share paid increased by 13% as compared to the first quarter of last year. Overall, it was a very strong quarter. We're on Slide number 8. The Retail segment grew total revenues by 10% with organic growth of 7.2%. The difference between total revenues and organic revenue was driven by acquisition activity over the past year. EBITDAC grew slightly slower than total revenues due primarily to higher non-cash stock-based compensation costs as well as lower contingent commissions. We're on Slide number 9. Programs had another strong quarter with total revenues growing 16.9% and organic growth of 11.8%. The incremental growth in total revenues in excess of organic was driven primarily by increased contingent commissions due to our strong underwriting performance and a quiet hurricane season in 2023. The growth in contingent commissions included approximately $7 million related to finalizing prior year estimates that we do not expect to recur in the first quarter of next year. Our EBITDAC margin expanded by 580 basis points to 42.3%, driven by the leveraging of our expense base, higher contingents and the sale of certain claims processing businesses in the fourth quarter of 2023. We're over on Slide number 10. Our Wholesale Brokerage segment delivered another great quarter with total revenue growth of 15.4% and organic growth of 10.8%. The incremental growth in total revenues in excess of organic was driven by higher contingent commissions and acquisitions completed over the last 12 months. Our EBITDAC margin increased by 150 basis points to 32.4% due to leveraging our expense base and higher contingent commissions. A few comments regarding cash generation and capital allocation. From a cash flow perspective, our first quarter is normally the lowest of the year. In addition, for this year, our cash flow from operations was impacted by paying two-quarters of federal income taxes for 2023 that were permitted to be deferred as part of Hurricane Idalia tax relief and the payment of income taxes associated with -- on the sale of certain businesses in the fourth quarter of last year. We're continuing to expect another strong year of cash generation and a conversion ratio of cash flow from operations to revenues in the range of 22% to 24%. Lastly, we ended the quarter with approximately $580 million of operating cash and are in a strong capital position. With that, let me turn it back over to Powell for closing comments."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Andy. Great report. From an economic standpoint, we expect growth to continue this year. As we've mentioned before, we do think this expansion will moderate towards more normal levels over the coming quarters. With persistent inflation and a tight labor market, we believe there's a good backdrop that will drive growth, hiring and investment for many businesses. Regarding the admitted markets, we believe overall rate changes will remain relatively similar to what we experienced in the first quarter. For the E&S markets, rate decreases for professional lines should continue to moderate as we expect casualty both primary in access to further increase. Based on what we see today, we believe there will be continued rate pressure for CAT property. This is highly dependent on early storm activity this year. Regarding M&A, we're in a great position with a strong balance sheet and access to capital. We continue to talk to a lot of companies and build relationships. Our disciplined approach has proven to be very successful as we're focused on acquiring high-quality organizations that fit culturally. We have great momentum coming out of the first quarter, there's good economic outlook and our team continues to win more net new business by leveraging our collective capabilities. This positions us to deliver another year of industry-leading financial results. With that, we'll turn it back over to Norma to open the lines for Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Robert Cox with Goldman Sachs. Your line is now open."
},
{
"speaker": "Robert Cox",
"content": "Maybe just firstly on the margins. I was curious if the margin breakdown this quarter was kind of how you envision this year playing out with National Programs leading the way? And is it right to think that divesting the claims processing business in the fourth quarter created sustainable margin improvement in National Programs that should flow through to coming quarters?"
},
{
"speaker": "Andy Watts",
"content": "Rob, it's Andy here. I think as we've talked about in the past, margins can move around in the segments by individual quarters. I think, overall, we're extremely pleased with the performance for the first quarter. There will probably be ups and downs of orders. And as an example, I know we've talked about in the past third quarter, we normally will budget for storms and a half. You never know how exactly that's going to turn out. So that kind of moves things back around. And then at least for this year, on the sale of some of those services businesses is, yes, year-over-year, we'll see an increase in the margin from that disposal."
},
{
"speaker": "Robert Cox",
"content": "Okay. Great. And then just in regard to the pricing moderation in property CAT, I'm just trying to wrap our heads around if increased demand for coverage could offset some of the pricing declines and kind of the magnitude of each of those factors, and how that could play out for Brown & Brown organic growth in 2Q and beyond?"
},
{
"speaker": "Powell Brown",
"content": "So, Rob, what I would say is this, we -- I actually thought that we would be at this place a little sooner in the cycle than today. So, I thought we might have been here a year ago or somewhere between a year ago and today. So, what are you seeing, and let me describe that and then I'll answer your question, number one, remember, most buyers of insurance have what I call pricing fatigue? So, if you have gotten a price increase on your condo or your properties or whatever for the past four or five years, you're just over it. That's the first thing. The second thing is sometimes even though you do the very best you can as the broker, sometimes the client shoots the messenger because they're just so frustrated with the marketplace. Having said that, what you're finding today is people that wrote a $10 million primary are giving you $20 million or $25 million now, and that's bumping out several of those buffer layers. So, you're going to have downward pressure on the overall program. So, you have several scenarios that could occur. One, yes, you could buy more limits although my instinct would be because of the pricing fatigue, they would probably not buy more limits right now. Number two, they might be able to get slightly better terms and conditions, which would be good. And three, in the event that we don't have another storm this year sometime, that pricing pressure, downward, will continue. That said, and we've always said in E&S, in our wholesale business and in our Retail business, we actually write a lot of business when the market is going up and when the market is going down. Usually, you don't see as much in that market, the E&S market when the rates are flat, which they're relatively never flat. That's the answer, excuse me."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Gregory Peters with Raymond James. Your line is now open."
},
{
"speaker": "Gregory Peters",
"content": "So, I would like to -- Powell, in your comments, you talked about different rate movements and then you mentioned this two-thirds to one-third ratio. I guess I'm trying to reconcile the downward pressure moderating upward pressure in some of the lines of business. Can you give us a perspective on like how much of your total business is excess and surplus lines? How much is property? How much is excess casualty, just so we can sort of gauge moving pieces?"
},
{
"speaker": "Powell Brown",
"content": "Well, Greg, it's nice to talk to you this morning and thank you for the question. I know you know the answer to this, but we don't give that level of detail out. However, what I would say is this, we write lots of CAT property in all CAT prone states, but we don't write it all exclusively from the CAT prone states. So, you could have an office that is in Chicago or Minneapolis or Milwaukee that writes business in these areas as well. That's number one. Number two, from a casualty standpoint, think about we write an enormous amount in our Retail business of package business. And in that package business, property many times is not the biggest part of the account. The largest account many times is workers' compensation followed by either auto or general liability. So, I know I didn't answer your question, but I'm just trying to give you a little color on our book in small, medium, upper middle market and even large accounts. And so, you're going to have a certain segment in the large accounts that are going to not be as affected up or down because if they're on fees. But what I would say is, we are very focused on delivering very, very competitive programs for our customers. And that is, in many instances, going to have downward pressure on our property book. There is some offset. I'm not going to say it's one for one, but there is some offset with this pressure in the casualty areas and the moderation in professional liability rates going down."
},
{
"speaker": "Andy Watts",
"content": "Greg, just on this, I mean, I know we've talked about it, we started last year going through a few different times. And then, we've been over on other calls. I think the reason why we mentioned a lot about diversification in the business is while we do write a lot of CAT property, we write a lot of non-CAT property. We write a lot of other lines. We're across multiple industries, geographies. So, we don't have this major concentration in any area, which we think is a really good thing for our business because if one thing could be up, something else could be down. It puts a nice balance across the organization."
},
{
"speaker": "Gregory Peters",
"content": "Right. Makes sense. I guess as a follow-up, Andy, I think in your prepared comments, you called out a one-time benefit in the program side. Can you quantify that again? You were going through this quickly so I didn't catch all the detail."
},
{
"speaker": "Andy Watts",
"content": "Sure. Yes, no problem. What we had called out as you said about $7 million of the contingent commissions that we recorded in the first quarter were related to finalizing the estimates that we recorded last year. So, we would not expect to see that in Q1 of next year. So just keep that in mind for modeling purposes next year."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Michael Zaremski with BMO Capital Markets. Your line is now open."
},
{
"speaker": "Michael Zaremski",
"content": "Back to the contingents, and we could take this offline, if you think it's warranted. But if we take out the $7 million, contingents were still much better than I feel like you've kind of directionally guided to, although the guide, I believe is for a full year. So, I'm just trying to get at is there -- was there -- is there a seasonality or a pull forward on your -- in 1Q that we should be cognizant of when we think about the next three quarters of the year? Or is there kind of a change in your view now, ex the $7 million of your view on contingents for the year?"
},
{
"speaker": "Powell Brown",
"content": "No, I wouldn't say that there was any pull forward in any nature, so no timing or anything in nature. When we record the contingent commissions based upon the policies that we place with the written premium that's out there. And we estimate those to the best knowledge that we have at the time on what we believe the profitability of the book will be. So that's why there's always going to be some sort of adjustments up and down to the estimates. I think as we went into the year, we thought that they would probably be flat to up a little bit. There'll probably be now with the first quarter looks like qualifying potentially for a little bit more than what we had before, which is good for us for the year. And then, there's always a question of kind of what happens during storm season. That's always kind of the wildcard that may adjust the calculations."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. That's helpful. Lastly, switching gears to cash flow as a percentage of revenues, loud and clear about the 22% to 24% guide still near term. I believe in the past -- not too distant past, you talked about a higher figure closer to 25% being normal. Can you walk us through quickly what -- why lower today and whether they're -- and I guess we can figure out whether it could go back to a higher level over time, depending on the -- what's keeping it down today?"
},
{
"speaker": "Powell Brown",
"content": "Yes. So, Mike, so your first question is, and I think what we said in the past is, we think that the business kind of over a medium term -- medium to long term has a conversion ratio of cash flow from ops, somewhere around 24% to 26%. We still feel really good with that range for the organization. It's come down over the last 1.5 years, 2 years, primarily associated with the higher interest expense. But as we're now kind of making that lap and you can see the impact on cash flow from interest expense for the quarter, right, it was minimal. The main thing impacting this year was really the incremental taxes that we talked about. So, if you were -- if you take those and kind of isolate that in your projections, you'd see we're actually back pretty close to our normal rate this year. So, we feel really comfortable upon what happens with interest rates or if we take on any incremental debt for acquisitions or whatever, that there's a pretty clear path back to that by next year."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Mark Hughes with Truist Securities. Your line is now open."
},
{
"speaker": "Mark Hughes",
"content": "You had mentioned the employee benefits, the medical pharmacy up 7% to 9%. Was the organic in benefits comparable to the overall organic number? Or was it a little bit faster in benefits, a little bit slower?"
},
{
"speaker": "Powell Brown",
"content": "Once again, we don't usually break out, as you know, the specifics on P&C and benefits, but I would tell you, we're very pleased with the way our benefits business is growing organically and the capabilities that we've built over the last 10 years there. We're able, Mark, to compete on basically any size account here domestically. It could have 100,000 lives. It could have 100 lives. And so, we're very pleased with how that business is performing."
},
{
"speaker": "Mark Hughes",
"content": "And then, the wholesale open brokerage, any observations there about the growth profile in that business kind of this quarter versus last quarter? And are you still seeing the mix shift into excess and surplus? Or has that stabilized? How do you see that?"
},
{
"speaker": "Andy Watts",
"content": "Yes. I think the short answer to that is yes, we continue to still see accounts coming in to the E&S marketplace. That's number one. Number two, I would say that to my earlier comments, any time the rates are going up or going down, there is opportunity to write a lot of new business. Having said that, there also is sort of a reset in the market. So, I'm going to use my term is sort of -- I'm not going to say chaos, but it's a little bit chaotic in terms of who will do what and how do you get to additional limits or some markets will put out more limits. And so, you've had a lot of very strong results in some carriers domestically and overseas. And those carriers or marketplaces will want to play in the CAT property market. So, I would say that it creates a lot of opportunity for us, but don't lose sight of the fact that I made the comment when you have five years of increasing rates, sometimes we, as the messenger gets shot in the process. Now that works both ways. We pick up a lot business that way, but we also are subject to lose business that way because the buyer is just tired."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Elyse Greenspan with Wells Fargo. Your line is now open."
},
{
"speaker": "Elyse Greenspan",
"content": "My first question, you guys have continued to post pretty strong organic growth within the program segment. I know you guys pointed out, I think -- Powell, you that you guys lapped some one-off revenue last Q1. So, can you just dive into a little bit more detail on what's driving the really strong growth there? And should we expect to persist throughout the rest of the year? And I guess, I'm looking more kind of away just from some of the revenue -- from the captive just in the programs, the traditional programs ex the captive business?"
},
{
"speaker": "Powell Brown",
"content": "And glad that you recognize that strong performance in programs today. We appreciate that. Number one, remember, inside of programs, we have several programs that have either significant wind exposure, that would be CAT property or earthquake exposure. So that's not really a CAT event, but it is an area where there is more competition. So, what I would tell you is we do think that there are good growth opportunities us going forward in programs. We -- as we said last quarter, we have moderated those slightly just because we are starting to see more entrants, i.e., in the E&S space on wind, so CAT wind, and we're starting to see some more competitors in quake. That said, we feel really good about the Programs business, as you know. And we think about it very long term. So, the performance of our underwriting facilities has delivered really good results for our carrier partners. And so, what we find is more and more carrier partners want to come and join our facilities. That doesn't mean that we can put them all in those facilities, but I'm just saying there continues to be a great deal of interest. And I would remind you and everyone else, only 12 short years ago when we bought Arrowhead, there was a feeling that maybe MGAs were not as good as they are today. So, you all in the investment community sort of said, that might be a mistake or you're changing the business or the case may be, and we've been very fortunate, Arrowhead was a very good acquisition, and we got a lot of very good leaders out of it. And so, we're very pleased, but it is interesting how the tide turns. I would also mention one final thing. We have a lender-placed business where we do loan processing and things like that and that business has performed very well in terms of, we've written a lot of new business there as well. So, I hope that answers your question, Elyse."
},
{
"speaker": "Elyse Greenspan",
"content": "Yes. And then my second question is on margin. You guys have said your guidance last quarter, Andy, I think, was slightly up for the full year, obviously started off pretty strong. And it sounds like you're not changing the guidance for contingents, right, because to a prior question, there was no forward. So, does it now feel like margins should come in better than expected for the full year? And how should we think about -- I know there are some headwinds from captives in the back half as we think about losses. But is there anything else you could point out if we just think about, I guess, there's some tailwinds relative to the original margin guide for the full year?"
},
{
"speaker": "Andy Watts",
"content": "We still feel really good about the guidance for the full year right now. And I think to your point, the question is, what's the potential impact, and more than likely in the third quarter, but it could be the fourth quarter of storm claim activity. So, I think would it just be in the first quarter. I was very, very pleased with the first quarter. But I think right now, we're probably hold with still up slightly, but feel -- we feel really good about the year."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Jing Li with KBW. Your line is now open."
},
{
"speaker": "Jing Li",
"content": "I just have a question on the program margin. So, I know you mentioned you included the sale of the service segment. Is it possible to see what's the impact on the margin that can you put a number on? Or..."
},
{
"speaker": "Andy Watts",
"content": "Yes. Jing is probably the easiest way to give that if you go back to the 8-K that we put out in early March, you can kind of see the impact of the businesses, and the businesses that we sold rolled into National Programs, that will give you a pretty easy way to calculate that."
},
{
"speaker": "Jing Li",
"content": "Just follow-up on the Retail segment margin. They also contracted a little year-over-year. Can you please add more color on that?"
},
{
"speaker": "Powell Brown",
"content": "Sure. And I would tell you that, as you know, we don't think one quarter makes a trend. We were very pleased with the organic growth in our Retail business and the amount of new business that we are winning on a net new basis. I'll also tell you that we write business in Q1 and not all the revenue comes in, in Q1, as you know. So, it comes in over subsequent quarters. So having said that, please don't think one quarter, whether it's up slightly, down slightly, create the trend. We're trying to improve the business over the long term. That's one year, three years, five years, 10 years. And if you look at the performance of our retail business in the last, let's say, three years, we're extremely pleased with not only the organic growth, but the margin profile. So, we're very bullish on Retail as we have been. And so, thank you for the question, but I would say that we're very pleased and don't take a little up or a little down too far out of context."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question will come from the line of Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"content": "Powell, I'm just curious, there's some data out this quarter that showed -- stamping that showed E&S kind of premium slowing in some of the major states. I'm wondering if that's what you're experiencing seeing that maybe the standard markets are getting a little more of a risk appetite here and the E&S kind of growth rates that we've been seeing are slowing? Or maybe we're just misinterpreting that?"
},
{
"speaker": "Powell Brown",
"content": "I think, Brian, I would hold judgment on that, and let me tell you why. Let's just use the state of California for a moment. You read a lot about the state of California and what's going on. There was a large carrier that's a direct writer that has a bunch of folks. I think [Caitlin Clark] is a spokesperson for who they just had their carrier in the state downgraded to be, okay? And so, they are talking about non-renewing 30,000 policies in that state. So, the question is, where is it going to go? And the answer is it may go into the fair plan, which is not the desire of the state. And so -- but they may -- that may flow into this fair plan in the near term. Those ultimately may come out of the fair plan and into the E&S market. So, there's an example in the state of California. In the state of Florida, as you probably know, the number of policies in Citizens, the state facility, has technically gone down year-over-year. I think that's a little misleading because what you had is you had a number of depopulation companies come and they allocated those policies to them. So again, in states like California, Florida, as noted, even Texas and others, Louisiana, the insurance commissioners are trying, first and foremost, to create an environment where there is a competitive environment that actually there is affordability and availability. And so, I would not read too much into those early indications because the next time that report comes out, Brian, it might say up substantially. I don't think it would say up substantially, but up. So, I would just hold judgment on that one."
},
{
"speaker": "Brian Meredith",
"content": "Got you. And then specifically on Florida, are you seeing any additional capacity coming at this point because of the legislative changes? I think we're hearing a little bit about that."
},
{
"speaker": "Andy Watts",
"content": "Yes. So, what I would say is the legislative changes, that's going to take time for that fully to bake in. So don't make the assumption that you effectuate a law and then all of a sudden, immediately, they start lining up. It just doesn't work that way. What I would say though is on the flip side, as I described, carriers that might provide a $10 million primary limit on a property might actually provide a $20 million or a $25 million, and we are seeing that on certain properties in Florida. So technically, I view that as more willingness to write and extend limits, which in turn is downward pressure for the buyer, the client -- that's good for the client. And so, we're seeing some of that. It is not all downward. I do not want anybody to come away from this call saying, hey, every piece of property is going down. That is not the case. If you talk to our senior leaders and leaders in Florida and our Retail business, and you said, what's happening in property? Depending on the line or the type of business, they might say it's down in condos. It might be up overall slightly with all properties and -- but there are just very, very unique distinctions in there. So, think not so much legislative action yet, it's more market action."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Grace Carter with Bank of America."
},
{
"speaker": "Grace Carter",
"content": "Looking at the contingent commissions and national program past couple of quarters, even taking out the non-recurring benefit this quarter, there's been some pretty significant growth. I was hoping you could help us kind of frame that across underlying growth in the business versus maybe improvements in underwriting performance versus just the contribution from the relatively low storm activity last year, just to kind of help us think about how that might look going forward and what sort of growth rate we should assume?"
},
{
"speaker": "Andy Watts",
"content": "I think as we mentioned in our comments or prepared remarks, really driven off of both of those factors that are out there. We think we deliver some of the best underwriting results for our carrier partners in the industry. And so, I think that's reflective of the contingent commissions that we're able to participate in. And then with the lower storm claim -- or the lower storm activity last year, that is providing for at least incremental also this year again, we'll kind of see what happens as we get through the storm. And then you've got some which is just based upon the growth in the business. The one thing to keep in mind is Programs is very different than if you look at Retail. And the Retail generally kind of trends right along with the growth in commissions and fees. You can see ups and downs within Programs that you wouldn't get the same correlation in some of the other divisions just because we may qualify for a program -- or qualify for contingent commissions for one program one year and another not inside of there. So, you may see a little bit more volatility over there. Okay."
},
{
"speaker": "Grace Carter",
"content": "And I guess thinking about the interest rate environment, it seems like rates might be staying a bit higher for longer relative to what a lot of economists thought at the beginning of the year. I know that you all said that the competition for M&A has stayed pretty steady so far this year, but just as some of your competitors that have historically been a bit more sensitive to interest rates when considering deal activity, just kind of come to the realization that rates might be higher for longer. Do you expect any sort of changes to the environment when looking at deals for the remainder of the year or everything should stay pretty steady?"
},
{
"speaker": "Powell Brown",
"content": "So, Grace, this is Powell. I would say that we think that it will continue to be a very competitive environment from M&A. Having said that, there are certain firms that are more short term in nature that are highly leveraged that would be more sensitive that to interest rates. And we may see one or some of them not be as active for a period of time because of their debt load. Having said that, there seems to be plenty of other shorter-term firms that are based on leverage that seem to be active as well. So, I don't want you to get the impression that the higher interest rate environment is going to dramatically change the level of competition. That might change the names of the participants, but not the number or how competitive it is. We haven't seen that."
},
{
"speaker": "Andy Watts",
"content": "Grace, I want to come back to one of the things just on the contingent. I know we talked about programs. Just other thing, keep in mind, in Retail, and you saw it in the numbers and everything, contingents were down in the Retail business and year-over-year, about $1.4 million or so is -- and we've had downward pressure on the contingents that we earn within personal lines just based upon overall profitability within personal lines in that -- just that sector right now. We expect that to probably continue on for this year. So, can you just kind of keep that in mind as you're looking at trending on also on retail, okay."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from the line of Scott Heleniak with RBC Capital Markets. Your line is now open."
},
{
"speaker": "Scott Heleniak",
"content": "There's some data showing M&A was slower for the industry in Q1. And just wondering, I know you talked about just a minute ago, what you're seeing in your pipeline and outlook there for 2024 as specific to you because your M&A has held up pretty well in 2023. Just any thoughts there?"
},
{
"speaker": "Powell Brown",
"content": "Sure. Scott, I want you to, again, don't draw too many conclusions from one quarter or even six months. Acquisitions are not linear as you know, and when and why people sell is different. And we are always talking to people to want to be at the table when and if, but it's usually when they decide to sell. And so, we believe it's all about cultural fit and obviously, it has to make sense financially for both parties. But usually, in these competitions when we are talking to someone, it becomes very obvious in the process that there may be on cultural fit, whether that's us or not, maybe it may not be us that fit with that seller. And then many times, that is who they do a transaction with, not exclusively, but many times. And so, when I say that, I would tell you that you'll laugh when I say this, but our pipeline is good. It will be good next quarter. It will probably be good next year or two, and I'm not trying to be funny, but we got plenty of opportunities. It's just a question of do they fit culturally and do they make sense financially. And we're not rushing to do something. The one thing that you may know about us is in the investment community, there are three things that they say about Brown & Brown this with certainty. Number one, we pay with cash. It's hard to argue with greenbacks. Number two, when we give someone a term sheet that is not a license to renegotiate after due diligence like some others. So, we do what we say and say what we do. And three is when we make a decision, we get a up and go. So those, we believe, are three redeeming factors, but we talk to people, and we are trying to make sure that they understand what day two is going to look like, not the process of courtship. And so, we feel really good about the things that we got going on. We got people talking to people all the time. And I think that there will continue to be an enormous amount of consolidation in our industry in the next three to seven years. And we are going to be right here able to look at and/or participate in a lot of it."
},
{
"speaker": "Scott Heleniak",
"content": "Okay. Just the other -- just the other follow-up I had was just -- I know you don't break it out specifically, but anything you can share on organic growth trends outside of the U.S. And just kind of -- I'm not looking for a specific number. Just anything you can comment on in terms of what you're seeing in Europe and with some of the acquisitions you've closed over the past few years. Just any kind of general comment on revenue growth trends you're seeing there?"
},
{
"speaker": "Powell Brown",
"content": "Sure. So, Scott, I would say that it is performing in a very similar fashion to our businesses domestically. So, we're very pleased with the performance of our businesses overseas. And that's not just Europe. I mean, Canada, we got a lot of cool stuff going. But we are very pleased and -- but I would say as a broad statement, I think that its performance is very similar to what we say."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] It comes from the line of Michael Ward with Citi."
},
{
"speaker": "Michael Ward",
"content": "Maybe just taking a step back on programs. There's been a lot of discussion around this. I just -- can you -- are you able to help us understand the breakout in the strength just between rate versus exposure versus new business?"
},
{
"speaker": "Andy Watts",
"content": "Andy here. So, we don't break out that level of granularity, but we're very pleased with the growth in the business of what we're driving from new business where we are on policy retention in that business as well as the rate mix across all the programs again to Powell’s earlier comment. Depends on individual programs, they can be impacted more or less by rate, but we operate 60 programs around the world. And so, we're really pleased with the overall mix. But generally, that overall business as well as the others, a lot of ours comes out of net new business as we talked about."
},
{
"speaker": "Powell Brown",
"content": "Let me mention one other thing, Mike, just as a broad statement, I know you know this. But remember, we're underwriting on behalf of our carry partners. So, we have this enormous responsibility to try to the best of our ability to write good risks. And so, we take that responsibility very seriously. And having said that, the growth that we have enjoyed, albeit quite good is I have to -- you've got to understand, we are doing our jobs of risk selection. So, what I'm trying to say is that is not we write everything that moves. And I know you know that, but I think it's important for everybody to hear that. There is a lot of business that just doesn't fit and that's okay. And so, we would rather show disciplined underwriting on both ends of that spectrum. So, some people -- and by the way, we've grown very nicely. But the answer is if we didn't do it the way we've done it, it could have grown a lot more, but the results longer term for our carrier partners would not have been as good. So very important distinction."
},
{
"speaker": "Andy Watts",
"content": "Well -- and also that one, Mike, is you can do that short term and grow the heck out of it. We also lose the contingents that probably come along with it, and that's an important part of our business because we want to make sure that we're placing good business for our carrier partners. We don't want to go through a carrier change. That's really painful for everybody. So, we try to think about these for a longer-term horizon rather than just growing it by a quarter or over four quarters."
},
{
"speaker": "Michael Ward",
"content": "Got it. Really helpful. Maybe just thinking back to your comments, Powell, around casualty and liability pricing ticking up. Just sort of curious your views like if you think we're kind of in the earlier innings of something a continued sort of upward trend or if it seems a little bit more short term?"
},
{
"speaker": "Powell Brown",
"content": "Well, Mike, it's -- as I said, I've only been in the insurance business for 34 years. And in that period of time, it seems most of that time, there's been downward pressure on GL rates. And now there is -- as you've read and are starting to see, there's more and more adverse development in the last couple accident years particularly '19, '18, maybe '20. And so, if you talk to our carrier partners more on a philosophical level, not just on an individual risk level, I think there is a feeling that there could be, well, a logical response would be there could and should be some upward pressure on liability rates in the near to intermediate term. That means the next several years. That's what I think the logic and the rationale would say. That said, our industry has never been known for being, on the risk-bearing side, totally rational or totally logical. But based on what I've seen, I think we're going to continue to see more upward pressure on excess, meaning umbrellas. And I do think we're going to start to see it may not be a big bump. I'm not talking about boom goes north, real fab, but I think we're going to continue to see some upward pressure on general liability, and it's not going to be this year or next year. It could be a couple of years."
},
{
"speaker": "Michael Ward",
"content": "Really helpful. Maybe if I could sneak one specific one just on dealer services. Just curious what you guys are seeing in terms of like inventory levels out there and activity in that segment."
},
{
"speaker": "Andy Watts",
"content": "Mike, it's Andy here. I think what we've seen, at least over kind of the last year or so in that range is inventories are back, probably not to where they were, we'll call it pre-COVID, but you can find cars and trucks today and RVs because we work in that space, which is good. I think you're seeing some of the prices for used cars are coming down a little bit that are out there. You've got some sensitivity around interest rates depending upon the profile of the buyer and everything. But I think our overall customer base is doing well. We're continuing to win more customers in that space and feel good about the outlook in comparison to kind of where we were coming down off of the highs of COVID when -- I mean, cars and trucks were just flying off the lots back then. We feel like we've kind of got through that space. So, we don't have at least today, thinking that we've got any headwinds coming at us."
},
{
"speaker": "Operator",
"content": "At this time, I'm currently showing no further questions. I would like to hand the conference back over to Mr. Powell Brown for closing comments."
},
{
"speaker": "Powell Brown",
"content": "Thanks, Norma, and thanks, everybody, for joining us. I just want to make a couple of concluding comments. One, we are seeing a lot of new business opportunities and capturing those. So, I'm very pleased about the amount of new business that we're writing and the net new that that's translating through into our books. Number two, change creates opportunity. And so, the changes that you've heard today, and I'm specifically thinking about CAT property, although it creates some chaos, that creates some opportunity and most importantly, it creates benefits for our customers. So, I just want to mention that. And three, relative to the acquisition space, we don't have a hard and fast rule of exactly how much we want to buy every year. We have a goal that we'd like to shoot at. But it's always about acquisitions that fit culturally and make sense financially. Do I think there are going to be a lot of opportunities this year? I do. Do I think there will be more next year? I think the -- I don't know if there's going to be more, but I think there will be an equal amount. I think there's lots of change ahead in distribution. I think there are a lot of firms that are owned that are -- that have private equity backing that are trying to figure out what the next step is. And so, it's going to be an interesting time. I'm not signaling one over the other. That's not what I'm trying to say. But we feel really good about the business. We had a great quarter. We feel really good going into Q2. And we look forward to talking to you next time. You all have a nice day. Good day, and good luck. Goodbye."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a wonderful day."
}
] |
bsx | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Boston Scientific Fourth Quarter 2024 Earnings Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jon Monson, Senior Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Robert Marcus",
"content": "Thank you, Drew, and thanks, everyone, for joining us. With me today are Mike Mahoney, Chairman and Chief Executive Officer; and Dan Brennan, Executive Vice President and Chief Financial Officer. During the Q&A session, Mike and Dan will be joined by our Chief Medical Officer, Dr. Ken Stein. We issued a press release earlier this morning announcing our Q4 and full year 2024 results which included reconciliations of the non-GAAP measures used in this release. The release as well as reconciliations of the non-GAAP measures used in today's call can be found on the Investor Relations section of our website. Please note that on the call, operational revenue excludes the impact of foreign currency fluctuations, and organic revenue further excludes acquisitions and divestitures for which there are less than a full period of comparable net sales. Guidance excludes the previously announced agreements to acquire Bolt Medical and Intera Oncology, which are expected to close in the first half of 2025 subject to customary closing conditions. For more information, please refer to the Q4 financial and operational highlights deck, which may be found on the Investor Relations section of our website. On this call, all references to sales and revenue are organic and relative growth as compared to the same quarter of the prior year, unless otherwise specified. This call contains forward-looking statements regarding, among other things, our financial performance, business plans and product performance and development. These statements are based on our current beliefs using information available to us as of today's date and are not intended to be guarantees of future events or performance. If our underlying assumptions turn out to be incorrect, where certain risks or uncertainties materialize, actual results could vary materially from those projected by the forward-looking statements. Factors that may cause such differences are discussed in our periodic reports and other filings with the SEC, including the Risk Factors section of our most recent annual report on Form 10-K. Boston Scientific Corporation disclaims any intention or obligation to update these forward-looking statements except as required by law. At this point, I'll turn the call over to Michael Mahoney."
},
{
"speaker": "Michael Mahoney",
"content": "Great. Well done, Jonathan. Thank you everyone for joining us today. In 2024, we had an excellent performance across the board, surpassing our financial goals that we set for the year. This outstanding and differentiated performance is fueled by innovation, and great execution across our global business units, and the earlier than expected approval and adoption of FerraPulse in the U.S. In fourth quarter 2024, company operational sales grew 23% and organic sales grew 20%, exceeding the high end of our guidance range of 14% to 16%. Full year 2024 operational sales grew 18.5% while organic sales grew 16% for the year, exceeding our guidance of approximately 15%. We believe that most of our global business units grew in line or faster than their respective markets in 2024, which is a testament to our broad diversified product portfolio and the winning spirit of our global teams. Fourth quarter adjusted EPS of $0.70 grew 26%, exceeding the high end of guidance range of $0.64 to $0.66. Full year adjusted EPS of $2.51 grew 22%, also exceeding the high end range of our guidance of $2.40 to $2.47. For the year, we drove 70 basis points of adjusted operating margin to 27%, representing a balance of margin drop through and the revenue upside we saw throughout the year, along with the reinvestment back into the business to drive long-term differentiated growth. Our 2025 outlook, we expect our differentiated financial performance to continue, fueled by our innovative portfolio and strong global execution. And we're guiding to organic growth of 14% to 16% and 10% to 12% for the full year. Our first quarter 2025 adjusted EPS guide is $0.66 to $0.68. We expect our full year adjusted EPS to be $2.80 to $2.87, representing growth of 12% to 14%. Daniel Brennan will provide more details on the financials, and then I'll provide some initial highlights in 2024. Originally, on operational basis, the U.S. grew 31% for the fourth quarter, full year 2024 was 21%, with double-digit growth in six of our eight business units. On an operational basis, Middle East Europe, Middle East and Africa grew 12% in fourth quarter and 14% on the full year. In 2024, we saw above market growth from all business units supported by strong commercial execution, talking about Europe here, and key franchises across the portfolio as well as price discipline. We expect to outpace the market again in 2025 with further momentum in EP, following the recent approval of Fairwave NAV, and increasing contribution from our growth in merchant markets. In Asia Pac, we grew 12% operationally in fourth quarter and 16% for the full year, led by excellent performance and double-digit growth across Japan, China, Australia, New Zealand. Japan really had a nice year growing double digits for the second year in a row. Driven by agent DCB, Resume Watchful Flex Pro, and very early contribution from FerraPulse. On a full year basis, China grew strong double digits across $1 billion in revenue. This differentiated growth in China was fueled by a broad portfolio focus on innovation and excellent commercial execution. Looking ahead, we expect China to grow mid-teens with increasing contribution from Ferropolz and our diverse portfolio, despite the ongoing VBP pricing pressures in the region. I'll now provide some additional commentary on our businesses starting with urology, which grew 8% in the fourth quarter, and 9% for the full year, and on an operational basis grew 20% in fourth quarter and 13% for the full year, following the November close of Axonics. Full year organic growth was fueled by prosthetic urology and stone management, where we had key launches with the Tannacio pump, at AMS-700, and continued success with our expanding LithaView portfolio. Prostate Health also performed well in 2024 with double-digit growth in Resume as well as strong performance and space work. We're pleased to have enrolled our first patient in the HydroSpace trial evaluating the safety and efficacy of our spacer hydrogel. In 2025, we expect to see continued strong above market growth for urology, and look forward to further integrating the highly complementary Axonics technologies into our portfolio."
},
{
"speaker": "Daniel Brennan",
"content": "Endoscopy sales grew 8% operationally and 7% in the fourth quarter organically. On a full-year basis, grew 9% operationally and 8% organically. Full year growth was led by double digit growth in our endoluminal surgery and single use imaging franchises along with sustained growth of our Axios platform, where we're investing to drive expanded indications and most recently receiving approval in Japan for Axios for gallbladder drainage. We Within endoluminal surgery, we continue to see positive reimbursement wins for our ESG weight loss Procedure. The recent category one CPT code announced, and now IFSO, an international bariatric committee endorsing ESG with guideline updates. Neuromodulation sales grew 12% operationally and 5% organic in Q4, and the full year basis grew 14% operationally and 3% organically. Brain franchise grew mid single digits in both the quarter and on a full year basis. And our pain franchise grew mid-single digits in the quarter and low single digits for the year. Within deep brain stimulation, we expect improving growth in 2025, with the recent FDA and CE Mark approvals of our unique Cartigia X and HX leads. The first and only sixteen contact directional leads that deliver precise personalized therapy. We also expect higher growth in our pain franchise in 2025, driven by continued strong momentum at Intercept, and the recently released data supporting safety, effectiveness, and durability through five years now. Cardiology delivered an exceptional quarter and year with sales growing 32% in fourth quarter and 25% for the full year. Within cardiology, interventional cardiology therapies sales grew 10% in fourth quarter and 11% for the full year. On a full year basis, the coronary therapies franchise growth driven by strong global performance, in our imaging and complex PCI franchises. And earlier momentum with the U.S. Launch of Agent DCB, which now has additional reimbursement in the outpatient setting. In addition, we recently announced our agreements acquired Bolt Medical, an intravascular lithotripsy platform for treatment of coronary and peripheral artery disease. Bolt's IVL technology is highly synergistic with our existing suite of devices in complex PCI imaging and drug eluting portfolios in both ICTX and PI. And we're excited to close the BOLD acquisition, which we expect to do so in the first half of this year. Our structural heart valves franchise grew double digits for the full year and low single digits fourth quarter. During fourth quarter, we launched our next generation Acura Prime Valve, in Europe, which features frame enhancements, simplified deployment mechanism, and includes a larger valve size. Watchmen sales grew 20% in the fourth quarter and 19% on a full year basis. U.S. Fourth quarter growth of 20% was both bolstered by an increase in concomitant procedures enabled by the new DRG which became effective in October. And positive data from our option trial demonstrating a similar stroke risk reduction with superior bleed risk reduction. Versus OACs in high risk patients following AF ablation. These positive outcomes from option were reaffirmed by data in the concomitant subset of Patience, which was recently presented at the AF Symposium. We're pleased with the performance of our Watchmen business in 2024 and expect this market to continue to grow approximately 20% driven by concomitant procedures ongoing clinical evidence and our initiatives to drive patient awareness, and physician training. Cardiac Rhythm Management sales grew 3% in the quarter and on a full year basis. Our diagnostics franchise grew double digits on a full year basis in outpatient market growth. Driven by our implantable cardiac monitors with early contribution from our Luxe DXG In Europe, In core CRM, in both fourth quarter, and on a full-year basis, both our high-end and low voltage business grew low single digits. As we look ahead, we're excited to bring our EMPowered Levios pacemaker and module the Centimeters system to market in 2025, likely in the second half of the year. Electrophysiology sales grew 172% in fourth quarter. And 139% on a full year basis. FerraPulse has continued to lead the transformation of the AFib market, surpassing $1 billion in revenue in 2024 globally, with over 200,000 patients treated. We expect the AF market to continue to rapidly convert to PFA in 2025 and beyond driven by FerraPulse's exceptional fourth-quarter sales performance, which was driven by FerraPulse uptake in the U.S. and Europe, as a result of a very strong safety profile, ease of use, and procedural efficiency, as well as our launches in both Japan and China. Initial feedback on our integrated system of Fairwave NAV on our OPAL mapping system, which we launched during the fourth quarter in the U.S, has been very positive. We expect to continue to enhance our capabilities in this segment of the market, including with our recently closed acquisition of Cortex, an advanced AF mapping solution. We continue to build the best-in-class compendium of clinical evidence, including the recent results of Phase one of the ADDvantage AF trial. The data demonstrating positive outcomes using FerraPulse system in AF patients, meeting the primary endpoint for efficacy and safety. With zero instances of stroke, pulmonary vein stenosis, esophageal injury, or major access complications. We expect an updated label for persistent AF in the second half of the year. In the coming weeks, we expect to complete the enrollment of Avantgarde evaluating the safety net efficacy of FerraPulse as a first-line treatment for persistent AF compared to antiarrhythmic direct therapy. Additionally, we anticipate data to be presented in the first half of this year from phase two of the ADDvantage AF trial. Evaluating FerraPoint, which is our point-by-point PSA ablation catheter, which is expected to support US FDA approval by year-end 2025. Turning to Purple Interventions, fourth quarter sales grew 22% operationally and 12% organically, on a full year basis, grew 15% operationally and 11% organic. Our interventional oncology and embolization franchise excelled again in 2024, with double-digit growth across the entire product portfolio, and growing mid-teens for the full year. Expanding clinical evidence for new indications continues to be a focus area. We're pleased to have completed enrollment in the first phase of the FRONTIER trial, which is an early feasibility study for the use of Therosphere to treat recurrent glioblastoma. Additionally, we look forward to closing our acquisition of Entera, expecting the first half of 2025, which will broaden our interventional oncology offerings to patients with liver cancer. Within our vascular franchise, on a full year basis, we saw high single-digit arterial performance led by double-digit growth in our drug-leaving portfolio and mid single-digit venous growth led by Gerathena in our cloud management portfolio. On a standalone basis, the silica business grew double digits for the full year and we're pleased to recently share the 30-day results from the ROADSFR-three study demonstrating the safety and effectiveness of TCAR for patients with standard surgical risk. So in closing, I'm very proud of our global team and what we're able to accomplish 2024 resulting in full-year organic growth of 16 adjusted EPS growth of 22%. We're very excited about the future of Boston Scientific Corporation and remain focused on our talents while enhancing our culture that is relentless in driving differentiated results. With that, I'll pass it off to Daniel Brennan to provide more details on the financials."
},
{
"speaker": "Daniel Brennan",
"content": "Thanks, Michael. Fourth-quarter 2024 consolidated revenue of $4.561 billion represents 22.4% growth versus fourth quarter 2023, and includes a 70 basis point headwind from foreign exchange, which was unfavorable versus our expectations. Excluding this $26 million foreign exchange headwind, operational revenue growth was 23.1% in the quarter. Sales impact from closed acquisitions contributed 360 basis points resulting in 19.5% organic revenue growth, exceeding our fourth quarter guidance range of 14% to 16%. Q4 2024 adjusted earnings per share of $0.70 grew 26% versus 2023, exceeding the high end of our guidance range of $0.64 to $0.66, primarily driven by our strong sales performance and favorable tax results. Full-year 2024 consolidated revenue of $16.747 billion represents 17.6% reported growth versus full year 2023 and includes a 90 basis point headwind from foreign exchange. Excluding this $127 million headwind from foreign exchange, operational revenue growth for the year was 18.5%. Sales from closed acquisitions contributed 210 basis points resulting in 16.4% organic revenue growth exceeding our guidance range of approximately 15%. Full-year 2024 adjusted earnings per share of $2.51 grew 22% versus 2023 exceeding the high end of our guidance range of $2.45 to $2.47. These results include a $0.05 headwind from FX which was slightly unfavorable to our expectation. Adjusted gross margin for the fourth quarter was 70.6%, which represents a 20 basis point sequential improvement versus the third quarter and results in full-year 2024 adjusted gross margin of 70.3%. In 2025, we anticipate our full-year adjusted gross margin improving from full-year 2024, and contribute to our adjusted operating margin expansion goal. Fourth-quarter adjusted operating margin was 27.4%, resulting in a full-year 2024 adjusted operating margin of 27.0%, improving 70 basis points versus the full year 2023. We expect to expand adjusted operating margin in 2025 by another 50 to 75 basis points balancing differentiated operating margin expansion, while making targeted investments to fuel long-term top line. On a GAAP basis, fourth-quarter operating margin was 14.8%, resulting in a full-year reported operating margin of 15.5%. Moving to below the line, fourth-quarter adjusted interest and other expenses totaled $87 million resulting in full-year adjusted interest and other expenses of $301 million in line with our expectations. On an adjusted basis, our tax rate for the fourth quarter was 11.9% for the full year 2024, including favorable discrete tax items and the benefit from stock compensation accounting. Our operational tax rate was 12.3% for the fourth quarter, and 13.2% for the full year, again, in line with expectations. Fully diluted weighted average shares outstanding ended at 1.149 billion shares in Q4, and 1.486 billion shares for the full year 2024. Free cash flow for the quarter was $1.181 billion, with $1.456 billion from operating activities less $275 million in net capital expenditures which include payments of $177 million related to acquisitions, restructuring, litigation and other special items. Full-year 2024 free cash flow was $2.648 billion, exceeding our expectations and importantly achieving 71% free cash flow conversion for the year. For 2025, we expect free cash flow to be in excess of $3 billion. As of December 31, 2024, we had cash on hand of $414 million and our gross debt leverage ratio was 2.2 times. Our top capital allocation priority remains strategic tuck-in M&A, followed by annual share repurchases. Our legal reserve was $326 million as of December 31, representing a $76 million increase versus Q3 2024, $50 million of this reserve is already funded through our qualified settlement funds. I will now walk through guidance for Q1 and the full year 2025. We expect full-year 2025 reported revenue growth to be in a range of 12.5% to 14.5% versus 2024. Excluding an approximate 100 basis point headwind from foreign exchange, based on current rates, expect full-year 2025 operational growth to be in a range of 13.5% to 15.5%. Excluding a 350 basis point contribution from closed acquisitions, we expect full-year 2025 organic revenue growth to be in a range of 10% to 12% versus 2024. We expect first-quarter 2025 reported revenue growth to be in a range of 17% to 19% versus the first quarter of 2024, excluding an approximate 100 basis point headwind from foreign exchange, based on current rates, we expect first-quarter 2025 operational revenue growth to be in a range of 18% to 20%. Excluding a 400 basis point contribution from closed acquisitions, we expect first-quarter 2025 organic revenue growth to be in a range of 14% to 16% versus 2024. As we indicated on our October call,"
},
{
"speaker": "Jonathan Monson",
"content": "we had one more business day in the fourth quarter of 2024, which was worth approximately 200 basis points. In the first quarter of 2025, we have one less business day again worth approximately 200 basis points. When adjusting for the impact of business days,"
},
{
"speaker": "Daniel Brennan",
"content": "the high end of our first-quarter 2025 guidance range is in line with fourth-quarter 2024 organic revenue growth."
},
{
"speaker": "Jonathan Monson",
"content": "We expect full-year 2025 adjusted below-the-line expense to be approximately $425 million. Under current legislation, including enacted laws and issued guidance, we forecast a full-year 2025 operational tax rate of approximately 13.5%, and an adjusted tax rate of approximately 12.5%. This includes a benefit from the accounting for stock compensation which we expect will be largely recognized in the first quarter resulting in a forecasted Q1 2025 adjusted tax rate of approximately 11.5%. Expect full-year adjusted earnings per share to be in a range of $2.80 to $2.87 representing growth of 12% to 14% versus 2024, including an approximate $0.05 to $0.06 headwind from foreign exchange which is in line with what we saw in 2024. We expect first-quarter adjusted earnings per share to be in a range of $0.66 to $0.68 as it relates to tariffs. We do not have significant levels of manufacturing in or sourcing from Mexico, Canada, or China. As such, while the recent executive actions relative to these countries could present a minor headwind for the year, we view these headwinds as manageable, and they've been contemplated in our guidance ranges. In closing, I'm extremely proud of what our global team delivered for 2024 financial performance and look forward to executing on our full-year 2025 guidance of 10% to 12% organic revenue growth, 50 to 75 basis points of adjusted operating margin expansion, 12% to 14% adjusted EPS growth. For more information, please check our Investor Relations website for Q4 2024 financial and operational highlights which outline more details on Q4 results and 2025 guidance. And with that, I'll turn it back to Jonathan Monson, who will moderate Q&A."
},
{
"speaker": "Jonathan Monson",
"content": "Thanks, Daniel. Drew, let's open it up for questions for the next thirty-five minutes or so. In order for us to take as many questions as possible, please limit yourself to one question. Drew, please go ahead."
},
{
"speaker": "Operator",
"content": "We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the key. If at any time your question has been addressed, and you'd like to withdraw your question, please press star then two. Again, please limit yourself to one question. At this time, we will pause momentarily to assemble our roster. The first question comes from Robert Marcus with JPMorgan. Please go ahead."
},
{
"speaker": "Robert Marcus",
"content": "Oh, great. Good morning, and congratulations on a really good fourth quarter. Wanted to ask on PFA and Watchmen. You had very good fourth quarters here. So, a slight tick-up in in U.S. growth in Watchmen. Would love to get your thoughts on sort of what you saw during the quarter after concomitant reimbursement kicked in October first and the option trial. And how you're thinking specifically about those products throughout 2025 given they're two of your better margin products and the implications. Thanks a lot."
},
{
"speaker": "Daniel Brennan",
"content": "Thanks, Robert. Yeah, we have excellent momentum in both FerraPulse and Watchmen, and increasing momentum, I would say. With Watchmen, we did see a bit of a benefit at the end of the fourth quarter with the concomitant news, which confirmed, based on the option trial data, safety and efficacy, with the reimbursement, we saw a little bit of uptick. As we stated before, we think the concomitant reinforces the 20% market CAGR for 2025. We'll be excited about the option readout in the first half of 2026. So we're well positioned with Watchmen. And we obviously continue to invest in our product portfolio, clinical evidence, our clinical teams around the world to fully maximize the concomitant opportunity. And obviously, with the momentum of FerraPulse, and our broader Rhythm Management Portfolio, ideally becoming the partner of choice for AFib and electrophysiologist. FerraPulse, I think the numbers are pretty stand out. Tremendous growth is the biggest transformation that I've seen in MedTech over $1 billion globally in one year. We launched less than a year ago in the U.S., so the execution of our commercial teams has been strong. The execution of our supply chain operation manufacturing to stay ahead of demand has really been impressive. We don't anticipate demand or I'm sorry, supply challenges given the investments that we made throughout the year. And so we're excited about our competitive position with FerraPulse in 2025. You've seen the clinical data. It's a bit unclear as to the competitive landscape in 2025 but we put that aside and we push every day to invest in our commercial execution our R&D and we want to become the clear leader as we are now in PFA as PFA is really transforming this market."
},
{
"speaker": "Robert Marcus",
"content": "Appreciate it. Thanks a lot."
},
{
"speaker": "Operator",
"content": "The next question comes from Lawrence Biegelsen with Wells Fargo. Please go ahead."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Obviously, a stellar quarter and year. Mike and Dan, I was hoping to ask one kind of long-term question. At JPMorgan, you increased your weighted average market growth to 9% in 2026. And, you know, I know you expect to grow faster than your end mark so does this imply you see Boston Scientific Corporation as at least a 9% grower in 2026? And can you grow EPS double-digits next year with the tax rate increasing by 200 to 300 basis points? Thanks a lot."
},
{
"speaker": "Michael Mahoney",
"content": "Sure, and, obviously, we're not gonna give any specific guidance relative to anything beyond 2025. But I think safe to assume as we've done over the last decade very well as a team, we seek to outgrow our end markets. So as those grow at an increasing rate, we still look to outgrow those markets. So I would stay tuned as we get through the year, potentially have an Investor Day at the end of this year and reset those goals for the long term. But we're excited if you look over the last decade to see the increase in that WAMGR very intentionally over that timeframe with both internal investments as well as smart tuck in acquisitions to get to that 9% by 2026. Relative to double-digit EPS, again, I I point to the track record, extremely strong record of double-digit adjusted EPS growth. That's always the goal. We'll see what happens to the tax rate. That could be obviously a fluid environment. In Washington, so if there's even an increase in that tax rate, our goal will still be to get double the GDP growth in 2026 and beyond."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Alright. Thanks, Daniel."
},
{
"speaker": "Operator",
"content": "The next question comes from Frederick Wise with Stifel. Please go ahead."
},
{
"speaker": "Frederick Wise",
"content": "Good morning, everybody, and thanks for the great quarter. Maybe it's a one and a quarter of a question. You typically start the year in what I like to call prudently conservative fashion in recent years. Maybe you can help us better understand where the upside and where the risks are. And should we view this as another attempt to start the year in a thoughtfully, prudently conservative fashion. And related to that, Daniel, how are you thinking about competition on the PFA side coming in? What is dialed into your guidance at this point? Thank you."
},
{
"speaker": "Michael Mahoney",
"content": "Hey, Frederick. You certainly want us to be thoughtful and prudent which we always are. Our guidance, and we have a nice track record of delivering on our commitments. So I would say that's the same strategy as we provided the guide in 2025. Clearly, the company has a lot of momentum. I would say we do have more tailwinds. You know, when you think about the tailwinds, there's a lot of momentum across every region. You obviously know about the FairPulse momentum in the U.S., and we're early days of our launch in Japan and China, a dominant really a big shout out to our coronary team, ICTX, with the agent launch. Other businesses like IO growing mid-teens, and our Endo Euro, PI, and Neuromod business, all very solid growth and we expect Neuromod to be above market in 2025. So strong momentum there on the tailwind side. There could be stronger PFA competition in 2025. A lot of that is, you know, out of our hands, but we, as I said before, we're focused on driving forward when we'll see every day, China VBP is more extensive this year in 2025 than it has been in the past. But despite that, we expect to grow mid-teens in China in 2025, but that'll be a little more difficult for us this year. And, you know, there are also some continuing strengthening lower cost competitors, I would say, for some of our med surg businesses in Asia. And in Europe. And the team is focused on our portfolio and innovation to counteract that, but that is a bit of a headwind for us in our endo and euro business. But overall, we feel that we certainly do have more tailwinds than headwinds and we are looking forward to it here."
},
{
"speaker": "Frederick Wise",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Joanne Wuensch with Citibank. Please go ahead."
},
{
"speaker": "Joanne Wuensch",
"content": "Good morning and nice end to the year. I want to spend just a little bit of time talking about margins, interest expansion. Sort of curious how do you think about managing that and I'm gonna sneak in a cash flow question. You're kicking out a lot of cash, how do you think about investing it? Thank you."
},
{
"speaker": "Daniel Brennan",
"content": "Sure, Joanne. I I can take that. I'll tell you what I really like about 2025 is the equation the operating margin expansion. Done it very well over the last decade each year with a variety of different scenarios. But I think one of the optimal scenarios is where gross margin goes north, SG and A, you get leverage. And then I think in 2025, you might actually see a little bit of an uptick in R and D spend as a percentage of sales. I think that's a winning hand for how to increase operating margin overall. And so in our 50 to 75 basis points, I'd look for gross margin to get better versus the 70.3% that we put up in 2024. I'd look for SG and A on the 10% to 12% sales growth to improve its leverage there and deliver margin expansion. And then, again, on R and D, not a significant increase. But, you know, maybe 20, 30 basis points of an uptick in R and D. To continue to help to fuel the top-line growth for the long term. I think that's a great equation for 25% for margin expansion. Cash flow, Oh, I could. You saw in if you heard in the commentary, we got to 71% free cash flow conversion. That wasn't by accident. That's a tremendous effort by the entire global team. On reducing DIOH, reducing DSO strong working capital management and of course, obviously significant growth in operating income. In terms of our capital allocation strategy, no change. It's worked well for us again over the last decade to have the number one priority for our for use of our cash to be high-quality tuck in innovative M&A. That will continue and then annual share repurchase after that. We ended the year at 2.2 times debt after the Axonics and Silk Road acquisitions. We're in a real great spot to continue to do that strategy and execute that strategy in 2025 and beyond."
},
{
"speaker": "Joanne Wuensch",
"content": "Terrific. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from David Roman with Goldman Sachs. Please go ahead."
},
{
"speaker": "David Roman",
"content": "Thank you. Good morning, everybody. I wanted just to dive into some of the different drivers here around the EP business. Clearly, on the FerraPulse side, you've seen huge conversion on that de novo paroxysmal segment of the market. But as you gain a persistent indication and then also launch FerraPoint exiting 2026, can you maybe help us think about the segment of the market that you're not able to address today and how much market becomes available to you with FerraPoint and the persistent indication? And then maybe as a corollary to that, help us think through kind of the the mapping strategy given your installed base relative to the other two participants in the market? And how you're thinking about remaining an open platform versus potentially looking to become more closed on as as some of your peers are?"
},
{
"speaker": "Michael Mahoney",
"content": "I'll turn over to Dr. Stein here."
},
{
"speaker": "Kenneth Stein",
"content": "Thanks, David. I'm going to start with the mapping strategy first. I guess as you point out, right, we intend to maintain an open platform. We don't need to force people to use our OPAL mapping system. And I think it's actually really important as we look o six. How the business evolves globally, as well as we look at potential future moves into, like, an ASC type environment. To be able to support doing cases without mapping. To be able to support doing cases with competitive mapping systems but also to provide differentiated features within OPAL and our Fairview software package. Yes. I think it provides the best possible solution for people who want to map their cases. And even though it's early into the launch of Fairwave Nav and Fairview in the US, we've really been very pleased with the feedback that we've gotten. Thus far. In terms of drivers, an important technology, right, that. The persistent atrial fibrillation population just in prevalence terms, is at least as large and probably larger than the population with paroxysmal atrial fibrillation. I'd also acknowledge that we are already seeing off-label use of FerraPulse in treating patients with atrial with persistent atrial fibrillation. It's why it was important for us to run trials like VANTAGE and Avant Garde, I think everyone's seen the data from the ADVANTAGE trial. And that all of our endpoints in terms of safety and efficacy in treating persistent atrial fibrillation. And so we do anticipate getting that label by the end of this year. Beyond that, right, then the next drivers in terms of at least expanding our labeling, as you say, getting FerraPoint to be used as an adjunct for treating atrial flutter in patients who are undergoing ablation for atrial fibrillation. Avant Garde moving to first-line therapy and also our REMATCH trial, which will qualify labeling beyond de novo use, but use in patients where they're going through repeat anti-ablations procedures."
},
{
"speaker": "David Roman",
"content": "Very helpful. Thanks so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Travis Steed with Bank of America. Please go ahead."
},
{
"speaker": "Travis Steed",
"content": "Hey, congrats on the quarter and also thanks for posting the slide deck early on. That was really helpful. I wanted to ask about M&A strategy. Now that you're kind of analyzing kind of seventeen billion in revenue and that revenue base is growing so fast. So much faster. Like, how do you balance that it's gonna take a larger deal to kinda move the needle on such a larger revenue base, but also, you know, finding growth accretive deals that, now that your baseline growth is so much faster already, just kind of thinking about like, your M&A strategy changes now that you're a bigger company and growing so much faster?"
},
{
"speaker": "Michael Mahoney",
"content": "It doesn't change that much. We're always investing for the long term at Boston Scientific Corporation. We obviously gave 2025 guide, but as we've said before, another conference in January, we're investing for products that won't be launched until 2030. Through internal organic M&A, through our VC portfolio, which is very extensive. We did nine new investments in our VC portfolio in 2025. And you're aware of the tuck-in acquisitions that we've done in 2025 for four or five of those. And so the formula remains. We really are focused on increasing our WAMGR, which was Dan talked about earlier, which just by 9% in 2026. Growing fashion that WAMGR consistently quarter by quarter, year over year, doing everything we can to enhance that WAMGR through those tools of internal R and D, VC portfolio and tuck-in M&A. So as the company gets larger, become larger every year, and we continue to find ways to improve our WAMGR and exceed the growth of our WAMR. So we placed a lot of focus and time internally on ensuring that we'll be a differentiated company in 2030 beyond 2025."
},
{
"speaker": "Travis Steed",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick Wood with Morgan Stanley. Please go ahead."
},
{
"speaker": "Patrick Wood",
"content": "Beautiful. I'd love to just broaden out a little bit. I appreciate the endoscopy business is kind of singles and doubles. But, you know, obviously, you guys have been flagging Apollo ESG. Quite a unique approach and illuminal. I'm super curious even though they're down a bit, there's a chunk of sleeves that are still done in the US, and it seems like a way better approach. I'm super curious how you think midterm, you know, how big that business could be, how you're feeling about the initial launch there, and just anything you gotta give us on ESG, I'd love to hear it. Thanks."
},
{
"speaker": "Michael Mahoney",
"content": "I would say that ties to the previous question. Investing in ESG now. We have a dedicated team that our group has organized on the ESG product around Apollo. We have dedicated clinical trials to broaden that indication out, improve the clinical science behind it. We have some recent momentum with CPG codes. So it's gonna be a nice driver over the long term for Endo. Yeah, it's not gonna reshape Boston Scientific Corporation or Endo in 2025. But we definitely see positive support by the physicians, by the industry groups, the reimbursements. We're unique and we're likely the only one who can offer the Apollo Procedure wrapped around with our other endo tools. So we think this will be a significant growth driver for Endo as you look towards the longer term of this wrap plant."
},
{
"speaker": "Patrick Wood",
"content": "Love it. Thanks for the question."
},
{
"speaker": "Operator",
"content": "The next question comes from Danielle Antalffy with UBS. Please go ahead."
},
{
"speaker": "Danielle Antalffy",
"content": "Hey. Good morning, everyone. Thanks so much for taking the question. Congrats on a really strong year. Just a quick question at a high level. You know, we talk we focus so much on the major growth drivers like FerraPulse and Watchmen. I'm just curious, Mike or Dan, where you think Boston Scientific Corporation's either underperforming or under-indexed, but see an opportunity or line of sight into improving performance over the next year or two. That maybe the street's under modeling or not appreciating. Thanks so much."
},
{
"speaker": "Michael Mahoney",
"content": "Yes. So most of our businesses did well against peers in the market and growing faster than the CAGR. Even if you take out Watchmen and FerraPulse results, the rest of businesses grew faster than WAMCORE. A couple of areas that we want to improve on in 2025, one is the overall NERMOT performance, which we anticipate will have a nicer improvement in 2025. With the launch in our DBS platform, we expect that to gain momentum in 2025. In the combination of our refocused commercial team in pain, and the benefit of relieving. So we do anticipate a better year for Neuromod. We want to strengthen US CRM. We continue to maintain share, I would say, in terms of the unit volume perspective and high voltage. We don't have the portfolio yet in Leadless Pacemaker. Which has a strong higher ASP which is driving on a dollar basis share loss in PACER. So we'd like to see improvement in our overall U.S. CRM business. We're launching SICU with a Leadless pacemaker in the back half of 2025. And we'll have increased focus on that business in 2025. So we'd like to see some improvements there. And as I mentioned before, we do see some increasing competition in some of our businesses from the lower cost competitors. So we're challenging our team to continue to drive a lower cost portfolio so we can serve our global customers more efficiently."
},
{
"speaker": "Danielle Antalffy",
"content": "Thank you for that."
},
{
"speaker": "Operator",
"content": "The next question comes from Michael Polark with Wolfe Research. Please go ahead."
},
{
"speaker": "Michael Polark",
"content": "Good morning. Thank you. I want to ask on the TAVR or the structural part update in the deck. Low single-digit growth in the fourth quarter, you just comment on kinda post-account IDE, that the influence that's driving the d cell there, or are there other things you'd call out? And then maybe pester for an update on the path in the US for your TAVR franchise. Thank you."
},
{
"speaker": "Michael Mahoney",
"content": "Sure. On the U.S., we haven't provided any updates. We're still in discussions internally and with the appropriate authorities there. So again, in some of the other calls, you'll receive an update once we can give you clear direction on that. In Europe, we did see some impact in EU based on the U.S. trial. But nonetheless, the team did have a strong year in TAVR in Europe. And we're launching Prime to centers primarily who are current users of Accurate today."
},
{
"speaker": "Operator",
"content": "The next question comes from Vijay Kumar with Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "Hey, guys. Thanks for taking my question and congrats on the nice win here. Maybe my one question is around mapping. What percentage of PFA procedures do you think are associated with mapping? And once you launch your mapping technology, when you look at the medium term, what percentage of those mapping procedures do you think we'll be using a Boston Scientific Corporation solution versus a competition?"
},
{
"speaker": "Michael Mahoney",
"content": "Yes. So I would just reinforce and Kenneth can comment further. Ken's overall strategy is an open platform. We do see mapping as a predominant modality, if you will, in the U.S. EU, you see more centers using without mapping. We do see some very high volume centers in the U.S. for PBI also not mapping. But predominantly, it's a heavy mapping region in the U.S. Little bit less so, still quite a bit in Europe. And heavy mapping in Japan and China. So as Kenneth said, we do believe that the OPAL platform is the best platform to optimize the use of variables. And we'll continue to enhance the OPAL platform as we continue to enhance FerraPulse catheter category and widen that out more. So we think that's the most cost-effective and the most efficient way to use FerraPulses is with OPAL. That being said, many physicians are used to competitive mapping systems, so excellent. We'll continue to ensure that they can use competitive mapping systems. On the share percent, we wouldn't speculate there. It's a big investment area for us in terms of technology and physical clinical mappers around the world to continue to enhance that group. A lot of investment behind that. And hopefully, we'll make good progress in that area in 2025."
},
{
"speaker": "Kenneth Stein",
"content": "I don't have too much to add to what Mike just said. I just reiterate, Europe predominant cases are done without mapping today. U.S., vast majority of procedures are done with mapping today. Intend to support all different workflows. Goal is to make things easier for physicians, not harder. And I think what you're gonna see over the long run is, right, the simpler the case is, the easier it is to do and more efficient it is to do without any mapping, the more complex the case is, the greater the need for mapping. We believe that we've got some really important differentiated advantages with FerraVu on OPAL, it's also behind our acquisition of Cortex, which is an AS mapping specifically AF mapping, platform for for very complex types of atrial fibrillation. And I mean, our goal overall, not just with MATIC, as we look at just EP strategy overall, right, is to provide physicians with the widest possible toolbox so they have exactly what they need to treat the particular patient who's in front of them."
},
{
"speaker": "Vijay Kumar",
"content": "Alright. Thank you guys."
},
{
"speaker": "Operator",
"content": "The next question comes from Peter Chickering with Deutsche Bank. Please go ahead."
},
{
"speaker": "Peter Chickering",
"content": "Hey, good morning. Look, as you comp out the China VBP and Japanese reimbursement cuts in the back half of the year, how should those markets be growing in the back half of this year without those cuts? And can you refresh us on the key drivers in both those markets? Thanks."
},
{
"speaker": "Michael Mahoney",
"content": "Those cuts are happening, so we baked that into our guide. China really impressive performance given the VBP which really is like taking a daily vitamin. It is. It happens every year. But the team continues to grow nicely above market and in line or faster than Boston Scientific Corporation in China. So we'll have more VBP, you know, tailwinds or headwinds, I guess, this year but they're overcome by product launches, FerraPulse, diversification of our portfolio, and greater access to more customers. It really speaks to the category leadership portfolio strategy we have across the company. So the team there continues to do well."
},
{
"speaker": "Kenneth Stein",
"content": "Japan, again, there's typically every other year price cuts in Japan. That we would know about them. They're built into our guidance. Japan is going to have a really nice year this year with the launch of FerraPulse."
},
{
"speaker": "Daniel Brennan",
"content": "And just an operating margin comment on that. So even with despite the price cuts in those countries, we still ask for and get operating margin improvement in those countries. So it's like we ask of every business unit that we have. So despite absorbing those price cuts, the operating margin for both those countries you mentioned goes north each year as well."
},
{
"speaker": "Operator",
"content": "The next question comes from Joshua Jennings with TD Cowen."
},
{
"speaker": "Joshua Jennings",
"content": "Hi, good morning. Thanks for taking the question. And congrats on the year. I wanted to just, Mike, get your views and maybe weigh too early with the new administration issuing some policy decisions, getting some nominees through the congressional process. Can you just talk about from a high level, any risk you see to the medical devices sector in general or to Boston Scientific Corporation specifically with this new leadership in place? Thanks for taking the question."
},
{
"speaker": "Michael Mahoney",
"content": "It's really a dynamic environment. We think our guide, as best we can, encompasses macro challenges around the world, including tariffs. FX is really not a policy name, but tariffs are probably the biggest one, which think is very manageable. We aim to hope that the FTC environment is appropriate. And so maybe that could be positive for the industry. We'll see on tax reform where that goes. Daniel made comments on that. But other than that, Med Tech typically hasn't been the tip of the spear for major policy changes over many, many different types of presidents that we've had. So we feel overall very comfortable with our guidance and how we can manage through that."
},
{
"speaker": "Joshua Jennings",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Christopher Pasquale with Cefran Research. Please go ahead."
},
{
"speaker": "Christopher Pasquale",
"content": "Thanks. You talked about the move to concomitant procedures being a growth sustainer rather than a catalyst for faster LA market growth. Our own conversations with High Line Center suggests many of them are expecting a meaningful uptick in their own procedures as a result of that change. So is there something else that you think really offsets that tailwind then maybe for Dr. Stein, can you just remind us how you think about the portion of the AF population that is really appropriate for both of these procedures?"
},
{
"speaker": "Michael Mahoney",
"content": "Yeah. On the volume side, we'll see over time. Right now, we're kind of calling it 20% market CAGR. As the market gets bigger and larger, it's that along with EP is the best market you can be in MedTech. We have a unique position in both of them. So I think we're comfortable with the 20% CAGR now. We'll see as the year progresses if that upticks or not. Want to continue to work with customers on productivity and workflow. They have tremendous demands that they have on their cath labs. There's other technologies and structural heart coming out and so forth. They're very, very comfortable with Watchmen FerraPulse, and the concomitant procedures. So we want to continue to work to make sure we can drive operational effectiveness and productivity for our customers who are still have a strong backlog and demand of patients and other technologies coming out. So besides safety effectiveness, we want to make sure Watchmen and FerraPulse really is the solution in terms of ease of use and procedural efficiency for hospitals."
},
{
"speaker": "Kenneth Stein",
"content": "And Christopher, just in terms of who are appropriate candidates for these procedures, again, we're very pleased with the results of Option. I think it shows really incontrovertibly that the WATCHMAN device, yes, at least as effective as oral anticoagulants and treating high-risk patients after AF ablation that it is certainly safer in terms of long-term leading risk. It also showed that you can do a concomitant procedures, in a randomized trial that there was no added risk by heading WATCHMAN to an AF ablation at the same time as the procedure. Particularly with FerraPulse, given its safety advantages, and isn't its efficiency and really facilitates people doing concomitant procedures. And as you said, we've certainly seen an uptick in concomitant procedures still do need to get our label expanded for WATCHMAN to allow for use as first-line therapy in people who don't otherwise already have a reason to avoid the long-term use of our ointment coagulants. We will be presenting the CHAMPION data in the first half of next year as a first line even in patients who aren't candidates for AF ablation. Today in the United States, between a half and two-thirds of patients undergoing ablation are considered to be at high risk of stroke. If you look at the CHAS VAST score, right, which is the scoring system we use, if you use transfusion s three or higher as your cutoff, that would be about a half of patients undergoing AF ablation. I think it's also important to point out when you think about concomitant procedures, there are patients who are undergoing AF ablation who may get their WATCHMAN Thanks. A kind of Watchmen that they might have otherwise gotten. We're also patients who were referred in for a WATCHMAN procedure who are now being considered for ablation, might never been considered previously for ablation, again, just given the safety and efficacy advantages of the FerraPulse system."
},
{
"speaker": "Christopher Pasquale",
"content": "So, great for patients. Right? Saves them having to undergo two consecutive procedures. It's also great for hospitals and practitioners. That's helpful. Thanks."
},
{
"speaker": "Operator",
"content": "I understand there's time for one last question. That comes from SURE Marie Thibault with BTIG. Please go ahead."
},
{
"speaker": "Marie Thibault",
"content": "Thanks so much for squeezing me in. I want to ask a question about a recent acquisition. I saw that interventional oncology and embolization killed it again this quarter. I wanted to understand what's going on in that product segment and understand how the Entera Oncology acquisition fits into that product segment, how it can help accelerate growth? So much for taking the questions."
},
{
"speaker": "Michael Mahoney",
"content": "Yes. So that division of interventional oncology doesn't get talked about enough, mid-teens for the full year. Again, it's in line with our category leadership strategy that we have across most of our business units. The team had a really excellent launch of organic R and D program in our robotics portfolio, which is a big growth driver for us. Obviously, Y90 does extremely well for us. So the combination of those two products and the rest of the remaining portfolio that we have gives us the widest portfolio and unique differentiation within there with our to capture high share at a partner with customers much like we do with other businesses in the acquisition, is again another extension for us to widen out to other adjacencies in interventional oncology with the pump. Portfolio. This gets us closer to the oncologist. Yeah. We also have additional software enhancements coming to improve the efficiency and workflow of our Y90 coming in 2025. So we want to continue much like we do with our other business units to expand into smart adjacencies, to accelerate our growth, and enable us to partner more closely with the enrichoradiologists and oncologists team."
},
{
"speaker": "Jonathan Monson",
"content": "Great. Thanks, everyone for joining us today. We appreciate your interest in Boston Scientific Corporation. If we are unable to get to your question, or if you have any follow-ups, please don't hesitate to reach out to the Investor Relations team. Before you disconnect, Drew will give you all the pertinent details for the replay. Thanks, everyone."
},
{
"speaker": "Operator",
"content": "Please note, a recording will be available in one hour by dialing either 1-877-344-7529 or 1-412-317-0088 using replay code 3976753 until February twelfth, 2025, at 11:59 PM eastern time. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
bsx | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to the Boston Scientific 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 Jon Monson, Senior Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Jonathan Monson",
"content": "Thanks, Drew, and thanks everyone for joining us. With me today are Mike Mahoney, Chairman and Chief Executive Officer; and Dan Brennan, Executive Vice President and Chief Financial Officer. During the Q&A session, Mike and Dan will be joined by our Chief Medical Officer, Dr. Ken Stein and Art Butcher, President of our MedSurg and Asia Pacific businesses. We issued a press release earlier this morning announcing our Q3 results, which included reconciliations of the non-GAAP measures used in this release. The release as well as reconciliations of the non-GAAP measures used in today's call can be found on the Investor Relations section of our website. Please note, on the call, operational revenue excludes the impact of foreign currency fluctuations, and organic revenue further excludes acquisitions and divestitures for which there are less than a full period of comparable net sales. Guidance excludes the previously-announced agreement to acquire Axonics, which is expected to close in the fourth quarter of 2024, subject to customary closing conditions. For more information, please refer to the Q3 financial and operational highlights deck, which may be found on the Investor Relations section of our website. On this call, all references to sales and revenue are organic, and relative growth is compared to the same quarter of the prior year, unless otherwise specified. This call contains forward-looking statements regarding, among other things, our financial performance, business plans and product performance and development. These statements are based on our current beliefs using information available to us as of today's date and are not intended to be guarantees of future events or performance. If our underlying assumptions turn out to be incorrect or certain risks or uncertainties materialize, actual results could vary from those projected by the forward-looking statements. Factors that may cause such differences are discussed in our periodic reports and other filings with the SEC, including the Risk Factors section of our most recent annual report on Form 10-K. Boston Scientific disclaims any intention or obligation to update these forward-looking statements, except as required by law. At this point, I'll turn it over to Mike. Mike?"
},
{
"speaker": "Michael Mahoney",
"content": "Thanks, John. Thank you, everyone, for joining us today. Our Q3 results exceeded our expectations and we continue to invest in our portfolio and capabilities to deliver differentiated performance over the long-term. In Q3 '24, total company operational sales grew 19% and organic sales grew 18%, exceeding the high end of our guidance range of 13% to 15%. Our excellent growth is and will continue to be focused on our category leadership strategy, fueled by innovation, clinical evidence generation and the winning spirit of our global team. Q3 adjusted EPS of $0.63 grew 27%, exceeding the high end of our guidance range of $0.57 to $0.59. In Q3, adjusted operating margin was 27.2%. Turning to our fourth quarter and the full year '24 outlook. We're guiding to organic growth of 14% to 16% for fourth quarter and raising our full year guidance to approximately 15%, reflecting momentum across our broad portfolio and particularly in AF solutions. Our fourth quarter adjusted EPS guidance is now $0.64 to $0.66 and we expect our full year adjusted EPS to be $2.45 to $2.47 representing growth of 20% to 21%. Dan will provide more details on our financials in a few minutes and I'll provide additional highlights on our third quarter results, along with our comments and our outlook. Regionally, on an operational basis, the US grew 24% with double-digit growth or higher in six of eight business units. Our EP business continues to deliver impressive performance fueled by FARAPULSE, new account openings and very strong reorder rates. Europe, Middle East and Africa grew 14% on an operational basis. This performance was driven by continued above-market performance in EP, where we continue to expand our PFA leadership, complex PCI and structural heart. In TAVI, we received CE Mark and recently launched our next-generation ACURATE Prime Valve. I also want to announce that following a nearly 30-year career at Boston Scientific, our President of EMEA, Eric Thepaut , will retire in December and Xavier Bertrand, currently the Vice President of Peripheral Interventions in EMEA will be appointed the new President of EMEA. I want to thank Eric for his many significant contributions to the organization and congratulate Xavier on his new role. Asia Pac grew 12% operationally with excellent performance in China, Australia, New Zealand and grew mid-teens despite recent VBP implementations. In Japan, we received PMDA approval of the FARAPULSE PFA system and anticipate reimbursement and commercial launch in the coming weeks. I'll now provide some additional commentary on our business units. Urology sales grew 10% with double-digit growth in Stone Management and Prostate Health, including double-digit growth in both Rezum and SpaceOAR. Within the quarter, we continue to see momentum from the launches of LithoVue Elite and the Tenacio Pump with our AMS 700 device. And looking forward, we expect to close the previously announced acquisition of Axonics in the fourth quarter and we're excited to add this excellent business into Boston Scientific in our Urology business. Endoscopy sales grew 7% organically and 8% operationally with strong growth, particularly in the US. Our anchor products continue to drive above-market growth with AXIOS and Exalt D, both growing double-digits in the quarter. We also continue to see strong double-digit growth in our Endoluminal Surgery franchise. We're pleased to recently received a Category 1 CPT code for the ESG weight loss procedure, which is expected to further momentum within this business. Neuromodulation sales grew 3% organically and 17% operationally including Relievant, which will turn organic in November. Our brains franchise returned to low double-digit growth in the quarter in the US, supported by de novo implants and competitive replacements. Our pain franchise grew low-single-digits organically and double-digits operationally. Our global SCS performance was below our expectations in a market that continues to be challenged, offset by growth in the rest of the pain portfolio, which reflects the value of our category leadership strategy. Peripheral Intervention sales grew 10% organically and 12% operationally. Within our Vascular business, we saw mid-single-digit growth in arterial with continued double-digit growth in Drug-Eluting therapies and low double-digit growth in Venous. We're also pleased to have closed our acquisition of Silk Road Medical in mid-September, adding the innovative TCAR system to our vascular portfolio. Our interventional oncology and embolization franchise grew double-digits again driven by continued momentum from recent launches in embolization and sustained double-digit growth in TheraSphere. Cardiology delivered another exceptional quarter with sales growing 29%. Within Cardiology, Interventional Cardiology Therapies grew 14%. Mid-teens growth in Coronary Therapies was supported by the launch of the US AGENT performance, continued global adoption of coronary imaging with our AVVIGO+ platform and our Calcium portfolio. The US AGENT launch continues to exceed our expectations with both new account openings and strong reorder rates. We also recently commenced enrollment in the aging IDE long lesion substudy and completed enrollment in our Vitalist early feasibility study in high-risk PCI patients. Congratulations to the team on that milestone. Our structural heart valves franchise grew double-digits in the third quarter led by another quarter of above-market growth of ACURATE Neo2 in Europe. In the US, we continue to collaborate with the FDA and our regulatory strategy and data from the US ACURATE IDE will be presented at TCT on October 30. WATCHMAN grew 18% with continued conversion to WATCHMAN FLX Pro in the US and Japan. And globally, we surpassed 500,000 patients treated with the WATCHMAN device, driven by our innovation, clinical evidence and patient awareness efforts. Key near-term catalyst for WATCHMAN drive our confidence in delivering high growth in this business, including the recently implemented DRG for concomitant LAAC and AF ablation. And if positive, the data readout from the OPTION trial, which will be presented as a late-breaking clinical trial at the American Heart Association Conference on November 16th. We also recently commenced enrollment of our SIMPLIFY trial, which studying the less intensive post-procedure drug regimen, enabled by our latest generation WATCHMAN FLX Pro and continue to expect data from the CHAMPION trial in the first half of '26. Cardiac Rhythm Management sales grew 2% in the quarter. In the third quarter, our Diagnostics franchise grew high-single-digits, driven by our implantable cardiac monitors, LUX-Dx, which both received CE Mark within the quarter. In Core CRM, strong international growth was offset by below market growth in the US. We're excited about new and upcoming product launches in this business, including the expanded indication of our INGEVITY lead for conduction system pacing, which received FDA approval in the quarter and our EMPOWUR leadless pacemaker, which we now have submitted to the FDA. Electrophysiology sales grew an exceptional 177% in the quarter, driven by continued commercial execution, pull-through in our Access Solutions business and increased procedure volumes driven by excellent outcomes as well as efficiencies gained with FARAPULSE. We have now treated over 125,000 patients with FARAPULSE, driving rapid and transformative conversion from RF and cryo to PFA, specifically using FARAPULSE. As a result of this accelerated conversion in the market, we now expect PFA to likely exceed our previously communicated range of 40% to 60% of global AF ablations by 2026. We are excited about the recent FARAPULSE approvals in both Japan and China and expect these launches to have a meaningful impact on our global EP business in 2025. Recently, we received USA approval of the FARAWAVE NAV Catheter, which combined with a FARAVIEW Software to visualize cardiac ablation procedures exclusively with our OPAL HDx mapping system. We are pleased to have completed the follow-up Phase I of the ADVANTAGE AF clinical trial, which is evaluating FARAPULSE in the treatment of patients with drug-refractory persistent AF. And we expect to submit the results of the trial to the FDA later this quarter and anticipating presenting the results in early '25 with label expansion expected in the second half of '25. We're also studying in a very new patient population of drug-naive persistent AF patients in AVANT GUARD. As we have neared the end of this enrollment, we have elected to temporarily pause the trial to assess a few unanticipated observations. It is our intention to resume enrollments in the near-term. And based on the totality of clinical evidence and commercial real-world experience, we remain extremely confident in the unique performance of FARAPULSE. In closing, we're very proud of the performance of our global teams and are confident in the sustainability of our top-tier financial performance. With that, I'll hand over to Dan and provide more details on the financials."
},
{
"speaker": "Daniel Brennan",
"content": "Thanks, Mike. Third quarter 2024 consolidated revenue of $4,209 million represents 19.4% reported growth versus third quarter of 2023 and includes a 10 basis point headwind from foreign exchange, which was favorable versus our expectations. Excluding this $4 million foreign exchange headwind, operational revenue growth was 19.5% in the quarter. Sales impact from closed acquisitions contributed 130 basis points, resulting in 18.2% organic revenue growth, exceeding our third quarter guidance range of 13% to 15%. Q3 2024 adjusted earnings per share of $0.63 grew 27% versus 2023, exceeding the high end of our guidance range of $0.57 to $0.59 primarily driven by our strong sales performance. Adjusted gross margin for the third quarter was 70.4%, slightly lower than anticipated, driven primarily by foreign exchange. We continue to expect second half adjusted gross margin to be higher than the first half and full year adjusted gross margin to be slightly below our 2023 rate. Third quarter adjusted operating margin was 27.2%, which expanded 110 basis points versus the prior year period. Given our strong year-to-date performance, we now expect full year adjusted operating margin to be approximately 27%. We believe this strikes a nice balance of delivering incremental margin from our sales upside and continuing to invest appropriately to drive strong top line performance. On a GAAP basis, third quarter operating margin was 17.4%. Moving to below the line. Third quarter adjusted interest and other expenses totaled $65 million, which was favorable to our expectations primarily due to higher interest income. On an adjusted basis, our tax rate for the third quarter was 13.2%, which includes favorable discrete tax items. Our operational tax rate for the quarter was 13.5%. Fully diluted weighted average shares outstanding ended at 1,487 million in the third quarter. Free cash flow for the third quarter was $822 million, with $1,002 million from operating activities less $180 million in net capital expenditures, which includes payments of $208 million related to acquisitions, restructuring, litigation and other special items. In 2024, we continue to expect full year free cash flow to exceed $2 billion, which includes approximately $900 million of expected payments related to special items. As of September 30th, 2024, we had cash on hand of $2.5 billion, and our gross debt leverage ratio was 2.4 times. Our top capital allocation priority remains strategic tuck-in M&A followed by annual share repurchases to offset dilution from employee stock grants. Our legal reserve was $250 million as of September 30th, roughly flat versus Q2 2024. $53 million of this reserve is already funded through our qualified settlement funds. I'll now walk through guidance for Q4 and full year 2024. We expect full year 2024 reported revenue growth to be approximately 16.5% versus 2023. Excluding an approximate 50 basis point headwind from foreign exchange, based on current rates. We expect full year 2024 operational revenue growth to be approximately 17%. Excluding a 200 basis point contribution from closed acquisitions, we expect full year 2024 organic revenue growth to be approximately 15% versus 2023. We expect fourth quarter 2024 reported revenue growth to be in a range of 16.5% to 18.5% versus fourth quarter 2023. Excluding an approximate 50 basis point tailwind from foreign exchange, based on current rates, we expect fourth quarter 2024 operational revenue growth to be 16% to 18% and excluding a 200 basis point contribution from closed acquisitions, we expect fourth quarter 2024 organic revenue growth to be in a range of 14% to 16% versus 2023. We continue to expect full year 2024 adjusted below-the-line expenses to be approximately $300 million. We also continue to expect a full year 2024 operational tax rate of approximately 13.5% and an adjusted tax rate of approximately 12.5%, which contemplates current legislation, including enacted laws and issued guidance under OECD Pillar 2 rules. We expect full year adjusted earnings per share to be in the range of $2.45 to $2.47 representing growth of 20% to 21% versus 2023, including an approximate $0.04 headwind from foreign exchange, which is unchanged from our previous expectations. We expect fourth quarter adjusted earnings per share to be in a range of $0.64 to $0.66. Before we move to Q&A, I want to provide a few housekeeping items related to 2025 that may be helpful with your modeling. There will be one less business day in 2025, which comes in Q1. Note that in 2024, we have two extra business days versus 2023, one here in Q3 and one upcoming in Q4. Below the line, we expect a meaningful increase versus 2024 related to higher adjusted net interest expense. In 2024, we will earn approximately $100 million of nonrecurring interest income on the cash raised earlier this year to fund the Axonics acquisition, which we expect to close here in the fourth quarter. In 2025, we also have approximately $1.6 billion of bonds coming due, which we expect to look to refinance likely at higher rates than the existing bonds while maintaining our strong balance sheet. The good news is, this incremental expense should largely be offset by the operating income dollars associated with the deals we have closed in 2024 and the expected close of Axonics. Based on current global tax legislation, we expect our tax rate to be in line with our historical rate of approximately 14% operational and 13% adjusted. In 2025, we will aim to outperform our markets, deliver meaningful margin improvement and grow adjusted earnings per share double-digits and faster than sales towards our goal of being the highest performing large-cap medtech company as we said at last year's Investor Day. For more information, check our Investor Relations website for Q3 2024 financial and operational highlights which outlines more details on Q3 results and 2024 guidance. And with that, I'll turn it back to Jon, who'll moderate the Q&A."
},
{
"speaker": "Jonathan Monson",
"content": "Thanks, Dan. Drew, let's open it up for questions for the next 40 minutes or so. In order for us to take as many questions as possible, please limit yourself to one question. Drew, please go ahead."
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Robbie Marcus with JPMorgan. Please go ahead."
},
{
"speaker": "Robert Marcus",
"content": "Great. Good morning and congrats on another fantastic quarter here."
},
{
"speaker": "Michael Mahoney",
"content": "Thanks, Robbie."
},
{
"speaker": "Robert Marcus",
"content": "My one question, there's so much to ask about here."
},
{
"speaker": "Michael Mahoney",
"content": "Make it a good one, Robbie."
},
{
"speaker": "Robert Marcus",
"content": "In our checks, we hear consistently that the upcoming OPTION trial that we'll see at AHA, combined with the recently started on October 1st reimbursement for concomitant, WATCHMAN and PF ablation has already started to kick in the gear and OPTION could meaningfully alter the usage patterns ahead of CHAMPION in the first half of '26. So I wanted to get your thoughts on the importance of both concomitant and should OPTION be positive what that can mean for both of those franchises, both in the short and long-term? Thanks."
},
{
"speaker": "Michael Mahoney",
"content": "Sure. I'll comment and Dr. Stein can add probably more helpful color. Clearly, independently, both platforms are doing incredibly well. WATCHMAN on its own with all the clinical evidence, and you saw the amazing results of FARAPULSE today. And doctors are so comfortable with both procedures. It's a very safe procedure. The concomitant reimbursement, we view as quite positive. It's also very positive economic for the hospital, benefits for the patient, the procedure will be performed safety. So we're really pleased with that concomitant. And so it's clearly an ongoing long-term tailwind for WATCHMAN and also further helps FARAPULSE. Both platforms, as you know, have a number of different clinical trials to continue to expand indications. And Dr. Stein, any other comments you'd like to make on it?"
},
{
"speaker": "Kenneth Stein",
"content": "No. Sure, Mike. Thanks, Robbie. I again reiterate what Mike said at the outset, right? I mean, the ability to do concomitant procedures and get reimbursed with them under the new CMS DRG, it's one of those things that it's positive for patients, it's positive for the health care system and hospitals and it's certainly positive for us given the unique advantages in doing concomitant procedures when you think of the safety and efficiency of FARAPULSE, and you think of the safety and efficiency and frankly excellent outcomes with FARAPULSE and with WATCHMAN FLX and WATCHMAN FLX Pro. Again, just to give some sense of the importance of this, right, there are approximately 350,000 ablations performed in the US every year for atrial fibrillation. And roughly half of those patients are at high risk of stroke according to things like the CHA2DS2-VASc scoring system. I think we are all anxiously looking forward to see the OPTION data when it gets read out and the impact that will have, I think stating the obvious will depend on what those data show. And if they do show a compelling benefit to WATCHMAN, right, how big is that benefit? And then, again, to reiterate what Mike said, beyond OPTION, we also have the CHAMPION trial. Expecting that trial to read out in early '26, which would look at WATCHMAN versus the new oral anticoagulants in all comers."
},
{
"speaker": "Robert Marcus",
"content": "Great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "The next question comes from Joanne Wuensch with Citi. Please go ahead."
},
{
"speaker": "Joanne Wuensch",
"content": "Good morning and thank you for the question. I want to talk about the amazing results of FARAPULSE that we just saw. And specifically how you're thinking about moving. I was really interested in one quote that you said to exceed 40% to 60% of global AF procedures by 2026. Thank you."
},
{
"speaker": "Michael Mahoney",
"content": "Sure. So this has just been a tremendous launch. Just a quick shout out to our operations supply chain team for staying ahead of the manufacturing. Extremely high demand for this product and the excellence that we're seeing in the field by the commercial and clinical teams. So doctors are moving surprisingly quickly towards FARAPULSE, surprisingly to what we thought it would be a year ago. So when we had the Investor Day, we weren't quite sure because we had didn't have approval in the US. We saw excellent momentum in Europe. And now our operations team is scaled to meet the demand. And those same excellent clinical outcomes and procedural efficiencies and safety benefits that patients received in Europe are being felt throughout the world now. We've been planning over 120,000 of them. So that was our point estimate about a year ago or so. And based on the rapid uptake, we're confident in stating that we do expect it to be at the high end and likely exceed that 40% to 60% based on how quickly physicians are transforming, especially for PVI from traditional RF and cryo to FARAPULSE. And it's also been supported by the studies within ADVENT that show the benefits of FARAPULSE versus traditional RF. So it's a great time in the market for the physicians and the patients. And we've also proven based on our competitive launches in Europe who have been out for a while that we clearly are the market leader in PFA and we have lots of plans in place to continue to extend that leadership with clinical differentiation and product enhancements."
},
{
"speaker": "Joanne Wuensch",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Larry Biegelsen with Wells Fargo. Please go ahead."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Good morning. Thanks for taking the question. I'll echo my congratulations on a really phenomenal quarter here. Dr. Stein, given the importance of FARAPULSE, can you provide more color on the AVANT GUARD trial and the observations you saw? And related to that, there are going to be more PFA ablation choices soon, including from the market leader. Once these new PFA catheters are launched, what are the factors that will lead existing FARAPULSE customers to stay with FARAPULSE or choose FARAPULSE if they haven't adopted it yet? Thank you."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. Sure, Larry. Let me take those successively. So first, on AVANT GUARD. Again, as Mike said, due to a few unanticipated observations in the trial which is studying a completely new population, which is drug-naive patients with persistent AF, which FARAPULSE is not currently indicated to treat. We did elect to temporarily pause enrollment until we develop better understanding of the observations. While none of the observations were life-threatening, we did make a decision to temporarily pause, but it is our intention to resume enrollments in the near-term. And this in no way at all affects our confidence in the overall performance of the FARAPULSE system as it's being used today commercially or in other clinical trials. Again, as Mike said in his opening comments, we remain confident that we're going to obtain expanded indication for drug-refractory persistent AF patients. And that's the data from our ADVANTAGE Phase I trial. Again, as Mike said, we expect to submit that data to the FDA later this quarter. We expect to present that data in early 2025, with indication expansion expected to come in the second half of 2025. And again, I just want to close by emphasizing that this patient population that we're studying in AVANT GUARD, which is drug-naive persistent AF patients has not previously been studied, it's a population that's not indicated for ablation today under guidelines, and it's not the population that's being treated today with FARAPULSE system. And I also want to emphasize that we remain highly confident in the global performance of FARAPULSE, which has now been used to treat more than 125,000 patients across more than 65 different countries and is supported by extensive clinical data demonstrating positive outcomes for the device. And I think that also leads into your second question, right, which is why is FARAPULSE going to maintain category leadership in Pulsed Field Ablation and what's going to prompt new users to continue to newly adopt the system. And it's several things. I think, first of all, it's just the compelling ease of use and straightforward nature of doing the ablation with FARAPULSE. It's just a tremendous clinical experience that people have when they start using the system. I am not aware of anyone who started using this and then has stopped and gone back to thermal ablation. It's also an extensive clinical trial data that we've got supporting it. As Mike mentioned, right, we had a sub-analysis, the ADVENT data, which is the first data that anyone has had to actually show superiority and efficacy outcomes when we look at AF burden as a secondary analysis of the ADVENT data. It's supported by published clinical data now in approximately 20,000 patients globally. And again, as Mike said, right, in Europe, where we've seen commercial systems launch, right, we really have not seen that meaningfully detract from the position that FARAPULSE has as the leading PFA system in those markets. And then last, just to make sure it doesn't get lost in all the other stuff here, right, the approval and the launch now of FARAWAVE NAV Catheter and FARAVIEW mapping system, which really becomes the first mapping system that's really designed around PFA, I think, provides just maybe it's the cherry on top of that sundae in terms of answering your question."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Thank you so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Rick Wise with Stifel. Please go ahead."
},
{
"speaker": "Frederick Wise",
"content": "Thank you, and good morning, everybody. I'm hoping, Mike, that you or Dr. Stein will expand on the NAV Cat comments from a couple of aspects. Just are you ready to fully launch and train? Will NAV Cat have a price premium, given premier technology first to market with something like this integrated. Can we assume that you're going to sell it at a higher price? And just last and sort of related to what Dr. Stein was talking about as well. If FARAWAVE is approved for, only AFib, obviously a huge portion of the market, how does it, how are you going to manage the argument that other imaging mapping systems, obviously are approved for all imaging? Just where will FARA NAV fit in, in the broader, the larger scheme? Thank you."
},
{
"speaker": "Michael Mahoney",
"content": "Dr. Stein?"
},
{
"speaker": "Kenneth Stein",
"content": "Yes, Rick. Let me take the second part of that question first and then get on to what some of the advantages are that we see unique to FARAVIEW right, which is on our refreshed OPAL HDx platform. And so again, right, the OPAL platform is approved for mapping navigation across the whole spectrum of cardiac arrhythmias. Now when we look at the use specifically as it integrates with FARAWAVE and FARAWAVE NAV like FARAWAVE is an AF ablation catheter. And I think part of the reason that we've seen the success that we've had, part of the reason I was able to give the answer that I did to Larry, right, is that it's just exquisitely beautifully designed for ablating atrial fibrillation. It's a fantastic tool for pulmonary vein isolation. And again, we hope to share our data from our ADVANTAGE clinical trial showing how it is also can be used to treat persistent atrial fibrillation. But it is really explicitly not designed to be the catheter to tackle some other arrhythmias. The next catheter in our pipeline is our FARAPOINT Catheter. And that catheter was studied in Phase II of our ADVANTAGE clinical trial. And we have completed enrollment in that Phase II of ADVANTAGE and are continuing to follow those patients. And to start, we'd expect to qualify that catheter for use for treating arrhythmia called atrial flutter as an adjunct to atrial fibrillation ablation procedures. But beyond that, right, it could see FARAPOINT used, right, for really any sort of arrhythmia where you would prefer a point catheter form factor. And then next to follow after that, right, is our so-called map and ablate catheter. It's a large focal lesion catheter called FARAFLEX, right, which, again, all of these will integrate with FARAWAVE on OPAL, right? And that would really give us building the capability to be able to target the vast majority of arrhythmias that are seen in clinical practice. In terms of FARAVIEW specifically, again, I think it's really important to emphasize. This is the first mapping and navigation software that's built around understanding Pulsed Field Ablation. And so it gives a lot of advantages to users to want to use it to navigate a catheter. It gives dynamic visualization of the FARAWAVE catheter as it moves into its various configurations, whether it's a basket or a flower or anything in between. And it's also got a unique feature of called field tagging, where physicians will be able to see where the pulsed field will intersect with tissue and hopefully allow them to better strategize where and when and how to put lesions in when they're doing an ablation procedure."
},
{
"speaker": "Frederick Wise",
"content": "That's an amazing answer. And just the price premium part? Thank you."
},
{
"speaker": "Kenneth Stein",
"content": "Yes, I'm not going to comment on pricing on specific products, Rick?"
},
{
"speaker": "Frederick Wise",
"content": "Thanks so much, everybody."
},
{
"speaker": "Operator",
"content": "The next question comes from David Roman with Goldman Sachs. Please go ahead."
},
{
"speaker": "David Roman",
"content": "Thank you and good morning everyone. I was hoping to switch gears a little bit from the EP side of the business. And maybe if you could spend a few minutes on the performance of the franchises kind of ex-WATCHMAN and EP, which are still trending very well, although a slowdown from where you started the year. How are you thinking about resource allocation and just the focus on those businesses and maintaining ongoing support for those franchises in light of the success of PFA? And how should we think about the growth drivers in some of those more established categories on a go-forward basis?"
},
{
"speaker": "Michael Mahoney",
"content": "Sure. I'll take that. I'll give Dr. Stein some oxygen here. We run as a very decentralized business units. And so we have -- the leaders of these divisions that's all they do. They have global teams, thousands of employees. They wake up and think about peripheral inventions, interventional oncology, endoscopy, urology, neuromod all day long and ICTx, which grew at what 15% in the quarter. So there's tremendous focus by their teams on the global execution of these businesses. We just announced the closing of Silk Road. We anticipate announcing the closing of Axonics in the fourth quarter here. Just as Ken said, we attempt to drive this category leadership in terms of our breadth of portfolio and unique innovation across each division. And we have different varying degrees of success in that. But in general, we're very strong in that area. So in terms of capital allocation, we've obviously invested significantly in the manufacturing ramp of PFA as well as ongoing R&D and clinical studies as well as commercial capabilities to continue to enhance our mapping sales force. But that in no way has detracted from the investments that we're making across these other businesses, which are really the foundation of the company. And despite doing both those at the same times, we continue to improve our margin profile, which I think shows the testament and the winning spirit of the team. So we have a rich pipeline of products organically within these business units. You've seen the performance for the quarter and the full year. We did see a bit of a slowdown in some procedure volume in the summertime in July, August, specifically in our endo, uro business. But we saw a nice procedure bounce back in September and essentially grew kind of in line where we have for the past eight quarters in those businesses. So we have a lot of confidence in them and we don't, Dr. Stein and I may spend a bit more time on PFA, certainly Dr. Stein does. But we don't take the gas pedal down on the other businesses at all in the company."
},
{
"speaker": "David Roman",
"content": "Great. Thanks. I appreciate the perspective."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick Wood with Morgan Stanley. Please go ahead."
},
{
"speaker": "Patrick Wood",
"content": "Perfect. Thank you very much for taking my question. I guess just one on capacity in totality for the system. Obviously, I get PFA adding some efficiencies to the system overall. But for EPs, between WATCHMAN and everything, there's a tremendous call on people's time. We saw in structural heart a little bit of noise on one of the players saying there were capacity constraints. How are you viewing that going forward? And how quickly do you think the system can adapt to enable you to keep growing these franchise and still have capacity to actually get them done? Thanks."
},
{
"speaker": "Michael Mahoney",
"content": "Well, we're still relatively early in our launch. In the US, we got approved in February. We started launching in late February and March. So that we still have a number of new accounts that have not used FARAPULSE in the US. And we have yet to launch in Japan and we've yet to launch in a meaningful way in China in many other countries. So we're still quite early in the launch in very major markets. And we're seeing, in currently launched accounts, we're seeing many accounts move from one system originally to two, three and sometimes four systems. So they're increasing their utilization of FARAPULSE across their multiple labs. So we have a lot to do to continue to increase share within existing accounts. And then thirdly, because of the efficiencies of the system, the hospitals are improving their workflow, and most accounts are doing, I don't know, Ken, 25%, 30% more procedure volume in a day. So there's a lot of efficiencies and the hospitals win economically and the patients benefit as do the physicians. And then to your term on capacity, that's why this concomitant procedure is also a big win for the workflow of the hospital and the patient. So now an extra 10, 15 minutes for the appropriate patient, you can do a FARAPULSE system as well as the LAAC with WATCHMAN. So it also drives procedural efficiency, which is very unique to Boston Scientific versus our competitors. So when we design these platforms, we look at operational efficiency and also the economics of the hospital. And we think FARAPULSE and WATCHMAN and concomitant are all very helpful to hospitals efficiency. And we're still really early in the launch of FARAPULSE."
},
{
"speaker": "Patrick Wood",
"content": "Love it. Thanks for the color."
},
{
"speaker": "Operator",
"content": "The next question comes from Travis Steed with Bank of America. Please go ahead."
},
{
"speaker": "Travis Steed",
"content": "Hey, thanks for taking the question. I wanted to follow up on the AVANT GUARD trial pausing. I guess a lot of questions on that this morning. So it seems like the observations you saw didn't change your thoughts drastically if you're restarting the trial soon. And then just making sure that maybe help us understand why this doesn't really change your view on safety of FARAPULSE overall or mitigate the real-world data you have or and maybe just help us understand this patient population that's in this trial today, how they're getting treated today would be great? Thanks a lot."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. Sure, Travis. Let me again begin, at least the patient population. And so right today standard of care for patients with newly diagnosed persistent atrial fibrillation is to get a trial of antiarrhythmic drug therapy first. And then guidelines would say only to be referred for ablation if they actually fail antiarrhythmic drug therapy. Obviously because even though we've paused enrollment for the moment, there's still an ongoing clinical trial. So I really can't get into any detail on the observations. Again, just to reassure everyone, nothing that we saw certainly was life-threatening. And I think we are very highly confident in the overall safety profile, overall efficacy and again overall efficiency of FARAPULSE system. And again that's just based on the extensive experience that we've got with it, which is both commercial experience, as we said, over 125,000 patients now have been treated with this system globally as well as extensive clinical data that's been published in approximately 20,000 patients and data that we see from all of our ongoing clinical trials."
},
{
"speaker": "Travis Steed",
"content": "Great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "The next question comes from Danielle Antalffy with UBS. Please go ahead."
},
{
"speaker": "Danielle Antalffy",
"content": "Hey, good morning, everyone. Thanks so much for taking the question. Congrats on this amazing quarter. I'm kind of speechless. But just wanted to ask, I appreciate there's not going to be a lot you can say, Dan, I appreciate the comments that you did give on 2025. But specifically, as we think about sales, you noted above-market sales growth. I mean market can be a moving target a little bit here about how you think about the market's growing next year. So I was hoping maybe you could give a little bit more color, if possible, even if it's just highlighting tailwinds and headwinds from a sales growth perspective to think about as we look ahead to 2025. Thanks so much."
},
{
"speaker": "Michael Mahoney",
"content": "I'll start and then Dan, you can clean up my mess. So we're excited, obviously, about '24 growing estimated 15% over a comp of 12% of 2023. And as we head into 2025, obviously, we'll have a nice comp at approximately 15%. But there's so many good things going on with the company. Thank you for the non-FARAPULSE question that was asked earlier about the other businesses like PI and ICTx and neurology commonly growing double-digits and the strength of endo and we want to strengthen neuromod and US CRM a bit more. And so but as we look at 2025, the big headlines obviously are FARAPULSE and WATCHMAN. We do think the Japan launch and China launch will drive meaningful growth for the franchise. And as I mentioned just prior, there's a number of new accounts to open in the US and there's a lot of penetration in current accounts to add additional volume to both FARAPULSE. You've heard all about the concomitant reimburse for WATCHMAN. So those are all nice tailwinds for the company. The procedure volumes we see is relatively consistent. We did see a bit of a slowdown in July, August, but strengthening in September. And so we think procedure volumes will maintain strong versus as they are now. And we see strong global performance. So obviously, we'll have some more challenging comps. There will be some more competition in PFA, but we're doing very well, I guess, that competition in Europe. I don't know, Dan, also we have the AGENT, which throw one out to the cardiology team, which has performed quite well. So we'll find out about reimbursement on that product in the next coming weeks. That should add some additional momentum to that franchise."
},
{
"speaker": "Daniel Brennan",
"content": "I think that summarizes it well. And just to give you a sense of the process, it's no different than it is any year. We have our annual operating plan process that's alive and well here through the fourth quarter. We'll review that as we go through the end of the quarter and into early next year and we'll let you know what we think for 2025 at our Q4 earnings call."
},
{
"speaker": "Danielle Antalffy",
"content": "Appreciate it. Thanks, guys."
},
{
"speaker": "Operator",
"content": "The next question comes from Anthony Petrone with Mizuho Group. Please go ahead."
},
{
"speaker": "Anthony Petrone",
"content": "Thanks and congrats on a strong quarter here. I think the question will be on the go-to-market next year, 2025, you go back to the October 18 press release and you have FARAWAVE NAV Catheter out there, but it indicates that it's exclusive to OPAL on the mapping side. So in other words, the company is coming with a closed loop offering here next year. And presumably, we'll have competitors that are coming with a bundled approach. So maybe the question here is just when we enter '25, it seems that three competitors will be out there with a bundled approach to PFA with mappers. So maybe just walk through that dynamic a little bit. Congratulations again on the quarter."
},
{
"speaker": "Michael Mahoney",
"content": "Yes. I'll just comment and Ken, again, you can finish this. So today customers using FARAPULSE with our legacy RHYTHMIA mapping system and they're also using it with our two primary competitors today. So the OPAL platform will not be closed out in such a way that if a physician wants to continue to use a competitive mapping system with FARAPULSE, they still can. We do think that with the OPAL mapping system, specifically with FARAPULSE, the user experience will be more meaningful and more streamlined and differentiated. So we're not closing the system and that we're shutting out competitive systems from doing FARAPULSE cases. But we're quite confident in the user experience, the overall economics and the value of the OPAL integration with FARAPULSE to be differentiated versus what they're using today."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. I mean, Anthony, just to again build on what Mike said, right, we do not feel that we've got to force people to use our products. And what we see with FARAWAVE is people want to use it. And people have used it in a variety of different ways and we are going to continue to support their ability to use it in the way that they want to. And that includes people who use no mapping navigation at all, which is really through the predominant use case that we see in Europe and throughout a lot of the world or use it with a mapping and navigation system. We're going to continue to keep the original , right, the FARAWAVE Catheter without the NAV sensor on the market for people who want to use it with a competitive mapping system. FARAWAVE NAV, because it's got a magnetic NAV sensor and it does have to get tied into a particular mapping system, which for us is the refreshed OPAL HDx system with FARAVIEW. But we're not going to force people to use it. we think it's got enough compelling differentiated advantages compared to what else is out there that people are going to want to use it."
},
{
"speaker": "Anthony Petrone",
"content": "Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Vijay Kumar with Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "Hi, guys. Congrats on a nice quarter here and thanks for taking my question. Mike, maybe one for you on next week's ACURATE Neo2 results here. What is the regulatory strategy? Do you expect to file with the FDA? And I think you mentioned that you expect to have a successful launch in the US. Is that referring to Neo2 or some other generation of the valves? So maybe talk about your TAVR strategy in the US?"
},
{
"speaker": "Michael Mahoney",
"content": "Sure. So as we've talked about before, the ACURATE Neo2 trial on the 1,500 patient will be TCT on what Wednesday?"
},
{
"speaker": "Daniel Brennan",
"content": "October 30th."
},
{
"speaker": "Michael Mahoney",
"content": "October 30th. So that is an important milestone to see that clinical trial datas that will be presented. And we'll actually be holding an investor meeting that day with Joe Fitzgerald and Lance Bates and the team to talk about the broader cardiology portfolio and the plan for ACCURATE post the data. As you know, we've continued to have excellent momentum in Europe. You saw the third quarter results. We continue to grow above-market. And kudos to the team on the launch of Prime, the next-generation ACURATE Neo2, which they just recently started implementing in Europe."
},
{
"speaker": "Vijay Kumar",
"content": "Sorry and does it mean you expect to file with the FDA, Mike? And what does successful launch mean?"
},
{
"speaker": "Michael Mahoney",
"content": "Well, a successful launch, we've never provided share, attainment goals just like we don't provide a share for FARAPULSE. So we obviously want to grow the business. It's a very large market, very mature, market growing, I don't know, 8% -- 7%, 9% and we continue to do quite well in the US, but we'll provide more information at the TCT at the investor call there."
},
{
"speaker": "Operator",
"content": "The next question comes from Matt Miksic with Barclays. Please go ahead."
},
{
"speaker": "Matt Miksic",
"content": "Hey, thanks so much for fitting us in and congrats on a really impressive quarter and all the great growth drivers you have running. I had a question just on maybe for Dan on some of the dynamics in the gross margin line in the quarter you mentioned FX being kind of one of the primary headwinds. But as you move into '25, maybe you can talk a little bit about where the leverage in the model is, if it's stable gross margin and levering some of the operating investments that you're making? Maybe just some color on how that -- how you see that progressing at this point? Thanks."
},
{
"speaker": "Daniel Brennan",
"content": "Sure, Matt. The Q3 story is actually pretty simple. So we were 70.4% gross margin in Q3, slightly below what we would have expected and that's really driven by foreign exchange in the quarter. So simple story for Q3. We've said consistently that we believe our full year adjusted gross margin will be below last year. Last year, we were 70.7%. So we've consistently said, you know what, we're probably not going to hit that 70.7% in 2024, that's okay because we're actually driving 70 basis points of adjusted operating margin expansion without that kind of testament to the hallmark of the DNA of the company of continuing to drive margin expansion through all lines of the P&L. So 2024 gross margin, not going to contribute, that's okay because we have the SG&A and other horses to ride there. As you go into '25 and beyond, I think all lines of the P&L could contribute. I think gross margin is part of that. And how does that happen? A big piece of that will be product mix. So call FARAPULSE today, the single-use catheter, that's a nice margin, but you have a lot of that, the capital placements that we have. As Mike mentioned, we're still launching this. It's only six or seven months into the launch. So we're still launching a lot of capital, placing a lot of capital. And next year, we'll have Japan and China. So we'll still be doing that. We'll be effectively launching there. But I think the story is as you go into '25 and work through '25 and beyond, FARAPULSE becomes accretive overall as the single-use catheter kind of swamps the overall margin within FARAPULSE and is accretive to overall Boston Scientific. WATCHMAN is obviously helpful. You heard a lot of commentary on the call today about the some of the tailwinds that could be there for WATCHMAN. That's great news for the gross margin line. So I think the takeaway is gross margin, '25 and beyond, gross margin can be a contributor to the overall operating margin journey that's been so successful for the company for the last decade."
},
{
"speaker": "Matt Miksic",
"content": "That's great. Thanks a lot. Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Josh Jennings with TD Cowen. Please go ahead."
},
{
"speaker": "Joshua Jennings",
"content": "Hi. Good morning. Thanks for taking the questions and congratulations on another home run quarter. I wanted to just check the box, Mike, you called out or you called out your ops and supply chain team for keeping up with the demand for FARAPULSE and staying on time. I just want to make sure that there's no manufacturing capacity issues next year if that franchise continues to outperform internal expectations? And then also just sorry to follow up on a two-parter. But wanted to just get your team's view on this mapping segment. I mean our understanding is that mapping capital and diagnostic mapping catheters, the kind of the percentage of the overall ablation market, it's even higher than the ablation catheter segment and just I know you guys are now well positioned there, but just to review that and maybe just the revenue -- the business model for Boston Scientific, whether there's FARAPULSE NAV Catheter will be single-use for PVIs and or and then just how you're building out your diagnostic mapping catheter portfolio. Sorry for the multipart."
},
{
"speaker": "Kenneth Stein",
"content": "Hey, Josh, I'll take the second part first and then we can get to the supply issue. So just for clarity."
},
{
"speaker": "Michael Mahoney",
"content": "Let me just jump up. There is no supply issue. So let's talk about that. So kudos to the team. Let me take the first part. We do not anticipate, even despite the high demand, our team has done a great job on the catheter supply and the console supply. So we don't anticipate any supply shortages."
},
{
"speaker": "Kenneth Stein",
"content": "Thanks. I should not have used that word. Yes, in terms of just for clarity. So the FARAWAVE NAV Catheter, it is a single-use device. It is, again, current indicated for PVI for patients with paroxysmal atrial fibrillation. As we said at the ADVANTAGE clinical trial is our clinical trial to get label expansion for the FARAWAVE Catheter family for use in patients with drug refractory persistent atrial fibrillation. And again I think what we really want to emphasize here is that there's some really significant differentiated advantages to FARAVIEW versus other systems that are currently on the market for mapping a navigation of PFA catheters, right? And that's specifically ability to dynamic visualization of the catheter shape as it changes ability also to do field tagging and so ability to plan where to put lesions in when you're doing an ablation procedure."
},
{
"speaker": "Joshua Jennings",
"content": "And just in terms of the diagnostic mapping catheter portfolio buildout, you guys do have a high-density mapping catheter in the pipeline is my understanding, but just wanted to get a better look on that."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. I mean, Josh, we already have a high-density mapping catheter, right, which is our ORION catheter, which can be used on the refreshed OPAL system. And then as we go down the road, right, we've talked about additional catheters and be part of the FARAPULSE family, which includes FARAPOINT and includes our FARAFLEX catheter, which would have the capability to do both high-density mapping and also do PFA ablation in the same catheter."
},
{
"speaker": "Michael Mahoney",
"content": "They're all -- just I'll just add on and we'll move on to the next one. There are elements of the procedure that we don't compete in today that pie like ice catheters and others. So we're doing extremely well in the ablation portion of it. We expect OPAL to do quite well in the mapping segment, which we've been underscaled in, but there are still segments within the EP procedure mix that we don't play in today that we're shooting to fill out in the portfolio over time. I'll just make one other comment on FARAPULSE relates to China for -- it wasn't a question, but we're excited about the approval in Japan and in China. We do expect the China launch to be a bit slower than what you typically see in the US and Japan based on obviously, not product or team, but it's more on getting approvals and registries and launch cadence in terms of the volume of new accounts. We've done some recent openings there that have gone quite well, but we don't anticipate the same aggressive launch in China that you've seen in US. We do expect to have a very strong launch in Japan. And also just a shout out to the China team. Despite the significant VBP headwinds that we've seen, which have impacted our IVUS franchise and there will be more VBPs in 2025. We continue to grow essentially at the company average in China despite those headwinds when many of our peers have faced tougher results."
},
{
"speaker": "Jonathan Monson",
"content": "Drew, let's take one more question."
},
{
"speaker": "Operator",
"content": "Thank you. That question will come from Matt O'Brien with Piper Sandler. Please go ahead."
},
{
"speaker": "Matthew O'Brien",
"content": "Good morning. Thanks for taking the question. And I'd much rather focus on all the positive things going on here, but I'm looking at the stock down now versus up prior to this AVANT GUARD commentary. So Dr. Stein, I'm not sure exactly what you can say, but is there any kind of safety signal that we should be aware of? And then if you can't comment on that, is there anything to think about in terms of this patient population really being the cause of the difference, maybe extra lesions that need to be created, higher risk benefit requirements because it's drug-naive patients. Just anything along those lines that you can share because I think folks are pretty nervous this morning just based on how important FARAPULSE is to the business. Thanks."
},
{
"speaker": "Kenneth Stein",
"content": "Yes, Matt, again, because this is an ongoing trial, I can't get into any details. Again, what I can say is we are highly confident in the safety of the system. Again, we've got extensive commercial use data and over 125,000 patients treated. We've got extensive published clinical trial data and other ongoing clinical trials and are highly confident in the safety, the efficiency and the efficacy of the FARAPULSE system."
},
{
"speaker": "Michael Mahoney",
"content": "We expect to re-launch this trial soon."
},
{
"speaker": "Jonathan Monson",
"content": "All right. Thanks, Ken. Thanks, Mike, and thanks, everyone for joining us today. We appreciate your interest in Boston Scientific. If we weren't able to get to your question or if you have any follow-ups, please don't hesitate to reach out to the Investor Relations team. Before you disconnect, Drew will give you all the pertinent details for the replay. Thanks, everyone. Have a great day."
},
{
"speaker": "Operator",
"content": "Please note, a recording will be available in one hour by dialing either 1877-344-7529 or 1412-317-0088 using replay code 2607711 until October 30th, 2024, at 11:59 P.M. Eastern Time. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
bsx | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Boston Scientific 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 Jon Monson, Senior Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Jon Monson",
"content": "Thank you, Drew, and welcome everyone and thanks for joining us today. With me on today's call are Mike Mahoney, Chairman and Chief Executive Officer, and Dan Brennan, Executive Vice President and Chief Financial Officer. We issued a press release earlier this morning announcing our Q2 results, which included reconciliations of the non-GAAP measures used in this release. We have posted a link to that release as well as reconciliations of the non-GAAP measures used in today's call to the Investor Relations section of our website under the heading Financials and Filings. The duration of this morning's call will be approximately one hour. Mike and Dan will provide comments on Q2 performance as well as the outlook for our business, including Q3 and full year 2024 guidance, and then we'll take your questions. During today's Q&A session, Mike and Dan will be joined by our Chief Medical Officer, Dr. Ken Stein. Before we begin, I'd like to remind everyone that on the call, operational revenue excludes the impact of foreign currency fluctuations, and organic revenue further excludes acquisitions and divestitures for which there are less than a full period of comparable net sales. Relevant acquisitions and divestitures excluded for organic growth are the majority stake investment in Acotec Scientific Holdings Limited and the acquisitions of Apollo Endosurgery and Relievant Medsystems, which closed in February, April and November 2023 respectively, as well as our acquisition of the Endoluminal Vacuum Therapy portfolio from B. Braun, which closed in March 2024. Divestitures include the Endoscopy, Pathology business, which closed in April 2023. Guidance excludes the previously-announced agreement to acquire Axonics and Silk Road Medical both of which are expected to close in the second half of 2024, subject to customary closing conditions. For more information, please refer to the Q2 Financial and Operational Highlights deck, which may be found on the Investor Relations section of our website. On this call, all references to sales and revenue, unless otherwise specified, are organic. This call contains forward-looking statements within the meaning of Federal Securities Law, which may be identified by words like anticipate, expect, may, believe, estimate, and other similar words. They include, among other things, statements about our growth and market share, new and anticipated product approvals and launches, acquisitions, clinical trials, cost savings and growth opportunities, our cash flow and expected use of cash, our financial performance, including sales, margins and earnings, as well as our tax rates, R&D spend and other expenses. If our underlying assumptions turn out to be incorrect or if certain risks or uncertainties materialize, actual results could vary materially from the expectations and projections expressed or implied by our forward-looking statements. Factors that may cause such differences include those described in the Risk Factors section of our most recent 10-K and subsequent 10-Qs filed with the SEC. These statements speak only as of today's date and we disclaim any intention or obligation to update them except as required by law. At this point, I'll turn over to Mike. Mike?"
},
{
"speaker": "Michael F. Mahoney",
"content": "Thanks, Jon and thank you everyone for joining us today. Our second quarter results exceeded our expectations, led by the strength of our differentiated global cardiovascular portfolio, particularly the execution in AF Solutions and the winning spirit of our global team. In second quarter, total company operational sales grew 16, organic sales grew 15, exceeding the high end of our guidance range of 10 to 12. Our top tier growth continues to be fueled by innovation, clinical evidence generation, and our strategy of category leadership. Consistent with prior quarters, most of our businesses and regions grew well above market. Second quarter adjusted EPS of $0.62 grew 15% versus 2023, exceeding the high end of our guidance range of $0.57 to $0.59. Second quarter adjusted operating margin was 27.2% and as a result of our first half margin performance and revenue upside versus previous expectations, we now expect to expand adjusted operating margin 50 to 70 basis points for the full year. Turning to the third quarter and full year 2024 outlook, we're guiding to organic growth of 13% to 15% for third quarter and raising our full year guidance from 10% to 12% to 13% to 14%, reflecting momentum across our broad portfolio, particularly in our EP business unit. Our third quarter adjusted EPS guidance is $0.57 to $0.59 and we expect our full year adjusted EPS to be $2.38 to $2.42, representing growth of 16% to 18%. Dan will provide more details on our financials and I'll provide some additional color on the quarter and the outlook for the second half of 2024. Regionally and on an operational basis, the U.S. grew 17% in second quarter with exceptional growth in EP, fueled by the continuous success of the FARAPULSE launch, as well as Watchman, coronary imaging, and strengthen our med-surg businesses. Europe grew 16% on an operational basis versus second quarter 2023. This impressive performance was driven by double-digit growth in seven of our eight business units, led by robust growth in EP and strength across our growth and emerging markets. Second quarter was also a record quarter in the region for our structural heart business, following positive data presented on ACURATE Neo2 at the recent Euro PCR Conference. We expect this momentum to continue, supported by the launch of the largest size ACURATE prime valve in late 2024. Asia-Pac grew 13% operationally versus a difficult comp in second quarter 2023, with excellent performance in China, growing high teens, and Japan growing double digits. We also recently received approval in China for FARAPULSE and AGENT Drug-Coated Balloon, and continue to expect approval for FARAPULSE in Japan in the second half of this year. We expect the contribution from these launches will ramp over 2025. Within the quarter, pricing actions in key geographies went into effect with a China VBP on coronary imaging, and Japan reimbursement cuts in June. We do expect Asia-Pac to grow low double digits in the second half of the year, including the full impact of these pricing actions. Some additional commentary on the business units. Our urology business grew 9% organically in the quarter with double digit growth in stone management and prosthetic urology, supported by our direct-to-patient efforts, driving patient awareness, and early contribution from the limited market release of the Tenacio Pump. International growth of 14% was driven by laser therapies and Rezum. We look forward to closing this previously announced acquisition of Axonics, which we are continuing to expect in the second half of this year. Endoscopy sales grew 8% both operationally and organically in second quarter. Second quarter results were driven by above market growth in our Biliary franchise, led by high teens growth in AXIOS, and the high teens growth in our Endoluminal Surgery franchise. We continue to expect Endo sales to go faster than the market throughout 2024, enabled by our innovative portfolio. Neuromodulation sales grew 16% operationally and 4% organically in the quarter. Our Brain franchise grew low single digits with some impact from competitive product launches. We expect this business to strengthen in the second half of the year, driven by our portfolio of differentiated technologies. In second quarter, our pain franchise grew strong double digits operationally and mid single digits on an organic basis. Our spinal cord stem business saw improved U.S. trialing cadence in the quarter and we expect that our U.S. SCS franchise will improve in the second half of the year. The relieving business continues to perform extremely well with more than 30,000 patients treated with the Intracept System to date. Peripheral Intervention sales grew 12% operationally and 9% organically versus second quarter. High single digit growth in Arterial was driven by continued momentum in our drug-eluting portfolio, with double digit growth in the quarter. Mid single digit growth in Venous was driven by momentum of EKOS supported by the real PE data set and continued double digit growth in Varithena. Our Interventional Oncology franchise grew double digits in second quarter, driven by our broad offering across embolization and cancer therapies. Looking forward, we continue to expect to close the previously announced acquisition of Silk Road Medical in the second half of this year. Cardiology; cardiology delivered another excellent quarter with organic sales growing 22% versus second quarter 2023. Within cardiology, interventional cardiology therapy sales grew 9%. Growth in coronary therapies was driven by continued strength in our global imaging franchise and APAC calcium franchise. Within the quarter we initiated a limited launch of AGENT DCB in the U.S., which has received positive initial physician feedback. Our structural heart valves franchise grew strong double digits in the second quarter, led by ACURATE Neo2, which continues to see growth from both new and existing accounts in Europe and Latin America. At the end of the quarter, we also completed follow-up of the full 1,500 patient cohort and the U.S. ACURATE IDE trial. We now expect to present this data in the first half of 2025 likely at the Annual ACC Meeting. Watchman had another excellent quarter growing 20% organically with strong contribution from the ongoing launch of Watchman FLX Pro in the U.S. and Japan. The U.S. grew 20% led by further penetration into the existing indicated patient population enabled by our innovation, clinical evidence, and patient awareness efforts. Cardiac Rhythm Management sales grew 3% organically in the quarter. In second quarter, our Diagnostics franchise grew double digits. This above-market growth was driven by our broad cardiac diagnostics portfolio. In Core CRM, our high and low voltage business grew low single digits with strong international growth partially offset by slightly below market growth in the U.S. At the recent HRS Meeting, data was presented from the MODULAR ATP Trial of the MODULAR CRM System, which is comprised of the EMPOWER Leadless Pacemaker and EMBLEM SICD, which met all pre-specified six-month endpoints and a high rate of ATP success with no patient requests for deactivation of pacing due to pain or discomfort. Turning to EP. EP sales grew an impressive 125% organically versus second quarter 2023, driven by the rapid and sustained adoption of the transformative FARAPULSE PFA System. Second quarter sales were driven by outstanding commercial execution, robust supply, and positive real-world outcomes, as well as increased AF ablation volumes, supported by the efficiency of the FARAPULSE workflow. Our Baylis Access Solutions business also continues to see strong double-digit growth in the U.S. with utilization in approximately 80% of PFA procedures and approximately 85% of Watchman procedures. Internationally, we saw continued FARAPULSE account openings and robust utilization in Europe and launched APAC markets. Importantly, evidence of more than 20,000 patients treated with FARAPULSE has been published or presented at medical conferences, demonstrating the safety, efficacy, and reproducibility of the system. And within the quarter, we completed an enrollment in the NAVIGATE-PF study of the FARAVIEW software module and FARAWAVE Nav-enabled catheter, both of which are expected to launch in the U.S. during the second half of the year. At the recent HRS meeting, outcomes from a sub-analysis of the ADVENT trial were presented. This is the very first randomized data for a PFA system demonstrating superior efficacy versus thermal modalities, with significantly more patients having achieved an arterial arrhythmic burden of less than 0.1% with FARAPULSE compared to RF and Cryo. We plan to continue a steady cadence of clinical evidence generation to maintain our PFA leadership, including Rematch-AF, a planned trial designed to study the FARAPOINT and FARAWAVE catheter in patients who need a redo ablation, which we expect to begin enrolling early in 2025. In closing, I'm very grateful to our global team for the commitment and winning spirit, enabling us to deliver life-changing technologies to millions of patients. We're in the most exciting chapters as a company with a track record of executing or exceeding our financial goals while delivering meaningful innovation. With that, I'll hand it over to Dan."
},
{
"speaker": "Daniel J. Brennan",
"content": "Thanks, Mike. Second quarter 2024 consolidated revenue of $4.120 billion represents 14.5% reported growth versus second quarter 2023 and includes a 160 basis point headwind from foreign exchange, which was slightly unfavorable, versus our expectations. Excluding this $57 million foreign exchange headwind, operational revenue growth was 16.1% in the quarter. The sales impact from closed acquisitions was 140 basis points, resulting in 14.7% organic revenue growth, exceeding our second quarter guidance range of 10% to 12%. Q2 2024 adjusted earnings per share of $0.62, grew 15.4% versus 2023, exceeding the high end of our guidance range of $0.57 to $0.59, primarily driven by our strong sales performance. Adjusted gross margin for the second quarter was 70.4%, contracting 160 basis points versus the prior year period, driven by higher than expected inventory charges related to the POLARx cryoablation system, given the strong commercial adoption of FARAPULSE in the U.S., as well as increased levels of capital placements in the quarter. We continue to expect second half adjusted gross margin to be higher than the first half, driven by the mixed benefit from key product launches and full recognition of our annual standard cost improvements. We expect full-year adjusted gross margin to be slightly below our 2023 rate. Second quarter adjusted operating margin was 27.2%, which expanded 40 basis points versus the prior year period. Given our strong first half operating margin and our expectations for the second half, we are raising our full-year 2024 adjusted operating margin expansion goal to 50 to 70 basis points from 30 to 50 basis points compared to 2023. We believe this strikes a nice balance of delivering incremental margin from our sales upside and continuing to invest appropriately to drive strong top line performance. On a GAAP basis, second quarter operating margin was 12.6%, which included intangible asset impairment charges related to the acquisitions of Cryterion Medical and Devoro Medical. The Cryterion impairment charges were related to the high conversion rates of cryoablation to FARAPULSE for ablation procedures in the U.S. The Devoro impairment charges were related to the decision to discontinue work advancing the Wolf thrombectomy platform. Moving to below the line, second quarter adjusted interest and other expenses totaled $68 million, which was favorable to our expectations. On an adjusted basis, our tax rate for the second quarter was 13.1%, which includes favorable discrete tax items. Our operational tax rate for the quarter was 13.6%. Fully diluted weighted average shares outstanding ended at 1.484 billion shares in the second quarter. Free cash flow for the second quarter was $660 million with $814 million from operating activities, less $155 million in net capital expenditures, which includes payments of $200 million related to acquisitions, restructuring, litigation, and other special items. In 2024, we continue to expect full year free cash flow to exceed $2 billion, which includes approximately $700 million of expected payments related to special items. As of June 30, 2024 we had cash on hand of $2.9 billion and our gross debt leverage ratio was 2.4 times. Our top capital allocation priority remains strategic tuck-in M&A, followed by annual share repurchases to offset dilution from employee stock grants. In alignment with our acquisition strategy, in Q2 we announced our agreement to acquire Silk Road Medical and closed the acquisition of SoundCath [ph], a pre-revenue, privately held medical technology company developing an intracardiac echocardiography product complementing our existing electrophysiology portfolio. Our legal reserve was $251 million as of June 30th, a decrease of $32 million versus Q1 2024. $54 million of this reserve is already funded through our qualified settlement funds. I will now walk through guidance for Q3 and full year 2024. We expect full year 2024 reported revenue growth to be in a range of 13.5% to 14.5% versus 2023. Excluding an approximate 100 basis point headwind from foreign exchange based on current rates, we expect full year 2024 operational revenue growth to be 14.5% to 15.5%. Excluding a 150 basis point contribution from closed acquisitions, we expect full year 2024 organic revenue growth to be in a range of 13% to 14% versus 2023. We expect third quarter 2024 reported revenue growth to be in a range of 13% to 15% versus third quarter 2023. Excluding an approximate 100 basis point headwind from foreign exchange based on current rates, we expect third quarter 2024 operational revenue growth to be 14% to 16%. Excluding a 100 basis point contribution from closed acquisitions, we expect third quarter 2024 organic revenue growth to be in a range of 13% to 15% versus 2023. We now expect full year 2024 adjusted below the line expenses to be approximately $300 million. Given discrete items recognized in the first half of 2024, we now expect a full year 2024 operational tax rate of approximately 13.5% and an adjusted tax rate of approximately 12.5%, which contemplates current legislation, including enacted laws and issued guidance under OECD pillar two rules. We expect full year adjusted earnings per share to be in a range of $2.38 to $2.42, representing growth of 16% to 18% versus 2023, including an approximate $0.04 headwind from foreign exchange, which is unchanged from our previous expectations. We expect third quarter adjusted earnings per share to be in a range of $0.57 to $0.59. For more information, please check our investor relations website for Q2 2024 financial and operational highlights, which outlines more details on Q2 results and 2024 guidance. And with that, I'll turn it back to Jon, who will moderate the Q&A."
},
{
"speaker": "Jon Monson",
"content": "Thanks, Dan. Drew, let's open it up for questions for the next 40 minutes or so. In order for us to take as many questions as possible, please limit yourself to one question. Drew, please go ahead."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. The first question comes from Robbie Marcus with J.P. Morgan. Please go ahead."
},
{
"speaker": "Robert Marcus",
"content": "Oh, thank you and congratulations on another fantastic quarter here."
},
{
"speaker": "Michael F. Mahoney",
"content": "Thanks, Robbie."
},
{
"speaker": "Daniel J. Brennan",
"content": "Thanks, Robbie."
},
{
"speaker": "Robert Marcus",
"content": "With my one question, I want to ask about guidance and the sustainability. This is a, it was a big quarter. You had a big first quarter. PFA is clearly outperforming. Watchman had a great quarter. A lot of the rest of the business continues to fire on all cylinders. So I'm seeing about 14% organic for the back half of the year, which is a really healthy rate. And I guess really the question is, how do you feel about continuing through 2024 and really into 2025, is this a pull forward of the revenues expected in the long range plan, or do you think there's better demand, better market adoption, better volumes underlying pricing that could keep maybe not 14%, but something elevated for the foreseeable future? Thanks."
},
{
"speaker": "Michael F. Mahoney",
"content": "Sure, Rob. I'll take a shot at. We're not going to give 2025 guidance here but at our Investor Day, we said our goal was to be the highest performing med tech company in terms of sales and EPS growth, which we believe we did in 2023. Our aim is to do that in 2024 and our aim is to do that for many years to come. And I think one is the primary drivers of you've seen the decade-long portfolio shift into faster-growth markets for the company, where weighted average market growth rate is probably closer to 7% to 8% versus what it used to be kind of flat. So one, we enjoy because of our portfolio choices, faster growing markets. Secondly, we have strong growth across the world. You're seeing Europe double digits, Asia Pac double digits where FARAPULSE is not yet launched. And obviously, the U.S. doing quite well as well. And then I think you just have to look at the durability of other businesses. We'll likely talk about FARAPULSE and WATCHMAN a lot on the call, but you see continued strong growth, 8% to 9%-ish through the first half within our MedSurg businesses. So that kind of gets diminished because of the strength of some other areas, but that's pretty good. And then the cardiovascular portfolio is just getting stronger and stronger. With our EP franchise, Baylis, what we're doing with coronary with Drug-Coated Balloon, you saw the results with ACURATE in Europe, and also potentially some benefits with concomitant reimbursement in the future. And who knows, maybe these procedures may move over time to an ASC center and EP, which also, we think would benefit Boston Scientific given our solution. So we had a tough comp in 2023 with a 12%. Our guidance for the full year is now 13% to 14%. We won't give 2025 guidance, but our goal is to be really distinguish ourselves from the peer group in terms of revenue growth and EPS, and we have the portfolio and the team to do it."
},
{
"speaker": "Robert Marcus",
"content": "Appreciate the thoughts, thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Joanne Wuensch with Citibank. Please go ahead."
},
{
"speaker": "Joanne Wuensch",
"content": "Thank you so much for taking the question and I echo a very nice quarter. Can we unpack just a little bit and you may not like this question, but I get it a lot, what's next, and how do we think about -- to your point, we're going to talk about FARAPULSE and Watchman a lot, but people are now sort of looking forward at how does this continue to roll out to deliver this kind of growth? And thank you."
},
{
"speaker": "Michael F. Mahoney",
"content": "Yes. I think it's -- thanks, Joanne. I think it's similar to some of the themes I just highlighted. We have -- we're in a higher weighted average market growth rate markets to start. We see consistent procedure volume around the world. We are in a pricing environment where we used to be a price giver, pretty significantly. Now it's getting closer to negative 1 to 0. We also expect on the margin front, we took our margin goals up for the year. We expect gross margin to improve over time. Right now, we're getting more margin benefit from SG&A primarily, which is good leverage. We would expect to get more gross margin upside over the LRP period and we just have a very strong product cadence in very fast-growing markets. Two of the best markets in all of MEDTECH, obviously are our EP and WATCHMAN and we have strong leadership position in PFA and that market is only growing. And we are going to launch that in Asia. And we have a lot of clinical work going on with WATCHMAN, as you know, to significantly increase the TAM of that market where it'll rival the TAVI market, three to five years from now. So the clinical evidence that we have in fast-growing market is different in the portfolio, and we continue to make and place strong M&A bets with Axonics and Silk and our venture portfolio, which we'll continue to leverage. So the playbook hasn't changed, but it's the execution of the team of continually putting this in better markets and out-executing the competition."
},
{
"speaker": "Joanne Wuensch",
"content": "Thank you very much."
},
{
"speaker": "Operator",
"content": "The next question comes from Larry Biegelsen with Wells Fargo. Please go ahead."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Hi, good morning. Thanks for taking the questions and congrats on a really nice quarter here. Mike, maybe just to drill down on EP and FARAPULSE. I guess it's a similar question, but just the sustainability here of the growth and the share. By our math, it looks like you've captured about 15% of the U.S. EP market in the second quarter, excluding Baylis. Help us understand how durable your EP share and growth is, can EP continue to be a growth driver for Boston Scientific for years to come and what's driving your confidence you can compete effectively with Athera [ph] and VeraPulse [ph] when they launch? Thank you."
},
{
"speaker": "Michael F. Mahoney",
"content": "So I'll start and then Dr. Stein can maybe talk about how we're really leading the field in our clinical evidence and some of the physician comment. We're competing with those companies today in Europe. With J&J, with all the companies that have PFA platforms. And you've heard us talk on many calls now on the differentiation of FARAPULSE in terms of its safety profile, the clinical data and the -- really, the usage of physicians who never considered using Boston Scientific EP prior, many of them have completely converted to using FARAPULSE for their A-fibrillation procedures. But we're still relatively early in our launch in the U.S. It's less than six months of launching in the U.S. and we have yet to launch in China, and we've yet to launch in Japan, and we have a lot more to do in Europe and we have additional indications coming and additional portfolio coming. So we think the short story is the FARAPULSE platform, combined with Baylis, combined with our clinical will be a differentiated growth driver for Boston for many years to come. Now will it grow as it continues to scale up over 100% a quarter, unlikely, but we expect this to be maybe the biggest business of Boston Scientific in the years to come here."
},
{
"speaker": "Kenneth Stein",
"content": "And Larry, maybe just to sort of add on Mike said first just -- I mean, AF is the most common sustained arrhythmia in the world. Ablation therapy for AF today is still dramatically underpenetrated, right. I mean ablation, high single-digit penetration for persistent afib, low double-digit penetration for paroxysmal afib and the safety advantages, the efficacy advantages, the efficiency advantages and just the overall simplicity of the FARAPULSE system, I think are just going to continue to drive the size of that market and penetration into that market. In terms of the competition, right, again, we do expect to see competitors bring out their first-generation products late this year, early next year, they're already approved in Europe. And frankly, as Mike said earlier, right, we have not seen that materially impact the rapid sustained adoption of FARAPULSE in Europe. And FARAPULSE is a transformative technology with really important differentiated advantages against these competitors. As Mike said, right, treated over 70,000 patients to date, published clinical trial data on over 20,000 patients to date, which really testifies to the safety, to the simplicity, to the efficiency and again, Mike referred to the data we presented at Heart Rhythm Society. It's the only system right now with any data testifying to actually superiority in an efficacy measure against traditional ablation."
},
{
"speaker": "Lawrence Biegelsen",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Rick Wise with Stifel. Please go ahead."
},
{
"speaker": "Jon Monson",
"content": "Hey Rick, can you hear us."
},
{
"speaker": "Frederick Wise",
"content": "Hi, there, can you hear me."
},
{
"speaker": "Jon Monson",
"content": "Yes, we can hear you now."
},
{
"speaker": "Frederick Wise",
"content": "Great, sorry about that. I was hoping also to talk about PFA from another perspective. In my recent doc checks I've heard a great deal of encouraging interest in RHYTHMIA. And obviously, in many cases that are being mapped now with other companies' systems. Just maybe give us some more color on when you launch your mapping integrated catheter in the second half, I assume that's still the target. How do we think about the implications for RHYTHMIA adoption for the percentage of cases that could be mapped on the RHYTHMIA system and the impact on your growth outlook as a result? Thank you."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. Thanks, Rick. I appreciate the question. Again, we still are projecting approval of both our NAV-enabled FARAWAVE catheter and a completely new software suite on RHYTHMIA that we're calling FARAVIEW to help support that. And we certainly do expect that to help drive more adoption of the use of RHYTHMIA and FARAVIEW to accompany FARAWAVE. Now I want to begin though by saying, FARAPULSE will remain an open system. We want to support workflows that don't involve any use of mapping or navigation, support workflows that involve these competitive systems, but also we'll expect with FARAVIEW and FARAWAVE NAV to provide some major advantages in terms of workflow. I think important for me I think emphasize that existing mapping and navigation systems don't understand PFA at all. They were built around an RF ablation paradigm. And so FARAVIEW is going to be the first software and a mapping system that fundamentally understands what we do with PFA and with FARAPULSE. There are some important features, dynamic visualization of the catheter as it changes shape from basket flower configuration, field tagging specific to PFA energy. I think when you put all of that together it has the potential to minimize the use of fluoroscopy during these procedures, minimize catheter exchanges, and really continue what we've tried to do and I think have accomplished with FARAPULSE to begin, right, which is to create a procedure that is safer, that is at least as effective, and that is far more simple and efficient compared to what people have been doing with legacy systems."
},
{
"speaker": "Michael F. Mahoney",
"content": "And on the financial side, as you know, you've seen some of the competitive reports. Mapping is a sizable chunk of the overall EP procedure. And when FARAPULSE is being used, you're seeing increased procedure volume based on the efficiency. So some competitors are benefiting from that productivity gain of FARAPULSE. So in addition to strong utilization rates and opening new centers, more broadly impacted in 2025, we do expect a number of physicians to adopt this Fairview platform that Ken said which is additional revenue that you're not seeing today in the FARAPULSE EP procedure."
},
{
"speaker": "Frederick Wise",
"content": "That’s great. Thank you so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Vijay Kumar with Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "Hi guys, thanks for taking my questions and my congratulations on the experience here. I had one question on U.S. PFA, the 220% growth. Can you parse what was capital contribution versus catheter contribution in the U.S. number. And I think you mentioned a TPT for -- in the U.S., in the outpatient setting, any update on has Boston submitted its TPT? thank you."
},
{
"speaker": "Michael F. Mahoney",
"content": "Yes. So thanks for the question. Unfortunately, we're not going to break out for you the capital and disposable. Disposable is obviously more sizable than the capital, but that's probably the color we'll provide on that. And on the overall pricing, as you do know the pricing is a bit of a premium. But based on the clinical benefits and efficacy and efficiency that physicians and customers are enjoying that seemed to be the proper price point. And on TPT, Ken, do you have any comments on that?"
},
{
"speaker": "Kenneth Stein",
"content": "Yes, Vijay. So we have submitted for TPT. Again, I think important to recognize there are some very strict criteria for eligibility for TPT. And I think just to reiterate what Mike said, which is, right now, we are not seeing pricing as a barrier to the rapid and sustained adoption of FARAPULSE."
},
{
"speaker": "Operator",
"content": "Next question comes from David Roman with Goldman Sachs. Please go ahead."
},
{
"speaker": "David Roman",
"content": "Thank you and good morning. I want to keep going a little bit on the EP side. But also, could you talk a little bit more about both the technology and commercial strategy and as you think about the technology side, right now, the bulk of your business right now sits in the ablation side. You talked a little bit about the importance of mapping and access. But how should we think about the portfolio evolving and how that unlocks new opportunities for you, whether that's in the non-AF side of the ablation market, be it with FARAPOINT or some of the other products? And then on the commercial side, where are the opportunities for pull-through here, so for example, are you training your mappers on generator replacements and ICDs and how should we think about the overall benefit to the portfolio?"
},
{
"speaker": "Michael F. Mahoney",
"content": "Again, I guess Ken and I will try to tag team this. Thank you for the question. It's maybe the best market in med tech. It's about a $10 billion market. The chunk that we're doing well in now is the $6 billion afib market that we continue to strengthen, and we'll get approval, as you know in Asia impact in 2025. There are a number of other areas that we're trying to move into the mapping segment based on the previous commentary is one. We do have an organic ICE program, which we hopefully will -- which is a 510(k) product, hopefully, we'll be competitive with the new ICE platform during this LRP period, which is another large slice of it. And Ken can probably detail out a bit more the clinical studies that we're doing to widen the indication for FARAPULSE beyond what is used today."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. Thanks, Mike. So David, let me start with the clinical strategy and then maybe say a little more about where we're going from a technology standpoint as well because I think it's important, right. That all the other stuff we're doing doesn't just get lost in the excitement around FARAPULSE as exciting as FARAPULSE is. From clinical trial standpoint, to begin with our ADVANTAGE clinical trial, which is aimed to get labeling for FARAPULSE persistent Afib has completed enrollment. We expect to present those results late this year, early next year. We are well underway in a trial called AVANT GUARD , which is aimed to prove that FARAPULSE used as first-line therapy for patients with persistent atrial fibrillation. We've announced the intent to run a trial called REMATCH, which will look at FARAPULSE for redo ablations. From a technology standpoint, we've already talked about the FARAWAVE NAV catheter. In addition to that, we have a point catheter, FARAPOINT that's through its clinical trial. And then down the road, I think more sophisticated catheters for both mapping and ablation catheter called FARAFLEX. And I think as you can imagine, we are interested in the use of this for many arrhythmias beyond atrial fibrillation, atrial tachycardia, and ventricular tachycardia, that pretty much you name it. But I don't want some of the other technology innovations to get lost. And so right, the EP performance was not only a FARAPULSE story, fantastic performance from our Access Solutions portfolio. And in terms of pull-through, right, see very good synergy between FARAPULSE and the Access solution products, likewise, in really good synergy between the WATCHMAN and the Access Solution products. Again, I think in terms of the pull-through question, with the most obvious opportunity, as Mike mentioned, is the opportunity now to have reimbursement in the U.S. for concomitant FARAPULSE ablation and WATCHMAN procedures, which we expect will be a growth driver and hope to see that finalized before the end of this year by CMS. Again, Dan mentioned our acquisition of SoundCath, so an ICE product to support EP procedures and potentially also WATCHMAN procedures, probably just a very long-winded way of saying we love FARAPULSE, but it is far from the only story."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick Wood with Morgan Stanley. Please go ahead."
},
{
"speaker": "Patrick Wood",
"content": "Fabulous, thank you. And on that note, I might flip the script if that's alright with everybody. And maybe switch to something a little different. Obviously, you guys announced Silk and appreciate that hasn't closed yet, but I'd love if you could unpack what was so exciting for you guys in TCAR and that asset overall and the ability to flip WALLSTENT into the package and how meaningful that is relative to just the capacity to plug it into Boston overall and drive sales? Anything around that would be great."
},
{
"speaker": "Michael F. Mahoney",
"content": "Sure. Silk is really a terrific asset we've looked at for a long time. Hopefully, we aim to close that in the second half this year. As a stand-alone business, they were really kind of leading the rejuvenation of that field through their clinical evidence and their performance over many years in the U.S. And it came to a point where we felt it was mature enough in terms of its sales ramp and for us to acquire it at the right price. So I guess, first of all, it always starts with clinical indications. We're really pleased with the data and the long-term durability of this procedure. So as a stand-alone company, they're growing certainly accretive to Boston Scientific faster, but clearly not there on the margin front. So now in Boston Scientific sense we feel like we can grow the company faster in the U.S. given the category leadership portfolio we have and a common call point with a vascular surgeon. We also have the ability to take it outside the U.S. to appropriate countries. And we also aim to improve the margin profile of the business by integrating the company as appropriately within our operations supply chain team like we've done for many other acquisitions in the past. So it's an accretive asset that we think will be stronger and more profitable in the hands of Boston and make us more important for the vascular surgeon, which is an area that as the needs improvement for us, I would say, within that business unit. So now we have the lever -- not the leverage, but the capabilities to present to vascular surgeons our broader PI portfolio, given the relationships that the Silk Road team has with the vascular surgeon."
},
{
"speaker": "Patrick Wood",
"content": "Brilliant, thanks Mike."
},
{
"speaker": "Operator",
"content": "The next question comes from Travis Steed with Bank of America. Please go ahead."
},
{
"speaker": "Travis Steed",
"content": "Hey, thanks for taking the question. I wanted to ask, given the strong margin guide raise and EPS guide raise here, where you're at kind of on the FARAPULSE getting those to full margins and the scale there. Are you halfway there, kind of more or less and your willingness to kind of continue to let that flow through? And I also wanted to ask about TAVR. It felt like a little bit of a time change and tone change on TAVR, so I just wanted to make sure we didn't miss anything on the TAVR update?"
},
{
"speaker": "Daniel J. Brennan",
"content": "Sure. I can start on the gross margin and then Mike can take the TAVR one. So where are we on the journey? As Mike said, we're early in the journey in the United States relative to the FARAPULSE launch. That corresponds pretty well with the gross margin story. So if you think of where we are, the standard margin for FARAPULSE is absolutely accretive relative to the catheter. So that's a great accretive gross margin growth driver. The things that in the initial stages are a little bit dilutive are obviously, you heard me talk about the inventory charges with respect to POLARx. So we don't want to take inventory charges, but when it's -- when you're taking them as a result of the success of FARAPULSE, that's -- it should be temporary and should not be something that continues. So those should get better over time. The manufacturing brands, so we have built our manufacturing capacity and our operations and supply chain team to be the leaders in this space. So we have significant capacity. So as we're making the product today, it's a little under absorbed relative to that. So that will get better, obviously, as we make more and that's obviously our plan. And then the capital placements are dilutive. Again, it's not a huge number relative to the overall gross margin for the company, but it does at the edges, kind of take that down a bit. So overall, I would say FARAPULSE, every quarter, FARAPULSE will be a better contributor to margin. And I think as you get into 2025 and 2026, it will be a significantly accretive growth driver for gross margin for the company."
},
{
"speaker": "Michael F. Mahoney",
"content": "On TAVI, the European team has done really an outstanding quarter and outstanding quarters back to back with ACURATE Neo2, over 20% growth. Importantly, we expect to launch in fourth quarter or maybe first quarter 2025 Prime, which is our next-generation ACURATE Neo2 that has all risk indications and the full-size matrix, which has been the challenge for us to date with an optimized delivery in the valve frame. On the -- just to reiterate on the U.S. timing, we did complete enrollment of the 1,500 patient cohort. And we do expect to present the data in the first half of 2025 likely at the ACC meeting. I think it's important to note that this is the largest randomized trial that's been done in TAVI really based on the timing of the last patient follow-up and the size of the trial and the multiple risk and mixed control groups that we have in it. It's an extensive trial and we believe that the first half 2025 and likely at ACC is the appropriate timing."
},
{
"speaker": "Daniel J. Brennan",
"content": "And then just as a quick follow-up to the gross margin question, Travis. None of that is a surprise relative to gross margin. So we've been saying all along the gross margin is not likely to help the margin improvement story in 2024. But lo and behold, we're able to increase the overall operating margin from 30 to 50 to 50 to 70. So I think all is well on the margin expansion front. Really proud of that 50 to 70 relative to the guidance for this year. And as you look to 2025 and beyond, I think gross margin, I think all lines of the P&L can contribute to the margin expansion journey and gross margin will be one of those."
},
{
"speaker": "Travis Steed",
"content": "Great, very helpful. Thanks a lot."
},
{
"speaker": "Operator",
"content": "The next question comes from Josh Jennings with TD Cowen. Please go ahead."
},
{
"speaker": "Joshua Jennings",
"content": "Good morning. Thanks a lot for taking the questions and congrats on the stellar results. Wanted to just follow up on Travis' two questions. I guess, first on TAVR, could we see top line data before the ACC presentation next year and could Boston file before that presentation? And then just the other follow-up is just on the profitability you guys you're seeing in a lot of profitability flow through on the outperformance on the top line. I wanted to just get a sense of taking some of that profitability and reinvesting that, where could we see -- where some of those dollars going and just some high-level commentary on that reinvestment driving -- supporting this sustainability of top-tier revenue growth in the med tech space? Thanks for taking the questions."
},
{
"speaker": "Kenneth Stein",
"content": "Yes, Josh, maybe I'll take the TAVR question first and then let Dan and Mike take the others. Just really what Mike said, last patient follow-up in the trial was just in this quarter, it's a very large, very complex trial. And just honestly, based on the timing of getting the data cleaned and getting the readouts from all of the various core labs [ph] that are engaged in getting us the analysis for the trial, we are going to miss the abstract deadlines for all of the major fall meetings. So those deadlines literally come up within a couple of weeks. And again, these data are so important and pivotal, right, we want to present this at a major meeting. And so right, the first major cardiology meeting, where we'll be able to meet an abstract deadline is going to be the ACC. Would not expect you to see any data released ahead of that."
},
{
"speaker": "Daniel J. Brennan",
"content": "And the second part of your question relative to the balance between reinvesting the sales upside and dropping some through. I think you're seeing the evidence of that here in our guidance raise for the 50 to 70. So I think we've struck a really good balance on that. So we've had sales upside during the year and the realization that we closed the first half a little bit ahead of expectations. So we're giving some of that back. So we're taking the 30 to 50 to the 50 to 70. So that's great. At the same time, we are reinvesting in the business, primarily in the commercial facing functions. We're leveraging the back office and the administrative areas, which makes sense. We don't need to grow those when you're growing the revenue at the rate that we're at. So we've got significant leverage opportunities there. And then as Mike said, this isn't just reinvesting in FARAPULSE. This is reinvesting across the whole portfolio, the broad portfolio that we have. So we picked the right spots to reinvest to be able to continue to deliver that top line performance for the long term. And I think we're striking a nice balance there."
},
{
"speaker": "Operator",
"content": "The next question comes from Daniel Antalffy with UBS. Please go ahead."
},
{
"speaker": "Danielle Antalffy",
"content": "Hey, good morning everyone. Thanks so much for taking the question. And I'll be a broken record here. Congrats on the really awesome quarter. Mike, I wanted to go in a different direction here away from PFA for a second and talk about how we should think, just on this theme of sustainability of growth into 2025, appreciating we'll give guidance here. But if we think about AGENT DCB launching back half of this year and Modular in the back half or, I guess, is that launching this year as well. So how do we think about those contributing maybe elevating CRM growth above the market in next year as well as the Interventional Cardiology portfolio? Thanks so much."
},
{
"speaker": "Michael F. Mahoney",
"content": "Thank you for pointing that out because I was getting hammered by tax from our agent team and our CRM team for not mentioning those in the prior question. So I think if you were to continue to add on that discussion, which is how do we maintain and sustain high performance, that's highly differentiated from the peer group for the -- for many years to come. It's all the things we talked about before with PFA and WATCHMAN indication expansion. And as you said, with the AGENT, kudos to that team, they're really transforming that portfolio. Drug-eluting stents next year will probably be 2% of overall Boston Scientific. And you're seeing tremendous growth in our imaging business with our IVUS imaging platform. And now we're the first one to have approval for AGENTS, and that TPT decision will be made soon and apply and hopefully, in January. And that is a market that we plan to drive where we have a multiyear advantage, where we have superiority data for what is at least 10% of the market with restenosis and appropriate price points. That's going to accelerate the growth of that division and significantly improve the margin profile over time. Why we continue to invest in clinical science and our structural heart portfolio and also, we have a very vast VC portfolio. And oftentimes, those VC investments come with dilution, which our team is able to manage consistently while investing for the future, while improving margins at the same time. So I think that's a big part of it. As you do know, the CRM business is a bit of a lag for us. International business did quite well. U.S. lagged a little bit and the Modular ATP, proud of the team for that. That was a long study, a very difficult project. But you saw the results of that S-ICD with the modular platform and we're excited to launch that in 2025. So there are two other areas that I didn't mention before that you pointed out. And also, what's not being mentioned here today is just the tremendous growth in our Endo and Uro businesses. Our Uro business is near double digits for the first half. Our Endo business is near double digit for the first half. Those are all accretive margin companies for us. We're very excited about the Axonics acquisition, which will have operational benefit in 2025 and organic in 2026 primarily. But it just makes those divisions even stronger. So there's many things to be excited about for the future of the company to continue on with a goal of differentiated performance."
},
{
"speaker": "Danielle Antalffy",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Matthew O'Brien with Piper Scientific. Please go ahead."
},
{
"speaker": "Matthew O’Brien",
"content": "Great, thanks so much. From Piper Sandler. Just maybe on just sticking with kind of where Danielle is going outside of PFA. Just on the WATCHMAN business, 20% growth is a little bit of a tick up versus Q1. Your competitor said they grew 45% in the quarter. So are you losing a little bit of share to those guys or is the market starting to accelerate for some reason, I don't know if it's in front of this concomitant reimbursement, just maybe talk a little bit about that? And then maybe for Dr. Stein specifically, if you get this concomitant reimbursement, can you just talk about the workflow for the clinician in terms of doing a PFA case plus a WATCHMAN case at the same time. I mean how much more challenging is that you have to bring in an ICE sometimes and other times not bringing ICE and to do the WATCHMAN part of the case, just maybe talk a little bit about that opportunity going forward? Thank you."
},
{
"speaker": "Michael F. Mahoney",
"content": "Yes, I'll just touch on the growth, 20% is excellent. We're in the midst of launching our WATCHMAN FLX Pro and maybe as importantly, this new steerable sheet, which is early in its launch. And so I think to clinical data and the extremely high market share of WATCHMAN speaks for itself and the ongoing R&D platforms that we're driving for WATCHMAN and clinical science. So we are extremely comfortable that we're nearly 90% of share in the U.S. and there may be some extremely price-sensitive accounts that will occasionally lose business to. But it's very, very small margin. Very, very small numbers. And if you look at the size of the WATCHMAN business and our share and our technology lead, we're very comfortable with the position we're in."
},
{
"speaker": "Kenneth Stein",
"content": "Yes. And then in terms of just workflow and concomitant, this is one of the areas where I think in between, right, the safety and efficiency advantages of WATCHMAN FLX and FLX Pro combined with the efficiency and safety advantages of FARAPULSE could create a real advantage for us as a unified ecosystem. The beauty of doing these two procedures together, right, is they both involve transseptal access into the left atrium. They both involve the catheter manipulation inside the left atrium. So there's a huge benefit to patients to be able to have it all done at one sitting as opposed to having to have one procedure and then go through many of the same risks of the first procedure go and have it done as a second procedure. And just to reiterate, when you think of doing it as a concomitant procedure what you want our technologies that enable you to do it safely and we do it reproducibly and enable you to do it efficiently. So you're spending as little time as possible, right, mucking about inside someone's left atrium. And FARAPULSE and WATCHMAN FLX Pro together are unmatched in giving you those advantages."
},
{
"speaker": "Operator",
"content": "And I understand there is time for one last question."
},
{
"speaker": "Michael F. Mahoney",
"content": "Yes, please."
},
{
"speaker": "Operator",
"content": "Okay. That last question will come from Matt Taylor with Jefferies. Please go ahead."
},
{
"speaker": "Matthew Taylor",
"content": "Hi, good morning guys, thank you for taking the questions. Congrats on a great quarter. I did want to ask a follow-up question on FARAPULSE just to help with thinking about the modeling and the opportunity there. Could you give us any kind of update or parameters on how many centers you're in, how many boxes you've placed, and maybe talk about whether the early experience has changed your views on how the market could evolve like you laid out at the Analyst Day several months ago?"
},
{
"speaker": "Michael F. Mahoney",
"content": "Yes, I think the only piece of that we'll provide color on is the last part of it. We don't want to break out catheter usage, capital usage, how many sites. I would say the utilization rates of sites once they use FARAPULSE is very quick and sustainable. So we're not seeing hospitals turn it on and turn it off and go in and out of it, like you see in many med tech products. So the sustainability and usage of FARAPULSE is very high once customers start using it. And obviously, we have a chance to sell more consoles to larger centers in the existing accounts besides opening new accounts. And the second part was what -- having a senior moment. [Multiple Speakers] Great, thanks. I ended it with a dud, sorry Matt."
},
{
"speaker": "Matthew O’Brien",
"content": "That’s okay, alright."
},
{
"speaker": "Jon Monson",
"content": "Well, thanks, everyone, for joining us today. As always, we appreciate your interest in Boston Scientific. If we were unable to get to your question or have any follow-ups, please don't hesitate to reach out to the Investor Relations team. And before you disconnect, Drew will give you all the pertinent details for the replay. Thanks so much."
},
{
"speaker": "Operator",
"content": "Thank you. Please note a recording will be available in one hour by dialing either 1-877-344-7529 or 1-412-317-0088, using replay code 2312308 until July 31, 2024 at 11:59 P.M. Eastern Time. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
bsx | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Boston Scientific 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 Jon Monson, Senior Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Jonathan Monson",
"content": "Thank you, Drew, and welcome, everyone, and thanks for joining us today. With me on today's call are Mike Mahoney, Chairman and Chief Executive Officer; and Dan Brennan, Executive Vice President and Chief Financial Officer."
},
{
"speaker": "",
"content": "We issued a press release earlier this morning announcing our Q1 results, which included reconciliations of the non-GAAP measures used in the release. We have posted a link to that release as well as reconciliations of the non-GAAP measures used in today's call to the Investor Relations section of our website under the heading Financials & Filings."
},
{
"speaker": "",
"content": "The duration of this morning's call will be approximately 1 hour. Mike and Dan will provide comments on Q1 performance as well as the outlook for our business, including Q2 and full year 2024 guidance, and then we'll take your questions. During today's Q&A session, Mike and Dan will be joined by our Chief Medical Officer, Dr. Ken Stein."
},
{
"speaker": "",
"content": "Before we begin, I'd like to remind everyone that on the call, operational revenue growth excludes the impact of foreign currency fluctuations. And organic revenue growth further excludes acquisitions and divestitures, for which there are less than a full period of comparable net sales."
},
{
"speaker": "",
"content": "Relevant acquisitions and divestitures excluded for organic growth are the majority stake investment in Acotec Scientific Holdings Limited and the acquisitions of Apollo Endosurgery and Relievant Medsystems, which closed in February, April and November 2023, respectively, as well as our acquisition of the endoluminal vacuum therapy portfolio from B. Braun, which closed in March 2024."
},
{
"speaker": "",
"content": "Divestitures include the endoscopy pathology business, which closed in April 2023."
},
{
"speaker": "",
"content": "Guidance excludes the previously announced agreement to acquire Axonics, Inc., which is expected to close in the second half of 2024, subject to customary closing conditions."
},
{
"speaker": "",
"content": "For more information, please refer to our Q1 Financial and Operational Highlights deck, which may be found on our Investor Relations website."
},
{
"speaker": "",
"content": "On this call, all references to sales and revenue, unless otherwise specified, are organic."
},
{
"speaker": "",
"content": "This call contains forward-looking statements within the meaning of federal securities law, which may be identified by words like anticipate, expect, may, believe, estimate and other similar words. They include, among other things, statements about our growth and market share; new and anticipated product approvals and launches; acquisitions, clinical trials; cost savings and growth opportunities; our cash flow and expected use of cash; our financial performance, including sales, margins and earnings; as well as our tax rates, R&D spend and other expenses."
},
{
"speaker": "",
"content": "If our underlying assumptions turn out to be incorrect or certain risks or uncertainties materialize, actual results could vary materially from the expectations and projections expressed or implied by our forward-looking statements."
},
{
"speaker": "",
"content": "Factors that may cause such differences include those described in the Risk Factors section of our most recent 10-K and subsequent 10-Qs filed with the SEC."
},
{
"speaker": "",
"content": "These statements speak only as of today's date and we disclaim any intention or obligation to update them, except as required by law."
},
{
"speaker": "",
"content": "At this point, I'll turn it over to Mike. Mike?"
},
{
"speaker": "Michael Mahoney",
"content": "Thanks, Jon. Thank you to everyone for joining us today. Our first quarter results surpassed our expectations, fueled by our innovative portfolio, including the nearly 90 new products we launched globally in 2023, the execution of our category leadership strategy and the winning spirit of our global team."
},
{
"speaker": "",
"content": "In the first quarter '24, total company operational sales grew 15% and organic sales grew 13% versus first quarter '23, which exceeds the high end of our guidance range of 7% to 9%. Our strong growth continues to be diversified across businesses and regions. In the quarter, 6 of our 8 business units in all of our regions grew double digits. We believe that most business units grew faster than their respective markets with differentiated portfolios and strong commercial execution, supported by healthy procedural demand."
},
{
"speaker": "",
"content": "First quarter adjusted EPS was $0.56, which grew 21% versus 2023, which exceeds the high end of our guidance range of $0.50 to $0.52. First quarter adjusted operating margin was 26.2%."
},
{
"speaker": "",
"content": "Turning to our second quarter and full year '24 outlook. We are guiding to organic growth of 10% to 12% for second quarter '24 and raising our full year guidance from 8% to 9% to 10% to 12%, reflecting momentum from our innovative portfolio, healthy procedural volumes and continued execution by our global team."
},
{
"speaker": "",
"content": "Our second quarter '24 adjusted EPS guidance is $0.57 to $0.59 and we expect our full year adjusted EPS to be $2.29 to $2.34, representing growth of 12% to 14%."
},
{
"speaker": "",
"content": "Dan will provide more details on our financials and I'll provide additional highlights on our first quarter, along with comments on our '24 outlook."
},
{
"speaker": "",
"content": "Regionally, on an operational basis, the U.S. grew 13% versus first quarter with particular strength in EP, fueled by the launch of FARAPULSE midway through the quarter, as well as on our WATCHMAN ICTx Urology and Endoscopy business units."
},
{
"speaker": "",
"content": "Europe, Middle East and Africa grew 13% on an operational basis versus first quarter '23. This above-market growth was led by exceptional performance in EP as well as double-digit growth in our Endoscopy, Urology and PI businesses. We expect to continue to outpace the market, driven by continued broad-based momentum across our business and investment in emerging markets."
},
{
"speaker": "",
"content": "Asia Pac grew 26% operationally versus first quarter '23, led by strong double-digit performance in all of our Cardiovascular business units. Japan grew double digits driven by AGENT DCB, Rezum and our Access Solutions products. China delivered excellent results, growing strong double digits with 7 of our 8 business units growing double digits."
},
{
"speaker": "",
"content": "I'll now provide some additional commentary on our business units. In Urology, sales grew 10%, both operationally and organically versus first quarter '23, with double-digit growth in stone management as well as prosthetic urology. Rezum performed well in the quarter, both in the U.S. and internationally, and secured reimbursement status in France. We look forward to closing the previously announced acquisition of Axonics now expected in the second half of 2024."
},
{
"speaker": "",
"content": "Endoscopy sales grew 12% operationally and 10% organically versus first quarter '23. Strong first quarter results were driven by the breadth of our portfolio, underpinned by differentiated anchor products such as AXIOS and our single-use imaging products."
},
{
"speaker": "",
"content": "Within the quarter, we also received CE Mark for our MANTIS Clip and NICE in the U.K. issued positive guidance for the ESG endoscopic bariatric surgery procedure, both expected to further momentum in our growing endoluminal surgery franchise."
},
{
"speaker": "",
"content": "Neuromodulation sales grew 10% operationally and declined 1% organically versus first quarter '23. Our brain franchise grew high single digits in the quarter with low double-digit U.S. growth driven by our comprehensive directional stimulation offering enabled by image-guided programming."
},
{
"speaker": "",
"content": "In the first quarter, our pain franchise grew low double digits operationally, but declined mid-single digits on an organic basis, with continued pressure in our U.S. SCS business."
},
{
"speaker": "",
"content": "In the U.S., during the first quarter, we did receive FDA approval and recently launched the WaveWriter symptom (sic) [ system ] nonsurgical back pain indication and our next-generation FAST AutoDose."
},
{
"speaker": "",
"content": "Importantly, the Relievant business continues to perform very well with steady expansion of payer coverage, and we expect sales from the novel Intracept procedure to grow about 50% in 2024."
},
{
"speaker": "",
"content": "Peripheral Intervention sales grew 16% operationally and 11% organically versus first quarter '23. Double-digit growth in arterial was bolstered by our drug-eluting portfolio supported by the strength of clinical evidence and global commercial execution."
},
{
"speaker": "",
"content": "In venous, we saw continued above-market growth from Varithena and clot management continued to perform well, in line with expectations."
},
{
"speaker": "",
"content": "Our interventional oncology franchise grew strong double digits in the first quarter, driven by our broad offering of embolization devices, including the Embold coil family in cancer therapies."
},
{
"speaker": "",
"content": "In the quarter, TheraSphere also grew double digits and data from the real-world study, PROACTIF, was presented, demonstrating positive outcomes in patients with intermediate and advanced HCC who were treated with TheraSphere."
},
{
"speaker": "",
"content": "Cardiology sales delivered another excellent quarter with both operational and organic sales growing 18% versus first quarter 2023."
},
{
"speaker": "",
"content": "Within Cardiology, Interventional Cardiology Therapy sales grew an impressive 13% organically versus first quarter '23."
},
{
"speaker": "",
"content": "Growth in Coronary Therapies was driven by continued strength in our international regions, led by our imaging portfolio and AGENT DCB in Japan."
},
{
"speaker": "",
"content": "In the U.S., we're also pleased with the ongoing launch of AVVIGO+, which is our AI-guided imaging platform. We also received FDA approval of our AGENT DCB in first quarter, and we expect to initiate a limited launch in the second quarter as we ramp supply following the earlier-than-anticipated regulatory approval."
},
{
"speaker": "",
"content": "Our Structural Heart Valves franchise once again grew mid-teens in first quarter, led by ACURATE neo2, which continues to see growth from both new and existing accounts. We have now submitted for CE Mark for our next-generation ACURATE Prime valve, which we continue to expect to launch in Europe in 2025."
},
{
"speaker": "",
"content": "WATCHMAN had another strong quarter, growing 19% organically and maintaining our market-leading share position. In the U.S., WATCHMAN FLX Pro moved into full launch and we received FDA clearance for the TruSteer steerable sheath, allowing physicians to achieve more optimal device positioning in the widest range of LAA anatomies."
},
{
"speaker": "",
"content": "International growth was driven by ongoing momentum in -- ongoing momentum within the quarter, and we received approval and launched WATCHMAN FLX Pro in Japan and Canada, which will support continued growth in these markets."
},
{
"speaker": "",
"content": "Cardiac Rhythm Management sales grew 5% organically in the first quarter '23. In the first quarter, our Diagnostics franchise also grew double digits, led by strong market adoption of our second-generation LUX-Dx ICM device."
},
{
"speaker": "",
"content": "In core CRM, our low-voltage business grew mid-single digits and our high-voltage business grew low single digits. Our Emblem S-ICD continues to maintain its strong share position and we've seen very limited impact in Europe or the U.S. from a recent competitor's launch."
},
{
"speaker": "",
"content": "We expect to remain the clear market leader in this space and look forward to the upcoming data presentation at HRS of MODULAR ATP, which is a pivotal trial studying the use of the Emblem S-ICD in conjunction with our EMPOWER leadless pacemaker to function as a single-chamber pacemaker, as well as to provide anti-tachycardia pacing when needed. We anticipate FDA approval of the modular CRM system and stand-alone EMPOWER leadless pacemaker in '25."
},
{
"speaker": "",
"content": "Electrophysiology sales grew 72% both operationally and organically versus first quarter '23 driven by the adoption of the transformative FARAPULSE platform."
},
{
"speaker": "",
"content": "International first quarter sales grew 59%, with continued FARAPULSE account openings and robust utilization in Europe."
},
{
"speaker": "",
"content": "U.S. first quarter sales grew 85% organically, propelled by the mid-first quarter launch of FARAPULSE. We have already made good progress entering to high-volume accounts, supported by compelling clinical evidence, commercial execution and investment in our supply chain."
},
{
"speaker": "",
"content": "Early feedback on FARAPULSE has been extremely positive with rapid adoption from both RF and cryo users. Electrophysiologists appreciate FARAPULSE's unique safety profile, ease of use, effectiveness and efficiency of the procedure. We expect our broad EP portfolio, coupled with our other AF solutions, to drive significant global growth in '24 and beyond."
},
{
"speaker": "",
"content": "We also intend to extend our leadership in PFA by investing in innovation, clinical evidence and global capabilities. Within the quarter, we commenced enrollment of the NAVIGATE-PF clinical trial, studying integrated cardiac mapping with a FARAVIEW software and FARAWAVE non-enabled catheter, both of which are expected to launch in the U.S. during the second half of the year."
},
{
"speaker": "",
"content": "We also completed enrollment of Phase II in the ADVANTAGE AF clinical trial, studying our FARAPOINT device for CTI ablations, which is expected to launch in the U.S. in 2025. And we also anticipate data from Phase I of the ADVANTAGE trial for persistent AF to be presented in fourth quarter 2024."
},
{
"speaker": "",
"content": "We also look forward to our clinical late-breakers at the upcoming HRS meeting in May, which aims to highlight the unique capabilities of FARAPULSE."
},
{
"speaker": "Also of note, this week, we released our 2023 Performance Report, highlighting the company's actions to improve patient outcomes while prioritizing our environmental, social and governance goals. We continue to make progress in all 3 key areas",
"content": "innovating care to meet patient needs, empowering people and shaping a healthier planet while performing with integrity. While we always have more to do, I know that our values-driven culture and the commitment of our global teams to challenge -- to this challenge of what's possible will continue to raise the bar."
},
{
"speaker": "",
"content": "In closing, I'm very grateful to our global employees who work every day to advance science for life. We remain committed to investing for the long term while delivering top-tier financial performance in 2024 and beyond."
},
{
"speaker": "",
"content": "And with that, I'll hand over to Dan to provide more details on the financials."
},
{
"speaker": "Daniel Brennan",
"content": "Thanks, Mike. First quarter 2024 consolidated revenue of $3.856 billion represents 13.8% reported growth versus first quarter 2023 and includes a 120 basis point headwind from foreign exchange, in line with our expectations. Excluding this $40 million headwind from foreign exchange, operational revenue growth was 15% in the quarter. Sales from the closed acquisitions and divestitures contributed 190 basis points, resulting in 13.1% organic revenue growth, exceeding our first quarter guidance range of 7% to 9%."
},
{
"speaker": "",
"content": "Q1 2024 adjusted earnings per share of $0.56 grew 20.6% versus 2023 exceeding the high end of our guidance range of $0.50 to $0.52, primarily driven by our strong sales performance."
},
{
"speaker": "",
"content": "Adjusted gross margin for the first quarter was 69.8%, which includes an approximate 30 basis point year-over-year headwind from foreign exchange. Adjusted gross margin was slightly lower than anticipated, primarily driven by inventory charges and less favorable product mix due to increased levels of capital placements in the quarter."
},
{
"speaker": "",
"content": "Despite a lower Q1, we continue to expect full year adjusted gross margin to be at or slightly below our 2023 full year rate, driven by increasing mix benefit from our new launches, lower inventory charges and the full recognition of our annual standard manufacturing cost improvements in the second half of the year."
},
{
"speaker": "",
"content": "First quarter adjusted operating margin was 26.2%. We remain committed to expanding adjusted operating margin by 30 to 50 basis points in 2024 as we balance progress towards our long-range plan goal of 150 basis points of improvement from 2024 to 2026 with the flexibility to make critical investments to support key launches."
},
{
"speaker": "",
"content": "On a GAAP basis, first quarter operating margin was 17.5%."
},
{
"speaker": "",
"content": "Moving to below the line. First quarter adjusted interest and other expenses totaled $80 million."
},
{
"speaker": "",
"content": "On an adjusted basis, our tax rate for the first quarter was 10.7%, which includes favorable discrete tax items and the benefit from stock compensation accounting. Our operational tax rate was 13.7% for the quarter."
},
{
"speaker": "",
"content": "Fully diluted weighted average shares outstanding ended at 1.482 billion shares in the first quarter."
},
{
"speaker": "",
"content": "Free cash flow for the first quarter was a negative $15 million with $164 million from operating activities less $179 million in net capital expenditures, which includes payments of $251 million related to acquisitions, restructuring, litigation and other special items."
},
{
"speaker": "",
"content": "In 2024, we continue to expect full year free cash flow to exceed $2 billion, which includes approximately $800 million of expected payments related to special items."
},
{
"speaker": "",
"content": "As of March 31, 2024, we had cash on hand of $2.3 billion, inclusive of the $2 billion -- 2 billion euro-denominated senior note offering completed on February 27, which we intend to use to partially fund the Axonics acquisition."
},
{
"speaker": "",
"content": "During the first quarter, we repaid approximately $500 million of senior notes upon maturity, and our gross debt leverage was 2.5x as of March 31."
},
{
"speaker": "",
"content": "Our top capital allocation priority remains strategic tuck-in M&A, followed by annual share repurchases to offset dilution from employee stock grants. In alignment with our acquisition strategy, we recently closed the acquisition of the endoluminal vacuum therapy portfolio from B. Braun, which complements our existing endoscopy portfolio and is expected to be immaterial to earnings per share in 2024."
},
{
"speaker": "",
"content": "Our legal reserve was $283 million as of March 31, a decrease of $94 million versus Q4 2023. And $71 million of this reserve is already funded through our qualified settlement funds."
},
{
"speaker": "",
"content": "I'll now walk through guidance for Q2 and the full year 2024. We expect full year 2024 reported revenue growth to be in a range of 11% to 13% versus 2023. Excluding an approximate 50 basis point headwind from foreign exchange based on current rates, we expect full year 2024 operational revenue growth to be 11.5% to 13.5%. Excluding a 150 basis point contribution from closed acquisitions, we expect full year 2024 organic revenue growth to be in a range of 10% to 12% versus 2023."
},
{
"speaker": "",
"content": "We expect second quarter 2024 reported revenue growth to be in a range of 10.5% to 12.5% versus second quarter 2023. Excluding an approximate 100 basis point headwind from foreign exchange based on current rates, we expect second quarter 2024 operational revenue growth to be 11.5% to 13.5%. And excluding a 150 basis point contribution from closed acquisitions, we expect second quarter 2024 organic revenue growth to be in a range of 10% to 12% versus 2023."
},
{
"speaker": "",
"content": "We now expect full year 2024 adjusted below-the-line expense to be approximately $315 million."
},
{
"speaker": "",
"content": "Under current legislation, including enacted laws and issued guidance under OECD Pillar 2 rules, we continue to forecast a full year 2024 operational tax rate of approximately 14% and an adjusted tax rate of approximately 13%."
},
{
"speaker": "",
"content": "We expect full year adjusted earnings per share to be in a range of $2.29 and to $2.34, representing 12% to 14% growth versus 2023, including an approximate $0.04 headwind from foreign exchange, which is unchanged from our previous expectations."
},
{
"speaker": "",
"content": "We expect second quarter adjusted earnings per share to be in a range of $0.57 to $0.59."
},
{
"speaker": "",
"content": "For more information, please check our Investor Relations website for Q1 2024 financial and operational highlights, which outlines more details on Q1 results and our 2024 guidance."
},
{
"speaker": "",
"content": "And with that, I'll turn it back to Jon, who will moderate the Q&A."
},
{
"speaker": "Jonathan Monson",
"content": "Thanks, Dan. Drew, let's open it up for questions for the next 40 minutes or so [Operator Instructions] Drew, please go ahead."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question comes from Robbie Marcus with JPMorgan."
},
{
"speaker": "Robert Marcus",
"content": "Great. Congrats on a fantastic quarter. I guess with my one question, it has to be on FARAPULSE and EP in general. The beat was substantial, both U.S. and OUS. The doc feedback we hear is phenomenal on FARAPULSE PFA in general."
},
{
"speaker": "",
"content": "So I'd just love to get your view on what you're seeing in the field, the willingness to adopt the new technology, how fast it could go and how much of the guidance raise is just from FARAPULSE here and the opportunity."
},
{
"speaker": "Michael Mahoney",
"content": "Yes. First, I want to shout out to early pioneering work by Chris O'Hara, the amazing work by the FARAPULSE team and really the work our team has done over multiple years. This is the most transformational product that I've seen in my career with the company. And Dr. Stein can comment on clinically, but we continue to invest significantly in the current platform and in future products and a significant amount of clinical science to really widen the gap in PFA with our FARAPULSE system."
},
{
"speaker": "",
"content": "And as I mentioned in the script, we're seeing very rapid adoption from both RF and cryo users. We continue to invest in our commercial footprint in the U.S. And we're able to meet the demand thus far with our talented supply chain teams."
},
{
"speaker": "",
"content": "But we're also excited about the ongoing momentum in Europe, where we've been live for a number of years. But we continue to increase utilization in Europe and open new centers now that they have a bit more supply than they did in 2023."
},
{
"speaker": "",
"content": "And we're also working diligently with our teams in Asia, in Japan and China, to train them up so they can also take advantage of FARAPULSE really kind of more of a fourth quarter 2025 story in Asia."
},
{
"speaker": "",
"content": "So it really -- it's a remarkable platform and we're seeing excellent safety results, ease of use, rapid adoption and excellent effectiveness. Dr. Stein, if you want to comment?"
},
{
"speaker": "Ken Stein",
"content": "Yes. Thanks. Thanks, Mike. Thanks, Robbie. Maybe the one thing I'd add, I'd just -- the caution here is against thinking of PFA in general, that every PFA system is very different and I think everyone really needs to be evaluated on its own. So the results you get with PFA are just completely dependent on catheter design, on waveform and on dosing strategy. And as Mike said, what people see when they use FARAPULSE clinically, when people see the data and we've now got published data including randomized clinical trial data, registry data, total data at well over 18,000 patients have reported at this point, and as Mike said, it just has compelling advantages in terms of safety, in terms of efficacy, in terms of ease of use and in terms of efficiency. And that's what you see driving the rapid uptake, both in the U.S. and globally."
},
{
"speaker": "Operator",
"content": "The next question comes from Larry Biegelsen with Wells Fargo."
},
{
"speaker": "Larry Biegelsen",
"content": "I echo Robbie's congratulations on a really strong quarter here. Just with my one question, I feel compelled to ask a big-picture question here. You updated your LRP in September of last year to 8% to 10% organic growth for 2024 to 2026. The assumption at the time was that growth in '25 would accelerate over 2024. You're guiding today to 10% to 12% organic growth."
},
{
"speaker": "",
"content": "So the question is, do you still expect growth to accelerate in 2025? And how should we think about the 8% to 10% CAGR in the context of this strong 2024 guidance?"
},
{
"speaker": "Michael Mahoney",
"content": "Yes. So we outlined at Investor Day the 8% to 10% and our goal to be a very high-performing med tech company. And so we're super pleased with the first quarter results that also led to -- and the business momentum led to the guidance you referred to at 10% to $12. So we're pleased with taking our full year guidance up. We did also receive FARAPULSE earlier than we expected."
},
{
"speaker": "",
"content": "So at this point, we'll hold off and look at our 2025 guidance later in the year. But we're super pleased with the momentum that we have across all regions and all business units. But at this point, we're not going to commit to accelerating growth in 2025. Certainly, our aim would be to do that, but it would be premature to confirm that at this point."
},
{
"speaker": "Operator",
"content": "The next question comes from Rick Wise with Stifel."
},
{
"speaker": "Frederick Wise",
"content": "I guess I'd focus on perhaps ACURATE neo. It sounds like it's performing well internationally. But can you maybe expand on where you are both internationally, the new product you spoke about and you're feeling about next steps in the United States? Are you feeling more optimistic, more cautious about timing? And just any incremental color would be just great."
},
{
"speaker": "Michael Mahoney",
"content": "Sure. Thanks, Rick. We're very pleased with the results in Europe. We continue to grow above market in Europe and have excellent adoption across most major countries in Europe. And importantly, as you said, we've invested quite a bit in this portfolio and we're excited about the Prime submission that we just recently did in Europe, which will enhance the valve further and provide additional valve sizes as well. So we expect that to go well in Europe."
},
{
"speaker": "",
"content": "In the U.S., there's really not going to be any new commentary that we haven't stated publicly. We are waiting for the full year follow-up. We also will be working with the regulators, and we'll communicate in the future date the timing of the release of that clinical data and our next steps in the U.S."
},
{
"speaker": "Operator",
"content": "The next question comes from Joanne Wuensch with Citi."
},
{
"speaker": "Joanne Wuensch",
"content": "Another nice quarter. A question on operating margins. I think your LRP was 450 basis points over -- was it over the 2-year period, I would assume? But anyway..."
},
{
"speaker": "Daniel Brennan",
"content": "No, it was over -- it was -- not to interrupt you, Joanne. It was just over the 3-year period. 2024 to 2026 was 150 basis points."
},
{
"speaker": "Joanne Wuensch",
"content": "Excellent. Thank you for that clarification. But as I'm looking at the quarter delivery, it looks like some of the leverage came from R&D, some of it came from SG&A. I'm just curious how you're thinking about providing that leverage over the 3-year period."
},
{
"speaker": "Daniel Brennan",
"content": "Yes. I think over the 3-year period, all lines will contribute. And I think it's really a great part of the history of the company and the kind of the DNA of the margin expansion story is that at any given point in time, all lines can contribute. So gross margin at that 69.8%, I didn't love that this quarter, but I'm optimistic that, that improves through the year."
},
{
"speaker": "",
"content": "But we said at Investor Day and we reiterated it on our January call, that gross margin probably is not going to contribute this year to the 30 to 50 points. So this year, it's more of an OpEx leverage story. But absolutely, in '25 and '26, I think gross margin can contribute. Recall, we used to be at 72.4% gross margin back in 2019. We're maniacally focused on getting back and improving that from where it is today and have the plans to do that."
},
{
"speaker": "",
"content": "So I think the summary is, as we look to improve the 150 basis points over the 3 years, it puts us kind of at the doorstep of 28% at the end of '26, which is a nice spot to be. It puts that 30% long-term goal that we have really in focus. And all lines of the P&L could contribute along that journey."
},
{
"speaker": "Operator",
"content": "The next question comes from Vijay Kumar with Evercore ISI."
},
{
"speaker": "Vijay Kumar",
"content": "Congrats on really solid finish here. Mike, maybe my one question on the EP portfolio. The 70% overall growth, 85% in the U.S., how -- can you give us a little bit of color on was there any stocking dynamic? How much of this was driven by the account openings versus a procedure uptake?"
},
{
"speaker": "",
"content": "And sort of related to that, does new tech add-on payment, does it matter where we are on TPT?"
},
{
"speaker": "Michael Mahoney",
"content": "Yes. So the results in the U.S., 85% as you mentioned, it was really a mid-quarter launch. So the teams moved pretty quickly to have some impact in the first quarter. And we look forward to good results, obviously, in the second quarter and the rest of the year based on momentum."
},
{
"speaker": "",
"content": "So there's not any big onetime stocking. So this is driven by new account openings and I would say very rapid adoption of the technology, and therefore, continued utilization of the product once they have the platform. We're also seeing multiple hospitals buying their second console, which also is a great sign because it shows the adoption and using it routinely every day."
},
{
"speaker": "",
"content": "And so it's really new account openings and increased adoption once they start using the platform, and that's driving the U.S. results."
},
{
"speaker": "",
"content": "And as I mentioned, in Europe, which I think is impressive, now that they have a bit more supply, they continue to open more accounts and increase the utilization of existing accounts with the FARAPULSE platform."
},
{
"speaker": "",
"content": "On the TPT, we think it's a bit less significant for FARAPULSE, but it's something we'll continue to evaluate. And we'll provide you updates as we see them. Dr. Stein?"
},
{
"speaker": "Ken Stein",
"content": "I described that, that's NTAP."
},
{
"speaker": "Michael Mahoney",
"content": "I'm sorry."
},
{
"speaker": "Ken Stein",
"content": "Yes. And Vijay, I think just important maybe to point out. First off, right, the NTAP applies to inpatient Medicare fee-for-service, which is really a small minority of AF ablations today. Having said that, we still do believe that FARAPULSE can use the proposed NTAP related to one of our customers."
},
{
"speaker": "",
"content": "And actually, I think it's important from a physician perspective and a hospital perspective, that we're not in a position of having to create unique ICD-10 codes that are product-specific. That's really not helpful to either the physicians or the hospitals."
},
{
"speaker": "Operator",
"content": "The next question comes from Travis Steed with Bank of America."
},
{
"speaker": "Travis Steed",
"content": "Congrats again on a good quarter. I wanted to ask about the new DRG for ablation and left atrial appendage closure. And then the overall LAC market, is that -- do you think that market can kind of sustain this 20%-plus growth through -- before the indication expansions? Or do you kind of need to see those indication expansions at some point sooner rather than later?"
},
{
"speaker": "Michael Mahoney",
"content": "I'll make comments and Dr. Stein. We're pleased with our WATCHMAN performance. We grew globally 19%. But keep in mind, that's coming off of nearly a 30% comp from first quarter 2023. And we still maintain, if not enhance, our strong share position."
},
{
"speaker": "",
"content": "And we're excited not only with the share position but with the growth of WATCHMAN, but also some upcoming trials that can further highlight with OPTION and CHAMPION, which we believe, if successful, will significantly widen the market, TAM, for WATCHMAN. So Dr. Stein, if you want to comment on any of that and also the concomitant item."
},
{
"speaker": "Ken Stein",
"content": "Yes. Thanks, Mike. Yes. So Travis, first on the trials, I mean, first of all, this is still a healthy market. This is still a very under-penetrated therapy when you look at patients who were at high risk for stroke and AF who stand to benefit from -- with the WATCHMAN procedure."
},
{
"speaker": "",
"content": "The trials that Mike mentioned, right, the first one is the OPTION trial, that evaluates the use of WATCHMAN as an alternative to oral anticoagulants following ablation. And we hope to be able to present the results of that trial late this year or early next year. Then that's followed CHAMPION, which is the all-comers trial versus the novel oral anticoagulants. Again, we expect that to report out in 2026. So these are now -- in the relatively near term that we're going to see those data points."
},
{
"speaker": "",
"content": "Before that, right, I think it is worth talking a little bit about that concomitant DRG that's part of the proposed rule from CMS. We're really gratified to see that. This is something that's good for everyone. This is good for patients. This is good for hospitals. When you think of valve outpatients who are undergoing an ablation procedure, first off, I'll tell you even back when I was doing these procedures, almost every patient who came in before wanted to know would they be able to stop their oral anticoagulants, and that is still true today."
},
{
"speaker": "",
"content": "And when you think about it from a patient-centered perspective, right, being able to do this all at one setting and avoiding the incremental risks that you have in undergoing two procedures, it really just makes sense. It also makes sense from a hospital standpoint when you just look at the procedural efficiencies and how that's going to help hospitals improve capacity to be doing more AF ablations and doing more WATCHMAN procedures over time."
},
{
"speaker": "",
"content": "So we're excited to see this. We think this is good for patients. We think this is good for hospitals. And we look forward to getting the data out from trials like OPTION and CHAMPION that's even going to further increase the impetus for doing these procedures."
},
{
"speaker": "Operator",
"content": "The next question comes from Danielle Antalffy with UBS."
},
{
"speaker": "Danielle Antalffy",
"content": "I'll also say congrats on a really strong quarter. For my one question, I wanted to look at some of the, I'll call them, legacy businesses, not sure if that's fair to describe the maybe slower-growth businesses."
},
{
"speaker": "",
"content": "I mean, a CRM mid-single-digit growth is very strong. Interventional Cardiology of double digits, very strong. Just curious about how to think about those sort of slower growth in Interventional Cardiology. I'm thinking more on the drug-eluting stent portfolio, obviously, and then CRM. Can they sustain these kinds of growth profiles given that the end markets, or from a volume perspective, are arguably probably some of your slower-growth end markets? And what needs to happen from an innovation perspective to sustain that sort of growth?"
},
{
"speaker": "Michael Mahoney",
"content": "Thanks, Danielle. Really appreciate you asking that question. I would say the innovation has already happened. Let me just explain a bit more. We call it ICTx, our interventional cardiology business essentially. And years ago, that was dominated by drug-eluting stents."
},
{
"speaker": "",
"content": "Today, drug-eluting stents, I think, represent close to 4% of our overall mix and likely will be 3% and 2% in the following years. So it's really a very small portion of Boston Scientific and a smaller portion of ICTx."
},
{
"speaker": "",
"content": "So what's driving the 13% growth within ICTx is our advanced imaging portfolio. So you're seeing more and more patients come with more complex calcium and the growing adoption of IVUS imaging, especially with our AVVIGO+ platform to identify that and help the effectiveness of these procedures."
},
{
"speaker": "",
"content": "So you're seeing wide adoption in Europe of our imaging platform, wide adoption in Asia and growing adoption in the U.S. based on this new platform. So it's really the imaging capabilities as well as our complex coronary capabilities to break calcium with Wolverine and our other products."
},
{
"speaker": "",
"content": "And then in Asia, they've been very successful in launching our AGENT drug-coated balloon and we recently received approval for that. We'll have some minor benefit in the second quarter '24 from that product in the U.S., where we expect enhanced growth from that product in the second half of '24 and particularly in 2025."
},
{
"speaker": "",
"content": "So the team there has really done a great job of completely revamping the portfolio and the growth trajectory of ICTx. Also included in that is our Structural Heart business in Europe."
},
{
"speaker": "",
"content": "And CRM, that grew 5% and we kind of essentially grow in line, I would say, with the market with pacemakers and defibrillators. S-ICD business continues to be quite robust. But the bigger growth driver in our CRM business is our diagnostics business. And we invested in that many years ago with our Preventice platform and also with our -- now our second-generation loop recorder ICM device."
},
{
"speaker": "",
"content": "So we've really reshaped the portfolio significantly in both of those markets to continue to support the growth of the company."
},
{
"speaker": "Operator",
"content": "The next question comes from Josh Jennings with TD Cowen."
},
{
"speaker": "Joshua Jennings",
"content": "Wanted to ask about the EP business and just opening an update on your view of the diagnostic mapping opportunity. You initiated the NAVIGATE-PF study where the software module is going to be in play."
},
{
"speaker": "",
"content": "I guess the question is really are you seeing increased demand in these early stages of PFA launch for RHYTHMIA? And just how are you viewing the opportunity for Boston to take share in this diagnostic mapping segment of the EP world?"
},
{
"speaker": "Michael Mahoney",
"content": "Dr. Stein, if you could take that one?"
},
{
"speaker": "Ken Stein",
"content": "Yes. It's still early in the launch. And I think one thing that I do want to sort of emphasize as you look at how things are playing out in the launch is we're really working with accounts to say don't change a lot of your workflow at the outset. Get used to using FARAPULSE, see how it works in your cases and then start modifying your workflow."
},
{
"speaker": "",
"content": "So really, what we've seen early in launch really are deliberately not a big shift in whether or not people are mapping. Not a big shift in what mapping platform they're using."
},
{
"speaker": "",
"content": "Now having said that, right, we have deliberately built our next-generation product and that's the FARAWAVE Nav-enabled catheter, right, that interfaces with the FARAVIEW software. And as I think everyone has seen, we've initiated our first human use studies of that earlier this year."
},
{
"speaker": "",
"content": "That really will bring some unique advantages to people who want to use a navigation system as they're using FARAPULSE. It is our desire and our belief, right, that there will be people who don't feel the need to use any mapping when they're doing pulmonary vein isolation with FARAPULSE who are adopting a very efficient workflow that's been used in a lot of centers in Europe. There will be others who want to continue to use a navigation mapping system. We have no intention of forcing people to use our system. We're not going to lock it down. But this new software platform really does bring some very compelling advantages to people who will use it."
},
{
"speaker": "Operator",
"content": "The next question comes from Chris Pasquale with Nephron Research."
},
{
"speaker": "Christopher Pasquale",
"content": "How are you thinking about the opportunity for AGENT in the U.S.? And you mentioned you're still working to ramp up manufacturing capacity. When do you expect to be in a position to move into a full launch with that product?"
},
{
"speaker": "Michael Mahoney",
"content": "Sure. So we have the NICE approval, excellent trial design by the clinical team and the product is doing extremely well in Japan and we have high hopes for the product has impact in the second half and more in 2025."
},
{
"speaker": "",
"content": "So currently, we're really going through the contracting process with most of the big accounts in the U.S. and that's initiated. And that's going well, given there is a high unmet clinical need with in-stent restenosis and the deliverability that's been proven with AGENT. So there's high physician demand for it. But we are going through the contracting process with the major health systems now, and you'll start seeing some sales in the second quarter. And we expect that to ramp more significantly throughout the second half of the year and accelerate more in '25."
},
{
"speaker": "Ken Stein",
"content": "Yes. And Chris, and just to remind everyone, right? Our current label indication in the U.S. in-stent restenosis, that comprises approximately 10% of current PCI volume. Internationally, we also see DCBs used and we believe there is a potential use case outside of in-stent restenosis, small vessel disease, bifurcation lesions, potentially even some acute coronary syndrome. And once we launch in the U.S., we are evaluating opportunities to expand the label. And those expanded indications could potentially take us up to 20% of current PCI volume."
},
{
"speaker": "Operator",
"content": "The next question comes from Matthew O'Brien with Piper Sandler."
},
{
"speaker": "Matthew O'Brien",
"content": "I don't have perfect numbers here, but in looking at the U.S. EP number in Q1, it looks like you did somewhere around $40 million in FARAPULSE revenue between the generator and the catheter itself. Is that roughly the right number?"
},
{
"speaker": "",
"content": "And then when I start to carry this out through the rest of the year plus the guidance increase, I'm getting something more like $300 million to even $400 million of FARAPULSE this year. Is that around the right number? And can you manufacture enough product to support that?"
},
{
"speaker": "Michael Mahoney",
"content": "Yes. We won't confirm your math. At this point, we're not going to be breaking out FARAPULSE cases, numbers, number of accounts, dollars and so forth yet. If you recall back to the WATCHMAN days, we really waited till it was about close to $1 billion platform before we provided that based on the materiality of the company."
},
{
"speaker": "",
"content": "But it's going extremely well. And importantly, we made significant investments in the supply chain 2 and 3 years ago to be ready for where we are today. And the supply chain team continues to perform extremely well, and they're able thus far to meet the demand in Europe and the U.S. and the future in Asia."
},
{
"speaker": "Operator",
"content": "The next question comes from Matt Taylor with Jefferies."
},
{
"speaker": "Matthew Taylor",
"content": "I actually wanted to follow up on your AGENT commentary. Two small questions. One is, can you talk about the materiality in Japan? And when you mentioned the indication expansions, could you talk about what those could look like and when we could see them in the U.S.?"
},
{
"speaker": "Michael Mahoney",
"content": "Just maybe really not a whole lot of new color in Japan. But they launched it last year and it was adopted very, very quickly and it's leading to the strong double-digit growth in Japan that we saw in the quarter."
},
{
"speaker": "",
"content": "In terms of indication expansion, Dr. Stein, do you want to take that one?"
},
{
"speaker": "Ken Stein",
"content": "Yes, Matt. Again, I think probably the first new indications we think about looking for would be small vessel bifurcation lesions. Still working through regulatory strategy on that. So not prepared to give you a time line for when we would initiate any of that work."
},
{
"speaker": "Operator",
"content": "The next question comes from Matt Miksic with Barclays."
},
{
"speaker": "Matthew Miksic",
"content": "Just maybe one follow-up on the cadence for FARAPULSE this year in the U.S. and sort of how the RHYTHMIA adoption navigation kind of plays into that. Any color for what we can expect as you get into the rest of the quarters would be great."
},
{
"speaker": "Michael Mahoney",
"content": "Thanks, Matt. Probably not too much new commentary here. I think in FARAPULSE overall, it's -- we're developing very strong capabilities to install, support and train doctors and really scale that up in the U.S., given the high demand for it. And we're able -- resource-wise, we put a lot of focus on that as we continue to expand that. And there obviously are a lot of strong relationships we have with those EPs given our WATCHMAN experience and our CRM experience. So it's a lot of resource planning and training and executing every day in the field to open up new accounts."
},
{
"speaker": "",
"content": "Dr. Stein gave some commentary on the mapping. So today, some accounts don't use mapping when they're driving maybe optimal workflow and many accounts are using their existing mapping system. And we don't intend to force our customers to move away."
},
{
"speaker": "",
"content": "However, we do -- as Dr. Stein mentioned, based on what we've seen with the our mapping navigation system, we do think there will be incremental clinical benefits and productivity gains in using that."
},
{
"speaker": "",
"content": "So we are starting to see an increase in RHYTHMIA orders, and we anticipate enhanced RHYTHMIA -- FARAPULSE mapping orders as we go through the second half of this year because there will be clinical benefits from it. But as Dr. Stein mentioned, we really want to have hospitals choose the correct mapping system and FARAPULSE works excellent today with the competitors, but we would expect some enhanced benefit with ours."
},
{
"speaker": "Operator",
"content": "And just to verify, is there time for one last question?"
},
{
"speaker": "Jonathan Monson",
"content": "Yes, Drew. We'll take one more, please."
},
{
"speaker": "Operator",
"content": "That will come from Michael Polark with Wolfe Research."
},
{
"speaker": "Michael Polark",
"content": "I want to ask the gross margin commentary, the inventory charges, Dan. Can you quantify the impact in the quarter? And what's the nature of those charges? What's going on? And the other thing I heard was increased mix of capital in the quarter. I think it seems highly likely to be FARAPULSE generator driven, but if there's anything else underneath that comment, I'd welcome the color."
},
{
"speaker": "Daniel Brennan",
"content": "Sure. Thanks for the question, Mike. We're not going to quantify the inventory charges, but it was much more than we're used to in a given quarter, and that's why we called it out and it has an impact."
},
{
"speaker": "",
"content": "I will say a piece of it, not an insignificant piece of it, is kind of due to the success of FARAPULSE. So it's not kind of all bad per se relative to our results, but it's still inventory charges and it still reduced the gross margin in the quarter. But that's what gives me the confidence and the optimism that heading into the rest of the year, we won't see inventory charges at the level that we saw them in Q1 as we go through 2024."
},
{
"speaker": "",
"content": "On the capital, yes, a piece of that is related to FARAPULSE. But we also -- as Mike mentioned, we also have a really successful launch in our IVUS business, which has some capital with it. And not insignificantly as well, we have some in the Urology business associated with the Lumenis."
},
{
"speaker": "",
"content": "So it was probably led by the launch of FARAPULSE, but we did have a little bit more in some of the other launches in some of the other businesses with respect to capital. But overall message should be 69.8%, a little lower than we would have liked, but still have a goal this year of getting back to that 70.7% or slightly below that for the year for gross margin."
},
{
"speaker": "Jonathan Monson",
"content": "All right. Thanks, everyone, for joining us today. We appreciate your interest in Boston Scientific. If we were unable to get to your question or if you have any follow-ups, please don't hesitate to reach out to the Investor Relations team."
},
{
"speaker": "",
"content": "Before you disconnect, Drew will give you all the pertinent details for the replay."
},
{
"speaker": "Operator",
"content": "Please note a recording will be available in 1 hour by dialing either 1 (877) 344-7529 or 1 (412) 317-0088, using replay code 8726199 until May 1, 2024, at 11:59 p.m. Eastern Time."
},
{
"speaker": "",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
bwa | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Thank you for standing by for the BorgWarner 2024 conference call. The call will begin momentarily. Thank you for your patience. Good morning. My name is Nick, and I will be your conference specialist. At this time, I would like to welcome everyone to the BorgWarner 2024 Fourth Quarter and Full Year Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Press star two. I would now like to turn the conference over to Patrick Nolan, Vice President of Investor Relations. Mr. Nolan, you may begin your conference."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Nick, and good morning, everyone. Thank you all for joining us today. We issued our earnings release earlier this morning. It's posted on our website borgwarner.com, both on the homepage and on our investor relations homepage. With regard to our investor relations calendar, we will be attending multiple conferences. You can see the events section of our IR page for a full list. Before we begin, I need to inform you that during this call, we may make forward-looking statements which involve risks and uncertainties detailed in our 10-Ks. Our actual results may differ significantly from the matters discussed today. During today's presentation, we will highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes with prior periods. If you hear us say \"on a comparable basis,\" that means excluding the impact of FX, net M&A, and other non-comparable items. If you hear us say \"adjusted,\" that means excluding non-comparable items. When you hear us say \"organic,\" that means excluding the impact of FX and net M&A. We will also refer to our incremental margin performance. Our incremental margin is defined as the organic change in our adjusted operating income divided by the organic change in our sales. Our all-in incremental margin includes our planned investment in R&D, any impact from inflationary impacts, and other costs. Lastly, we will refer to our growth compared to our market. When you hear us say \"market,\" it is weighted for our geographic exposure. Please note that we have posted today's earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I'm happy to turn the call over to Fred."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you, Pat, and good day, everyone. We're pleased to share our results for 2024 and provide a company update starting on Slide five. We delivered approximately $14 billion in sales, which was relatively flat versus 2023. Our industry production for the full year was down approximately 3%. We saw a solid 2024 outgrowth of about 280 basis points. I'm pleased that the outgrowth is both on the foundational and on the e-product side of our portfolio. This demonstrates to me the resiliency of these portfolios and our ability to drive our growth in particularly challenging and volatile end markets. As Joe will detail, we finished the year by securing multiple new product awards for both foundational and e-products, which we believe further supports our long-term profitable growth. Our adjusted operating margin performance was strong, coming in above 10% and above the high end of our guide. This strong underlying operational performance was once again driven by our focus on cost control across the businesses. As a result, our full-year adjusted earnings per share grew by 15%. We delivered $729 million of free cash flow and also exceeded our full-year guidance. As Craig will detail, we remain well-positioned to continue to generate strong free cash flow in 2025. We will do this while also investing in our business to support our focus on long-term profitable growth in efficient powertrains. Today is my final earnings call with BorgWarner. Before I turn it over to Joe, I would like to share a few thoughts with you. I believe that BorgWarner is positioned to grow at the pace of the powertrain mix change. I also firmly believe that BorgWarner is well-equipped, thanks to its decentralized operating model, to excel in a more regionalized powertrain outlook. I have spent 26 years at BorgWarner. I'm proud of the work that was done. I'm proud of our very special combustion portfolio and of the portfolio enhancements that we have executed over the past ten years. We created what I believe is one of the most powerful propulsion portfolios in the world while still keeping at the same time our strong culture, maintaining a double-digit margin, and a free cash flow generation that is quite unique in our tier-one auto supplier world. I want to thank our board of directors, who have been a key sounding board for me with unwavering support for the implementation of our strategies. I want to thank my team members for their stewardship to BorgWarner, their resiliency, and their leadership. I, of course, want to thank all the BorgWarner employees around the world who are making a key difference each and every day. I've been working with Joe on the CEO transition over the past few months, and I've collaborated with Joe over the past 15 years. I have full confidence that Joe is the leader that BorgWarner needs. I also want to thank the analyst community. It's been a pleasure to interact with you over the past few years, interactions that have made me stronger and from which I have always learned. And finally, of course, I would like to thank the shareholders for their trust. With that, I'm excited to turn the call over to you, Joe."
},
{
"speaker": "Joe Spak",
"content": "Thank you, Fred. On behalf of the management team and all of our employees, I would just like to thank you for your leadership over the last 26 years and especially the last seven as CEO. I also want to personally thank you for your mentorship and friendship over the years. You've been an inspirational leader to me, and I believe you've clearly positioned the company well for our next phase of profitable growth. We wish you nothing but success as you move on to the next chapter and hope you enjoy your well-deserved retirement. Now let's turn to Slide six for what I view as the drivers of BorgWarner's value proposition. First and foremost, we have what I view as a strong product portfolio that is resilient to the varied pace of propulsion mix changes that we see across the world. Second, we have strong market share positions across our foundational portfolio, with several of our e-products also improving their market share position. Third, I view BorgWarner's financial strength as a key driver of our success. It allows us to continue to invest in our business regardless of near-term fluctuations in market volumes or mix. Our financial strength is also a differentiator when our customers award us new business. And our financial strength is a direct end result of the financial discipline ingrained into the company's culture. Fourth, the long-term relationships that we've established with our light vehicle and commercial vehicle customers around the world are also a very important driver of our success. These relationships allow us to partner with our consumers to meet their efficiency and value needs beyond just pursuing individual program awards. Lastly, I firmly believe that our decentralized operating model creates speed, accountability, and agility. The agility afforded by our operating model allows us to navigate these times of industry turmoil like we are currently experiencing. With that said, Craig is going to review our detailed 2025 outlook in a few moments. We expect another year of declining industry volumes combined with the uncertainty of tariff implications. As such, let's turn to Slide seven, which outlines our strategic focus areas for 2025 and beyond. First, we aim to outgrow industry production by leveraging our core competencies. BorgWarner's DNA remains focused on efficiency, which includes both fuel efficiency for combustion vehicles and electron efficiency for hybrids and BEVs. Our anticipated outgrowth reflects our customers' demand for efficient propulsion products around the world. In combination with our strong product portfolio and deep customer relationships, we plan to continue to help the world deliver innovative and sustainable mobility solutions for a clean, energy-efficient world, which we believe will drive industry outgrowth for years to come. Second, we must continue to build upon our existing product portfolio. We plan to achieve this by continuing to make thoughtful organic and inorganic investments where we see a strong business case that delivers value to shareholders. Organically, our focus will be to accelerate our scale and gain additional market share across our entire portfolio, and we need to stay focused on driving a product culture that nurtures innovation. Inorganically, we intend to explore opportunities to improve our current market share positions or product adjacencies where we can apply BorgWarner's core competencies. We believe there will be high-quality opportunities in front of us due to the turbulence in our industry. Lastly, we must continue to drive enhanced financial performance. To me, this means striving to expand margins and generating strong cash flow. We will do this through business excellence. We'll achieve this by continuing to actively manage our cost structure as we navigate volatile industry volumes, changing regional propulsion mix, and launching new businesses across the globe. We believe it will be important to balance all these factors in order to preserve BorgWarner's strong financial foundation and enhance our margin and cash flow generation as we grow profitably. Now let's look at some new product awards on Slide eight, which I believe are strong indicators of our future profitable growth. First, BorgWarner has secured an award to supply a state-of-the-art variable cam timing system to a major East Asian OEM for their next-generation hybrid and gasoline engines. BorgWarner's VCT system dynamically optimizes the timing of intake and exhaust valve events, improving combustion efficiency and reducing emissions. These advanced engines will power a range of the customer's hybrid and combustion vehicles, delivering improved fuel economy and reducing environmental impacts. Production of these engines is scheduled to commence in the first quarter of 2026. Second, BorgWarner is expanding our partnership with a major North American-based OEM by extending four wastegate turbocharger programs for i4 and V6 engine platforms. These turbocharger extensions will be deployed on several of the automaker's midsize and large SUVs, as well as truck applications, with the start of production set to begin in 2026. BorgWarner has a longstanding relationship with this OEM, having supplied them with our turbochargers over the last 20 years. We believe these platform extensions are a testament to the strong collaboration between our engineering teams, and we look forward to continuing our work together through the rest of this decade and beyond. Third, BorgWarner will supply two types of transfer cases to SAIC Maxus for use in export vehicles. Both products are designed by BorgWarner's China R&D team and will be manufactured in China, with mass production expected to begin in 2026. BorgWarner's relationship with SAIC Maxus spans more than a decade. Our transfer case technology not only supports SAIC Maxus in strengthening its position in the Chinese market but also empowers its expansion into overseas markets. Finally, BorgWarner has secured four e-motor awards with three major Chinese OEMs, used on plug-in hybrids, range-extended hybrids, and electric vehicle platforms. These programs are expected to launch in 2025 and 2026. We are pleased to secure this business in the Chinese market. We believe these awards further validate our innovative technology and manufacturing processes, delivering high-quality products and services to meet the evolving needs of the Chinese new energy vehicle market. To summarize, the takeaways from today are that BorgWarner ended 2024 with strong results. We delivered 2024 outgrowth of just under 3%. Our adjusted operating margin was over 10%, and our free cash flow generation was very strong. Over the course of the year, we secured new foundational and e-product business awards, which we believe once again demonstrate our product leadership on both sides of our portfolio. As we look forward, we are expecting to deliver another solid year in 2025 as we focus on what we can control. As Craig will detail, our guidance includes that we expect to outgrow industry production, deliver an adjusted operating margin above 10%, and continue to generate strong free cash flow. My priorities align with our 2025 outlooks as we will strive to secure new business awards that will allow us to continue to outgrow industry production. We will build upon our existing product portfolio by increasing our e-product scale and gaining market share. We plan to do this through fostering a culture of innovation, customer intimacy, and thoughtful portfolio investments that drive shareholder value. And finally, we continue to drive enhanced financial performance. It's this financial strength and discipline of this company that help differentiate us from our peers, and we intend to continue to focus on that strength as I take over as CEO. If we effectively execute these priorities, I believe we will be well-positioned to continue to grow the earnings power of BorgWarner, which we believe will drive long-term value for our shareholders for years to come. With that, I'll turn the call over to Craig."
},
{
"speaker": "Craig Aaron",
"content": "Thank you, Joe. Good morning, everyone. Before I dive into the financials, I'd like to provide a quick overview of our fourth-quarter results. First, we reported just over $3.4 billion in sales, which was down approximately 2% versus the prior year, excluding FX and M&A. Market production in the quarter was down approximately 4%, so we saw sales outgrowth in the quarter of approximately 220 basis points, which was slightly below our full-year outgrowth of 280 basis points. Second, we had strong adjusted operating margin performance in the quarter at 10.2%. This was driven by solid operational performance, a continued focus on cost controls across the business, and restructuring actions. This strong fourth-quarter performance allowed us to deliver a full-year adjusted operating margin above 10%, which was up 50 basis points from 2023. Third, we had strong free cash flow in the quarter, up $539 million, which allowed us to outperform our 2024 free cash flow guidance and deliver $729 million in free cash flow for the full year. Now let's turn to Slide nine for a look at our year-over-year sales walk for Q4. Last year's Q4 sales from continuing operations were just over $3.5 billion. You can see that the weakening U.S. Dollar drove a year-over-year decrease in sales of $32 million. Then you can see a decrease in organic sales of about 1.5%, which was 220 basis points above market production. This outgrowth was primarily due to strong e-product growth in Europe and Asia, as well as strong foundational growth in Europe, North America, and the rest of the world. In China, we saw challenges in the quarter due to lower volumes on an existing EV program, which we previously highlighted, and declining foundational sales. Finally, the acquisition of Eldor added $6 million of sales year over year. The sum of all this was just over $3.4 billion of sales in Q4. Turning to Slide ten, you can see our earnings and cash flow for the fourth quarter. Adjusted operating income was $352 million, equating to a strong 10.2% adjusted operating margin. That compares to adjusted operating income from continuing operations of $332 million or a 9.4% adjusted operating margin from a year ago. On a comparable basis, excluding the impact of foreign exchange and M&A, adjusted operating income increased $37 million on $57 million of lower sales. This is a great result and reflects our ability to deliver profitability despite a declining production environment. This performance was driven by the benefit of our PowerDrive systems restructuring that we announced in July, as well as our continued focus on cost controls across our business. The net impact of Eldor was a $12 million drag on operating income year over year. Our adjusted EPS from continuing operations was up $0.11 compared to a year ago as a result of strong adjusted operating income, lower net interest expense, and the impact of our share repurchases. This was partially offset by a higher effective tax rate due to various tax restructuring initiatives that we executed in the quarter. Free cash flow from continuing operations was $539 million during the fourth quarter, which was down $140 million from a year ago as a result of lower business activity compared to 2023 and the timing of customer payments. Our free cash flow for the full year was strong at $729 million. Finally, I'd like to briefly address the $646 million of goodwill and fixed asset impairment charges that we recorded during the fourth quarter. In the fourth quarter of each year, we perform an impairment test. The discounted cash flow analysis we perform requires us to make long-term estimates of our sales and operating income and compare that to the carrying value of each business unit. Due to the continuing delay of BEV adoption across the Western world, our discounted cash flow estimates for our PowerDrive system and Battery and Charging Systems business units from prior years had to be reduced and pushed out. As a result, the company recorded a goodwill impairment charge of $577 million in the fourth quarter. We also recorded a charge of $69 million primarily related to certain property, plant, and equipment. It's important to note that these items are non-cash and have a minimal impact on the future earnings or margin profile of the company. In our opinion, the delay of BEV adoption in parts of the Western world is exactly why we have built a resilient technology-focused portfolio that we believe will provide strong results no matter the pace of regional propulsion adoption. If regional BEV adoption continues to be delayed, we believe our foundational portfolio will compensate with significant margin and free cash flow generation. Next on Slide eleven, I would like to review our perspective on global industry production for 2025. We expect our global weighted and light commercial vehicle markets to be down 1% to 3% this year. In 2024, this forecast includes potential industry volume headwinds of global tariffs. Looking at this by region from a light vehicle perspective, we're planning for our weighted North American markets to be down approximately 3% to 4%, primarily driven by inventory headwinds and potential inflation due to tariffs. In Europe, we expect our weighted market to be down approximately 4% to 6% year over year as we see signs of a lower backlog and economic headwinds. In China, we expect the overall market to be flat to down 1%. This is due to a tough comparison following last year's growth and the possible economic impact of tariffs. With that in mind, now let's take a look at our full-year outlook on Slide twelve. First, as I just highlighted, we have included some level of industry volume headwinds from tariffs in our market volume assumptions. However, we have not incorporated the net cost of tariffs in our financial guidance at this time since the impact to BorgWarner is influenced by multiple factors. These include, but are not limited to, the timing of implementation, any exemption on imported materials, and our ability to share the impact with our customers and suppliers. Now let's move to our outlook. We are projecting total 2025 sales in the range of $13.4 billion to $14 billion. Starting with foreign currencies, our guidance assumes an expected full-year sales headwind from weaker foreign currencies of $410 million compared to 2024. As I just highlighted, we expect our end markets to be down 1% to 3% for the year. However, we expect the company to outperform market production by 100 to 300 basis points, which once again demonstrates the resiliency of our portfolio that we believe is positioned to outgrow market production. It's important to note that our guidance includes a 30 basis point outgrowth headwind from lower battery cell prices, which we directly pass through to our customers. Based on our updated outlook, we expect our organic sales change to be down 2% to up 2% year over year. Now let's switch to margin. We expect our full-year adjusted operating margin to be in the range of 10.0% to 10.2% compared to our 2024 adjusted operating margin of 10.1%. The low end of our margin outlook contemplates the business delivering a full-year decremental conversion in the low double digits, while the high end of our outlook assumes an incremental conversion in the high teens. We view this as strong underlying performance building off of 2024 that well exceeded our expectations. Based on this sales and margin outlook, we're expecting full-year adjusted EPS in the range of $4.05 to $4.40 per diluted share. We expect full-year free cash flow to be in the range of $650 million to $750 million, with the 2025 midpoint being a decline versus 2024's strong result due to FX headwind. With that, that's our 2025 outlook. So let me summarize my financial remarks. Overall, we delivered solid 2024 results despite a difficult production environment. We delivered a very strong 10.1% margin, which was 50 basis points higher than 2023 and well ahead of the 9.2% to 9.6% margin reflected in our initial 2024 guidance. This great performance is a result of our focus on appropriately managing our costs across our business. We generated strong free cash flow of $729 million. Now as we look ahead to 2025, our outlook aligns with the priorities Joe highlighted earlier. First, we expect to continue to outperform market production with an expected full-year outgrowth of 100 to 300 basis points despite headwinds from battery cell pricing and BEV program delays. Second, we expect to once again deliver an adjusted operating margin above 10%. We believe this shows our ability to manage our cost structure effectively even in light of a declining production environment. Finally, we expect to have another year of strong free cash flow, which we believe, in combination with our investment-grade balance sheet, will allow us to continue to invest in our business while navigating a challenging and uncertain market backdrop. As I look back on our 2024 results and our 2025 outlook, I'm extremely proud of the BorgWarner team around the globe and their ability to deliver strong financial results during a challenging and volatile market backdrop. With that, I'd like to turn the call back over to Pat."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Craig. Nick, we're ready to open it up for questions."
},
{
"speaker": "Operator",
"content": "At this time, we will pause momentarily to assemble our Q&A roster. And your first question today will come from John Murphy with Bank of America ML. Please go ahead."
},
{
"speaker": "John Murphy",
"content": "Good morning, everybody, and Fred, congratulations. Look forward to visiting you in Burgundy. It'd be a lot of fun, hopefully. And, Joe, I apologize. You're gonna have to deal with us now. But thank you. First question, the portfolio that is well balanced almost in whichever direction powertrains go seems like a very good way to be positioned, and you're set there. Just curious as you look at sort of the short-term swings that we're seeing in programs, stuff like Ford canceling the three-row EV last year, when those shifts happen very quickly, how well do you think the portfolio is hedged? And do you think you pick up those lost sales with something like the Explorer, the ICE version, or something like that? How quickly did that get balanced out? And maybe sort of, with that, is that one of the key drivers of why we're seeing this $100 million variance in inorganic sales, or what else is driving that $600 million organic variance?"
},
{
"speaker": "Joe Spak",
"content": "Yes. Hi, John. So you look at the RFQs outside of China, they have been slowing a little bit, and we've seen some delays or cancellations. On the other side, we see more RFQs for foundational products, and those usually result in higher volumes of our existing products we're serving a customer with, or it might be extensions because they've delayed an EV truck or SUV. So we're in a great position to take advantage of that and also be ready when they launch those new programs on EVs in the markets."
},
{
"speaker": "John Murphy",
"content": "Okay. And that $100 million organic variance in the 2025 outlook, is that being driven by deltas in volume or program shifts? What's the key driver of that variance?"
},
{
"speaker": "Joe Spak",
"content": "So for the outlook, or let's say the 2024 results, as you know, we outgrew those markets in that 2% to 3% range. As we look forward, we continue to expect that outgrowth as Craig had mentioned, in 2025."
},
{
"speaker": "John Murphy",
"content": "Okay. And then just maybe one quick follow-up, if you could just remind us what your China exposure is right now with domestics versus international players and where you think that's gonna land in 2025 and how much it may shift towards the domestics in the next few years?"
},
{
"speaker": "Joe Spak",
"content": "Specifically in China?"
},
{
"speaker": "John Murphy",
"content": "In China specifically, yes."
},
{
"speaker": "Joe Spak",
"content": "Yes. So as you know, China is about 20% of our global sales. And in China, 75% of our total sales are with the Chinese OEMs. So we're very well positioned with them as they grow in their domestic market and in support of their strong export. One other thing I mentioned, 90% of that business is on NEV with those domestic OEMs. So we're in a great position."
},
{
"speaker": "John Murphy",
"content": "That's very helpful. Thank you very much."
},
{
"speaker": "Operator",
"content": "Your next question today will come from Colin Langan with Wells Fargo. Please go ahead."
},
{
"speaker": "Colin Langan",
"content": "Oh, great. Thanks for taking my questions and congrats, Fred, on your retirement. It's been a pretty impressive pivot to e-powertrains under your leadership. On e-powertrains, any color on how e-products should perform this year? I noticed the battery side was a bit weaker sequentially, and I think there's some slowing in North America you've indicated. Should we start seeing help? I know Europe with regulations, there should be a light vehicle bounce there. Likely some increase in the US. Does that start showing up in maybe the second half? Or how should we think about that?"
},
{
"speaker": "Joe Spak",
"content": "So Colin, we are growing year over year in the e-product business. It is softened a little bit mainly due to the battery business, which you referenced. The way we, I guess, you want to think about it is we are flat year over year in battery sales. When it comes to units, the revenue was down a little bit mainly due to cell pricing, which is bringing the overall revenue down. But overall, it's, you know, greater than a $600 million business. We really like that Akasol business we bought, and it's ahead of where we purchased it despite a lot of the turmoil and despite the lower cell pricing."
},
{
"speaker": "Colin Langan",
"content": "Got it. And then the guide for this year has 200 basis points growth over market. In the past, you've kind of talked about 4%. You've called out a couple of things. I mean, should we think about eventually getting back to something like a 4% or is this lower EV adoption just kind of holding that back for several years from now?"
},
{
"speaker": "Joe Spak",
"content": "Yeah. The past few years, our outgrowth has been in that 2% to 3% range. So 2025 is close to this range. You know, my focus is really on outgrowing our markets. We think the portfolio is the right one. In the short term, the biggest driver in 2025 of the lower outgrowth is the delay of a North American EV program, which we previously disclosed. And as I mentioned, the cell pricing on the battery pack business. My focus is really to outgrow on both sides of the portfolio. So we want our foundational products to do what they can to expand market share, and we're in a great position because, as you know, on our foundational products, we're number one or number two in that side of the business. And then on the e-side, as new launches and RFQs start to come out, we're in a good position to also outgrow those markets."
},
{
"speaker": "Colin Langan",
"content": "Got it. Alright. Thanks for taking my questions."
},
{
"speaker": "Operator",
"content": "And your next question today will come from Ryan Brinkman with JPMorgan. Please go ahead."
},
{
"speaker": "Ryan Brinkman",
"content": "Hi. Thanks for taking my question. Just curious, with regard to the products that you manufacture and the extent to which they are installed on products in Mexico versus, you know, brought across the US border. And then what any preliminary conversations with automakers might look like in terms of the pass-through of any potential tariff costs. Thank you."
},
{
"speaker": "Joe Spak",
"content": "Yeah. Ryan, let me take that one. So I'll start by saying we generally produce in the same regions as our customers produce. But when we look at 2024, and the amount of imported material and value to the US, it was about $875 million. When you break that down, about half of it originated in Mexico, 10% of it originated in Canada, and 5% originated in China. Ultimately, there's a lot of news going on right now. We're going to continue to watch that. But ultimately, if there's an impact to BorgWarner, we're going to need to find a way to share that with our customers and our suppliers. That's how we're thinking about it."
},
{
"speaker": "Ryan Brinkman",
"content": "Great. Thanks much."
},
{
"speaker": "Operator",
"content": "Thank you. And your next question today will come from Luke Junk with Baird. Please go ahead."
},
{
"speaker": "Luke Junk",
"content": "Good morning. Thanks for taking the questions and my congratulations. Maybe starting with the outgrowth, hoping you could just help us understand at least directionally what that assumes for e-products and PowerDrive. I guess I'm looking specifically in Europe where you had a big launch here in 2024 and in China relative to what are, of course, continued tailwinds around NEV adoption overall? And I guess any offsets we should be thinking beyond what you've already mentioned in any distinct book of business in either Geo as well? Thank you."
},
{
"speaker": "Joe Spak",
"content": "Yeah. Hi, Luke. So we see EV adoption increasing year over year in all the markets. When we think about our segments, one of the things we did last July, as you recall, we organized into four operating segments to give better transparency in how each of those businesses are performing. So we think that's going to be a good indicator of how the businesses are performing in terms of outgrowth."
},
{
"speaker": "Luke Junk",
"content": "Got it. And then for my follow-up, I'm hoping you could just maybe expand on your comments around foundational awards. It's now been a couple of quarters in a row you've highlighted a good number of foundational awards. As you mentioned, you're seeing a reacceleration in RFQs. I just want to try to square how that might translate to outgrowth, not this year, but looking out 2026-2027. And especially, you know, it seems like there may have been a lull just given where the industry's focus was a few years ago in those awards. And how that might translate to some pickup in 2026 plus? Thank you."
},
{
"speaker": "Joe Spak",
"content": "Yeah. As you mentioned, we have highlighted awards on both sides of our portfolio and an increasing number on the foundational side. I think that speaks to the strength of our portfolio. And as customers are evolving their cycle plans, they're looking toward us since we're number one or number two in those foundational products to support them. Those often look like program extensions. In some cases, it may be some new programs that they're putting out for bid. But I think what's important here is we want to help grow across our entire portfolio. And those are great examples that we highlighted. You see wins in both the foundational and on the e-side."
},
{
"speaker": "Luke Junk",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "And your next question today will come from Joe Spak with UBS. Please go ahead."
},
{
"speaker": "Joe Spak",
"content": "Thanks. And, Fred, again, my congrats as well. Enjoy. Just maybe one on the guidance, just a little bit more color. I just want to understand, like, that is what you're saying that, you know, that North America weighted down 3% to 4%. I think if we look at some third parties, it's closer to down 2%. Is that delta sort of the, you know, I guess, conservatism you're sort of putting in for maybe some disruption as to what could happen if tariffs come in? I just want to be clear on that. And then I don't think I heard, I turned a little bit late, I don't think I heard sort of any, you know, e-products overall. I know you have the new segments, but any sort of e-products sort of expectations for this year? Is there any color you can provide there just so we could sort of, you know, track, I guess, performance relative to some of the underlying market dynamics?"
},
{
"speaker": "Joe Spak",
"content": "Yeah. So starting with some color on the market, we formulate our industry forecast internally. And directionally for the last few years, we've been fairly accurate. You know, when we think about the global markets, maybe we can break it down a little bit. So that minus 1% to minus 3%, starting with North America, down 3% to 4%. As you know, there's a lot of inventory in the system. We've also baked in a little bit of headwinds pending tariffs that may come. In Europe, 4% to 6% down due to signs of both the backlog and economic headwinds that they're seeing. China is a brighter spot. They're flat to down 1%. So that's a little bit of color on your first question. Yeah. I'll jump in with sales. So I reported 2024 sales a little over $2.3 billion for e-products. As we move forward, you'll see disclosure in our 10-Qs breaking out e-products from foundational. And so you'll see that as we move forward."
},
{
"speaker": "Joe Spak",
"content": "But anything on e-products in relation to the overall guidance? We're not providing that outlook. As Joe indicated, our focus is outgrowth on both sides of our portfolio."
},
{
"speaker": "Joe Spak",
"content": "Okay. I heard the second question is thinking in some of your prepared remarks, you talked about building on your portfolio organically and inorganically. And I don't think that's a change from what you've talked about in the past as an organization. Right. You know, there had been some messaging or communication that, you know, inorganic has been paused. I guess I'm wondering, as you sort of take over here, how you think about that going forward, especially since we've seen some, you know, activity in M&A in the space, and I'd say I would even say sort of more broadly in the markets. Like, do you expect a little bit more focus on inorganic opportunities as we move forward from here?"
},
{
"speaker": "Joe Spak",
"content": "Yeah. So we will continue to invest organically as our top priority. We have a terrific product portfolio, and we see lots of opportunities to keep building on that and growing that to outgrow the market. We will continue to look at acquisitions as it remains an important part of our strategy. So the industry turbulence that we're all witnessing right now actually provides a unique opportunity for BorgWarner given our financial strength. So as we execute them, if we execute them, it'll be in a very thoughtful way. And our focus is to create long-term shareholder value."
},
{
"speaker": "Operator",
"content": "Thank you. And your next question today will come from Edison Yu with Deutsche Bank. Please go ahead."
},
{
"speaker": "Edison Yu",
"content": "Thank you for taking the questions and congrats, Fred. I wanted to ask about eRev. You've obviously had quite a bit of success in China with that. How are those conversations going in the US and Europe? And do you think the volumes there could, you know, in three or four years, be similar?"
},
{
"speaker": "Joe Spak",
"content": "So we have seen some success on eRevs in China, as you mentioned. I would say the other regions are starting to look at eRevs as a way to, especially in the truck market, meet all the requirements for our customers, but also provide, you know, better overall fuel economy and emission reduction. So we don't see it in big volumes just yet, but we do see it as an emerging option architecture for the customers to meet their emission requirements."
},
{
"speaker": "Edison Yu",
"content": "Understood. And just one thing on the guidance for China. Are you assuming the scrappage incentives still continue? I think there's probably, to your point, you know, you mentioned some risk, but in terms of the upside, curious what kind of you're assuming there?"
},
{
"speaker": "Joe Spak",
"content": "No. We're really looking at a China market that is flattish year over year. So we haven't factored that in at this point."
},
{
"speaker": "Edison Yu",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question today will come from Emmanuel Rosner with Wolfe Research. Please go ahead."
},
{
"speaker": "Emmanuel Rosner",
"content": "Thank you. My first question is on the CapEx outlook. Can you provide a little more context around the lower CapEx budget and to what extent this extra free cash flow would go, you know, towards buybacks versus something else?"
},
{
"speaker": "Joe Spak",
"content": "Yes. So let me address CapEx. When you go back a few years, our CapEx was in kind of the mid-5s as a percent of sales, 5.5%, 5.4%. We saw this year come down to below 5%. Our guidance as we look at it this year is maintaining that around the high 4s, low 5s as a percentage of sales. So that's how you should think about it. From a buyback perspective, we have not announced any specific plans. So I wanted to address that a little bit. You know, when we step back and think about buybacks as a company, we've deployed a lot of cash to shareholders, about $3.4 billion since 2020. So we've deployed a lot of cash to our shareholders. I want to step back and talk about our goal. Our goal as a company is to really focus on earnings and cash flow, grow earnings and cash flow over time. And as we think about buybacks for this year, we're going to use the full power of BorgWarner to focus on earnings growth, to focus on full cash and cash flow growth. As we continue throughout the year, we'll look at this lever as an item to pull, and we'll look at it appropriately as we move forward. That's how we're thinking about buybacks this year."
},
{
"speaker": "Emmanuel Rosner",
"content": "Got it. That's helpful. And then how are you thinking about the growth outlook this year and also beyond for EV products in China, specifically given very competitive market dynamics?"
},
{
"speaker": "Joe Spak",
"content": "Yes. So, I mean, more broadly speaking, 20% of our total business is in China. And as we mentioned, we're very strong with the Chinese OEMs. In fact, the Chinese OEMs have over 90% of the market share on EVs, and they are 75% of our business. So we feel very well positioned with the Chinese, whether they're serving the domestic market or, as we've seen in the last few years, exporting those vehicles."
},
{
"speaker": "Operator",
"content": "We have time for one final question, and that question comes from Dan Levy with Barclays. Please go ahead."
},
{
"speaker": "Dan Levy",
"content": "Hi, good morning. Thanks for taking questions, and Fred, congratulations to you. Wanted to first just start with a follow-up on that last question there. PowerDrive was disappointing or soft in 2024. Maybe you can give us a flavor for what turns around in that business. And maybe you could just comment or remind us why Asia, in PowerDrive, was as soft as it was despite EV in China doing as well as it did."
},
{
"speaker": "Joe Spak",
"content": "Yeah. Maybe I'll start on the year-over-year performance. So we were down a little over $200 million in sales. When you think about that, that was really on the foundational side of their portfolio as a customer program. When you look at the e-side of the portfolio, it was actually relatively flat. There was just volatility in the market. I'll let Joe comment on going forward."
},
{
"speaker": "Joe Spak",
"content": "Right. So as we look forward in 2025, we're in the middle of launching a number of new products and platforms. So that's what's really bringing the additional growth on the PowerDrive side of the business."
},
{
"speaker": "Dan Levy",
"content": "And how much of that is China?"
},
{
"speaker": "Joe Spak",
"content": "Yes, we don't break out specifically China, but let's say that they're a strong, they've got a strong position in the overall market. Let Pat maybe cover that in a follow-up."
},
{
"speaker": "Dan Levy",
"content": "Okay. Thank you. And then as a follow-up, wanted to just understand the EBIT bridge. And maybe we could just compare versus 2024 because on organic revenue, flat or down slightly, you still had EBIT up some $60 million. Now in 2025, you know, you've talked about restructuring benefits for e-product. And I would presume there's going to be some pricing benefits for programs that you've tooled for, but the volume is never appreciated. So why aren't we seeing maybe a little more margin benefit given these?"
},
{
"speaker": "Joe Spak",
"content": "Yeah. So let me walk through the guide. When you start with last year's sales of $14.1 billion, the midpoint of our guide is $13.7 billion. And when you look at the difference and exclude foreign exchange, again, that $410 million, we're basically slightly up about 40 basis points against the market backdrop that we expect is down 2%. So that's where you get about our 250 basis points of outgrowth. As you look at our EBIT line, we're maintaining 10.1% on that relatively flat sales. As we look at the low end of the guide, we're basically decrementing at 10%. At the high end, in the mid-teens. So we feel really good about the performance that you're seeing in the guide. That's how we're thinking about it. It does incorporate the savings year over year from our e-product restructuring."
},
{
"speaker": "Dan Levy",
"content": "And what was unique in 2024 that is not repeating in 2025 that you had such strong incrementals?"
},
{
"speaker": "Joe Spak",
"content": "I think when you look at our performance in 2024, we really focused on restructuring savings. We focused on cost controls across the business, including GSM and productivity. And we're maintaining that as we look into this year. And so we feel really good with where we landed in 2024 and this outlook for 2025. We're going to keep our focus on cost controls as we move forward."
},
{
"speaker": "Dan Levy",
"content": "Okay. Thank you."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you all for your great questions today. If you have additional follow-ups, feel free to reach out to me or my team. With that, Nick, you can go ahead and conclude today's call."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes the BorgWarner 2024 Fourth Quarter and Full Year Results Conference Call. You may now disconnect."
}
] |
bwa | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Connie, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2024 Third Quarter 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 period. [Operator Instructions] I would now like to turn the call over to Patrick Nolan, Vice President of Investor Relations. Mr. Nolan, you may begin your conference."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Connie, and good morning, everyone. Thank you for joining us today. We issued our earnings release earlier this morning. It’s posted on our website, borgwarner.com, both on our home page and on our Investor Relations home page. With regard to our Investor Relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the Events section of our Investor Relations home page for a full list. Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. During today’s presentation, we will highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A and other non-comparable items. When you hear us say adjusted, that means excluding non-comparable items. When you hear us say organic, that means excluding the impact of FX and net M&A. We will also refer to our incremental margin performance. Our incremental margin is defined as the organic change in our adjusted operating income divided by the organic change in our sales. Our all incremental includes our planned investment in ER&D, any impact from net inflationary items and other cost items. Lastly, we refer to our growth compared to our market. When you hear us say market, that means the change in light and commercial vehicle production weighted for our geographic exposure. Please note that we’ve posted today’s earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I’m happy to turn the call over to Fred."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you, Pat, and good day, everyone. I’m very pleased to share our results for the third quarter and provide an overall company update, starting on Slide 5. At more than $3.4 billion, our Q3 organic sales were down about 5% year-over-year, modestly outperforming a 6% decline in our market. Year-to-date, we have outgrown our market by about 270 basis points. This demonstrates the resiliency of our technology-focused portfolio that we believe is positioned to outgrow the market production. We secured multiple new product awards for both foundational and eProduct, which we believe further support our long-term profitable growth. Turning to our bottom line for the quarter. We delivered a very strong 10.1% margin which was 50 basis points higher than last year. We also delivered earnings per share of $1.09, which was $0.11 higher than prior year. This strong underlying operational performance was primarily driven by our focus on cost controls across the business. Our strong year-to-date margin and cash performance enabled us once again to increase our full year margin and earnings guidance, as Craig will detail later. Lastly, we remained focused on the efficient deployment of our capital and completed our planned 2024 repurchase of $400 million of BorgWarner stock. Now let’s look at some new product awards on Slide 6. First, BorgWarner has furthered its business with a major North American OEM by securing the extensions on two transfer cases for full-size pickups. BorgWarner will supply two types of transfer cases to the OEM for use on three platforms. Start of production for two of the platforms are slated for 2027 with the third expected to begin in 2028. We have supplied this OEM with transfer cases for over 40 years. We believe this extension solidify our team’s reputation and the proven architecture, field performance and quality of our products. Next, BorgWarner has secured three high-voltage coolant heater business wins in Asia, expanding our technological reach in the Asian electric vehicle markets. In China, our high-voltage coolant heater will be used in a leading domestic OEM’s fully electric SUV with production expected to start in the second quarter of 2025. This partnership marks a significant step forward in our continued expansion in China’s rapidly growing electric vehicle industry. In Korea, the product will be used in an electric pickup vehicle with production estimated to begin in March 2025. The heater will be critical in managing cabin temperatures, improving energy efficiency and enhancing the driving experience. In Japan, our high-voltage coolant heater has been chosen by a Japanese OEM for its small battery electric vehicle, with production expected to start in 2028. This marks the company’s first heater program in the country. The compact heater design offers a perfect fit for smaller vehicle platforms, delivering superior performance and efficiency. These three important business wins demonstrate the strength of BorgWarner in this growing field and further solidify our presence in the Asia-Pacific region. And lastly, BorgWarner will deliver its turbochargers for use on GM’s Corvette ZR1 sports car platform, marking the largest passenger car twin turbochargers to be released and produced to-date. We’re proud to secure this contract and support General Motors in making the most powerful Corvette ever built. This technology has been in the works for some time now and to see it come to fruition is both exciting and fulfilling for our passionate teams. BorgWarner and General Motors have a long history of producing market-leading application across a wide range of segments, and we look forward to continuing to develop new technologies with them and push industry boundaries. Now let’s turn to Slide 7, where I would like to share our net sales breakdown following our business unit realignment that was effective July 1. Our business units are now aligned with our externally reported segments. On the left side of the slide, you see that our turbos and thermal technologies and Drivetrain and Morse Systems segments, each represent approximately 40% of our net sales. These segments generate most of their net sales from our foundational products. They both enjoy a number one or number two positions in the different product market segments they serve. These are mature businesses with strong margin and cash flow profiles that we expect will continue to strive as the world looks for more efficient combustion and hybrid powertrains. The remaining 20% of our net sales is comprised of our Power Drive Systems business unit, which was previously reported as ePropulsion and our battery and charging systems business unit except for engine control products. All of these sales generated from these two segments, our eProducts for hybrid and battery electric vehicles. These segments are expected to be significant drivers of our future growth. As these businesses continue to scale, we expect to capitalize on their growth by converting at mid-teens, which is what we are seeing this year. I also want to highlight our regional and customer diversity shown on the right side of the slide. Regionally, Americas, Europe and Asia, Rest of the World, each represent approximately a third of BorgWarner’s net sales. We are also strongly positioned in terms of exposure to various customer groups. For example, our sales to the Chinese local OEMs represents roughly 15% of our overall net sales so far this year. This is comparable to our net sales to the German OEMs in Europe and our North American sales to the Detroit 3. I think this chart clearly shows BorgWarner’s sales resiliency and highlights the benefits of strong diversification across products, customers and regions. To summarize, the takeaways from today are, BorgWarner’s third quarter results were strong. Sales performance was slightly better than market production. Our adjusted operating margin was over 10%, and our cash generation was very strong. This allowed us to accelerate our second half $300 million share repurchase plan, taking our full year repurchases to $400 million. We secured new foundational and eProduct business awards in the quarter, which we believe once again demonstrate our product leadership on both sides of our portfolio, further supporting our focus on profitable growth over market production. As we look forward, our formula for success is unchanged. We expect to continue to secure business opportunities that will allow us to continue to grow faster than market production. As I mentioned before, BorgWarner’s DNA is to focus on propulsion efficiency, which includes both combustion fuel efficiency and electrons efficiency for hybrids or BEVs. I expect efficiency to remain an industry trend for years to come and strong drivers of BorgWarner’s growth regardless of propulsion architecture. We continue to seek to appropriately manage our cost structure as industry volumes and propulsion mix outlooks change while continuing to preserve our long-term profitable growth and product leadership edge. We believe this focus will allow BorgWarner to continue to deliver sales performance through organic growth above market convert that growth into higher earnings and create long-term value for our shareholders. With that, let me turn the call over to Craig."
},
{
"speaker": "Craig Aaron",
"content": "Thank you, Fred, and good morning, everyone. Before I dive into the financials, I’d like to provide a quick overview of our third quarter results. First, we reported just over $3.4 billion in sales, which was down approximately 5% versus prior year, excluding FX and M&A. This was slightly above market production in the quarter, which was down approximately 6%, so we saw modest sales outgrowth in the quarter of approximately 50 basis points, which was primarily driven by European battery growth. Second, we had strong margin performance in the quarter at 10.1%. This was driven by solid operational performance, the continued benefit of restructuring actions we announced in July, our continued focus on cost controls across the business and customer recoveries. Third, we had strong free cash flow in the quarter of $201 million, which allowed us to accelerate our second half $300 million share repurchase plan. Importantly, we delivered this result while also continuing to organically invest in our business to support our focus on long-term profitable growth. Now, let’s turn to Slide 8 for a look at our year-over-year sales walk for Q3. Last year’s Q3 sales from continuing operations were just over $3.6 billion. You can see that the weakening U.S. dollar drove a year-over-year increase in sales of $4 million. Then you can see a decrease in organic sales of approximately 5% which was 50 basis points above market production, primarily due to strong European battery growth. And finally, the acquisition of Eldor added $9 million of sales year-over-year. The sum of all this was just over $3.4 billion of sales in Q3. Turning to Slide 9, you can see our earnings and cash flow performance for the quarter. Our third quarter adjusted operating income was $350 million, equating to a strong 10.1% margin. That compares to adjusted operating income from continuing operations of $349 million or a 9.6% margin from a year ago. On a comparable basis, adjusted operating income increased $15 million and $186 million of lower sales. This is a great result and reflects our ability to deliver profitability despite a declining production environment. This performance was partially helped by $24 million of favorable items related to customer recoveries for eProduct program volume shortfalls and the benefit of our PowerDrive Systems restructuring that we announced in July. The net impact of Eldor was a $14 million drag on operating income year-over-year. Our adjusted EPS from continuing operations was up $0.11 compared to a year ago as a result of strong adjusted operating income, a decline in our effective tax rate and the impact of $300 million in share repurchases during the quarter. And finally, free cash flow from continuing operations was $201 million during the third quarter, which was up $165 million from a year ago, as a result of strong working capital and capital expenditure performance. Now, let’s take a look at our full year outlook on Slide 10. We are projecting total 2024 sales in the range of $14.0 billion to $14.2 billion, which is a reduction from our prior guidance of $14.1 billion to $14.4 billion. This reduction is due to a lower market production outlook and modestly lower eProduct sales. Despite the sales reduction, we expect the company to outgrow market production by 200 basis points to 300 basis points, which once again demonstrates the resiliency of our technology-focused portfolio that we believe is positioned to outgrow market production. Starting with foreign currencies. Our guidance now assumes an expected full year sales headwind from weaker foreign currencies of $20 million compared to 2023. Within this guidance, our full year end market assumption has been reduced to down 3% to 3.5% versus down 2% to 3% previously. Finally, the Eldor and SSE acquisitions are expected to add approximately $30 million to 2024 sales. Based on our updated outlook, we expect our organic sales change to be flat to down 1.5% year-over-year or outgrowth above industry production of 200 basis points to 300 basis points. Now, let’s switch to margin. We are increasing our full year margin outlook to 9.8% to 10.0% from our prior guidance of 9.6% to 9.8%. This is based on our year-to-date performance and continued benefits of our PowerDrive Systems restructuring that we announced in July. This expected margin increase demonstrates the resiliency of our technology-focused portfolio and our ability to drive profitability in very challenging end markets. Our implied fourth quarter outlook assumes that our boat [ph] business delivers a mid-teens decremental conversion compared to our average year-to-date results, excluding the benefits of third quarter volume-related eProduct customer recoveries and second quarter stock forfeitures related to a senior executive retirement. We view this mid-teens decremental conversion as strong underlying performance given the anticipated 5% to 7% year-over-year decline in market production during the fourth quarter of 2024. Based on the sales and margin outlook, we’re expecting full year adjusted EPS in the range of $4.15 to $4.30 per diluted share. This 4% EPS increase compared to our prior outlook is being driven by the impact of our strong third quarter results, a lower share count due to the third quarter execution of our share repurchase plan and a reduction in our full year effective tax rate. We continue to expect full year free cash flow to be in a range of $475 million to $575 million. Our ability to increase our margin and EPS guidance during a challenging production environment demonstrates our focus on managing costs in order to hold our prior guidance absolute income dollars, and we’re doing this despite a significant reduction in global industry volumes. Now, let’s turn to Slide 11 and take a look at how we will deploy our expected $475 million to $575 million in 2024 free cash flow. As I just highlighted, we expect another strong year of free cash flow generation. At the midpoint of our guidance, we expect to generate $525 million in free cash flow. It is important to note that $475 million of this cash flow has already been deployed to shareholders with $400 million of shares repurchased and $75 million of dividends already paid through the end of the third quarter. If we assume that we will declare and pay our consistent quarterly dividend in the fourth quarter, almost all of our expected free cash flow will be deployed to shareholders in 2024. We believe our ability to return capital to shareholders while also investing in the business demonstrates the underlying strength of the company and the importance of maintaining a strong balance sheet that allows us to invest in our long-term profitable growth and follow a balanced capital allocation approach that reward shareholders. So let me summarize my financial remarks. Overall, we delivered a strong third quarter with sales outperformance compared to industry production. We delivered a very strong 10.1% margin, which was 50 basis points higher than 2023 and the second quarter in a row with a margin above 10%. Additionally, we generated $201 million in free cash flow, which allowed us to accelerate our second half $300 million share repurchase plan. And we did this despite challenging market production in the quarter. This once again shows the resiliency of our technology-focused portfolio that we believe is positioned to outgrow industry production and deliver strong profitability and free cash flow. We are proud to be increasing our margin and EPS outlook for the second time this year despite a declining industry volume [Technical Difficulty] Connie, can you hear us?"
},
{
"speaker": "Patrick Nolan",
"content": "I apologize for the audio interruption. Connie, if you can hear us, we can open up the call up for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And we’ll take our first question from Colin Langan, Wells Fargo."
},
{
"speaker": "Colin Langan",
"content": "Oh, great. Thanks for taking my questions and I congrats on a good quarter in a pretty tough market. I wanted to ask, if we go back to the Investor Day in June of last year, you actually talked about a 10% margin in 2027. Now I think at the high end of your guidance, you could be there this year, which is pretty impressive since the world has actually been a bit worse over the last 1.5 years. How should we think about margins from here? Is there anything kind of that might prevent you from getting above that 10%. It sounds like you expect to convert EV or ICE at the same contribution, so that would imply if we have growth, if we could kind of beat that 2027 target already?"
},
{
"speaker": "Craig Aaron",
"content": "Yes, thanks Colin for the question. Can you hear me okay?"
},
{
"speaker": "Colin Langan",
"content": "Yes."
},
{
"speaker": "Craig Aaron",
"content": "Okay, great. Let’s start with the quarter. Overall, the quarter, really strong operational performance. As I mentioned in my script, we benefited from restructuring actions, a real focus on cost controls across the business. And I mentioned that we also had a bit of a tailwind from PDS volume-related customer recovery. So really pleased with our performance in the quarter. As you look to the fourth quarter, I think how you should look at our performance really two ways to look at it. First, against our average performance for the full year. If you look at that at the midpoint of our guide, we’re expecting revenue to be down, let’s just call it roughly 3% and when you remove the onetime items in the second quarter and the third quarter that I mentioned in my script, we’re decrementing in the mid-teens, which is what you would expect. That’s one way to look at our fourth quarter performance. That gets us to 9.6% for the guidance. If you look at our year-over-year performance for the fourth quarter, again, revenue down about 2% year-over-year, and we’re actually holding incomes flat. Again, that gets us to 9.6% at the midpoint. So either way you look at it from our perspective, good operational performance in the fourth quarter. And I think we’re focused on delivering that guidance at the midpoint, again, right around 9.6%."
},
{
"speaker": "Colin Langan",
"content": "I guess a follow-up on the long-term 10% target, you’re pretty close. Anything that we should be thinking about as we think about 2025, 2026 that would sort of prevent getting above that target because it seems like you’re pretty awful close?"
},
{
"speaker": "Frédéric Lissalde",
"content": "It’s Frederic. It’s not the time to talk about longer term. We’re focusing on 2024. We’re focusing on controlling our incremental or decremental for that matter. And I think you can see it in our guide and we’ve talked about 2025 in the Q4 call."
},
{
"speaker": "Colin Langan",
"content": "Got it. All right. Thanks for taking my questions."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you, Colin."
},
{
"speaker": "Craig Aaron",
"content": "Thank you, Colin."
},
{
"speaker": "Operator",
"content": "And your next question comes from Dan Levy, Barclays."
},
{
"speaker": "Dan Levy",
"content": "Hi. Good morning. Thank you. I wanted to just double-click on the margin in 3Q. Based on the revenue decline at a 20% decremental, that would have been call it, a $37 million EBIT hit but instead you were plus 15% on the year-over-year. So that’s a $50 million plus swing. It’s even more if you’re adjusting for Eldor. So maybe you can just decompose that? I know you mentioned there was the $24 million benefit for ePropulsion, but there’s still another gap. And then maybe on the $24 million, how much of that is sort of recurring – sort of the ongoing restructuring benefit versus maybe a onetime benefit?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. Overall, when you look at the quarter, like you said, it was just really strong operational performance. We’re benefiting from the PDS restructuring that we announced in July. We’re benefiting from our focus of cost controls productivity, restructuring savings, et cetera. To answer your question, the $24 million of volume-related PDS customer recoveries, that’s a onetime item in the quarter. You should not expect that to repeat quarter-after -quarter."
},
{
"speaker": "Dan Levy",
"content": "And what’s the ongoing restructuring benefit?"
},
{
"speaker": "Craig Aaron",
"content": "The PDS restructuring, you said $20 million to $30 million for the full year."
},
{
"speaker": "Dan Levy",
"content": "Okay. Got it. Thank you. Second, I appreciate with the new segment structure, we can now better see the battery business. If you could maybe just double click on the growth there. How much of that is just strong demand versus getting new supply online. I think a lot of it is new supply. What type of growth profile we can expect for this business? And then interesting to see that it’s near breakeven, should we just assume that this is going to increment that your mid- to high teens and working your way up as you continue to grow? Just a way to think about sort of the margin profile of that business over time?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Dan, I’ll start. Yes, on the battery and challenging for the quarter, it was a good incremental of about 36%, strong sales, especially in Europe. And I think for – when you look at the segments too, on the other segment, there was a very, very efficient decremental on the way there, right? So we’re really focused on controlling what we can control, adjusting to the volatility of the market and driving margin performance. And I think you can see that in the guide. I don’t see a reason why this business should not carry on incrementing at the meeting."
},
{
"speaker": "Dan Levy",
"content": "And the supply versus demand dynamics, how much of this is just sort of new supply hitting?"
},
{
"speaker": "Frédéric Lissalde",
"content": "I would say the supply versus demand dynamic is not a dynamic where we are, let’s say, short of supply, we now have aligned capacity to demand in both regions, North America and Europe. So this is behind us."
},
{
"speaker": "Dan Levy",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "And we’ll take our next question from Joe Spak, UBS."
},
{
"speaker": "Joe Spak",
"content": "Thank you. I guess, maybe just to sort of follow on Dan’s question there with some of the new segmentation like, we have seen pretty steady improvement in the margins in battery and charging. And I know I think your capacity is sort of fully built out by the end of this year, and you’re going to sort of fill that up. So is getting to positive margins, just sort of the remaining – filling up that sort of remaining capacity? Or are there other actions in that segment?"
},
{
"speaker": "Craig Aaron",
"content": "Yes, it’s really at scale. We got to continue to scale the business. So you saw revenue in the quarter coming in right around $200 million as we continue to scale that business and increment in the mid-teens, then we’ll get to breakeven and above. And that’s what we’re focused on doing."
},
{
"speaker": "Joe Spak",
"content": "And the build-out is effectively done this quarter?"
},
{
"speaker": "Craig Aaron",
"content": "It’s complete."
},
{
"speaker": "Joe Spak",
"content": "And then just Craig, you sort of stressed, I think a couple of times, right, all the cash generation was redeployed to shareholders this year between the buyback and the dividend. I appreciate we’re sort of not talking about 2025 yet. But I mean, is that a sort of similar paradigm that we should expect going forward here over the coming years?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. We’ll comment on 2025 when we get to 2025. Really happy with the way that we’ve deployed cash this year. Again, as you mentioned, we have line of sight [ph] to $525 million at the midpoint of our guide. We’ll effectively apply all of that to shareholders. I’m really pleased with the way that we’ve allocated capital this year. Again, we’ll give you insight into 2025 as we get into February."
},
{
"speaker": "Joe Spak",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And your next question comes from Adam Jonas with Morgan Stanley."
},
{
"speaker": "Adam Jonas",
"content": "Thanks, everybody. Joe just asked my question on the free cash flow paradigm and how much of that’s returned. So just one left for me. I know you’re saying the $24 million of recoveries is onetime, won’t be repeated. But it does seem like the narrative from your customers is pushed out, written off, canceled at the margin, EV programs and some of them are quite sizable, including from the likes of Ford and some others. We suspect that will continue. So I didn’t know if that was, again, not calling out in a specific quarter or the occurrence of onetime items. But is – am I right that if I’m looking ahead 12 months, there is a possibility for more recoveries from OEMs, given what has been announced and what you’re seeing in your discussion so far of cancellations of E product and EV-related products that you spend money on and may not be made at anywhere near the volumes which you expected or at all? Thanks."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thanks. And yes, each case is specific. I would say that this case is a little exceptional. What we’re focusing on at BorgWarner is also bringing flexibility from a modular design standpoint, flexibility from a production standpoint, reusing the four walls and transforming our plants from combustion into electrification in a measured way. So we are with our customers for the long run. And I would say that each case is very specific, and we’re going to manage the business going forward depending on what’s happening."
},
{
"speaker": "Adam Jonas",
"content": "Thanks, Fred."
},
{
"speaker": "Operator",
"content": "Your next question comes from John Murphy from Bank of America."
},
{
"speaker": "John Murphy",
"content": "Good morning guys. Fred, I just wanted to ask on Slide 6, when you look at something like the transfer case extension, how much new capital needs to go into investing in sort of that next-gen product? Is it minimal? And as we see these extensions on the ICE side, could the profits and returns be significantly or margins and returns could be significantly better than they have been historically or even just a bit better?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Yes. I won’t comment specifically on this transfer case program. But what we see from a combustion standpoint is you have three elements happening in the marketplace. First is program extension, like the transfer case, where some capital maybe have to be put in place to go with the extension and sometimes less. So that’s the first case. Second case is program prolongations where the combustion engine is going to be run for longer. And the third case is hybrids carrying over combustion gasoline engines for an hybrid [ph] application. And that’s what’s driving also the outgrowth of the combustion market in that specific case."
},
{
"speaker": "John Murphy",
"content": "Okay. That’s helpful. And then just a second question. A lot of other suppliers are kind of alluding to the bidding process or the program bidding process being pushed out quite dramatically. But once again, on Slide 6, you’re showing some pretty good wins. I just wonder if you could characterize your quoting activity right now and if you think it’s very different than history or disrupted by EVs, I mean, what’s your current take on that? And is there anything that’s really shifted maybe in absolute terms or maybe just timing terms?"
},
{
"speaker": "Frédéric Lissalde",
"content": "John, so what we’re seeing is that in the Western world, there is a bit of a slowdown in new quoting activities for electrified powertrains. And I think one of the key reasons is that we’re all focused on launching including at BorgWarner. There are many, many electrified hybrid and BEV launches in Europe and North America. And again, that opens other opportunities for us on the combustion with what I alluded to before extensions that the transfer case, prolongations and/or carrying over combustion engines into hybrid powertrains. So that’s the dynamic that we see in the marketplace."
},
{
"speaker": "Unidentified Analyst",
"content": "But would it be fair to say that, that does not have a significant impact on your mid- to long-term growth over market prospects?"
},
{
"speaker": "Frédéric Lissalde",
"content": "We expect to have a portfolio that is resilient on the various propulsion architecture, mix scenario and regional mix scenario, and we expect to carry on outgrowing our respective markets."
},
{
"speaker": "Unidentified Analyst",
"content": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"content": "And your next question comes from Luke Junk from Baird."
},
{
"speaker": "Luke Junk",
"content": "Good morning. First question, Fred, just hoping you could – building on the last response there, just comment on your hybrid pipeline, specifically in – I’d just be interested if you’re seeing any evolution more on a bigger picture standpoint, I guess, relative to the regulatory backdrop and how you solve for that, both in Europe in U.S. from a powertrain standpoint, and the real hybrid is going to play in that. Thank you."
},
{
"speaker": "Frédéric Lissalde",
"content": "For us, it’s fairly simple. Our combustion portfolio is fully fungible into hybrid powertrains. The most advanced and modern hybrid powertrains carry most of our combustion products. And on an eProduct standpoint, as we mentioned in the past, an inverter for BEV is the same as an inverter for hybrid. So I’m over simplifying, but the gas are the same the motor is actually pretty much the same. And a P4 [ph] for hybrid can be an IDM [ph] for BEV, it’s the same types of products. So we are in a position to serve our customers globally into wherever they want to go from a powertrain architecture standpoint going forward. So for us, I wouldn’t say that it doesn’t really matter, but this is why we think we can carry on outgrowing the market or the markets and convert on that outlook."
},
{
"speaker": "Luke Junk",
"content": "And then for my follow-up, Craig, just wondering if we could get some flavor for incremental cost controls productivity. Just help us understand some of the areas that you’re leaning into and what might carry over into 2025 for the back half of this year?"
},
{
"speaker": "Craig Aaron",
"content": "I think we’re leaning into all of those things. We’re real focused across the business on cost controls. Luke, the items that you mentioned were – helped us in the quarter, whether it’s restructuring actions, whether its continued focus on savings, whether that’s supply chain or productivity, we’re leaning into all that across the business. And I think you can see that in our segment performance through the first nine months. We’ll continue to have that focus, especially as the top line stays very volatile."
},
{
"speaker": "Luke Junk",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "And your next question comes from James Picariello from BNP Paribas."
},
{
"speaker": "James Picariello",
"content": "Hi guys. Just on the LVP assumption for this year, you’re signaling down 2% to 2.5%. Like there are other suppliers out there that are calling for down 4 now, right, which implies the fourth quarter precipitous down something close to 10%. Just curious on your thoughts there and the visibility in your own build schedules, in your own customer mix, on that point. Yes, that’s my first question."
},
{
"speaker": "Frédéric Lissalde",
"content": "Hey James, our view is the market will be down 3% to 3.5% year-over-year. Our biggest reductions North America, Europe are down 5% to 5.5% year-over-year and with a slight increase in China. That’s what we see. And we are going to carry on managing our costs effectively and adjust to potential production environment changes. And I think this is evidenced in our dated guide too."
},
{
"speaker": "James Picariello",
"content": "Yes, I was referring to just the light vehicle component, but yes, still splitting hairs [ph], I suppose. My follow-up is just as we think about your foundational product suite and the potential for hybrids to run much stronger in demand. Between your turbos and Thermal segment versus the drivetrain and more systems, how do you view hybrid demand between those two segments, again, on the foundational side is one position then the other if there’s some kind of ranking that you could share? Thanks."
},
{
"speaker": "Frédéric Lissalde",
"content": "I don’t think we’ve broken down that potential. I would say that it would touch both segments of the most advanced hybrids carry engine components that we have in motors, in turbos and other subsystems. It will also carry everything related to shift shifting mechanism between the eDrive and the combustion driver hybrid. So I would say that advanced hybrid powertrain will grow products from those two essentially foundational segments."
},
{
"speaker": "James Picariello",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "And your next question comes from Mark Delaney with Goldman Sachs."
},
{
"speaker": "Mark Delaney",
"content": "Yes. Good morning. Thanks for taking my questions. First, I believe you are now assuming growth over market of 200 to 300 basis points. And I think it had been 350 to 450, assume for 2024 previously. So maybe you can help us better understand what’s changing in the growth of our market outlook for this year."
},
{
"speaker": "Frédéric Lissalde",
"content": "So Mark, our growth has dropped off about $200 million and a half, probably coming from eProduct portfolio. The other half is coming from our foundational business, which is about $100 million out of $12 billion [ph], I would say it is not extremely material so and from a quarter-over-quarter, our growth, I would not really look at it. We are year-to-date at 270 basis points. And I think it’s now always smooth quarter-to-quarter."
},
{
"speaker": "Mark Delaney",
"content": "Okay. That’s helpful. My other question was just following up on John’s question around the pace of bookings and understanding the Western OEM bookings activity has slowed. I’m curious if you think post-U.S. election results, if there’s the potential for award activity from Western OEMs to accelerate once they have a better sense on the likely path of CO2 requirements in the coming years? Thanks."
},
{
"speaker": "Frédéric Lissalde",
"content": "I am not sure I can comment on this. Let’s wait and see. At least at BorgWarner, we’re already wherever the customers want to go."
},
{
"speaker": "Mark Delaney",
"content": "Understood. Thank you."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We have time for one final question, and that question comes from Emmanuel Rosner with Wolfe Research."
},
{
"speaker": "Emmanuel Rosner",
"content": "Great. Thank you so much. I was hoping you can help us put a finer point on the cost actions and how do you think about them? How should we think about the amount of structural cost reduction that you’re taking out this year? How do they annualize like into next year? Like how much of it is left over from more recent actions? And generally speaking, the programs you’ve announced or you have in place, how much cost is left to take out?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. Thanks for the question. So I’ll point to the PDS restructuring because those are structural changes that we’re making. What we indicated this year is $20 million to $30 million. We announced that in July. So if you annualize that $40 million to $60 million next year with a target of $100 million by 2026. Those are structural changes that we’re making. As you think about our business as we move forward, even with these restructuring actions, what’s our goal? Our goals are to grow over the market from a sales perspective, turn that growth into income in the mid-teens, regardless of the growth is on the foundational product side of the portfolio and to generate cash. So I think, ultimately, how you should think about our growth is incrementing in the mid-teens. That’s a great way to model it."
},
{
"speaker": "Emmanuel Rosner",
"content": "Thank you for the color. And then I was hoping to hone in a little bit more again on the commercial vehicle battery business. Can you maybe talk to us about BorgWarner’s competitive advantages in that business and then also the operating leverage on this business specifically. Obviously, very strong incrementals that we just saw, then I think your earlier comments spoke about no reason why you shouldn’t stay in the mid-teens. That’s obviously quite a big difference between 40% and the mid-teens. So maybe the longer-term question is, okay, what are BorgWarner’s competitive advantages, but maybe shorter term is how do you think about the operating leverage, please?"
},
{
"speaker": "Frédéric Lissalde",
"content": "So from a product perspective, Emmanuel, as you know, we are focused only on commercial vehicle trucks and buses. With this, we are pretty agnostic from a sales form perspective, in production within NMC and preparing production with LFP in the light of our association with FinDreams. We have capacity installed in both sides of the ponds in the U.S. and in Europe. And we are in charge of software, cybersecurity, assembly of the pack, testing of the pack and everything that goes around the pack, which I think is pretty differentiated. And we are one of the only one in the Western world building very impactful commercial vehicle trucks and buses as an independent supplier."
},
{
"speaker": "Craig Aaron",
"content": "Yes. And I’ll comment on the margin profile. Obviously, really happy with the performance of that business. It grew quite significantly in the quarter, converted at a really high level, like you mentioned, about $0.35 on the dollar. As we move forward, I wouldn’t say one quarter makes a trend. So we’re focused on that business, incrementing in the mid-teens like all of our other businesses. That’s how we’ll measure success for the battery business in the charging business."
},
{
"speaker": "Emmanuel Rosner",
"content": "Thank you."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you."
},
{
"speaker": "Patrick Nolan",
"content": "With that, I’d like to apologize for the audio issues that we had today, and thank you all for your great questions. If you have additional follow-ups, feel free to reach out to me or my team. With that, Connie, you can go ahead and conclude today’s call."
},
{
"speaker": "Operator",
"content": "This does conclude the BorgWarner 2024 Third Quarter Results Conference Call. You may now disconnect."
}
] |
bwa | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, everyone. My name is Beau, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2024 Second Quarter 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 period. [Operator Instructions] I would now like to turn the call over to Patrick Nolan, Vice President of Investor Relations. Mr. Nolan, you may begin your conference."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Beau. Good morning, everyone, and thank you for joining us today. We issued our earnings release earlier this morning. It's posted on our website, borgwarner.com, both on our home page and Investor Relations homepage. Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today. During today's presentation, we'll highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A and other non-comparable items. When you hear us say adjusted, that means excluding non-comparable items. When you hear us say organic, that means excluding the impact of FX and net M&A. We will also refer to our incremental margin performance. Our incremental margin is defined as the organic change in our adjusted operating income divided by the organic change in our sales. Our all-in incremental margin includes our planned investment in R&D any impact from net inflationary items and other cost items. We will also refer to our growth compared to our market. When you hear us say market, that means the change in light and commercial vehicle production weighted for our geographic exposure. Please note that we've posted today's earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion. With that, I'm happy to turn the call over Fred."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you, Pat, and good day, everyone. I'm very pleased to share our results for the second quarter of 2024 and provide an overall company update, starting on Slide 5. At approximately $3.6 billion, our Q2 sales were relatively flat year-over-year, outperforming a modest decline in production. For the first half of the year, we outgrew our market by about 350 basis points. Once again, the sales outgrowth shows the resiliency of our efficiency-focused portfolio, which is, I believe, positioned to outgrow the market in any type of propulsion mix scenario. We secured multiple new product awards across combustion, hybrid and electric for both passenger cars and commercial vehicles. Turning to our bottom line for the quarter. We delivered a very strong 10.4% margin, which was up 30 basis points versus prior year. We delivered EPS of $1.19 per share, which was $0.13 increase versus prior year. Our first half 2024 margin and EPS performance has allowed us to increase our full year margin and earnings guidance, as Craig will detail later. We carried on our restructuring actions, now focusing our ePropulsion segment to adjust our cost structure to current market dynamics. We expect that these actions will result in annual run rate cost savings of about $100 million by 2026, with immediate positive impacts. We also introduced a new business unit structure, designed to maximize cost synergies, enhance our go-to-market global strategies and bring further simplicity and clarity to our shareholders. Lastly, we remain focused on efficient deployment of our capital and announce our intention to repurchase $300 million of BorgWarner stock in the second half of 2024. Next, on slide 6, I would like to take a moment to highlight our 2024 sustainability report, which was published earlier this month. BorgWarner's vision is a clean, energy-efficient world. And I'm proud to lead a company where our business goals go hand-in-hand with our sustainability goals. At BorgWarner, sustainability means delivering value to all stakeholders for today and tomorrow. I would like to highlight just a few points of progress described in the report. First, BorgWarner has reduced Scope 1 and 2 greenhouse gas emissions by 32% from the 2021 baseline, making progress on our SBTI validated goal to reduce it 85% by 2030. Second, the company engaged our supply chain management and engineering teams to advance the company's goal of reducing Scope 3 emissions, 25% by 2030 compared to a 2021 baseline. And third, we performed above all benchmarks on employee sense of inclusion and belonging on the company's engagement survey. I would like to thank our entire team for their dedication and excellence in innovating products for cleaner mobility, making leaps towards achieving our climate and other sustainability goals, and investing in our people. Now, let's look at some new product awards on slide 7. First, BorgWarner has secured multiple contracts to supply its electric cross differential or exD to three major OEMs. The companies will incorporate BorgWarner exD technology into both rear and front wheel drives of electrified powertrain application. Start of production is expected in 2024 and 2026. Our exD is part of our Electric Torque Management System, which offers a range of products that intelligently controls, wheel torque, to increase stability provide superior dynamic performance and improve traction during launch and acceleration. Next, BorgWarner secured awards to deliver high-voltage eFan systems for use on a major global OEM series of electrical commercial vehicles in North America. This marks the largest eFan business win in North America for us with expected start of production in Q4, 2027. BorgWarner complete eFan system is comprised of three components, including a fan and eMotor and an integrated high-voltage inverter with the capacity to reach up to 10 kilowatts of power and 40-newton meters of torque. Lastly, BorgWarner has secured two EGR Cooler Awards with a prominent North American-based commercial vehicle customer. Start of production is expected to be in Q4, 2027 with implementation across various medium-duty commercial trucks. Our emissions reducing EGR solution offers high robustness against thermal fatigue and optimizes cool and distribution throughout the engine for increased performance. We continue to see strong interest across our EGR product portfolio, which supports the need for highly efficient combustion engine that meets increased fuel economy needs and stringent emission requirements across the world for combustion and hybrids. Now, let's turn to Slide 8, where I would like to discuss our new business unit structure. As we have continued to outgrow the market, and leveraged the leadership, robustness, and scale of our product portfolio, it is now the right time to align our business unit structure to further enhance our ability to execute on our strategy. We believe this will drive cost synergies, higher focus, and clarity for all stakeholders. As such, beginning in the third quarter, BorgWarner will reorganize its four business unit and associated financial reporting segments as follows; our Turbos and Thermal Technology business unit is led by Dr. Volker Weng. This business unit is unchanged. Our Power Drive System, which today is our externally reported ePropulsion segment will continue to be led by Dr. Stefan Demmerle. This business unit is also unchanged. Our Drivetrain and Morse Systems businesses are now combined into one business unit and is led by Isabelle McKenzie. We've combined our Commercial Vehicle Battery and Charging businesses into one business unit, which is led by Henk Vanthournout. To summarize, the takeaways from today are this, BorgWarner's second quarter results were strong. Our sales performance once again outperformed the industry. Our adjusted operating margin was the highest since the PHINIA spin-off, and our cash generation was very strong and support our $300 million of intended share repurchase in the second half of the year. We secured multiple new business awards in the quarter, which we believe further demonstrate our product leadership position in all powertrain architectures. BorgWarner is focused on powertrain efficiency, this includes combustion fuel efficiency and electron efficiency, whether it is for Hybrids or BEVs. I believe BorgWarner can support any powertrain architecture. We are world leader in efficient mobility with a product portfolio that we believe is uniquely positioned to outgrow industry production for years to come. This quarter, we took additional meaningful steps to manage our cost structure in response to the industry mix dynamics, as well as to provide increased clarity and transparency from a global product line organization. As we look forward, we expect to continue to secure global growth opportunities as the world transitions to more efficient mobility, thanks to our product leadership position in combustion, hybrids and BEVs. At the same time, we will continue to appropriately manage our cost structure, as industry volumes and production mix outlook change, while continuing to preserve our long-term profitable growth and technological edge. This will allow BorgWarner to continue to deliver sales performance through organic growth above market production, convert that growth into higher earnings and create long-term value for our shareholders. With that, let me turn the call over to Craig."
},
{
"speaker": "Craig Aaron",
"content": "Thank you, Fred, and good morning, everyone. Let's start on Slide 9 with a look at our year-over-year sales walk for Q2. Last year's Q2 sales from continuing operations were just under $3.7 billion. You can see that the strengthening US dollar drove a year-over-year decrease in sales of almost 2% or $62 million. Then, you can see a modest decrease in organic sales, which was a 120 basis points above market production. Finally, the acquisition of Eldor added $6 million of sales year-over-year. The sum of all this was just over $3.6 billion of sales in Q2. Turning to Slide 10. You can see our earnings and cash flow performance for the quarter. Our second quarter adjusted operating income was $376 million, equating to a strong 10.4% margin. That compares to adjusted operating income from continuing operations of $372 million or a 10.1% margin from a year ago. On a comparable basis, excluding the impact of foreign exchange and M&A, adjusted operating income increased $22 million on $12 million of lower sales. This is a great result and reflects our ability to deliver profitability despite a declining production environment. This performance was partially helped by $15 million of favorable items, including the initial benefits from our ePropulsion restructuring, stock forfeiture related to a senior executive retirement and timing of a supplier cost record [ph]. The net impact of Eldor was a $9 million drag on operating income year-over-year. Our adjusted EPS from continuing operations was up $0.13 compared to a year ago as a result of higher adjusted operating income, a decline in our effective tax rate and the impact of recent share repurchases. And finally, free cash flow from continuing operations was $297 million during the second quarter, which was up $267 million from a year ago as a result of strong working capital and capital expenditure performance. Now let's take a look at our full year outlook on Slide 11. We are projecting total 2024 sales in the range of $14.1 billion to $14.4 billion, which is a reduction from our prior guidance of $14.4 billion to $14.9 billion. This reduction is due to weaker foreign currencies, a lower market production outlook and eProducts coming in at the low end of our prior guidance range. Despite this revenue reduction, we expect the company to outgrow market production by 350 to 450 basis points, which once again demonstrates the resiliency of our technology-focused portfolio, that we believe is positioned to outgrow market production during any kind of propulsion mix environment. Starting with foreign currencies. Our guidance now assumes an expected full year sales headwind from weaker foreign currencies of $175 million compared to 2023. This is also a sales headwind of $75 million versus our prior guidance, with the Euro, Chinese RMB and Korean Won being the largest drivers of the change in our outlook. Within this guidance, our full year end market assumption has been reduced to down 2% to 3% versus flat to down 2.5% previously. Finally, the Eldor and SSE acquisitions are expected to add approximately $30 million to 2024 sales. Based on end market and eProduct headwinds, we expect organic growth of approximately 0.5% to 2.5% year-over-year compared to our prior guidance of 2% to 5%. However, our expected overall growth above market production remains strong at 350 to 450 basis points. Now let's switch to margin. We are increasing our full year margin outlook to 9.6% to 9.8% from our prior guidance of 9.2% to 9.6%. This is based on our year-to-date performance and the expected benefit of our ePropulsion restructuring actions, which I'll discuss in a few moments. We believe this margin guidance increase reflects our ability to drive profitability against very volatile end markets. Excluding the impact of Eldor related losses in 2024, and the benefit of our ePropulsion restructuring, the high end of our second half outlook contemplates the business delivering an incremental conversion in the mid-teens, while the low end of our guidance provides a decremental conversion in the low double-digits. We view this as strong underlying performance given the anticipated 3.5% to 5.5% decline in market production during the second half of the year. Based on this sales and margin outlook, we're expecting full year adjusted EPS and in the range of $3.95 to $4.15 per diluted share. This increase compared to our prior outlook is being driven by the impact of our higher margin guidance and $300 million in share repurchases that we expect to execute before the end of the year. With an expected $475 million to $575 million in 2024 free cash flow, we expect to allocate all of our cash flow to shareholders through share repurchases and dividends. In summary, this is simply another example of the company utilizing its strong free cash flow to deliver value to shareholders. Let's turn to slide 12, and discuss our planned restructuring actions within our ePropulsion segment. As mentioned earlier, the initial benefits of these actions helped our second quarter results by $5 million. We continue to see short-term sales challenges in this business due to various individual platform shortfalls and other regional market dynamics. Therefore, it was critical to rightsize the ePropulsion cost structure to their current level of sales with restructuring actions that we started in June. We estimate cumulative cash restructuring costs of approximately $75 million that will extend through 2026. These actions are expected to generate cost savings of $20 million to $30 million in 2024 and approximately $100 million by 2026. The intention of this restructuring is to improve the near-term earnings of this business, but it also positions the business to be able to deliver mid-teens incremental margins on future growth. So let me summarize my financial remarks. Overall, we delivered a strong second quarter with sales performance better than market production. We delivered a very strong 10.4% margin, which was 30 basis points higher than 2023. And we generated $297 million in free cash flow, which was $267 million higher than 2023. And we did this despite declining market production in the quarter. I believe this once again demonstrates the resiliency of our technology focused portfolio that is positioned to outgrow market production and to deliver strong profitability and free cash flow in any type of end market environment. Last quarter, I shared three financial goals for BorgWarner for 2024 and beyond. I would like to give you my view of these goals as it relates to our 2024 outlook. First, we outperformed market production by approximately 350 basis points during the first half of the year. And despite anticipated weaker second half production environment, we expect to outperform the market by 350 to 450 basis points for the full year. This is a reflection of our leading-edge technology that we believe is positioned to outgrow a very volatile powertrain mix environment. Second, our margin profile remained extremely strong through the first half of the year. When combined with our continued focus on profitable growth, including our planned ePropulsion restructuring actions, this allowed us to increase our full year margin outlook by 30 basis points despite a challenging production environment. And lastly, we generated strong free cash flow during the second quarter, and we have strong liquidity, which supports our intention to repurchase 300 million of additional shares during the second half of the year. This means that we expect all of our 2024 free cash flow will be returned to shareholders through the combination of a consistent quarterly dividend and tenant share repurchases. The combination of our 2023 and intended 2024 share repurchases represents more than 7% of our outstanding shares post the finance spin-off. And we expect to do this while also continuing to invest in our business to support our focus on long-term profitable growth. As I look back at the first half of the year, I'm very proud with how we have performed, and I'm equally excited to see our results in the back half of the year. With that, I'd like to turn the call back over to Pat."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Craig. Bo, we're ready to open it up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll go first this morning to John Murphy with Bank of America."
},
{
"speaker": "John Murphy",
"content": "Good morning, guys. Just a main question here around the eProduct restructuring. One, why does why does include -- it not include Europe? Why is it only North America and China? And is this -- just in response to program cancellations or push-outs, meaning that the business is just not materializing the way you're expecting? And it appears, just given the very quick savings that some of these programs may have been loss-making for you, even if they come through. So maybe just kind of confirm that. So, why not Europe? Is it just program cancellations and push-outs? And were the programs loss-making to start with and maybe any other color around this?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Yeah, John, from an engineering and I see no footprint perspective, this business unit is essentially tilted to North America and China. That's where the -- most of the restructuring will happen, because this is where we have the weight. But it also touches some parts of Europe. The restructuring is sized so that when PDS carries on launching so many products for major OEMs globally, we're converting mid-teens the way up, and that's how we sized. We sized the restructuring. We're focusing on launching the products that we've booked, and we've also focused on very defined programs for long-term product leadership and enhanced product efficiencies."
},
{
"speaker": "John Murphy",
"content": "Okay. And then maybe just a follow-up on the Seesaw on the ICE and potentially on the hybrid side. Are you seeing any benefits that might come to that side of the business where you're gaining a little bit of revenue that might come in at higher incrementals, that maybe it's this year or maybe it is we go through 2025 and 2026 through the course of this program?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Yes. So the propulsion mix is volatile and unpredictable. And what we're doing at Borg is making sure that we are converting on the additional revenue wherever the revenue comes from. We're focusing on launching our new business that were booked, and this is what translates in the numbers and the updated guide."
},
{
"speaker": "John Murphy",
"content": "Okay. And just one just Bob, most of this, it sounds like it's head count on R&D. Is that a fair statement?"
},
{
"speaker": "Frédéric Lissalde",
"content": "It is head count and other types of spend. But it's more SC&O than any other things, overall."
},
{
"speaker": "John Murphy",
"content": "Got it. That's really helpful. All right. Thank you guys."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you, John."
},
{
"speaker": "Operator",
"content": "Thank you. We go next now to Colin Langan at Wells Fargo."
},
{
"speaker": "Colin Langan",
"content": "Thanks for taking my question and congrats on a great quarter. If I look at the midpoint of full year guidance, it does imply something like over a 30% decremental, if I go first half to second half on those lower sales, kind of at the higher end of conversion on lower sales. And on top of it, I think you mentioned there's actually a little bit of savings from the restructuring program into the second half. What is driving that? Is that just normal seasonality? How should we be thinking about first half, second half decremental?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. So when we think about first half, second half, I think actually, the better way to look at it is year-over-year. And when you think about our margin 9.3% to 9.6% in the second half of the year, when you look at the high end of our guide, we're incrementing in mid-teens. On the low end, we're decrementing in the low double digits. That's excluding the benefits of restructuring. So Colin, when you include restructuring, we're incrementing in the 30% range on the high end of our guide, and on the bottom end of the guide, we're holding flat. For us, I think that's really good underlying performance. And so that's how we're looking at it year-over-year."
},
{
"speaker": "Colin Langan",
"content": "Got it. And if I look at growth over market, I think it came down a little bit less than 100 basis points. It seems they're pretty small considering some of the issues. I mean, what is driving that site change? Is that all the EV delays? And is there any customer mix as other suppliers have reported? Or is that not an issue for you given your pretty strong position in China with domestic?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Yes. Colin, the outgrowth for Q2 is 120 basis points. And this is essentially impacted by eProduct revenue at the low end of our guide. And also essentially the program in North America -- BEV program in North America that's not really not really performing well. I would look at a smooth out growth quarter-over-quarter as a good proxy. I think 300 basis points for the first half is where we want to be, and -- be around 400 basis points for the full year, which is also where we kind of want to be."
},
{
"speaker": "Colin Langan",
"content": "I was kind of referring to the full year guide, growth of a market that was implied. It seems like it's slightly lower. Is that also all EV-related?"
},
{
"speaker": "Frédéric Lissalde",
"content": "It is."
},
{
"speaker": "Colin Langan",
"content": "All right. Thanks for taking my questions."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We go next now to Chris McNally at Evercore."
},
{
"speaker": "Chris McNally",
"content": "Thanks so much team. Maybe if I step back for the impressive guide raise of 30 bps. I mean, basically, the way I think about it is essentially given the organic revenue reduction of a little bit less than $300 million, you probably would have lost 20 or 30 basis points on normal incremental. So if you add those two, it's about a 50 to 60 bps of operational sort of better-than-expected performance, and I think what we're all trying to work out is if you look at Q2 and a 10.4% margin, while you still have ePropulsion losses in the double digits. Can you just walk us through some of the contents why we can't propel out that 10% plus margin for 2025, 2026? Where obviously, where you've discussed lower what rolls off? Anything just qualitative, I know there's a lot of moving parts and one quarter doesn't make sort of a trend. But we're all trying to figure out if ICE is here for a little bit longer, what is the negative that trains that down? Because obviously, ePropulsion you will get better than this minus double-digit margins. It's a long question, but curious why we can't see more strength in the foundational business."
},
{
"speaker": "Craig Aaron",
"content": "Yeah, Chris, I'd say the way to look at it is when you look at Q2 we're at 10.4%. There was -- as I mentioned in my script, about $15 million benefit in the quarter with some items. So when you remove that, it's about 10% for Q2. As we move into the second half of the year, as mentioned, revenue is coming down about $200 million purely market, $75 million foreign exchange and the balances on the eProduct side of our portfolio. And ultimately, at the midpoint operating income is unchanged. And so I think your question is, how are we doing that? And I think it's coming from our strong first half performance and our restructuring benefits is offsetting the sales decline. I think it's really as simple as that."
},
{
"speaker": "Chris McNally",
"content": "And then this idea is obviously, we're going to see pure ICE, right, so ex plug-in, ex-hybrid, ex-EV volumes decline over the next couple of years. Should we assume that if we were to be able to isolate that margin of business that's coming down, meaning they'll see decrementals, because also often at the end of life of a lot of these programs, you actually see R&D also come down. So that's one of the things that we're trying to figure out. If we were to isolate specifically ICE foundational programs, will they see margin decline as units go down over the next couple of years? And, obviously, then the question will some of these programs may be extended or volumes may come down less. But just if we were to think about it, not how you report but should we see margins on a like-for-like basis on pure ICE coming down?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Yeah. So I would say, first, a lot of our combustion products go into hybrids and are a key element of making the combustion side of hybrid lean and efficient. So I think I think when you think about BorgWarner, I don't think you should try and split combustion, hybrid and BEV. Because our combustion product goes on combustion and hybrid, our eProduct also a very versatile item go on EV and hybrid. Those are the same products. And so we have the portfolio to play in all three segments, if you call that segment. And outgrow the segment and convert on outgrowth. It is as simple as this."
},
{
"speaker": "Chris McNally",
"content": "No, that's helpful. I know that's a tough one to isolate. And I think as you -- as we also see in the four new segments, some of the margin progression, I think Fred that actually may be easier for the investment community to kind of see the trend segmented in these segments where we do get a little interplay of ICE, EV and Hybrid. Thanks so much. Really appreciate it."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We go next now to Joe Spak at UBS."
},
{
"speaker": "Joe Spak",
"content": "Thanks. Good morning. Just -- I think before you were looking for eR&D to be plus $40 million to $50 million for the year. Now with this restructuring, and it does sound like it's again, mostly people. Is that now like a $20 million year-over-year pace? Or is there some other sort of savings from the restructuring?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. Thanks, Joe, for the question. You're right. Yes, we said $40 million to $50 million starting the year. Now after this restructuring, it's going to be down to $20 million to $30 million. And how I look at it is our eProduct portfolio is still growing $0.5 billion. It's still going to be up about 25% year-over-year, and that $20 million to $30 million is supporting a lot of launches that are going to be happening in the future. It's really focused on application engineering, and that's really what that $20 million to $30 represents year-over-year."
},
{
"speaker": "Joe Spak",
"content": "So I guess just to follow on and more importantly, like how should we think about R&D there and capital investment on eProducts, given your new view of sort of how this market is going to evolve here?"
},
{
"speaker": "Craig Aaron",
"content": "On that growth, we're going to continue to support those programs with R&D, and we're still focused, as always, on 15% return on invested capital on all new programs."
},
{
"speaker": "Joe Spak",
"content": "Okay. And then maybe just one more quick here on eProduct sort of the lower end here. Maybe -- apologies if I missed this, but -- is that -- is the battery ramp still on track? I think you're looking for that to be like $700 million to $800 million. So the reduction is really in some of those other products? Or was there a revision to the battery side as well?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Yes. Back to your prior question, I just want to add that we're incrementing mid-teens, including the year-over-year additional $20 million eR&D spend. On battery, it's on track. Seneca is doing a great job, and they're now food in production. We are on track also for Europe. And the battery business performance is, of course, contributing positively to the incremental margins that we are delivering for the first half and also an important part of our guiding up for the full year."
},
{
"speaker": "Joe Spak",
"content": "Thank you. I’ll pass it on."
},
{
"speaker": "Operator",
"content": "Thank you. We’ll go next now to Dan Levy at Barclays."
},
{
"speaker": "Dan Levy",
"content": "Hi. Good morning. Thank you for taking the question. I wanted to start first with the question on the drivetrain and Battery Systems segment, which is another really strong quarter. So maybe you can help us disaggregate the margin strength. How much of this was on the core foundational piece versus the battery side? Where -- and you just talked to it a second ago, but that's obviously ramping."
},
{
"speaker": "Craig Aaron",
"content": "Yes. The quick answer is coming from both really, really strong growth in the quarter like you saw. It's coming from both sides of the portfolio on the Battery business and the Foundational business. And I think we're also -- so we're converting on that extra sales at the same time, really focused on cost, taking productivity actions supplier savings, restructuring, those are all the benefits that you're seeing come through our P&L. But the short answer, it's really coming from both sides of the business."
},
{
"speaker": "Dan Levy",
"content": "And the foundational side within drivetrain, is there one particular region or one particular product that's trending to them? I'm just trying to get a sense of how sustainable -- when I recognize the margin -- the segments are getting reshuffled, but how sustainable these drivetrain foundation results are?"
},
{
"speaker": "Craig Aaron",
"content": "Yes, the drivetrain, the foundational side, we're seeing good strength out of Asia."
},
{
"speaker": "Dan Levy",
"content": "Got it. Maybe just as a follow-up, maybe you can help us understand on the forward assumptions on the end markets. We've obviously seen the negative revisions. But maybe what you're seeing in terms of a customer mix standpoint, how much conservatism you might be including because we've seen a number of reductions to the end market outlook, talk about production cuts, your views on customer mix and the conservatism schedules, please?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Dan, our guide reflects what we see in the market, and we expect the market to be down 2%, 3% year-over-year, with the biggest reduction being in China, followed by North America and Europe. In China, we see a bit of a weaker consumer demand now impacting production rates. In North America, we're seeing some customers working to address their inventory level. And in Europe, there is also a bit of a weaker demand and depletion of backlog. But all that is embedded in our guide, both on the top line and bottom-line."
},
{
"speaker": "Dan Levy",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll go next now to Mark Delaney at Goldman Sachs."
},
{
"speaker": "Mark Delaney",
"content": "Yes, good morning and thanks very much for taking the question. Wondering, I was hoping to better understand was eProduct within China, and that's a market where EV sales have held up better than some of the other regions. And the company has spoken about some good design wins within eProduct with the domestic Chinese OEMs. So, maybe you could speak a little bit more around what you're seeing in the China market with the eProduct? And to what extent, if at all, are some of the incremental tariffs that the U.S. and Europe based on Chinese imports having an effect on your eProduct business for Chinese domestic OEMs?"
},
{
"speaker": "Frédéric Lissalde",
"content": "Hey Mark. So, remember, eProduct are -- go both into hybrids and BEVs and in China, NEVs encompasses both hybrid and BEV. The fastest growth is hybrids in China. We're launching a lot of new products in China, about 95% of our eProduct in China are made with a big Chinese carmakers. A lot of our products also are used for potential exports and also potential localization. So, we're very happy with our business in China. The impact of the tariff. I think it's a little early to anticipate. But China is certainly a part of the world where we are gaining scale, and that's very helpful when we go with those eProducts supporting the e side of Hybrids and BEV in other parts of the world."
},
{
"speaker": "Mark Delaney",
"content": "That's helpful. My other question was on capital allocation. And I understand that the plan for the balance of this year is for capital allocation to be prioritized for shareholder returns, and you spoke about the $300 million of share repurchases. As you think beyond 2024, can you help us better understand how you're thinking about allocating capital we've seen the company use tuck-in M&A in recent years to bolster the capabilities? Is that something you think may be part of the calculus going forward? Or would you think the preference for shareholder returns and buybacks will be more of the uses of capital as you're looking out into 2025? Thank you."
},
{
"speaker": "Frédéric Lissalde",
"content": "Thanks. Yes, acquisition, together with organic product development has allowed us to create that very unique portfolio that we're growing organically. Acquisition may remain an important part of the strategy over the long term. But I can tell you that I would classify our approach as being even more stringent and prudent than in the past. And I don't see M&A highly likely to be announced over the next couple of 2, 3 quarters, thus our intention to repurchase $300 million of stock or pretty much giving back to shareholders 100% of our cash generation. That's what I would tell you Mark."
},
{
"speaker": "Mark Delaney",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We go next now to Adam Jonas of Morgan Stanley."
},
{
"speaker": "Adam Jonas",
"content": "Thanks, Freddie and team, I just got a couple of questions. So BorgWarner ranks around 490 out of 500 companies in the S&P and PE multiple. It is by far the cheapest auto supplier, auto-related supplier, in the S&P 500, which is really astonishing given, in my opinion, I think in yours too Freddie, this is one of the most accomplished engineering firms in industry, maybe in the world. You have custom alloys and the tolerances and the pressures that your products are used. It's just -- it's very, very high-tech stuff. Why -- what -- in your opinion, your team's opinion, what is the market telling you about your capital allocation strategy? And I don't know what clues you're getting from today's share price reaction, for example, versus other -- it seems like the market is penalizing investments in E [ph] and then rewarding pulling back or rewarding capital return. I don't know if you agree with that message or you're in tune with that? Or do you have a different hypothesis? And then I have a follow-up. Thanks."
},
{
"speaker": "Frédéric Lissalde",
"content": "Adam, I think we need to focus on what we can control. And what we can control is create a great product that is versatile across different production mix scenario. Outgrow the market, increment, generating cash and be smart about the cash utilization. As I mentioned before, in Mark's prior question, M&A was essential and helped us together with organic product development to create that very unique portfolio. Now, I think we have a great portfolio, and we're focusing on growing it organically and going back to the BorgWarner basics of outgrowing, converting generic in cash."
},
{
"speaker": "Adam Jonas",
"content": "Okay. That's great. My follow-up is a simple question, I guess. What is the logic for advertising the share buybacks? Why -- like to me, it's like going to someone and like you want to buy a house and you tell the owner, hey, I love your house. It's fantastic and then making a bid later. Why advertise the target, in this case, being your own stock in a way that might make you a hostage to your own fortune. I just don't understand the logic. Can you explain why you do that? Thanks."
},
{
"speaker": "Craig Aaron",
"content": "I think for us, it's about transparency to our shareholders. When you look at the second quarter, we were blacked out for the majority of the second quarter, and we wanted to provide clarity to the investment community that we wanted to allocate all of our free cash flow to shareholders. It was the right time given Fred's comments earlier about M&A. So we wanted to provide clarity and transparency."
},
{
"speaker": "Adam Jonas",
"content": "Okay. My only feedback is you can do that in real time and you don't always have to have the forward time horizon with the amount. But that's just feedback and you guys run the business. I appreciate you taking the time to answer the questions."
},
{
"speaker": "Craig Aaron",
"content": "Thank you Adam."
},
{
"speaker": "Operator",
"content": "Thank you. And we do have time for one final question, and that will come from James Picariello of BNP Paribas."
},
{
"speaker": "James Picariello",
"content": "Hi, everyone. Just as we think about eProduct sales, now trending towards $2.5 billion for the year. The first quarter finished at $500 million for your 10-Q filing. Can you confirm how the second quarter trended? So if you gain a sense for what's implied in the second half? And on AKASOL, specifically, another -- and I think a few other questions, we're getting at this another supplier this morning that is pretty decent commercial vehicle BEV exposure, just cut its commercially sales expectation for the year by a substantial clip. That supplier doesn't compete directly against Ford, but from an end market perspective, is this something that BorgWarner seeing at all in your Battery Systems business? Thanks."
},
{
"speaker": "Craig Aaron",
"content": "Okay. Thanks, James. And I'll confirm Q2 sales were $576 million. You'll see that in our 10-Q later today, and I'll turn it over to Fred on your other question."
},
{
"speaker": "Frédéric Lissalde",
"content": "Yeah. I think our numbers in commercial vehicle have been adjusted a little bit in the prior quarter. The impact of eProduct is essentially linked to light vehicle at this point in time. I would just remind you that we're growing 25% year-over-year on eProducts from about $2 billion to about now about $2.5 billion, which is if you take a step back, in our growth versus what you see in powertrain electrification."
},
{
"speaker": "James Picariello",
"content": "Understood. And then just last, can you provide color on how Eldor losses are now slated to trend for this year? I believe the prior guidance, call it, the $45 million or so. And will your reproposing restructuring actions also include future efforts at Eldor? Thanks."
},
{
"speaker": "Craig Aaron",
"content": "Right now, Eldor is unchanged, and that's how you should think about it. Obviously, we're focused on the total business and targeting $100 million in cost savings by 2026."
},
{
"speaker": "James Picariello",
"content": "Thanks."
},
{
"speaker": "Patrick Nolan",
"content": "With that, I'd like to thank you all for your questions today. If the any follow-ups, feel free to reach out to me or my team. Bo, you can go ahead and conclude today's call."
},
{
"speaker": "Operator",
"content": "Thank you, Mr. Nolan, and again, ladies and gentlemen, that will conclude today's BorgWarner second quarter earnings call. Again, thanks so much for joining us, everyone. We wish you all a great day. Goodbye."
}
] |
bwa | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Britney, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2024 First Quarter Results Conference Call."
},
{
"speaker": "",
"content": "[Operator Instructions] I would now like to turn the call over to Patrick Nolan, Vice President of Relations. Mr. Nolan, you may begin your conference."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Britney. Good morning, everyone, and thank you for joining us today. We issued our earnings release earlier this morning. It's posted on our website, borgwarner.com, both on our home page and on our Investor Relations homepage. With regard to our Investor Relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the Events section of our Investor Relations homepage for a full list."
},
{
"speaker": "",
"content": "Before we begin, I need to inform you that during this call, we may make forward-looking statements, which involve risks and uncertainties as detailed in our 10-K. Our actual results may differ significantly from the matters discussed today."
},
{
"speaker": "",
"content": "During today's presentation, we'll highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed and for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A and other noncomparable items. When you hear us say adjusted, that means excluding noncomparable items. When you hear us say organic, that means excluding the impact of FX and net M&A."
},
{
"speaker": "",
"content": "We will also refer to our incremental margin performance. Our incremental margin is defined as the organic change in our adjusted operating income divided by the organic change in our sales. Our all-in incremental includes our planned investment in eR&D, any impact on net inflationary impacts and other cost items."
},
{
"speaker": "",
"content": "Lastly, we refer to our growth compared to our market. When you hear us say market, that means the change in light and commercial vehicle production weighted for our geographic exposure. Please note that we posted today's earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion."
},
{
"speaker": "",
"content": "With that, I'm happy to turn the call over to Fred."
},
{
"speaker": "Frederic Lissalde",
"content": "Thank you, Pat, and good day, everyone. I'm very pleased to share our results for the first quarter of 2024 and provide an overall company update, starting on Slide 5. With approximately $3.6 billion in sales, we delivered close to 7% organic growth in the quarter despite a modest industry decline. We delivered strong incremental performance in the quarter on an all-in basis, which allowed us to achieve a 9.4% margin. This Q1 performance provides a nice start to the year, and we believe it positions us well to deliver on our full year guidance."
},
{
"speaker": "",
"content": "Additionally, we continue to take steps in the quarter to create longer value for our shareholders. We secured multiple new eProduct awards. These awards once again demonstrate our focus on taking the leading-edge technology, working closely with our customers to help support them as they transition towards electrification. And as I will discuss, we continued to expand our product offerings for electrified vehicles."
},
{
"speaker": "",
"content": "We focused on the efficient deployment of our capital by repurchasing $100 million of stock during the first quarter, as Craig will highlight, we received an increased share repurchase authorization of $500 million from our Board of Directors."
},
{
"speaker": "",
"content": "Now, let's look at some new eProduct awards on Slide 6. First, BorgWarner secured additional eMotor award with Xpeng. These awards include BorgWarner's 800 volts eMotor systems comprised of stator and rotor components, which are customized for use on 2 upcoming SUV models. Start of production is planned for 2025. BorgWarner's HVH220 eMotor offers high torque density, enhanced efficiency and superior durability. We are thrilled to extend our eMotor business with Xpeng and build upon on our strong partnership with them."
},
{
"speaker": "",
"content": "Next, I would like to highlight a new product line for electrified vehicles, which is our electric Torque Vectoring Disconnect or eTVD. BorgWarner secured new business awards with Polestar and an additional major European OEM, supply eTVD for their battery electric vehicles. eTVD is currently in production for the Polestar 3 SUV and production for the major European OEM is expected to begin later in 2024."
},
{
"speaker": "",
"content": "The eTVD offers a 3-in-1 system, replacing the differential and featuring both torque vectoring and an on-demand disconnect functionality for and BEVs and hybrids. eTVD is part of BorgWarner's electric Torque Management System portfolio which helps improve electrified vehicles' traction and stability. The added weight in hybrids and battery electric vehicles often results in reduced agility and safety performance. BorgWarner Systems helps overcome this by enabling a lighter feel and increasing traction, which improves safety. The eTVD is a great example of applying our foundational expertise and capabilities to develop an innovative solution to address our customers' needs as they transition towards electrification."
},
{
"speaker": "",
"content": "Now I want to take a few moments to remind you of the strength of our foundational portfolio on Slide 7. First, it's important to highlight BorgWarner's estimated average content opportunity for combustion vehicle, which is approximately $550 on a global basis. You'll note that this content opportunity varies by region. I would point out that our content opportunity in North America is the highest of the 3 major regions we operate in. So to the extent that combustion vehicles have a longer tail in North America, that could provide a positive sales, margin and cash flow tailwind for BorgWarner."
},
{
"speaker": "",
"content": "We also continue to see potential opportunities for growth across our foundational portfolio, which had a 2023 revenue of about $12 billion. I would like to list just a few. In turbo, we continue to see North American opportunities as penetration in the region is about 44% compared to 92% penetration in Europe and 69% penetration in China. If EV growth slows in North America, the remaining combustion vehicles may need to improve efficiency, and turbocharging is one of the biggest enablers to make this happen."
},
{
"speaker": "",
"content": "For our EGR business, we see penetration opportunities on hybrid architectures. The efficiency benefit of EGR on cooling on hybrids is higher than traditional combustion-only vehicles as the internal combustion engine operates in a steadier state. Our timing system business also sees penetration opportunities in plug-in hybrids and range-extended EVs as engine timing chain is the preferred technology in those hybrids due to its superior durability and strength."
},
{
"speaker": "",
"content": "And finally, we see our all-wheel drive business benefiting from penetration score on combustion vehicles in Southeast Asia and from a longer tail for North American vehicles. Maximizing the value of our foundational products means capitalizing on these potential growth opportunities, while at the same time, maintaining the strong margin and cash profiles of these businesses."
},
{
"speaker": "",
"content": "Now let's turn to Slide 8 and take a step back. Let's discuss how we believe our foundational and eProduct portfolios are positioned for growth under various combustion, hybrid or BEV growth scenarios. Starting with our combustion or foundational portfolio, which are on the top left of the slide, BorgWarner has decades of experience in product leadership in these fields. We have a #1 or #2 market share for these products and can support our customers around the globe. This is critically important as customers potentially consolidate their supply base and look to industry leaders that have the financial strength and long-term technology leadership to support them."
},
{
"speaker": "",
"content": "Let's jump to the right side of this page where you see the breadth of our eProduct portfolio. This portfolio has grown organically through M&A over the past several years. We have systematically built a technology-focused portfolio that supports our customers' needs in EVs from grid to wheel. This has allowed us to establish product leadership in multiple areas of our portfolio, including inverters, eMotors, high-voltage coolant heaters and batteries. We expect that our technological differentiation, scale and share leadership will continue to enable us to secure new business."
},
{
"speaker": "",
"content": "Quite simply, our foundational and eProduct portfolio support hybrid propulsion since the hybrid vehicle needs both, a downside combustion engine as well as an electric powertrain. We can utilize the expertise of both our portfolios to support our customers which we are already doing successfully in Europe and in China."
},
{
"speaker": "",
"content": "Importantly, when we sell products for hybrid applications, we're able to utilize the same engineering resources, modular design, manufacturing footprint and sometimes even actual product lines that are utilized for BEVs and combustion vehicles. We believe BorgWarner is well positioned to be successful under various electrification adoption scenarios, including regional specificities."
},
{
"speaker": "",
"content": "Our product has been purposefully built for this type of an environment, we will focus on achieving above-market growth regardless of varying levels of electrified propulsion adoption. Our focus is to convert growth into income at the mid- to high-teens level on an all-in basis."
},
{
"speaker": "To summarize, the takeaways from today are this",
"content": "BorgWarner's first quarter results were strong. Our sales growth once again outperformed the industry, and we delivered strong conversion on an all-in basis. We secured multiple new eProduct awards in the quarter, which further demonstrate our product leadership position. We focused on efficient powertrains, and we believe that we have a resilient portfolio of products that allows us to convert mid- to high teens wherever the incremental revenue comes from. And we continue to return capital to our shareholders through our first quarter share repurchases and increased authorization from our Board."
},
{
"speaker": "",
"content": "As we look forward, we expect to continue to manage our business holistically. We plan to take the necessary steps to manage our costs while continuing to preserve our long-term profitable growth. While we cannot control the near-term volatility in propulsion mix across the globe, we can focus on what BorgWarner does best, driving sales growth above market production through technology-focused product leadership, converting that growth into earnings on an all-in basis and following a balanced capital allocation strategy that creates long-term value for our shareholders."
},
{
"speaker": "",
"content": "With that, I will turn the call over to Craig."
},
{
"speaker": "Craig Aaron",
"content": "Thank you, Fred, and good morning, everyone. Before I dive into the financials, I'd like to provide a quick overview of our first quarter results. First, we reported close to 7% organic sales growth despite a modest decline in industry volume. Second, we had strong margin performance, which was driven by solid conversion on higher revenue as well as appropriately managing our costs. This led to a year-over-year incremental conversion of over 23% on an all-in basis."
},
{
"speaker": "",
"content": "Now, let's turn to Slide 9 for a look at our year-over-year sales walk for Q1. Last year's Q1 sales from continuing operations was just under $3.4 billion. You can see that the strengthening U.S. dollar drove a year-over-year decrease in sales of almost 1% or $32 million. Then you can see the increase in our organic sales which was up roughly 7% year-over-year driven by growth in China and in Europe. Finally, the acquisitions of Eldor and SSE added $11 million to sales year-over-year. The sum of all this was just under $3.6 billion of sales in Q1."
},
{
"speaker": "",
"content": "Turning to Slide 10. You can see our earnings and cash flow performance for the quarter. Our first quarter adjusted operating income was $339 million, equating to a 9.4% margin. That compares to adjusted operating income from continuing operations of $305 million or a 9% margin from a year ago. On a comparable basis, excluding the impact of foreign exchange and M&A, adjusted operating income increased $54 million on $233 million of higher sales. That translates to an all-in incremental margin of roughly 23%, driven by our higher year-over-year sales and strong cost controls. The net impact of M&A was a $12 million drag on operating income year-over-year."
},
{
"speaker": "",
"content": "Our adjusted EPS from continuing operations was up $0.22 compared to a year ago as a result of higher adjusted operating income, a decline in our effective tax rate and the impact of our recent share repurchases on our share count. And finally, free cash flow from continuing operations was a usage of $308 million during the first quarter, which was a higher usage than a year ago as our working capital performance was impacted by the timing of customer collections due to the Easter holiday as well as the timing of tax payments."
},
{
"speaker": "",
"content": "Now let's take a look at our full year outlook on Slide 11. Starting with foreign currencies. Our guidance now assumes an expected full year sales headwind from weaker foreign currencies of $100 million compared to 2023. This also is a sales headwind of $100 million versus our prior guidance with the Chinese renminbi and Korean won being the largest drivers of the change in our outlook."
},
{
"speaker": "",
"content": "Next, we expect organic growth of approximately 2% to 5% year-over-year compared to our prior guidance of 1% to 5%. This increase is predominantly driven by strong sales growth in the first quarter. Within this guidance, our full year end market assumptions of flat to down 2.5% is unchanged. Additionally, we continue to expect to deliver between $2.5 billion to $2.8 billion eProduct sales, which is up significantly from approximately $2 billion in 2023. Finally, the Eldor and SSE acquisitions are expected to add approximately $30 million to 2024 sales. Based on these expectations, we're projecting total 2024 sales in the range of $14.4 billion to $14.9 billion, which is in line with our prior guidance despite the additional FX headwinds."
},
{
"speaker": "",
"content": "Now let's switch to margin. We continue to expect our full year adjusted operating margin to be in the range of 9.2% to 9.6%. Excluding the impact of Eldor-related losses in 2024, our outlook contemplates the business delivering full year incrementals in mid- to high teens on an all-in basis. We believe this margin performance reflects the underlying earnings power of our company and our focus on delivering strong conversion on higher sales while also appropriately managing costs."
},
{
"speaker": "",
"content": "Based on this sales and margin outlook, we're expecting full year adjusted EPS in the range of $3.80, $4.15 per diluted share. This increase compared to our prior outlook is being driven by the impact of our share repurchases and full year share count and a reduction in our tax rate outlook compared to our prior guidance."
},
{
"speaker": "",
"content": "Turning to free cash flow. We continue to expect that we'll deliver free cash flow of $475 million to $575 million for the full year."
},
{
"speaker": "",
"content": "Let's turn to Slide 12 and discuss our recently increased share repurchase authorization. As Fred highlighted in his opening remarks, we repurchased approximately $100 million in BorgWarner stock during the first quarter. This brings our share repurchases since 2020 to approximately $733 million. In addition, our Board of Directors approved an increase in our share repurchase authorization of up to $500 million over the next 3 years. When combined with the $267 million remaining under our prior authorization, management has the ability to repurchase up to $767 million of the company's outstanding shares."
},
{
"speaker": "",
"content": "In addition to the share repurchases I just highlighted, we have also returned about $623 million to shareholders in dividends since the start of 2020. We also completed the tax-free spin-off PHINIA, which returned roughly $1.7 billion of additional capital to shareholders. Adding this all together, BorgWarner has distributed roughly $3.1 billion of capital to shareholders since 2020, while also investing in the company's future."
},
{
"speaker": "",
"content": "A return of capital to shareholders has been a significant area of focus over the past several years. We believe our ability to return capital to shareholders while also investing in the business demonstrates the underlying strength of the company and the importance of a balanced capital allocation approach that is focused on maximizing shareholder value. The $500 million increase in our share repurchase authorization is simply another example of our commitment towards a balanced capital allocation approach."
},
{
"speaker": "",
"content": "So let me summarize my financial remarks. Overall, we delivered a solid first quarter. Our revenue growth was ahead of our expectations. And importantly, we delivered strong conversion on this revenue growth on an all-in basis."
},
{
"speaker": "",
"content": "As this is my first call as BorgWarner's CFO, I wanted to share how I think about the key financial goals for BorgWarner for the remainder of 2024 and beyond. As we move forward, I expect the company to first, deliver organic growth despite volatility in the global BEV and hybrid markets; second, drive strong incremental margin performance on an all-in basis; and third, generate strong operating cash flow that allows the company to make organic and inorganic investments to support our long-term profitable growth while also returning capital to shareholders through a consistent quarterly dividend and opportunistic share repurchases."
},
{
"speaker": "",
"content": "Executing towards these goals is how we measure financial success at BorgWarner, and how we hope to create long-term value for our shareholders for years to come."
},
{
"speaker": "",
"content": "With that, I'd like to turn the call back over to Pat."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you, Craig. Britney, we're ready to open it up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your first question comes from Colin Langan with Wells Fargo."
},
{
"speaker": "Colin Langan",
"content": "You started off very strong here, I think, something like 8% growth over market in Q1. Your margins seem to be in the midpoint of your full year guidance. But the guide for the year is -- has implied sort of growth over market, but actually moderate a bit and maybe at the midpoint, margins wouldn't change. Anything sort of onetime in nature we should be thinking about in Q1 that kind of boosted results? And then any reasons we should be thinking about things moderating a bit as we go through the rest of the year?"
},
{
"speaker": "Craig Aaron",
"content": "Thanks, Colin, for the question. Nothing unique in the quarter. It was just a really strong operational performance for our business units. They did an exceptional job. As you think about our full year guide, it implies a 13% to 16% incremental conversion, 13% on the low end, 16% on the high end. We feel really good about our first quarter performance, sets us up quite well for the remainder of the year. We're just focused on executing towards the near term, and we're going to keep doing that as we into the second quarter. It's just a really good operational performance for -- the company."
},
{
"speaker": "Colin Langan",
"content": "Okay. That sounds good. Slide 8 was pretty helpful. Maybe if you could talk a little about your plug-in -- PHEV opportunity. The content there, how much of your sales today are there? And have you seen any change yet, I guess, quite early on interest in that given the EPA rules seem to be more favorable towards PHEV?"
},
{
"speaker": "Frederic Lissalde",
"content": "Colin, that the PHEV is one architecture where we have our foundational products coming in and also most of our eProducts coming in. I don't think we have given the granularity of our per -- plug-in hybrid content. But on the hybrid overall, full hybrid, plug-in hybrid and range-extended EV, about 40% of our light vehicle eProduct, which is guided at the midpoint at $1.9 billion this year is going into those advanced hybrids."
},
{
"speaker": "Colin Langan",
"content": "Got it. And have you seen any interest in PHEV improve? Or is it still just too early?"
},
{
"speaker": "Frederic Lissalde",
"content": "So globally, the interest of PHEV has always been there. In the U.S., I would say that it's a little bit early to see request for quotes from some of the American OEMs. But outside of the U.S., plug-in hybrids and advanced hybrids are an important part of new energy vehicles and we have our fair share of those."
},
{
"speaker": "Operator",
"content": "Your next question comes from John Murphy with Bank of America."
},
{
"speaker": "John Murphy",
"content": "I just wanted to follow up on that question that Colin asked on hybrids. Is there any increase in schedules that you're seeing for hybrids at the moment? I know you said -- you mentioned 40% of the eProducts is -- the $1.9 billion is on the hybrid side, and you're not seeing any new activity necessarily, but is there any step-up in schedules for hybrids at the moment that you're seeing that might provide some upside there?"
},
{
"speaker": "Frederic Lissalde",
"content": "Yes. In China and in Europe, we see upticks in hybrids. Actually, if you look at the share of growth of new energy vehicle in China, actually, hybrids are growing faster than BEV over the past few months. So -- and we're part of those. So the answer to your question is, on a global basis, yes. And in North America, it's too early to say."
},
{
"speaker": "John Murphy",
"content": "Okay. And then a second question. There's a -- I mean you debate whether it's stalling, whether it's short term, whether it's long term on EVs. But the reality is some of your customers, particularly in China and Europe are heading in that direction, maybe less so in the U.S. than we may have thought. I'm just curious, as you think about your investment, whether it be on the R&D side or the capital invested side, do you have the ability to pull back and maybe spend at a slightly more measured pace, or is it just because there's such a push in China and Europe that you can't pull back and there's nothing you can really -- you do here other than service your clients as best you can and try to cut costs to keep it down as much as possible."
},
{
"speaker": "",
"content": "And maybe you could comment on really what you might think about doing on the R&D side and then also sort of on the CapEx or capacity add side?"
},
{
"speaker": "Frederic Lissalde",
"content": "Yes. We are managing our costs holistically in line with the current sales outlook. As Craig and I mentioned in our prepared remarks, we are setting up the company to convert mid- to high teens, no matter where the incremental revenue comes from. What I would say is try not to box BorgWarner into BorgWarner is a BEV player or a hybrid player or combustion player. We are focused on efficient powertrain. And we are now having scale in all those architectures in order to convert mid- to high teens no matter what."
},
{
"speaker": "John Murphy",
"content": "And on the capacity side, is there any way to potentially be a little bit more capital efficient? Or is that possible? And I would certainly box you into a powertrain tech company across the board. That's where I'd box you, Fred. Didn't mean to put you in one direction or the other."
},
{
"speaker": "Frederic Lissalde",
"content": "I think from a facility standpoint, we're flexible for some of the products that I alluded to in the prepared remarks. We have the same engineering, the same -- sometimes the same production equipment, sometimes actually the same product."
},
{
"speaker": "",
"content": "Let me give you an example. We've talked about the past few years of dual inverters for hybrids. And we've talked about inverters for BEVs. All those are the same animals. They might not look exactly the same from a space and form perspective, but all the inside of the guts of those things are similar. So it's difficult to answer without a specific program. But overall, we're quite flexible across all different elements that both go in BEVs and hybrids."
},
{
"speaker": "Operator",
"content": "Your next question comes from Dan Levy with Barclays."
},
{
"speaker": "Dan Levy",
"content": "Maybe in the quarter, you could just break out what was the split of revenue between eProducts and foundational? And then foundational, I assume, is still putting up pretty solid growth of the market. Maybe you could just talk about some of the dynamics driving that, please?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. So Dan, the breakout of eProducts and foundational in the quarter was about $500 million, a little over $500 million eProducts. The rest was foundational. And I'm sorry, your other question just was growth in the quarter?"
},
{
"speaker": "Dan Levy",
"content": "Yes. Within the growth over market, do you have a sense of what the growth of the market was for foundational and what regions or products were driving that?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. So I would say overall, the growth was both in China and in Europe. And that includes both the growth that you saw on the foundational side of the business as well as the eProduct side of the business."
},
{
"speaker": "Dan Levy",
"content": "And the outgrowth within foundational was -- any sense on where that was?"
},
{
"speaker": "Craig Aaron",
"content": "You can see a lot of it in the drivetrain side of our business."
},
{
"speaker": "Dan Levy",
"content": "Great. Okay, and then a second question on margins. And I know you've noted that you're aiming for mid- to high teens incrementals across the business. But maybe if you could just give us a sense of within some of the foundational product, is it possible that we actually are seeing higher incremental margin simply because there's less R&D that you've incurred, less application engineering, more that you are leveraging, getting a sense whether there is some split in that contribution margin between eProduct versus foundational."
},
{
"speaker": "Frederic Lissalde",
"content": "I would say that we are balancing all those costs in order to get to the mid- to high teens. And we're taking that business holistically and taking cost actions so that all product lines are being able over time to deliver those incrementals."
},
{
"speaker": "Operator",
"content": "Next question comes from Noah Kaye with Oppenheimer."
},
{
"speaker": "Noah Kaye",
"content": "Craig, after the dividend and the repurchases you've done year-to-date, kind of leads me around $250 million, $300 million in deployable free cash flow based off of the guide for the year. And I think we would certainly say that shares are trading below intrinsic value. So how are you thinking about the pace of buybacks for the rest of the year? Is this going to be more ratable? Or are you remaining opportunistic?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. Thanks for the question, Noah. So I just want to take a step back. We repurchased $277 million of the company's shares over the last 2 quarters. So $177 million in the fourth quarter of last year. $100 million in the first quarter of this year. Obviously, pleased with our Board of Directors, we got that additional authorization, takes our total authorization up to -- a little over $760 million. We're going to continue to repurchase opportunistically, just like we did in Q4 and just like we did in Q1."
},
{
"speaker": "",
"content": "I'd say as we think about capital allocation, we take a holistic approach to it. So we look at liquidity, we look at leverage, we look at is there any short-term funding for M&A that's needed. Obviously, as you mentioned, we have a dividend that's a fixed obligation. We don't want to turn that on and turn that off. And we look at stock buybacks as a lever as well. So I think as we move forward, continue to think about it, that we'll do it opportunistically. That's how should think about it."
},
{
"speaker": "Noah Kaye",
"content": "Okay. Helpful. And then good to get the housekeeping on eProduct sales in the first quarter. Just can you give us some guideposts, even getting to the midpoint of guide for the year around how you're thinking about the cadence of ramp? I know you have some capacity coming online for battery. But is this a fairly ratable ramp? Is it really heavily weighted to 3Q or 4Q, any particular quarter? Can you just help us think through how the ramp should proceed over the course of the year?"
},
{
"speaker": "Frederic Lissalde",
"content": "Yes. Noah, so in Q1, our eProducts revenue went up 25%, and this is in line with our full year outlook of 25% to 40% for the year. And you're right, in the next quarter, in our ePropulsion segment, we're launching numerous programs with VW Group, with Daimler, HMC, BYD and others. We're ramping up our battery pack capacity in Seneca and later in the year in Europe, we're launching in other areas of eProducts. So you're right, it's going to increase over the next quarters."
},
{
"speaker": "Operator",
"content": "Your next question comes from Joe Spak with UBS."
},
{
"speaker": "Joseph Spak",
"content": "Fred, I know you sort of already touched on plug-ins a little bit in the Q&A. In your comments, you also sort of talked about turbos and other sort of core BorgWarner technology that can help with what's seemingly an increasingly choppy powertrain transition. But presumably, your customers would need to do at least some engineering, and it's going to take time to sort of have a greater adoption. So what are -- what's the conversations like with customers on some of the traditional sort of core foundational products? And how quickly can we really see potentially greater levels of adoption there?"
},
{
"speaker": "Frederic Lissalde",
"content": "And Joe, I guess you were thinking about North America here in your question, aren't you?"
},
{
"speaker": "Joseph Spak",
"content": "Yes, yes, yes."
},
{
"speaker": "Frederic Lissalde",
"content": "Okay. Yes, because in the rest of the world, as I alluded to before, it's happening, right? I think we have all the building blocks to support our customers here in North America as they also want to have those advanced hybrids. I feel that it's still a little bit early to get into the specific cities or which products they need from BorgWarner. We are in the early phases of discussions about architecture. So I think it's going to take a little bit more time."
},
{
"speaker": "Joseph Spak",
"content": "Okay. And Craig, obviously, great job sort of managing to the incrementals. You talked about continuing to manage to that. And I think in the past, you talked about on the foundational side, right, if things continue to go down, you'd look to restructuring or some pricing actions. But I'm curious on the other side, just given not what's a still mid- to long-term sort of trajectory towards electrification, but certainly, a lot of volatility on the programs within that. Is there an opportunity -- not this year because it's probably locked, but is there an opportunity as you think about eR&D for next year to maybe push some of that? Or is there even a pricing opportunity on some of the eProducts stuff if the volumes don't hit certain thresholds?"
},
{
"speaker": "Frederic Lissalde",
"content": "Joe, you may have seen that our ePropulsion segment is running at about 30% incremental a year, and we're not satisfied with that. So we'll take some steps to improve the margin performance. And again, we have a strategy to adjust costs to wherever the market is going. And we are doing that wherever it is necessary, and this is what we're looking at right now."
},
{
"speaker": "Joseph Spak",
"content": "One follow-up on the decrementals, I guess, in -- well, I guess the battery stuff is not in eProducts. So never mind..."
},
{
"speaker": "Operator",
"content": "Your next question comes from Douglas Dutton with Evercore ISI."
},
{
"speaker": "Douglas Dutton",
"content": "Just a quick one here and then one follow-up. Can you maybe tell us the percentage of your orders from those Chinese domestics? And how that compares to the percentage of anticipated recognized revenue from that same group for 2024?"
},
{
"speaker": "Frederic Lissalde",
"content": "You're talking about eProducts?"
},
{
"speaker": "Douglas Dutton",
"content": "Correct, yes."
},
{
"speaker": "Frederic Lissalde",
"content": "So on eProducts for 2024, about 45% of the $1.9 billion in light vehicle is for China. Within that, 95% is for the Chinese OEMs."
},
{
"speaker": "Douglas Dutton",
"content": "Okay. Great. And then just on a more granular note, can you maybe quantify the exposure you have to some of those newer growers in China, the BYDs, Xpengs, Xiaomis of the world?"
},
{
"speaker": "Frederic Lissalde",
"content": "I unfortunately can't disclose some of those names, and I can't disclose which product we have with those names in particular. So not that I would love to do it, but I just can't."
},
{
"speaker": "Operator",
"content": "Your next question comes from Alex Potter with Piper Sandler."
},
{
"speaker": "Alex Potter",
"content": "Great. So first, maybe following on that question from China. I'm interested in, I guess, hearing your opinion regarding the degree to which China, that market can serve as maybe foreshadowing or a harbinger of the way the rest of the world will evolve. Obviously, China has been moving much more quickly toward electrification. There's a lot of dynamism regarding the architectures that those new companies are pursuing. Do you think that China represents the way the rest of the world will eventually evolve? Or do you see those markets sort of trending in different directions with China doing its own thing and the rest of the world doing their own thing?"
},
{
"speaker": "Frederic Lissalde",
"content": "In China, under the umbrella of new energy vehicle, you will see that hybrids, essentially the advanced hybrids are having about 40% shares in China. And actually growing faster within that segment or growing the fastest within that segment. That is also our ratio of eProducts versus -- eProducts within hybrids and BEVs."
},
{
"speaker": "",
"content": "For us, I wouldn't say that it doesn't matter, but it kind of doesn't matter. We have the right product portfolio to support customers around the globe. And we don't -- we're not attached to any regional specificities. We are resilient to any propulsion scenarios, fuel combustion, hybrids or BEVs. So I'm not -- I don't have a crystal ball. I won't -- I can't tell you if China is a good proxy for the rest of the world. But we believe that you will see a variety of electrified propulsion architecture, and we're ready to support those on a global basis at Borg."
},
{
"speaker": "Alex Potter",
"content": "Okay. Yes. Good. Very clear. Maybe the other question, more of a near-term tactical question, on another call this morning, one of your peers noted particularly over the last couple of weeks or several weeks in the month of April, some real volatility and generally downward adjustments to production schedules at the OEMs. Have you seen anything similar to that? I know that your overall market projections haven't changed versus last quarter, but anything you'd be willing to say regarding near term or back-half production schedules would be helpful."
},
{
"speaker": "Frederic Lissalde",
"content": "Yes. I don't have the granularity of what happened over the past 2 weeks, but overall for the full year, our view of the market is already below companies like IHS. So -- but we will adjust to whatever comes to us."
},
{
"speaker": "Operator",
"content": "Your next question comes from James Picariello with BNP Paribas."
},
{
"speaker": "James Picariello",
"content": "Just back to the eProduct, based on the first quarter's performance and the visibility into the year. Can you just speak to AKASOL's Battery Systems revenue? I believe this business guidance, called for $700 million to $800 million in revenue. Just curious if there are any moving pieces tied to this within the eProduct range? And can you clarify what portion of this year's eProducts sales attributes to hybrid?"
},
{
"speaker": "Frederic Lissalde",
"content": "So this year's guidance, $2.65 billion for eProducts at the midpoint, out of which $750 million are battery packs for commercial vehicle. So $1.9 billion is for light vehicle, 40% of which is for hybrids on a global basis."
},
{
"speaker": "",
"content": "Regarding your first question on battery packs, there is nothing particular in Q1. The ramp up is to plan. And what we see in Seneca and the preparation of increasing capacity in Europe is also in line with our expectations."
},
{
"speaker": "James Picariello",
"content": "That's helpful. And then just as we think about foundational profitability versus eProduct the rest of the year, and I think this touches on Colin's question regarding margin cadence given that the first quarter was squarely in line with your full year range. As your eProducts revenue improves sequentially through the remainder of the year, is it safe to assume that the margin loss rate also improves? And so my question, if that's true. My question is, why would the foundational profitability degrade through the year if the full year guidance range is the right number, if that makes sense?"
},
{
"speaker": "Craig Aaron",
"content": "Yes. I think the way we're looking at it is we're focused on executing at the mid- to high teens on an all-in basis, wherever that growth may come from. So I think that's how you should think about it. We're really pleased with our 23% all in, in the first quarter. We think it sets us up quite well to execute for the full year. So that's how we're looking at it. We're really focused on incrementing on an all-in basis regardless of where the revenue growth comes from."
},
{
"speaker": "Operator",
"content": "Your next thing comes from Luke Junk with Baird."
},
{
"speaker": "Luke Junk",
"content": "First, looking at the segments. Just hoping you can maybe unpack the top line strength that you saw year-over-year in Drivetrain and Battery Systems? This quarter sounded like that was foundation related in large part, maybe just sustainability of that strength in the margin, they've stepped up nicely sequentially, especially as well. I don't know if there's anything specific to point to."
},
{
"speaker": "Craig Aaron",
"content": "Yes. I would say it was just overall good performance from a margin perspective. Again, 23% all-in, great performance by our business units. When you think about growth, it's really China and Europe both on the foundational side of the business and on the battery side of the business, particularly in that DBS segment. But we also had nice growth overall just in general, both in China and in Europe. But again, you can see most of it in the DBS segment. That's where I would point you to."
},
{
"speaker": "Luke Junk",
"content": "Got it. And then for my follow-up, maybe a bigger picture question, Fred. And just thinking about eProduct net engineering requirements going forward, both as you think about on a gross basis and ePropulsion margins going forward here now you can improve those margins. But I'm also wondering, just given some increases in uncertainty in the West, if you can push for more engineering recoveries as you book business or building structures to pay for more of that engineering?"
},
{
"speaker": "Frederic Lissalde",
"content": "Yes. I mean we're looking at all this from an engineering recovery. We're also looking at adjusting costs, especially in those segments for which growth is not happening as fast as we thought in order to improve the margin performance. So in those eProducts segments, we fully expect this business to grow going forward. And with those upcoming cost actions to get to mid- to high-teens incremental when it ramps."
},
{
"speaker": "Operator",
"content": "We have time for one final question, and that question comes from Mark Delaney with Goldman Sachs."
},
{
"speaker": "Mark Delaney",
"content": "I think that a part of BorgWarner's customer value proposition for eProducts has been that utilizing BorgWarner's power electronics products can be a more efficient way for OEMs to do business. I'm curious if you think that played a role in some of the wins you were able to announce today. And given the challenges that a lot of the OEMs are dealing with in BEVs and a lot of the price competition, might that be an opportunity for your bookings to outperform some of the broader market trends if some of these customers do need to find ways to be more efficient?"
},
{
"speaker": "Frederic Lissalde",
"content": "You're absolutely right. Power electronics is a key strength of the company. Borg has always been focused on efficient systems and efficient mobility. And power electronics is the new frontier of efficiency in BEV and -- or hybrids, fighting against those switching losses and fighting against those mechanical losses, downstream the inverter. So the answer to your question is absolutely yes. We're focused on that and at the system level, at the electronics level, at the power module level. And that's our DNA. That's what we do best."
},
{
"speaker": "Mark Delaney",
"content": "And on eProducts, the company reiterated the $2.5 billion to $2.8 billion eProducts revenue outlook for this year. Of course, we've seen a lot of volatility in light vehicle BEV plans. And so as we've seen that, I'm hoping to better understand, do you think that the 2025 outlook that you've previously communicated in eProducts of $4.5 billion to $5 billion. Is that something you still see as achievable?"
},
{
"speaker": "",
"content": "And as you think about the revenue ramp and what -- maybe for 2025, maybe you could also touch on how you're thinking about eProducts profitability not only this year but into 2025?"
},
{
"speaker": "Frederic Lissalde",
"content": "So you're right. It will absolutely depend upon customer volume, and that will ultimately decide what 2025 will be. We are, as we mentioned, focused on what we can control, which is securing new businesses in eProducts for BEV and hybrids, focusing on strengthening our portfolio for it to remain in a great position and managing our costs in order to overall deliver mid- to high-teens incremental on an all-in basis. That's our focus, and we'll give you more color on '25 closer to '25."
},
{
"speaker": "Patrick Nolan",
"content": "Thank you all for your great questions today. If you have any follow-ups, you can follow with me or my team. With that, Britney, you can go ahead and conclude today's call."
},
{
"speaker": "Operator",
"content": "That does conclude the BorgWarner 2024 first quarter results conference call. You may now disconnect."
}
] |
bx | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Blackstone Fourth Quarter and Full Year 2024 Investor Call. Today's call is being recorded. At this time, all participants are in a listen-only mode. [Operator Instructions]. At this time, I'd like to turn the conference over to Weston Tucker, Head of Shareholder Relations. Please go ahead."
},
{
"speaker": "Weston Tucker",
"content": "Great. Thanks, Katie, and good morning, and welcome to Blackstone's fourth quarter conference call. Joining today are Steve Schwarzman, Chairman and CEO; Jon Gray, President and Chief Operating Officer; and Michael Chae, Vice Chairman and Chief Financial Officer. Earlier this morning, we issued a press release and slide presentation, which are available on our website. We expect to file our 10-K report later next month. I'd like to remind you that today's call may include forward-looking statements, which are uncertain and may differ from actual results materially. We do not undertake any duty to update these statements. For a discussion of some of the factors that could affect results, please see the risk factors section of our 10-K. We'll also refer to non-GAAP measures, and you'll find reconciliations in the press release on the shareholders page of our website. Also note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Blackstone fund. This audio cast is copyrighted material of Blackstone and may not be duplicated without consent. Quickly on results. We reported GAAP net income for the quarter of $1.3 billion. Distributable earnings were $2.2 billion or $1.69 per common share, and we declared a dividend of $1.44 per share, which will be paid to holders of record as of February 10. With that, I'll turn the call over to Steve."
},
{
"speaker": "Steve Schwarzman",
"content": "Thank you, Weston, and good morning, and thank you for joining our call. Blackstone just reported one of the best quarters in our history. Distributable earnings increased 56% year-over-year to $2.2 billion, as Weston mentioned, underpinned by record FRE. Our limited partners entrusted us with $57 billion of inflows just in the fourth quarter and $171 billion for the year, reflecting strong momentum with the institutional, insurance and private wealth channels. Of particular note, we raised $28 billion in private wealth in 2024, including $23 billion in the potential strategies, nearly double. We beat that nearly double what we raised from individuals in these strategies in the prior year. All signs point to further acceleration in 2025. After quarter end, in January, we raised an additional $3.7 billion for our private wealth perpetuals. We did the launch of our new infrastructure vehicles, representing a powerful affirmation of our unique position in this channel. We believe our $260 billion private wealth business is multiples the size of our next largest competitor. Largest single contributor to the firm's financial results in the fourth quarter was our dedicated infrastructure strategy, BIP, which generated $1.2 billion of fee revenues. BIP has delivered remarkable investment performance since inception only six years ago, including 17% net returns annually for the co-mingled strategy. This performance has fueled exceptional growth with AUM today of $55 billion, up 34% just in the past year alone. BIP anchors a broader infrastructure platform as a firm that exceeds $120 billion across equity, credit and [indiscernible]. In relatively short period of time, we've established one of the world's largest infrastructure business. Our success in this area is a powerful illustration of how we build an enduring leading business at Blackstone. It reflects the same blueprint for how we've been able to grow from $400,000 in startup capital in 1985 to more than $1.1 trillion of AUM today, the largest alternative asset manager in the world and why I believe we will continue to achieve strong growth in the future. It starts with innovation as a core competency of the firm as we're always working to identify the next paradigm shift in the market. We evaluate whether we can create something truly differentiated for our limited partners, but the opportunity can be scaled significantly. If we have the right team to lead it, drawing upon the firm's deep well of talent. Importantly, any new area also add to the firm's intellectual capital and create synergies with our other businesses to make the rest of the firm better. We have carefully considered infrastructure as a stand-alone business for a number of years. We've been investing successfully in energy infrastructure projects for over a decade, other private equity and credit funds, which along with our extraordinary real estate franchise made infrastructure natural extension as a new business line. In 2017, we saw a historic investment opportunity emerging in the U.S. and around the world, made the decision to launch a dedicated strategy. We identified a talented individual in our private equity energy area, our partner Sean Klimczak, to lead the new business. We began raising capital in 2018, supported by an anchor commitment from an important limited partner. Today, with $55 billion in outstanding investment performance, BIP has exceeded our initial and predictably very high expectations. The team has done an exceptional job portfolio construction focused on compelling thematic areas, including digital infrastructure, energy and power and critical transportation infrastructure. And we see enormous runway ahead, massive funding needs for projects globally mean there are more opportunities and available capital. We envision a growth path for our infrastructure business that parallels that of our real estate business, including geographic expansion, new client channels, moving across the capital structure and risk return spectrum. We started raising the European infrastructure perpetual vehicle last fall. And earlier this month, as I mentioned, launched a vehicle designed to give individual investors access to the full breadth of our infrastructure platform. Over time, we also see opportunities in Asia and the potential for sector-specific strategies. The growth of our infrastructure business was greatly helped by the other businesses at Blackstone and the firm's resources around the globe. These advantages include sourcing opportunities from and investing alongside our other funds. For example, BIP joined our real estate team in 2021 to privatize the QTS data center business, which has become the largest and fastest growing data center platform in the world. And now our leadership position in data centers is creating additional synergies across the firm, enabling us to address many new opportunities. And as BIP has continued to scale, it has in turn enhanced the firm's intellectual capital, relationships and deal flow, supporting our growth in other areas, including our $90 billion infrastructure and asset-based credit platform, our infrastructure Secondaries business and our dedicated energy and energy transition focused funds. And I'm pointing -- what I'm outlining this morning is just one compelling proof point of the power of the Blackstone platform. We designed the firm from the beginning to work this way with each business making the other stronger. This network effect sets Blackstone apart in the asset management area, underpins the strength of our brand, acts as an accelerant for the firm's overall growth. Our clients have a positive experience in one area. We're much more likely to invest in additional Blackstone products and support our expansion. Building things organic from the ground up, this challenging fix time involves upfront costs. However, we think our approach ultimately creates a stronger, more integrated firm as well as significant economic benefits as compared to a strategy focus acquisitions. And if reserves and perpetuates our unique culture, which is foundational for the firm's success. As we head into the new year, we're moving into an environment where we see consequential tailwinds for our overall business. Market participants have been focused recently to volatility in the U.S. treasury yields, reflecting persistent inflation concerns in the context of resilient U.S. economic growth as well as policy uncertainty. With respect to inflation, what we see based on our expansive portfolio and our proprietary data that the U.S. is continuing for the path of disinflation, albeit at a more moderate pace than before. The policy, where there are different factors to consider, I believe the direction of travel fundamentally is for policies that are pro-growth and pro-deregulation, which ultimately, it should be quite positive for our business. Closing, the power of Blackstone's platform will continue to drive us forward. Our positioning has never been stronger nor our prospects brighter. I couldn't be prouder of our people and their dedication to serving our investors. With that, turn the ball over to Jon. I will catch it."
},
{
"speaker": "Jon Gray",
"content": "Thank you, Steve, and good morning, everyone. This was an outstanding quarter for Blackstone. Steve highlighted the power of our platform, and I'll take you through three areas where that power was on full display. First, our large-scale deployment; secondly, our continued momentum in credit and insurance; and third, the acceleration in our fundraising, including both private wealth and the institutional channel. Starting with deployment. Over the past 12 months, we've been talking about a strengthening transaction environment and our desire to invest significant capital in anticipation of improving markets. We're pleased to say that we deployed $134 billion in 2024, up 81% year-over-year, planting the seeds of future value of what we believe is a favorable time. The combination of a healthy U.S. economy, historically tight financing spreads, greater debt availability, the prospects of a more business-friendly regulatory climate and importantly, accelerating technological innovations have given us confidence to deploy capital at scale. We invested or committed $62 billion in Q4, our most active pace in 2.5 years. New commitments in the quarter included fast-growing franchise business and very tasty Jersey Mike’s, the privatization of a grocery-anchored retail REIT, our third cake [ph] private and real estate in 2024. And a luxury mixed-use complex in Tokyo, representing the largest ever real estate transaction in the country by a non-Japanese investor. In credit, we reported record deployment for both the quarter and full year, including a $3.5 billion financing for EQT Corp, 1 of the largest natural gas producers in the United States. This venture is an excellent illustration of the scale of what we're doing today in the investment-grade private credit space and our position as a trusted solutions provider to many of the world's leading corporations. We leveraged the full breadth of our platform to design a custom solution across the capital structure for the borrowers secured by the long-term contractual cash flows of their critical pipeline infrastructure. For our clients, we provided access to a high-quality, directly originated investment and we executed the transaction, as always, without taking on balance sheet risk. We see a significant opportunity for more corporate partnerships over time, given the scale of our platform and our reputation. Stepping back, our credit insurance business continues to see huge momentum following a remarkable 2024. We built a private credit juggernaut and the largest third-party business of its kind in the world, with over $450 billion of total assets across corporate and real estate credit. Inflows for the combined platform exceeded $100 billion in 2024, comprising 60% of the firm's total inflows. Our non-investment grade private credit and real estate credit drawdown strategies appreciated 16% and 18%, respectively, for the year. These are extraordinary results for performing credit underpinning robust investor interest in these areas. We're also seeing strong traction for our investment-grade private credit offerings, as I noted, and now manage over $100 billion in that area, up nearly 40% year-over-year, virtually all on behalf of insurance clients, but we are now seeing receptivity from pensions and other LPs as well. In the insurance channel specifically, our business has reached nearly $230 billion, up 19% year-over-year, invested across IG private credit liquid credit and other strategies. Today, we have 23 SMA clients in addition to our 4 large strategic relationships, replaced or originated $46 billion of A minus rated credits on average for our private IG focused clients in 2024, up 38% year-over-year which generated nearly 200 basis points of excess spread over comparably rated liquid credits. We've achieved these results while remaining true to our capital like brand-heavy open architecture model designed to serve a multitude of insurance clients without taking on any liabilities. Resolution Life, one of our four strategic relationships is a perfect validation of our model. Last month, Nippon Life, the largest Japanese life insurer and an existing resolution shareholder announced it would acquire the remainder of the company it didn't already own at a $10.6 billion valuation. Blackstone had taken a small 6% stake in resolution in 2023, alongside other limited partners in connection with becoming the company's asset manager for private and structured credit. Nippon's investment will monetize our stake, deliver an attractive gain to our limited partners and the firm all while positioning resolution to accelerate growth under an extremely well-capitalized and capable parent. Importantly, we will remain resolutions investment manager going forward and we are excited to partner with Nippon on this next stage of the company's development. Turning to private wealth, where our momentum accelerated significantly in 2024. 2025 is also off to a terrific start. We are uniquely positioned in the wealth channel, given the breadth of our product lineup, our performance and the power of our brand. Sales in the channel exceeded $28 billion in 2024, as Steve noted. BCRED led the way raising over $12 billion for the year, driving 36% year-over-year growth in NAV. Our private equity strategy, DXP has already grown to over $8 billion in its first year, including January sales. And for BREIT, flows trended favorably with net repurchase requests in December, down 97% from the peak. We raised an additional $3.7 billion for the private wealth perpetuals in January, as Steve highlighted, marking their best month of fundraising from individuals in over two and half years. This included more than $1 billion each from BCRED, BXPE and our new infrastructure strategy. The launch of the infrastructure strategy marked the largest ever first close for a vehicle of its kind and was 5x to 6x the size of competitors' product launches. To give you the sense of the strength of our brand in this channel, over 90% of advisers who allocated to this strategy had previously allocated to another Blackstone perpetual vehicle and over 50% allocated to all four of our perpetual flagships. BREIT's exceptional performance, 9.5% net annual return since inception for its largest share class to a real estate superstorm has helped us here a lot. We're now in the process of launching our multi-asset credit product, as discussed previously, targeting the first half of this year. We see enormous opportunity ahead in the $85 trillion private wealth market. Our drawdown fund area is also benefiting from robust client engagement today with the tenor of discussions feeling far better than it had in several years. We held major things in Q4 for our real estate credit flagship, bringing it to $7.1 billion so far. European real estate, which has raised $9.5 billion to date and our private equity energy transition strategy, which has raised $5.2 billion, all of which will soon complete fundraising. We raised additional capital for our opportunistic credit strategy, bringing it to over $4 billion and held initial closings of 1.6 billion for our new Life Sciences flagship, targeting at least the size of the prior $5 billion fund. We will also soon begin raising the new vintages of a number of other highly successful strategies including private equity Asia, for which we expect very significant closings in the coming months, along with private equity Secondaries, GP stakes and tactical opportunities. Overall, the fundraising outlook is quite positive for the firm. Investor affinity for Blackstone is as high today as ever, and it all ties back to investment performance. As you'll hear from Michael in a moment, we again reported strong returns across nearly every area of the firm in the fourth quarter. Our LPs have benefited significantly from the way we've positioned the firm and their capital, including building the largest third-party credit complex, the largest data center business, one of the largest energy infrastructure platforms in a leading life science business and what we believe is the largest alternatives platform in India. These areas have continued to outperform, and we believe will drive outstanding future results for our clients as well. In real estate, however, our equity-oriented funds were down in the fourth quarter as the portfolio absorbed the 80 basis point increase in the 10-year treasury yield and our non-U.S. holdage were also impacted by the stronger U.S. dollar. We wouldn't expect to see a move of this magnitude in treasury yields going forward given the underlying inflation data. And while disappointing in the near term, our portfolio is in excellent shape with cash flows growing solidly overall across virtually all our real estate strategies. One year ago, we said that real estate values were bottoming, but that the recovery would take time and was unlikely to be the shape. That's exactly what happened. We remain firm believers that a sustained commercial real estate recovery is underway. Debt markets have vastly improved as borrowing spreads tightened by approximately 50% from the 2023 wise and CMBS issuance was up nearly threefold in 2024. At the same time, new construction starts are down dramatically from virtually all types of real estate, including by two thirds from '22 levels in U.S. logistics and apartments, our largest sectors. Meanwhile, demand is resilient with the potential for acceleration in the context of a stronger U.S. economy. Given our conviction, we deployed 25 billion in real estate in 2024, up nearly 70% year-over-year, and we expect to continue to deploy at scale. Real estate is a cyclical asset class that has been through a cyclical downturn. And we believe Blackstone is the best positioned firm in the world to benefit from the recovery. In closing, the firm is in terrific shape by any measure. We expect to achieve great things on behalf of all of our investors. And with that, I will turn things over to Michael Chae."
},
{
"speaker": "Michael Chae",
"content": "Thanks, Jon, and good morning, everyone. Our fourth quarter results represented an exceptional finish to an outstanding year, and we entered 2025 in a position of significant strength. I'll first review financial results and will then discuss investment performance and the outlook. Starting with results. We reported the best quarter of fee-related earnings in the firm's history and one of the two best quarters of distributable earnings. We saw the full benefit of multiple drawdown funds that were activated throughout the year, Key perpetual strategies continue to scale significantly, including the very notable contribution from the BIP infrastructure business, and we believe net realizations have begun to move off cyclical lows. First, with respect to fee-related earnings. In the fourth quarter, FRE grew a remarkable 76% year-over-year to a record $1.8 billion or $1.50 per share. Management fees rose 12% to a record $1.9 billion, including the 60th straight quarter of year-over-year base management fee growth at the firm. We activated the investment period for multiple major drawdown funds in 2024, which contributed full fees in Q4. Alongside that, key perpetual strategies, BIP, BCRED and BXPE continue to grow in scale and contribution to the firm's financials with their combined NAV up nearly 50% year-over-year. Fee-related performance revenues increased more than eightfold year-over-year in Q4 to $1.4 billion, driven by BIP's major scheduled crystallization event with respect to 3 years of substantial accrued gains, BXPE's first significant crystallization event with respect to full year 2024 gains and the steadily growing contribution for BCRED and our direct lending platform overall with a 47% year-over-year increase in these revenues for the credit insurance segment. In terms of distributable earnings, DE grew 56% year-over-year to $2.2 billion in the fourth quarter or $1.69 per common share. In addition to the strong growth in FRE, net realizations increased 42% year-over-year to $601 million, the highest level in 10 quarters. We executed a number of realizations across both the public and private portfolios in the quarter, concentrated in corporate private equity. These included the sale of public energy positions along with the IPO and sale of a portion of our stock in an India-based company at a multiple of invested capital of over 5x with the stock trading up further since then. In addition, our multi-asset investing segment, BXMA, generated outstanding investment performance in 2024, including the best year for the absolute return composite in 15 years. The BXMA crystallized incentive fees for most of its open-ended strategies annually in Q4, and the segment's performance revenues increased 144% year-over-year to $338 million. Now turning to the full year. The firm delivered strong results amid a complex external environment in 2024 with robust growth across all key financial and operating metrics. Distributable earnings grew 18% to $6 billion. Fee-related earnings increased 21% to a full year record of $5.3 billion. Net realizations rose 12% to $1.4 billion, supported by the strong performance in BXMA and yet another example of the benefits of our diverse business mix. Firm's expansive breadth of growth engines lifted total AUM up 8% to more than $1.1 trillion, another record, with $171 billion of inflows for the year. Inflows deployment and overall fund appreciation all accelerated meaningfully in 2024 expanding the foundation of future value. We achieved these results against a backdrop where the market for large-scale realizations was very challenged for much of the year and the significant underlying earnings power of our real estate business has yet to reemerge, reflecting the breadth and power of our platform that Steve and Jon described. Moving to investment performance. The firm delivered strong returns in almost every area in the fourth quarter. Our corporate private equity funds appreciated 4.9% and 17% for the full year. Our operating companies overall reported stable mid-single-digit year-over-year revenue growth in the quarter, along with continued notable margin strength. Our infrastructure business reported 4.8% appreciation in the fourth quarter and 21% for the year. In credit, our non-investment grade private credit strategies generated a gross return of 3.1% in the fourth quarter and 16% for 2024. We continue to see resilient fundamentals across the credit portfolio and the LTM default rate across our 2,000-plus non-investment-grade credits remained under 50 basis points. BXMA reported a 3.7% gross return for the absolute return composite, the 19th consecutive quarter of positive performance and 13% for the year. BXMA has generated compelling all-weather returns in liquid markets, helping to insulate our LPs from the volatility of the past several years. Indeed, since the start of 2021, BXMA's cumulative absolute return composite, net of fees is 34% or nearly double the traditional 60-40 portfolio. In real estate, the opportunistic funds declined 5.1% in the fourth quarter and 4% for the full year, while the core plus funds declined 0.8% in the quarter and were stable for the year. As Jon discussed, the fourth quarter was impacted by the sharp increase in treasury yields and the stronger U.S. dollar. Outside of our major reported business lines, the growth and performance of other key strategies further highlights the firm's ability to innovate and build businesses. Our dedicated life sciences platform delivered standout performance in 2024, with the funds appreciating 11.3% in the fourth quarter and 33% for the full year, driven by the achievement of positive milestones for multiple treatments under development. Our real estate credit high-yield drawdown funds appreciated 4.4% in Q4 and 18% for the year, underpinned by resilient credit performance in its real estate loan portfolio. And our GP Stakes business appreciated 4.1% in the fourth quarter and 28% for the year, reflecting its focus on top-performing managers in private markets. The resiliency and strength of the firm's investment performance continues to power our growth. Turning to the outlook. The firm is advancing with strong momentum across multiple drivers. First, in our drawdown fund area. In 2025, we will see the full year benefit from funds that were activated throughout 2024. Second, our platform and perpetual strategies has continued to expand overall now comprising 46% of the firm's fee-earning AUM, setting a higher baseline for management fees as we enter 2025. In addition, BXPE is now eligible to generate fee-related performance revenues on a quarterly basis and our infrastructure strategy for individual investors in its first year will be eligible in Q4 of 2025 with respect to full year 2025 games. And while BIP's significant Q4 crystallization event will not recur in 2025, we do expect smaller crystallizations periodically starting in the second quarter of this year. Third, there is significant underlying momentum in our credit insurance business, as you've heard this morning. Segments FRE and DE grew 26% and 24%, respectively, in 2024 and with robust inflows and record deployment, the business is exceptionally well positioned to deliver strong financial performance again in 2025. Finally, with respect to realizations, we see a much more constructive environment for realizations in 2025. In the near term, we would expect disposition activity to be concentrated in our private equity strategies, as real estate exit markets strengthen over time and for overall activity levels to be meaningfully higher in the second half of the year. Meanwhile, net accrued performance revenue on the firm's balance sheet stood at $6.3 billion at year-end or $5.14 per share. And performance revenue eligible AUM in the ground reached a record $561 billion. These are strong indicators of our future realization potential. In closing, we are highly confident in the multiyear picture of growth at Blackstone. The power of our platform has driven extraordinary results for our investors, and we believe it will continue to do so in the future. With that, we thank you for joining the call. I would like to open it up now for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions]. We'll take our first question from Dan Fannon with Jefferies."
},
{
"speaker": "Dan Fannon",
"content": "Thanks, good morning. Jon, I was hoping you could expand on some of the fundamentals you're seeing in the real estate market that gives you the confidence on the recovery. And while the recovery has been slow, as you highlighted in 2024, how do you see that ramping in terms of 2025?"
},
{
"speaker": "Jon Gray",
"content": "Good question. I would say when we think about the conditions for real estate recovery, you look for a number of things. First, you obviously want demand which is tied to economic growth. And we've got a pretty healthy U.S. economy, which leads to demand for logistics and apartments and hotels. So I think if the economy accelerates further, that's certainly a positive. Then, of course, supply, which I think is the key element here. We've seen a decline from 3%-plus new supply starts back in 2022 in logistics and rental housing, our biggest areas. That's declined now to 1%, so a two-third decline, which is very helpful. So we think cash flows as we move over time will be pretty good. They actually have been strong throughout this challenging period the last few years, which really hit real estate, of course, has been the cost of capital. And there, what we see is spreads have tightened quite a bit. Sort of overall borrowing costs have gone from, say, 9% to 6%. That's obviously helpful. And the availability of capital has improved. So CMBS last year was up threefold, and that's obviously very important for transaction activity. In the near term, that 80 basis point move, as you saw in our numbers, obviously had a negative impact but that's now been absorbed by the market. And so I think the combination of favorable cash flows and probably a more stable rate environment going forward gets us on this path. Ultimately, hard assets have to revert to replacement costs. With a growing economy, you need more real estate. And so rents and ultimately values have to grow. So the path of travel is clear, the slope may be a little different, but the reason we're leaning in is because we see that we're firmly on this recovery path for real estate."
},
{
"speaker": "Dan Fannon",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Craig Siegenthaler with Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "Good morning, Steve and Jon. Hope you are both doing well. We wanted to circle back on Michael's monetization commentary and the expected ramp in transaction activity. Blackstone is still a net buyer of assets, but given the macro setup, with the high stock market valuations and anticipated rise in IPOs, when do you expect to inflect and be a net seller of assets in corporate private equity? And then on Michael's prepared comments again, how far behind is the real estate cycle relative to private equity?"
},
{
"speaker": "Jon Gray",
"content": "Craig, I think a few things. The environment is clearly here getting better. Again, the strength of the economy, the health of the equity market, the S&P being up 60%, the IPO market, the pipeline for IPOs now is double where it was a year ago. Those are very constructive facts. We think large profitable companies can go public, the debt markets improving, certainly helpful both investment grade and high-yield spreads are basically at record types. Base rates are still a bit elevated, but the debt market is very constructive. We've got a regulatory climate for M&A that is far better for us. Strategics can now start to buy again and some of those dialogues are picking up. And then you do have this sort of desire for people to get transactions after three years being on the sidelines. So we sort of see the ingredients for a very positive M&A cycle coming together. We did see a little bit of a slowdown in the fourth quarter given the election and some volatility around rates. But I think it's going to build during the year. To your question and Michael's comments, private equity is definitely going to be stronger. I think there, we have a number of things where we'll see realizations earlier on. Real estate, we need this recovery to take a little more time. So we see that as more back half of the year, certainly not at the beginning of the year just given the nature of that market healing over time. So overall, I think a better environment certainly in '25 and '24, but more back-end weighted and first half of the year, definitely more private equity focused."
},
{
"speaker": "Craig Siegenthaler",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "Great. Thanks so much. Good morning. Just a question on AI and data centers. Just curious how you're thinking about the evolving investment opportunity around AI, particularly in the infrastructure layer with data centers and power. We've seen a lot of capital flow into the space, and you guys at Blackstone have been quite active in this space in particular. But just given some of the recent developments, for example, like with DeepSeek over the weekend that suggests that AI models maybe could be a bit less capital and energy intensive. Just curious how attractive do you see the infrastructure layer here moving forward? How much more capital investment do you guys see needed across the industry? And how are you thinking about potential shifts for investment opportunities across into the application layer?"
},
{
"speaker": "Jon Gray",
"content": "So Mike, we've obviously been spending a lot of time the last week looking at the impact of DeepSeek. I'd start with our data center business, which is the largest in the world. We have $80 billion of leased data centers. The good news in that business is these are long-term leased data centers with some of the biggest companies in the world. And we do not build data center speculatively anywhere in the world. So we have a very prudent approach when we think about data centers. The real question and the heart of your question is what is demand going forward? And on that front, we would echo what you're hearing, I think, from a lot of commentators, which is the cost of compute is coming down pretty dramatically. But at the same time, that's going to lead to more usage to more adoption. And so what does that mean for the physical infrastructure side? I'd go to the calls last night for both Meta and Microsoft they talked about the importance of physical infrastructure. Mark Zuckerberg said that he thought it was a strategic advantage for them, but they did acknowledge that some of this may need to be more fungible. Maybe there's a little less training that's done as a result of less intensity, but at the same time, there's more inference, maybe there's more cloud, maybe there's more to do with enterprise. So we have a sense in talking to our clients also that there's a belief as usage goes up significantly, there's still a vital need for data centers. The form of that use may change. And related to that, power usage, we think will continue because our lives are migrating online in all these questions, there'll be even more questions coming even if the amount of power used on an individual question goes down. So we still think there's a vital need for physical infrastructure, data centers and power. Some of it may change. And the good news for our investors is we're not doing things speculatively. It's based on the demand signals from our tenants. That's when we go out and spend the big dollars to build these things. So we still think it's a very important segment, and there's a way to run. But obviously, we're watching what's happening very closely."
},
{
"speaker": "Michael Cyprys",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Kyle Voigt with KBW."
},
{
"speaker": "Kyle Voigt",
"content": "Hi. Good morning, everyone. Maybe a question on BXPE the last few quarters have been in a healthy $1 billion to $2 billion zone in terms of quarterly fundraising. I guess, first, can you remind us where you're at in terms of distribution of the product, whether that's number of platforms or international breadth and what the runway looks like to expand that. And then with respect to the $1 billion to $2 billion quarterly inflow range, is that the pace that you are really comfortable growing the type of product or now with having some investment track record and entering the second year of the product, is there comfort in ramping the flows above that $1 billion to $2 billion quarterly pace if there is demand?"
},
{
"speaker": "Jon Gray",
"content": "Well, we've been steadily building out our partnerships distributors on BXPE. This is always the way you start with a smaller number as you work your way through the first two or three years, you steadily expand within the United States and geographically we're on that path. I don't know if we quote exactly how many distributors we use, but the number continues to grow. We've had some good success in places like Canada recently, the key for these products is investment performance. And BXPE did a terrific job, the first year. And the first year is the hardest year because you're just getting the product started. You don't have existing assets you're going from a standing start. We delivered very strong performance. And it really speaks to, I think, the unique scale we have. We have obviously large-scale corporate private equity. We do it in the U.S., Europe and Asia. We've got core private equity, tactical opportunities. We've got growth, we've got life sciences, we've got Secondaries. The breadth of that platform has allowed us to deploy the capital real time. In terms of where we go from here, we had a terrific month in terms of fundraising for BXPE in January. But I think it will be driven by performance. We have the capabilities to deploy more at scale. I feel great confidence at that. I just think it's -- we deliver performance, we deliver for the clients they're going to get more and more comfortable. We're going to open with more distributors and the product will continue to grow. We've done this in the past with both BREIT and BCRED. We think this is a similar model. But again, we've got to deliver for the customers. We've got to deploy the capital. I've got a lot of confidence in those areas. And given our strength in the channel and our brand strength, it's really powerful. I mean the fact that 50% of our financial advisors who invested in BXINFRA are invested in all four of our products just speaks to that powerful network effect. And financial advisors and their underlying clients know and trust the Blackstone name and that is so important. And so we're dedicated to delivering for them. If we do that, this can grow a lot just like our other products in this space."
},
{
"speaker": "Kyle Voigt",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll go next to Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Okay, thank you very much for the commentary. You didn't talk at all about retirement. I know it's an area that the whole industry is incrementally focused on, but you did mention the perhaps a more favorable regulatory backdrop. How do you see the evolution of the commentary coming out of your conversations with the regulators as that takes shape into 2025 on the Trump administration, what should we be looking for, for that opportunity set to potentially open up from a real estate perspective?"
},
{
"speaker": "Jon Gray",
"content": "Well, I guess where we start is the way the defined contributions and retirement business has evolved. And I do think it's created a bit of a have-not environment. So if you think about it, wealthy individuals are able to access our products through financial advisors and get the benefit of strong long-term returns and compounding. If you were an employee at a major corporate pre-2005, you probably have the benefit of pension fund where people are working hard every day to deliver these returns, allocating to alternatives. If you work at a state pension fund today, you also are getting that same benefit. But for the vast majority of private sector workers in the United States, they are giving a 401(k) plan where because of the litigation environment, they basically focus on the lowest fees and it's not about long-term performance. And it would seem highly logical to us that at some point in for instance, target date funds with the right gatekeepers and controls, picking the right managers that you would put private assets into this marketplace. So individual investors, all individual investors could get the benefit for retirement. And when you think about who should be in the position to do that, if the regulation changes Blackstone given our brand, our performance, the breadth of what we've done and the range of perpetual products we've created, we seem to be uniquely positioned. So I think this will happen. It's a question of when. And when it does, as I said, I think we'll be in a good spot. It certainly seems logical given the way the market's developed over time, and we really wanted to democratize access to these products into higher returns, so people can generate more for their retirement."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Glenn Schorr with Evercore ISI."
},
{
"speaker": "Kaimon Chung",
"content": "This is Kaimon Chung in for Glenn Schorr. Some of the insurance companies seem to be looking to do more on their own in private markets. I'm just curious what you're seeing and your expectations of further growth with your insurance partnerships. And also I heard your comments about Nippon Life. Just want to get more thoughts on the growth opportunities for insurance and credit in Asia? And what else are you doing in that region?"
},
{
"speaker": "Jon Gray",
"content": "Well, I think the biggest change that we've seen in the insurance industry over the last few years is that moving beyond just commercial mortgages into broader private investment-grade credit has gone from something people saw a novelty to a necessity. And so I think now if you're competing in the annuity space, certainly in the life space, even the P&C companies now are looking at this that if you can get comparably rated A- credits and get 200 basis points higher spread, that makes you more competitive with your sales organization. And what we're seeing across the landscape is an embracing of this model where they move a greater percentage of their assets into private investment-grade credit. And for us, the reason we're up nearly 20%, we're at $230 billion in insurance is because of this dynamic. And I would say the number of conversations, the scale of the conversations, it seems to be accelerating. And the other comment I would make is the fact that we have an open architecture model. We are not an insurance company ourselves with hundreds of billions of liabilities. We are not out there selling these products. We're just a third-party manager, the way the liquid managers used to manage liquid credit and still do on behalf of insurers. They see us as an attractive place to allocate capital. We're trusted. And the scale is really important because no insurer wants too much concentration given their important risk aversion. They need diversification. So what we're finding is there's a desire to talk to us on a larger strategic basis. We've got four of those clients. We now have 23 SMA clients, which is up 3% from where we were at the end of last quarter. This feels like it's going to continue to grow. It's obviously started in the U.S. You referenced Nippon Life, which is a terrific company we've seen Asian insurers who are also open to this idea. So I think there's opportunity there. There's select opportunity in Europe as well. The key again is do we deliver performance? Can we deliver them higher returns at the same or lower risk? We believe we can. And as we continue to scale up with our origination capabilities, being able to speak for larger transactions like we did this $3.5 billion EQT transaction in the midstream space that's going to put us in a better and better spot. So I think you will see this business continue to grow in a material way. And as an aside, as I mentioned in the prepared remarks, we're also seeing interest in investment-grade private credit now from some of our pension and sovereign wealth funds. It's very early days, but it feels like that's going to grow in momentum. But overall, insurance feels like an area where we're going to see a lot of growth in the years ahead, particularly at Blackstone."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Hi. Good morning, everybody. Thank you for the question. So staying on credit for a second, really strong fundraising across the platform, and it was really well balanced, which is obviously great to see as well. Can you give us a sense of the amount of capital that's sitting on the platform now that's not earning fees yet that will turn on upon deployment? And I guess, in that context, can you talk a little bit about your expectations for credit deployment over the next 12 months or so? And including maybe some of the partnerships, Jon, that you highlighted earlier, I think you said that you've expanded or trying to expand more corporate partnerships in that part of the business?"
},
{
"speaker": "Jon Gray",
"content": "Well, as the business grows and broadens, as we continue to move beyond it started, as you know, more opportunistic direct lending. But as we move into this asset-based area, where the penetration from us and the industry is very small, we think this is going to grow a lot. And I think you'll see us partnering more and more with banks oftentimes on a white label basis where there may not be a big announcement, but they want to move some things off their balance sheets as they want to try to drive higher ROEs we just see -- we see a lot of these corporate solutions transactions like EQT, I think we'll see more and more of those. I see investment pace growing basically with the capital that's coming in. And it's not different than direct lending or opportunistic, which is obviously very tied to transaction activity. What's nice about the private investment grade and the ABF, it's really just tied to the basic economy. It's tied to things like consumer finance and rail car finance and a bunch of fundamental things in commercial residential real estate that are just the essence nuts and bolts to the U.S. economy. So as capital comes in, I see this continuing to ramp up. We're not going to put a percentage number, but I would expect that it will keep up with the inflows. Michael, you have the specifics."
},
{
"speaker": "Michael Chae",
"content": "Yes, Alex, it's Michael. Out of our AUM base 375 in BXE, total AUM, 265 fee earning AUM, about $40 billion is not yet -- is eligible for management fees and not yet earning it, to put it in perspective. And there's another $9 billion or so in the bread's business within real estate."
},
{
"speaker": "Alex Blostein",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Brian Bedell with Deutsche Bank. Please go ahead."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thanks. Good morning, folks. Thanks for taking my questions. Maybe just to, Michael, on the FRE margin outlook for '25. Just you're highly likely to get back to solid double-digit base fee growth, not even considering FRPR. So just wondering what your outlook for the FRE margin might be in '25, even just not even considering fee-related performance revenue. And then I guess on top of that, I mean that can certainly create a lot of delta to the margin given the compensation on performance -- fee related performance revenue, but then I guess if that creates a lot of uncertainty into that outlook, to what extent is that compensation fungible across the firm so that you can, therefore, scale that margin and improve that this year versus last year?"
},
{
"speaker": "Michael Chae",
"content": "Brian. So I'll just step back on the question margins. You've heard me -- I reminded you this before, but I'll say it again, it's early in the year, so we don't want to get too granular. And as always we encourage you to look at it on a full year basis. We did throughout your last year. I think that approach hopefully was validated when you look at the full year performance. There are different variables to consider. You've touched on at least one. But I'd just start by saying we continue to feel really good about our margin position fundamentally. And again, the idea of margin stability as a starting point at the beginning of the year. A few items I'll just note in terms of those variables. First and you hit this on management fees and OpEx in terms of baseline. So on management fees, we have this embedded ramp, the full year benefit in '25 in flagship vehicles activated in 2024. So that lifted our base management fees in the fourth quarter. It's 10% year-over-year after more like single-digit growth throughout the course of the year. And we consider that growth rate a reasonable starting point as we enter 2025. And at the same time on the OpEx side and I think we talked about this in prior quarters. And we talked about, I think, the third quarter, how we saw in the fourth quarter, it would come in, in that low double-digit area and that was sort of a better run rate. We came in at 11% in the fourth quarter. And again, I would say that is a good starting point as we enter 2025. So to your point, that relationship between management fee growth stepping up from last -- from 2024 and the OpEx growth I think is a good thing. Second, as we've said before, there is a level of sensitivity to fee-related performance revenues as core plus and BREIT FRPR as we call them, generally carry higher incremental margin as these are direct lending platform. So that is of note. To your question, we do manage compensation ultimately holistically across the firm. So that's in play, but I think it is worth noting that sensitivity. And then third as you heard this morning, we continue to build out a number of really significant new initiatives which are in investment mode today, but will be meaningfully additive over time. So we are investing to grow and scale these new products, these new platforms to very significant ultimate profitability, but we are investing to do that in real time. So I'd just say those are some of the ultimate pillars around this. But again, stepping back, we've got a robust underlying margin position, multiple engines of growth and ultimately a high degree of control, we feel over our cost structure and this ability to scale products is the key over time. So whether it's in the private wealth space or any other space being subscale does not lead to, I think compelling profitability, but we approach it a little differently."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Mike Brown with Wells Fargo Securities."
},
{
"speaker": "Mike Brown",
"content": "Okay. Great. Good morning everyone. I wanted to ask on the new multi-asset credit fund that is set to launch. I think you said in the first half of this year. I'm just hoping to compare and contrast that fund versus BCRED. So the new fund will invest across a variety of credit strategies. So it sounds like it's kind of like a broad exposure to your credit business. Curious how that will be kind of marketed just to ensure it doesn't cannibalize BCRED. And then given it's an interval fund, does that mean it has potential to be kind of distributed differently into a wider array of distributors?"
},
{
"speaker": "Jon Gray",
"content": "Well, I'm looking at my General Counsel and how I can answer this question. What I would say is the product will have the breadth what we do in credit as opposed to just direct lending and have a piece of that, but a bunch of other things we obviously do it this firm related to asset-backed finance and real estate finance things on a global basis. So -- and it will be in a different structure that we believe will be more accessible to investors, but I don't think there's much more I could say about this."
},
{
"speaker": "Mike Brown",
"content": "Okay, well, thank you for that call. Thank you, Jon."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Brennan Hawken with UBS."
},
{
"speaker": "Brennan Hawken",
"content": "Good morning. Thanks for taking my question. I have a couple of questions on FRPR, specifically within credit, one on the fourth quarter and then one more forward-looking. So a nice uplift here in the quarter. Is it possible to quantify what impact you saw from spread tightening working through the FRPR line here this quarter? And then how should we think about -- on a forward-looking basis, how should we think about the impact of base rates and tighter spreads on excess return and therefore FRPR generation going forward?"
},
{
"speaker": "Jon Gray",
"content": "I would just say -- I'll leave Michael some of the technical answers here. I would just say that there has been some of the excess spread coming out of the credit business really over the last 18 months. You've seen it broadly across investment grade, non-investment grade credit spreads have been tightening. We've seen base rates come down. But our vehicles, as you've seen in the numbers have continued to produce very strong results. And I think the key thing to remember for investors is, yes, they may not be able to produce mid-teens returns in private credit on a go-forward basis, but the relative returns and the spread premium to fixed income to liquid fixed income is continuing to endure. And so that's what gives us a lot of confidence that we'll continue to generate favorable returns for our customers is that this farm-to-table model we have, where we bring investors right up to borrowers and avoid those origination distribution, securitization costs. That's going to continue and that's why we think this private credit area has so much room to run, both noninvestment-grade and investment-grade. But yes, the overall level of yields are coming down as spreads are tightening, but I think this bigger trend is really the key to the growth of that business."
},
{
"speaker": "Michael Chae",
"content": "And Brennan on the math, I'll just say that approximate math is across our current BCRED platform that a 50 basis point decline in base rates impacts our fee-related performance revenues on a run rate basis by about 4%. It's like a low single-digit number. And we obviously absorbed that in more in the last 12 months and purpose overall in BCRED grew at 18%. So through the NAV appreciation, through the growth in inflows, that's been the net of that."
},
{
"speaker": "Brennan Hawken",
"content": "Great. And spread tightening, did that have an impact in 4Q?"
},
{
"speaker": "Jon Gray",
"content": "Spread tightening. I mean most of what we have is floating rate. So spread tightening generally doesn't credit quality is, frankly, more important because you don't have a lot that trades above par. So I don't think spread tightening was a big driver of what you're seeing."
},
{
"speaker": "Brennan Hawken",
"content": "Great. Thanks for taking my question."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Ken Worthington with JPMorgan."
},
{
"speaker": "Ken Worthington",
"content": "Hi, good morning. I wanted to dig a bit deeper into the big four insurance relationships, if I could. So maybe setting the stage of the 230 billion you called out a couple of times in insurance assets, about how much come from the Big 4. As we think about '25, what are the contractual commitment obligations expected from the Big 4? And then lastly, given the acquisition of resolution by Nippon Life, you mentioned, I think, that the IMA remains intact. Does the transaction impact the remainder of the 60 billion of resolution flows expected over the next few years?"
},
{
"speaker": "Michael Chae",
"content": "Great. Ken, it's Michael. I'll start with your first question on the numbers. We -- at the end of '24 across the Big 4, we had 156 billion of AUM."
},
{
"speaker": "Jon Gray",
"content": "And what I would say is, I think in virtually every one of our situations, we've been allocated more capital than what was in there, faster than what was in there contractually that our partners here are extremely pleased with what we've been doing. So the relationship with Corebridge is rock solid, with Resolution, with Fidelity Guaranty and with Everlake, the former Allstate Life & Retirement business. And what I think is interesting is by making these vehicles more competitive with our work, they're going to continue to grow. And I think having resolution now owned by Nippon with their capital and their expertise this, I think will be a very good development in terms of the future. So we view these partnerships and our model is very powerful. As you're seeing in resolution, we'll return that capital. I think it's a good example of what we're doing. We use capital at the beginning of these partnerships. We did back with Fidelity Guaranty. We ultimately recycle that capital and we continue to stay with these partners long term as they grow their asset bases and we make them more competitive. And so we think this strategic partnership model is working extremely well. We see a bright future for it. We are really -- will continue to be the dedicated asset manager for these folks. And as we've talked about before, we're not going to do it by taking on insurance liabilities and everything that comes with this. For us, our partners are greatly appreciative of what we're doing and I actually see accelerating growth with our strategic partners, given what we're delivering for them and their ambitions."
},
{
"speaker": "Ken Worthington",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Steven Chubak with Wolfe Research."
},
{
"speaker": "Steven Chubak",
"content": "Hi. Good morning. Wanted to ask a question on BREIT. The second derivative on BREIT growth in net flows appears to be improving. That being said, given stickier rates at the long end. Just wanted to better understand the catalyst for retail allocations into BREIT to increase from here, what the feedback has been from retail partners? And how do you see BREIT flows evolving over the medium term relative to history, given your outlook?"
},
{
"speaker": "Jon Gray",
"content": "Look, it's all tied to performance. I think we did an excellent job navigating the difficult period for real estate, providing liquidity to customers we've been providing now full liquidity in the last 11 months. We've seen this 97% decline in net redemptions. And I think the key to your question is, when does this turn on and become a growth vehicle? And I would tie it to performance once BREIT starts showing good performance, the customers have had a good experience. And so what they're waiting to see is a few months of positive NAV growth in a meaningful direction. And I think if that happens, then we'll begin to see it. It may take a little bit of time, but we think it will build. And when you look at what BREIT owns, the fact that it has got this terrific rental housing portfolio where there's a structural shortage in the U.S., it's got a terrific exposure to logistics where, of course, the movement to e-commerce continues, and now there's a reshoring underway. And then the data centers, which have been very important in the last few years in terms of adding value to BREIT, all of that and the geography in the South and Southwest of the United States, all of that gives us confidence. But I think from the investor standpoint, they want to see a steady number of months of solid performance we believe that as we get rates to settle in here and we see the continued growth in cash flow, interestingly, BREIT last year was up 4% in same-store NOI. As cash flow continues to grow, rate settles out, there's this lack of new supply. We think BREIT will, again, at some point here, become a growth vehicle. And we've got to remember the customers have had a very good experience here. They have a lot of confidence in Blackstone and Blackstone real estate. But I do think you're going to need to see that before you really start to see an acceleration."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Ben Budish with Barclays."
},
{
"speaker": "Ben Budish",
"content": "Hi. Good morning, and thank you for taking the question. I was wondering if you could talk a little bit more about the trajectory -- the potential trajectory for BIP, FRPR. I understand you said that I think they should start to pick up in Q2. But as we sort of look back over the last several years, there's been a not in substantial amount of fundraising quarterly since the beginning of 2022. So just curious if there's anything else you can share in terms of what of FRPR looks like, just given the size of that fundraising and the performance? And any other nuances we should be aware of around the FRPR margin side? It seemed like that came in maybe a little better than expected, but -- it has to do perhaps with the timing of BXPE, I'm wondering if we could see something like that next -- this year in Q4?"
},
{
"speaker": "Jon Gray",
"content": "I would just say and then hand it to Michael that the momentum in our BIP, our infrastructure business is extraordinary. When you deliver 17% net in an open-ended format where the capital is invested in the ground and you build up the kind of portfolio they have in digital infrastructure, in power and energy and in transportation. You have a lot of happy customers. And so the fundraising momentum there continues to be quite strong, exactly as Steve laid out in his remarks, Michael, I'll hand it to you."
},
{
"speaker": "Michael Chae",
"content": "And then on sort of the sequencing of incentives from here. As I mentioned in my remarks, in Q2, we will realize a more modest but a material amount of incentive fees. And so you can expect in the next 4 quarters in 2025, you won't see infrastructure incentive fees and FRPRs in the first and fourth quarter, you'll see a modest amount in the second and the third quarter. As we talked about margins on that, we sort of gave this a forward look last year that given the development mode we're in on at the effective FRPR margin for infrastructure would be a bit lower than the overall firm. And that was the case obviously, on very big dollars. So that was a happy event. And I think in terms of -- looking ahead to Q4 this year versus Q4 this year and what was or wasn't anticipated, not a lot of color to go on."
},
{
"speaker": "Ben Budish",
"content": "Understood, thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Patrick Davitt with Autonomous Research."
},
{
"speaker": "Patrick Davitt",
"content": "Hi. Good morning, everyone. Thank you. I know there's still a lot of uncertainty on the direction of the new administration's policies, but sure you guys have been running different scenarios internally, like others have said they are. So through that lens, curious if you have any initial thoughts on how the in-ground portfolio could be impacted either positively or negatively by more significant tariffs or a trade war. And within that theme, more specifically, give us an update on the invested capital exposure to Europe, Asia and then specifically China?"
},
{
"speaker": "Glenn Schorr",
"content": "So what I'd say at the headline level, Patrick, is we don't have a lot of businesses who export physical goods at scale to the United States. So I think that's obviously the area at most risk. The other thing I would say is, I think we got to wait and see where this settles. Clearly, tariffs are going to be higher, but we don't know which countries, which industries and what the level is, and there seems to be a lot of negotiation. This tariff diplomacy as we saw in Colombia a week ago, can move pretty dramatically in a short period of time. So, I think we have to wait and watch. The good news overall for us is very few of our businesses are really reliant on exporting goods into the United States, physical goods. And so we just don't see it either in Europe and Asia having a major impact on our business."
},
{
"speaker": "Michael Chae",
"content": "And then just on the geographic dimension. Patrick, if you step back at the whole firm. So these are sort of gross numbers, but we have heavy concentration as international and global as we are in the U.S., about 3 quarters of our portfolio is in the U.S. And that's a pretty historical level, about 15% in Europe and then a quite modest single-digit amount in Asia. So we're a global firm, but the nature of our business is that sort of more, I think, manageable exposure to non-U.S. markets."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our next question from Crispin Love with Piper Sandler."
},
{
"speaker": "Crispin Love",
"content": "Thank you and good morning, everyone. Can you just discuss your outlook on interest rates as Steve stated, you are seeing disinflation based on your data, but there are some worries more broadly on inflation, just shown by treasury yields recently. Would you expect more cuts than currently priced in or perhaps a rally in rates? I'm just curious on how that could impact PE activity, real estate performance in 2025 just based on your in-house views?"
},
{
"speaker": "Jon Gray",
"content": "Always dangerous to predict interest rates. But what I would say is our confidence comes from our portfolio on the inflation data. So we're obviously a very major owner of rental housing and shelter is the biggest component of CPI. It's 36% today. The Fed data is 4.6%. We would say what we're seeing is closer to 1% in that area. And what we've seen steadily is the government data is catching up to what's happening sort of on the ground in the real world. And so if you take a 36% weighting and you slowly bring that down, I think that's going to give the Fed some air cover. The other thing we'd say right now is in the labor market, we survey our CEOs, and they would say, basically, it's the easiest to hire that it's been since the post-COVID period. Wages for hourly workers are at the lowest level of 3.7%. Now it's possible things could change if we get a resurgence in economic activity, but right now, the labor market seems to be in balance. And so that should be helpful as well. As to what the Fed is going to do, I think they have the luxury of being patient. I think the fact that the economy is so strong. They want to see what kind of policies are coming from this administration. I think they're going to wait and see. But I do think the inflation data will generally be supportive it is showing as inflation continues to come down, although the pace of that disinflation is slower."
},
{
"speaker": "Operator",
"content": "Thank you. We will take our final question from Arnaud Giblat with BNP Paribas."
},
{
"speaker": "Arnaud Giblat",
"content": "Yes, good morning. Just, if we you could look at the perpetual products, if we look 5 years out from now and assuming a continued acceleration in flows in these products in the U.S. and in the global private wealth channels. I'm just wondering how we might see your distribution evolve. In other words, how much AUM are you currently set up to distribute today? And do you require a lot of investment in distribution over the next 2, 3, 5 years? I'm just wondering about the shape?"
},
{
"speaker": "Jon Gray",
"content": "Well, it's clearly in the area where we have a significant amount of optimism. I think you could see this grow quite substantially. The good news is we've made an enormous investment in this area ahead of others. We really started on this now almost 15 years ago. We have teams around the globe, more than 300 people dedicated to our private wealth area. We've built these products track records, which is pretty differentiated. We think the opportunity to distribute these more broadly in different formats is going to grow. And this is really where the power of the Blackstone brand is so important. Sometimes it's hard to quantify when you're doing financial models. But our ability to launch new products to sell to different distribution partners. The fact that we have a differentiated brand that allows us to sell more to expand on a capital-light basis, all of that is very favorable for our shareholders. We think it's early days in this. If you think about the big picture, we think there's close to $90 trillion of wealth of people who have more than $1 million in savings around the world. And we think it's allocated around 1% to private assets. If you think about our institutional partners, they're 30% allocated. And so we've come out of a difficult period the last 2 years or 3 years with this cost of capital shock people are reemerging, risk appetites going up. Short-term rates are going down, so people are starting to think about moving out of deposits into other assets at Blackstone, given the breadth of what we've got and the track record and the investment we've made in people, we think we're really well positioned. So I wouldn't be surprised if this is far larger than it is today 5 years from now."
},
{
"speaker": "Operator",
"content": "Thank you. With no additional questions in queue. I'd like to turn the call back over to Mr. Tucker, Weston for any additional or closing remarks."
},
{
"speaker": "Weston Tucker",
"content": "Thanks so much for joining us today and look forward to following up after the call."
}
] |
bx | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the Blackstone Third Quarter 2024 Investor Call. Today's conference is being recorded. At this time all participants are in a listen-only mode. [Operator Instructions] At this time, we'd like to turn the conference over to Weston Tucker, Head of Shareholder Relations. Please go ahead."
},
{
"speaker": "Weston Tucker",
"content": "Great. Thank you, Katie, and good morning and welcome to Blackstone's third quarter conference call. Joining today are Steve Schwarzman, Chairman and CEO; Jon Gray, President and Chief Operating Officer; and Michael Chae, Chief Financial Officer. Earlier this morning, we issued a press release and slide presentation, which are available on our website. We expect to file our 10-Q report in a few weeks. I'd like to remind you that today's call may include forward-looking statements, which are uncertain and may differ from actual results materially. We do not undertake any duty to update these statements. And for a discussion of some of the factors that could affect results, please see the risk factors section of our 10-K. We'll also refer to non-GAAP measures and you'll find reconciliations in the press release on the shareholders' page of our website. Also, please note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Blackstone fund. This audio cast is copyrighted material of Blackstone and may not be duplicated without consent. On results, we reported GAAP net income for the quarter of $1.6 billion. Distributable earnings were $1.3 billion or $1.01 per common share and we declared a dividend of $0.86 per share, which will be paid to holders of record as of October 28. With that, I'll turn the call over to Steve."
},
{
"speaker": "Steve Schwarzman",
"content": "Thank you, Weston. Good morning and thank you for joining our call. Blackstone reported strong third quarter results including distributable earnings of $1.3 billion as well as, as Weston mentioned and the highest fee-related earnings in two years. Since the Fed began its interest rate tightening cycle in 2022, we've spent considerable time on our earnings calls discussing how we see the macro environment unfold. This included sharing our view on inflation, when we saw it moderating more quickly than many other market participants, which paved the way for the Fed to begin cutting interest rates last month. We also stated our belief that an easing of the cost of capital would be very positive for Blackstone's asset values and would be a catalyst for transaction activity, including deployment and ultimately realizations, which in turn fuel fundraising. This is the virtuous cycle that powers our business. We believe we're now advancing towards the stage in the cycle that is always the most fun. In anticipating -- an anticipation of improving markets, we substantially increased our investment pace starting in the fourth quarter of 2023, close to a year ago, which coincided with the peak of the 10-year treasury yields. Since then, over the last 12-months, Blackstone has deployed $123 billion, representing one of the most active periods in our history, and double the prior year comparable period. We've been planting the seeds of future value at what we believe is a favorable time. In terms of future harvesting, the third quarter marked the highest amount of overall fund depreciation in three years. Stepping back, this is a time of profound transformation across the economy and markets as well as geopolitically. Today, more than ever, we believe Blackstone is the partner of choice to help investors navigate a complex world. Our scale and reputation provides a foundation for deep engagement and ongoing dialogue with our limited partners. As the reference firm in our industry, we have a distinctive ability to convene the key decision makers from our limited partners to discuss what's happening around the world. The insights we draw from our expansive platform and portfolio are highly valuable to them. Most recently, we've been engaging with our clients on a number of important areas, including the revolution underway in artificial intelligence, the build-out of digital energy infrastructure needed to support AI, the renewable energy transition, the rise of private credit, the development of the secondaries market or alternatives, the extraordinary advances in drug development in the life sciences area, the emergence of India as one of the most important major economies, and the cyclical recovery in commercial real estate. I'll spend a moment discussing two of these areas in more detail. The platforms we are building in support of artificial intelligence and the recovery in real estate. First, with respect to AI. On previous calls, we've provided updates on our data center investments. Today, Blackstone is the largest data center provider in the world with holdings across the U.S., Europe, India, and Japan. Last month, we announced another major expansion by agreeing to acquire AirTrunk, the largest data center operator in the Asia Pacific region for $16 billion. We were uniquely positioned to execute on this investment, given our expertise in this sector, the scale of our capital, the global integration of our teams, and our connectivity to the world's largest data center customers. Our ability to serve these customers represents a powerful illustration of how Blackstone has become a trusted solutions provider on a massive global scale to many of the largest and most valuable companies in the world. The Blackstone portfolio consists of $70 billion of data centers and over $100 billion in prospective pipeline development, including air trunk and facilities under construction. We've conceptualized this new business area, built conviction, and in only three years, scaled it to the largest platform in the world. And there is much more we're doing and plan to do in this area, including addressing the sector's growing power needs, which we believe will create enormous additional opportunities for investment over time. Turning to the recovery in commercial real estate. With the cost of capital moving lower, we've previously discussed our expectation of a new cycle of increasing values and improving investor sentiment towards the sector. One indication of this shift now underway is the renewed interest in the asset class from limited partners and financial advisors, notably for BREIT. Repurchase requests in September were down over 90% from their peak, and we're seeing encouraging signs in terms of new sales. BREIT is clearly moving towards positive net flows based on current trends. The vehicle's largest share class has outperformed the public REIT index by approximately 50% annually since its inception nearly eight years ago. We believe BREIT's standing as the largest vehicle of its kind by far with strong investment performance and exceptional portfolio construction, including nearly 90% concentrated in warehouses, federal housing, and data centers. It positions the vehicle extremely well in the context of improving flows into private real estate. Historically, in multi-year recovery periods following a downturn, private real estate has delivered approximately double the returns of all periods. As the largest owner of commercial real estate, this dynamic should be quite positive for Blackstone and our investors. Overall, our limited partners have benefited significantly from the exceptional balance of the firm and the careful way we've positioned their capital in a volatile world. Looking forward, our business is accelerating, and we are in the early days of penetrating markets of enormous size and potential. We've established leading platforms in what we view as the most compelling high growth areas. The alternative industry still represents a small portion of investable assets globally. And I believe Blackstone is the best position firm in the world to capitalize on its long-term growth trajectory. In closing, we've navigated many cycles since our founding in 1985. While each has presented challenges, they've also created opportunities to invest, expand market share in existing product lines, and to innovate and launch altogether new businesses. Blackstone has emerged from every cycle, even stronger than before. With our firm moving on to extraordinary new heights, I fully expect the most recent cycle will lead to the same result. With that, I'll turn it over to Jon."
},
{
"speaker": "Jon Gray",
"content": "Thank you, Steve. Good morning, everyone. Over the past several quarters, we've been advancing along the path we outlined for investors as we emerge from the high cost of capital environment. We are pleased to see our business progressing on this path, especially the strong investment performance with broad-based acceleration across the firm. First, we said we would deploy significant capital ahead of the all-clear sign, as we believe some of the best investments are made during times of uncertainty. In Q3, for the second consecutive quarter, we invested or committed over $50 billion, the highest in more than two years. New commitments were concentrated in some of our favorite thematic neighborhoods, including digital infrastructure, renewable energy and power solutions and enterprise software. Our largest commitment in the quarter was AirTrunk, as Steve noted, across multiple Blackstone funds. In private equity, we agreed to acquire work management software company Smartsheet for $8.4 billion, representing one of the largest take privates of the year and our credit business had its second busiest deployment quarter in history, investing over $18 billion, up more than 50% from Q2, driven by significant activity in global direct lending, as well as our infrastructure and asset-based credit strategies. Turning to the second key development we've been highlighting, the recovery underway in commercial real estate. In January, we made the call that values in the sector were bottoming. This informed our decision to invest or commit $22 billion in real estate in the first nine months of the year, nearly 2.5 times the same period last year. Our $30 billion global flagship fund is now nearly 40% committed. Green Street's index of private real estate values has increased each quarter since, while the public real estate market has rallied sharply. Liquidity in the private market is also improving meaningfully, providing the foundation for greater transaction activity. At the same time, new construction starts are falling dramatically for most types of real estate, including declines of approximately 40% to 75% from recent peak levels in logistics in U.S. apartment buildings, our two largest sectors in real estate. While the recovery will play out over time, the combination of lower base rates, lower borrowing spreads, and lower new supply makes the direction of travel quite positive for our real estate business. The third key development we've been speaking about regularly is the secular rise of private credit. And the integrated platform we've been building to offer clients and borrowers a one-stop solution across the full spectrum of credit strategies. Today, we manage the largest third-party private credit business in the world, with $432 billion across corporate and real estate credit, up a remarkable 20% year-over-year. We have one of the largest, if not the largest, businesses in direct lending, CLOs, real estate debt, and private investment grade credit. Total inflows across the combined platform were over $100 billion in the last 12-months. In our non-investment grade strategies, even as base rates move lower, there continues to be significant opportunity to generate excess returns for clients relative to liquid markets. Meanwhile, we expect lower base rates will be supportive of transaction activity and deployment. Importantly, private credit markets are expanding rapidly beyond financing M&A, and we're seeing a dramatic increase in demand for all forms of investment grade private credit, including from many of the largest insurance companies and institutions in the world. Our farm to table approach, which brings investors directly to borrowers, results in a strong value proposition for clients. In the insurance channel, our business has grown to $221 billion, up 24% year-over-year, including four strategic relationships and 20 additional FMA clients. We placed or originated a record $38 billion of A-rated credits on average year-to-date for our private IG-focused clients, up nearly 70%, which generated approximately 185 basis points of excess spread versus comparably rated liquid credits. Overall, Blackstone's scale and reach create extraordinary connectivity with borrowers across the market, resulting in more opportunities to originate high quality private credit investments. Our equity and debt strategies operate in multi-trillion dollar markets that generate enormous flow of investment grade debt, often where Blackstone is the leading player, including data centers, energy infrastructure, and real estate. In the energy area, we estimate we were a lead financing provider for nearly 15% of all renewable projects in the U.S. in the last 12-months. We've also established contractual relationships and forward flow agreements with banks and other originators across a wide range of areas, including credit card receivables, home improvement, fund finance, and equipment finance. We are building a third-party performing credit juggernaut, and we expect our business to grow significantly from here. The fourth key development we've been talking about is our momentum in private wealth. Following a challenging two-year period for markets, we've seen a robust reacceleration of sales in 2024. We raised $21 billion in the channel year-to-date through September, nearly double what we raised from individuals in the same period last year, including $18 billion for the perpetual vehicles. BCRED led the way with over $9 billion raised in the first nine months of 2024, including $3 billion in the third quarter. BXPE is approaching $6 billion only nine months after launch, and for BREIT, flows are trending favorably as Steve discussed. We're also in the process of launching two more private wealth perpetual vehicles in credit and infrastructure, as we noted previously. With the track record of our products, the depth of our relationships with financial advisors and their clients, and the strength of the Blackstone brand, we are more confident about our prospects in this channel than ever. In addition to private wealth, momentum is building in our drawdown fund area with a number of exciting new initiatives in front of us. The receptivity from our limited partners feels more positive today than in the past several years. We will soon complete fundraising for a number of our flagship vehicles, including corporate private equity, private equity energy transition, European real estate, and real estate debt. In credit, we recently launched fundraising for the successor to our $9 billion opportunistic strategy with initial closings of $2.4 billion. And in our equity oriented business, we've launched or will soon launch fundraising for the next vintages of three highly successful strategies, our $22 billion private equity secondary strategy, $6 billion private equity Asia strategy, and $5 billion life sciences strategy. We expect the successors to be at least as large or larger than the current vintages. Also worth noting, as of this week, we've closed on EUR1 billion for our new open-ended Europe-focused infrastructure vehicle, a very promising development. Finally, alongside these multiple positive developments unfolding in our business, something that is not changing is our commitment to our capital light, brand heavy, open architecture model. We rely on our track record our people and the power of our brand to grow. The firm's balance sheet investments comprise less than 1% of AUM. We have virtually no net debt, no insurance liabilities, and a share count that is almost unchanged over the past seven years, despite the extraordinary growth we've achieved. We've done that while also returning 100% of earnings to shareholders over this period through dividends and share repurchases, totaling over $30 billion. In closing, the firm is in terrific shape by any measure. We have powerful tailwinds at our back, and the virtuous cycle underpinning our business is accelerating. With that, I'll turn things over to Michael Chae."
},
{
"speaker": "Michael Chae",
"content": "Thanks, Jon, and Good morning, everyone. The firm delivered strong results in the third quarter. And as we've highlighted previously, we are moving toward a meaningful step up in the firm's earnings power. I will first review financial results and we'll then discuss investment performance and the outlook. Starting with results. The firm's extraordinary breadth continues to power AUM to new record levels. Total AUM increased 10% year-over-year to $1.1 trillion, with inflows of $41 billion in the third quarter and $167 billion over the last 12-months. Fee earning inflows were $161 billion for the LTM period, lifting fee earning AUM by 12% to $820 billion. We activated the investment periods for our corporate private equity and PE energy transition flagships in the second quarter and our infrastructure secondary strategy in the third quarter, representing $26 billion of fee AUM in aggregate. These vehicles were in the respective fee holidays for most or all of Q3, depending on the strategy. Notwithstanding the temporary impact from these fee holidays, management fees in the third quarter increased 8% year-over-year to a record $1.8 billion, and the forward outlook is quite positive, which I'll discuss in a moment. Fee-related earnings were $1.2 billion in the third quarter or $0.96 per share, up 5% year-over-year, underpinned by the growth and management fees. The firm also generated $264 million of fee-related performance revenues in the third quarter. These revenues included $186 million in the credit and insurance segment, up 27% year-over-year, reflective of the steadily growing contribution from our direct lending business, along with the contribution from a co-investment vehicle in the BPP platform. Distributable earnings were $1.3 billion in the third quarter or $1.01 per common share, up 7% on a per share basis. Net realizations were $226 million in the quarter, primarily generated by the sale of public stock of an India-based retail REIT and certain energy positions, along with proceeds from other public and private holdings. Overall disposition activity has remained more limited in the current environment characterized by nearly three-year period of lower activity levels in the broader capital markets. However, we are optimistic about a meaningfully more constructive environment for realizations in 2025. Moving to investment performance, our funds generated the highest overall dollar appreciation in three years in the third quarter, highlighted by corporate private equity and infrastructure. The corporate PE funds appreciated 6.2% in the quarter and 15% over the last 12-months. Our operating companies overall reported stable mid-single-digit year-over-year revenue growth in the quarter along with continued notable margin strength. Infrastructure reported 5.5% appreciation in the third quarter and 18% for the LTM period, with significant gains across digital transportation and energy infrastructure. Our data center platform was again the single largest driver appreciation in our infrastructure real estate businesses and for the firm overall in the third quarter. The co-mingled BIP strategy has generated 16% net returns annually since inception, powering continued robust growth with total BIP platform AUM increasing 32% year-over-year to $53 billion. Our credit business also reported another strong quarter against a healthy backdrop for private debt markets. The non-investment grade private credit strategies generated a gross return of 3.6% in the quarter and 17% for the LTM period. The default rate across our 2,000 plus non-investment grade credits was less than 50 basis points for the last 12-months. Our multi-asset investing platform, BXMA reported a 2.2% gross return for the absolute return composite, the 18th consecutive quarter of positive performance, and 12% for the last 12-months. In real estate, values were stable overall in the third quarter, supported by strengthened data centers, rental housing, and global logistics, offset primarily by decline in the unrealized value of our interest rate hedges as treasury yields fell in the quarter. These hedges, which locked in low-cost fixed-rate financing ahead of the rise in interest rates, had the effect of reducing appreciation in the third quarter by approximately 50 basis points for the opportunistic funds and 200 basis points for the core plus funds. Within core plus, BREIT's Class I net return was flat in the third quarter, but positive 2.3% excluding the effect of its interest rate hedge. Finally, outside of the firm's major reported business lines, we have a number of strategies in various stages of development that have been generating outstanding results. I'll highlight two of them. Our GP Stakes platform appreciated 12.6% in Q3 and 31% over the last 12-months, reflecting the attractiveness of investing in high quality alternative managers. And our life sciences funds appreciated 5.9% in the third quarter and 28% for the LTM period, benefiting from key milestones achieved for multiple treatments under development, including medicines for the prevention of heart failure and arrhythmia, along with a vaccine for pneumonia. The firm's investment performance lifted net accrued performance revenue on the balance sheet, up 13% sequentially from Q2 to $7 billion or $5.72 per share, the highest level in two years. Meanwhile, performance revenue eligible AUM in the ground increased to a record $553 billion. These are strong indicators of future realization potential. Turning to the outlook, we anticipate a material step up in FRE in the fourth quarter driven by several factors. These include the onset of full management fees for multiple funds exiting fee holidays. We also expect robust growth in fee-related performance revenues, in particular from a scheduled crystallization event for the commingled BIP infrastructure strategy, comprising the substantial portion of the strategy's associated net fee-related performance revenue accrual on the balance sheet. We do expect to sequentially lower FRE margin in Q4, compared to Q3 related to the infrastructure crystallization and other seasonal expense factors. But for the full-year 2024, as we noted last quarter, we continue to expect margin to be within a reasonable range of 2023. In closing looking forward to 2025 and beyond we have powerful momentum across the firm and the outlook for Blackstone is very positive. With that, we thank you for joining the call. I would like to open it up now for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll go first to Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "Hey, good morning. Thanks for taking the question. Maybe just on insurance, the platform continues to grow nicely there. So I was hoping you could maybe comment on the opportunity on both fronts on the strategic partnership side with the existing partners, how you're helping them grow? How are the conversations progressing for new potential relationships? And then on the regular way third-party side, I think you mentioned 20 or so separate accounts. If you could help size that part of the business today and how you envision that continuing to grow from here? Thank you."
},
{
"speaker": "Jon Gray",
"content": "Thank you, Mike. So the overall insurance business, as we noted $221 billion, up 24% year-on-year. We do have these four strategic relationships 20 SMAs. I would say the dialogue with insurance companies is exceptionally strong. On the strategic side, those take time. You need to find a party who's interested in doing something broader. We continue to have dialogues. It's hard to predict when and how those will happen. On the SMA side, we're just seeing more insurance companies recognizing the benefit of investment grade private credit, particularly in the asset-based space. As you know, they've always done commercial real estate on a private basis. Some have done private placements, but the movement into this $25 trillion asset-based arena feels like it's in its very early days. And we have been meeting with CIOs on a regular basis. Gilles Dellaert, who runs our credit and insurance business, came from this area in his past, has terrific relationships, and we're continuing to build out our capabilities. And I would just say the tenor of the conversation is very open. And it starts with, you know, one $500 million commitment, we fill that up, it can grow over time. You add to that the strategic relationships where we've got contractual flows coming in, and hopefully some new partners over time. You know, it's hard to put a number on it, but it feels like to us, this should continue to grow at a very high rate for the foreseeable future. Because when you look at the insurance companies, their allocations are still pretty small to the area. And the 185 basis points of excess return for A-rated paper is very valuable to them. And so I would say the optimism around this space for us is very high. And then of course, the open architecture model is helpful. We're not in the market selling annuities. We are a third-party investment manager, and that definitely helps the conversations and helps our momentum here."
},
{
"speaker": "Michael Cyprys",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Mike Brown with Wells Fargo Securities."
},
{
"speaker": "Mike Brown",
"content": "Hi, good morning. I was hoping if, Michael, if you could expand on the increase in the operating expenses this quarter? How much is driven by placement fees and where could that go? And then if we think about the embedded FRE growth through 2025. How should we think about how that operating leverage could drive margin expansion next year? Could it be north of called the 100 basis points that you've kind of historically delivered over the years? Thank you."
},
{
"speaker": "Michael Chae",
"content": "Sure, Thanks, Mike. Good morning. On the operating expense growth, it was a few items in that mix of a few different elements. First, there is third-party servicer fees relating to our Signature Debt Portfolio Acquisition. Second, as you noted, placement fees primarily related to BXP and then there's some initiative driven consulting spend and some other items. These are obviously all associated with very compelling growth areas, but they did add to OpEx. And I'd say adjusting for these items, the underlying growth in OpEx is running fairly close to last year, which was very low-double-digits. And I would say for Q4, we would expect a lower rate of growth year-over-year than what you're seeing in Q3. So that's, I would say, the overall outlook on that and some of the background. In terms of 2025 margins, as you know, it's sort of early on that. We don't like to get too granular, especially this early. I would just say that given the overall drivers of both the top line and our expense structure, we continue to feel very good about the idea of stability as a starting point in the short-term and then upside from there and over the long-term continued operating leverage."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Glenn Schorr with Evercore."
},
{
"speaker": "Glenn Schorr",
"content": "Hi, thanks. Big picture and Blackstone specific question on in the asset-back world. So I wonder if you could size the asset-back opportunity in your mind in terms of maybe put in relative terms to what we've seen in the direct lending market, just you know multiples bigger in the range of the same size, you know, something like that? And then for you specifically, you talked about the different pieces of your juggernaut. I'm curious if you think relative to that backdrop that we could be looking at in terms of share from the banks, do you think you've done enough to get your fair share in terms of bank partnerships and owning or third-party origination, piecing it together for that juggernaut? Thanks."
},
{
"speaker": "Jon Gray",
"content": "Thanks, Glenn. So I would say to size it up, if you look at the leveraged finance world, it's roughly a $5 trillion universe today. About a third of that is in high yield, a third of that is in leveraged lending, and a third of that is in direct lending. And it certainly feels like direct lending will continue to get more share, because of the certainty we can deliver to borrowers and that farm-to-table approach. But that's that universe, and we have a $120 billion platform in that space. If you compare that to the asset-based world, including commercial real estate, residential real estate, transportation, digital infrastructure, energy, fund finance, that whole world, we estimate that at $25 trillion. And whereas private players have a third of the leveraged finance world, which is a much smaller world we just described, of that $25 trillion, I think we're, private players today are 1%, 2% of that. So the multiple in terms of scale is much larger and the penetration is much lower and that's the reason why you heard that enthusiasm from me on the insurance side because these clients see the opportunity and I think over time it's going to move beyond insurance. We're having good dialogue with pension clients. I think we'll see sovereign wealth funds start to do this as well. It's probably less of an individual investor market, but I think almost all institutions will look at this premium they can get for making asset-based loans and at the same or lower risk, and will choose to do some of this. And that means that number can grow a lot. And as we get scale, we can speak for, you know, whole transactions, $1 billion, $2 billion, $3 billion, put it amongst our 20 different clients today, and that creates a really good cycle for us. So I'd say overall, I think this market can grow a lot, I would expect our numbers here to grow a lot. On the bank partnership front, what I would say is, we tend to have a bias for do it yourself. But there are areas where partnerships make sense. So for us, direct lending, where we have so much scale, wouldn't make a lot of sense, but definitely in certain origination areas and we've done partnerships in terms of home improvement loans. We've done some in fund finance with some banks. We've done a number of things with originators in certain verticals. I think we'll continue to do more of those. We haven't done as many announcements, but we have a lot of oars in the water in terms of origination. I think our origination volume in investment grade, private was up 40% year-on-year. So this is an area where we have a lot of momentum. The other thing that I think is important to remember is our scale as an equity investor, you know, massive scale in digital infrastructure, in real estate and energy, the relationships we have there, that deal flow is very helpful to our credit business as well. So we feel good about what we're doing. Will we find some more partnership in specific areas? Yes. Will we continue to build out our own origination capabilities? Yes. We still think there's a long way to go."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Craig Siegenthaler with Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "Good morning, Steve, Jon, Michael. Hope everyone's doing well. We have a big picture question on the investing pipeline, and we heard a lot of positive commentary in the prepared remarks, but it looks like ‘25 will be a lot stronger overall. So, I wanted your perspective on two key points. One, how much is the November election delaying investment decisions into next year? And two, is the backdrop broadly more favorable in real estate or private equity given the declining setup in both discount rates and cap rates?"
},
{
"speaker": "Jon Gray",
"content": "So I would say on the election, we haven't really seen a slowdown. I mean, I do think there are some folks who are waiting to launch to get through the election. So maybe, you know, sellers or IPOs have been a little bit delayed either later into the fourth quarter or first quarter. So you know, I haven't seen people pulling back from buying, but it's probably delayed a few sales processes and that should be a good sign for deal activity. In terms of relative pickup and activity, you know, percentage wise probably real estate because it was coming off such a low base. And we've now seen borrowing spreads and borrowing costs come down a ton. But I think in both areas, you're going to see a pickup in activity. And, you know, you have all the conditions, sort of the recipe for more transaction activity. Base rates, both at the long and short end have come down. I think they'll come down further on the short end as the Fed eases. Spreads have tightened a bunch. I mean, we were looking, you know, high yield today between spread and base rates down 300 basis points. In some cases in real estate, down 400 basis points, really meaningful movement. And that is obviously very helpful for transaction activity. A strong equity market, of course, helps things in people's confidence. And then I would say investors, of course, their sentiment is improving as well. So I think we've been a little ahead of the curve in our investing before the all clear signs, Steve talked about the $120 billion we've invested, but it feels like things are picking up and anecdotally I was talking with the private equity guys, the last day or so, and the number of non-disclosure agreements, confidentiality agreements, is up 2.5-fold in September versus where it was a year ago. Now that doesn't necessarily mean it's going to turn into that volume of deals, but it clearly shows you there is more enthusiasm. And we know in the private equity world, there's a lot of companies that need to be sold, similar story in real estate. So it feels like there's a lot of pent up demand for realizations for DPI. And I think we'll see that in 2025."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Hey, Jon. Good morning, everybody. Just maybe piggybacking on that a little bit and zoning in on real estate a little more specifically, it's obviously very encouraging conditions improving. Can you talk a little bit about your outlook over the next 12 to 18-months in terms of Blackstone being a net buyer or a net seller or real estate assets, and maybe a little bit on which asset classes in particular you expect to be more active in on both sides of that equation?"
},
{
"speaker": "Steve Schwarzman",
"content": "Well, we definitely have been a net buyer here the last nine months. And we do think that the sentiment is improving, but it's still negative. And people look at the headlines, sort of the wreckage from the past and that concerns them and they're waiting to see, hey, is it safe to go back in? We tend to be in the seed planting mode for that. But at the same time, as we look into next year, as the public reach rally, as debt becomes more available at lower costs, we're seeing more people show up. So we've seen, call it 2 times to 3 times, the number of buyers showing up to buy things like apartments and logistics. So I think the balance this year has been very heavy towards the investing relative to the harvesting. I think that'll start to balance out still probably more investing earlier on as we work through the year, I would then expect to see more realizations. In terms of sectors we like, we continue to be heavily leaning towards areas like logistics where the global trends long-term particularly as we get through the supply bubble we think will look very good rental housing that the shortage of housing around the globe particularly in developed markets. Data centers we've talked about at length has been a huge theme for us in real estate. It's really powered a number of our vehicles. And so I think we will find interesting places to deploy capital and it's possible in office on a selected basis that you could find some interesting things, particularly higher quality buildings and even retail around the grocery anchored space as opposed to the enclosed malls. So I think we're in the middle of a broad-based recovery in real estate. We're trying to capture that as much as possible. U.S., Europe, and Asia deploying capital. As we work through the cycle and values recover, you'll see a pickup in sales and you can feel that happening now."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Dan Fannon with Jefferies."
},
{
"speaker": "Dan Fannon",
"content": "Thanks, good morning. Several funds came off the holiday in the third quarter. Can you repeat the size of that AUM? And then also just given the elevated levels of deployment that have been going on and seem to be continuing, can you talk about what that means for some of the larger funds or fundraising into 2025?"
},
{
"speaker": "Michael Chae",
"content": "Sure, on the fee holiday side, I mentioned that, sort of, the main items. Our new private equity corporate fund, Global Fund, BCP IX, our fourth energy transition fund, and then our SP infrastructure fund. Those were in partial or full holiday in the third quarter. They'll all be in full fees in the fourth quarter. Just to quantify, it was sort of based on the fee holidays, foregone fees from those, just those three funds of around $40 million or so. So that maybe will help you with the math. Do you want to mention…"
},
{
"speaker": "Jon Gray",
"content": "We’re going to talk about. I mean, look, as it relates to the pipeline, what I would say is institutional investors are certainly feeling better. The quality of the dialogue is getting better. As equity markets have rallied denominator, a fact looks a lot better today. I think the key thing will be DPI is picking up as we move into next year, as the IPO market gets better, as we have more sales, that's that virtuous cycle of capital moving back to them and them allocating more. I would expect that we talked about in the remarks, some of the things that are working their way through the system. Our next private equity Asia fund, our next life science fund, at some point next year, our next large private equity secondaries business, we've got the opportunistic credit business, and then we're continuing to clean up or finalize a number of these funds and energy transition, real estate credit, real estate Europe. So it feels like we're going to be in a better fundraising environment. As everybody knows here, the last 2.5 years have not been easy. Remarkably, as a firm, the last 12-months, we raised $167 billion. In a tougher period of time, it feels like it's going to be a better environment. But certainly, more realizations working their way through the system will free up capacity from our big customers."
},
{
"speaker": "Operator",
"content": "We'll go next to Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Great, Thanks. Good morning. Thanks for taking my question. Maybe just move back to the AI and the data center theme and just trying to connect the deployment opportunities, which obviously you described as pretty massive in this space. Just connecting that, trying to connect that with the supply of investment capital from fundraising. So as you see that deployment come through, to what extent do you think the fundraising can keep up or to what extent will this theme accelerate fundraising? Or say over the next two years? Maybe just one example there would be the prep fund is 40% committed. I know data centers are a part of that. Could be coming back to market even by the end of 2025 for the next vintage of that, is that too early?"
},
{
"speaker": "Jon Gray",
"content": "Well, it's an important question. What I would say on data centers is the fact that we have large-scale pools of capital that we've been able to deploy has been a huge competitive advantage. So the ability to privatize QTS, a $10 billion company at the time, which we've since grown eightfold in lease capacity. We did that jointly with infrastructure and various BREIT and BPP and real estate. The AirTrunk transaction, we just did a $16 billion deal. We were able, I think, to be in a very favorable competitive dynamic, because we did it really on our own with one institutional partner. And in that case, we had infrastructure, opportunistic real estate, Asia, global, our tactical opportunities area, our strategy for individual investors and private equity. We were able to bring all this capital together. And that's enabled us to do this at scale, because it does require a lot of capital to both buy these companies and then have the firepower to build these out. And so I do think it is a meaningful area of deployment. Will it lead to an acceleration of fundraising in real estate, let's say, opportunistic globally. I think it's too early to say, but it certainly has helped us. It's helped us in performance. It's been the lead driver in our infrastructure business. Michael talked about the 16% net since inception. The biggest driver of that has been data centers and it feels like we've got more momentum ahead for us in the U.S., Europe, and Asia. So it's one of the most exciting areas. And I would say just more broadly, playing this sort of need for compute power, AI, and electrification on a broad base. And so it's clearly the data centers, but it's also the energy and power. And in that area, again, having infrastructure, having our energy credit funds, having our energy equity funds, that consortium, and even some of this that's gone into real estate and then what we're doing in credit, that's another area. So when you think about where alternative firms are positioned, particularly our firm. There's a huge need for capital in a few of these areas, and we have what we think are the right vehicles to invest in it. I think it will lead to faster deployment, and it should lead to higher returns as well, and that gives us a bunch of optimism."
},
{
"speaker": "Brian Bedell",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Brennan Hawken with UBS."
},
{
"speaker": "Brennan Hawken",
"content": "Great, good morning. Thanks for taking my questions. So rates declining, you know, you spoke to that helping out many of your businesses, but I was curious to hear, you know, how to think about the impact of lower base rates and tighter spreads on a credit business? And, you know, maybe specifically how should we think about the rate sensitivity of FRPR within credit?"
},
{
"speaker": "Jon Gray",
"content": "So what I can credit is certainly we've generated very favorable returns for customers nearly 17% in private investment grade appreciation over the last year. And some of that of course goes away as base rate comes down and spreads come down. But the real question I think for investors is can they earn a premium to liquid fixed income? And when you look at liquid fixed income where corporate BBB's are paying a little over a 100 over, I think we can produce a durable premium. I think we can do it certainly in non-investment grade. If you look at our BCRED product, it's delivered 700 basis points over base rates since inception. So even as base rates come down, a very attractive return. And when you look in the investment grade space, as we talked about earlier, the idea that we can deliver 185 basis points over comparable A-rated credit is also very encouraging. So yes, there will be some pressure on absolute returns as spreads and base rates come down, but relative returns that durable premium, I think will continue. And that's the reason why I think we'll continue to see investors migrate towards private credit, both investment grade and non-investment credit."
},
{
"speaker": "Michael Chae",
"content": "And, Brennan, I just add on your question on impact on fee related forms revenues. I would actually, in isolation, talked about what's the effect of a decline in yields or an investment income? Not necessarily base rates for reasons I'll mention, but so call it a 50 basis points decline in yield or an investment income equates to pretty minimal impact, something like in the low-mid-single digits around 3% or 4% on sort of run rate, fee related performance revenue, that's sort of the math, which you could probably derive yourself. But importantly there are offsets. These are under levered vehicles. These are non-traded and traded BDCs. The cost of liabilities, even though they're lowly levered, that also moves in tandem down. And so there will be offsets, I think, in terms of just what's the impact all else equal of a move down in base rates. It really becomes a question of where are we on yields and investment income."
},
{
"speaker": "Operator",
"content": "We'll go next to Benjamin Budish with Barclays."
},
{
"speaker": "Benjamin Budish",
"content": "Hi, good morning and thanks for taking the question. I wanted to maybe ask another question on the FRE outlook for next year. Maybe thinking about the comp ratio in management fees versus realized performance revenues. I know in the past you've commented that you're not really looking to make a structural change like some of your peers have done. But when we look back across the last like three, four, five years, it does look like overall -- the overall fee-related comp ratio has come down a little bit and the opposite on the performance side? And so just digging through next year, I'm curious what your appetite is, particularly given if we do see a big pickup in performance revenues, it could be an opportune time given it would really smooth out the total comp picture for your employees. So, I appreciate any thoughts there. Thank you."
},
{
"speaker": "Jon Gray",
"content": "Sure, Benjamin. Look, First of all, as you know, our comp model has multiple levers and we look at them in an integrated way and feel like we've got a fair degree of control around them and we want to optimize across them. So you've seen some of that movement, I would say in terms of the performance revenue comp ratios relative to fee comp ratios. And, you know, in certain businesses, we've had the ability and from time-to-time we've chosen to allocate more performance comp to certain professionals and we manage the mix of incentives that way. You know, we haven't done it in the larger scale programmatic way, but it's a tool in our toolkit we can use along with others. So that is really how we think about it. We have these controls. There are multiple elements to this overall comp model. And I would just step back and say, as we've, I think, delivered on from a margin standpoint, comp ratio standpoint, you know, we feel good about the path forward."
},
{
"speaker": "Benjamin Budish",
"content": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"content": "We'll go next to Steven Chubak with Wolfe Research."
},
{
"speaker": "Steven Chubak",
"content": "Good morning."
},
{
"speaker": "Jon Gray",
"content": "Hi, good morning, Steven."
},
{
"speaker": "Steven Chubak",
"content": "How are you? I wanted to ask a question on the FRE and Net Flow outlook. So, certainly encouraging to see the improved fundraising deployment activity in the quarter. One metric which fell short of expectations was [FPAM] (ph) growth, and it has reinforced at least some of the challenges of overcoming back book headwinds, which are running at about 10% of the FPAM. Just given the strong fundraising tailwinds you cited, I was hoping you could speak to the FRE growth outlook just in the context of some of these back book pressures and how you're thinking about a sustainable organic net flow rate just as we refine some of our modeling assumptions for next year and beyond."
},
{
"speaker": "Jon Gray",
"content": "I’d just start, Steven, on sort of the overall outlook. I mean, the overall outlook, longer term, certainly looking at 20, we talked about the fourth quarter, so around FRE 2025. We don't give sort of granular guidance, and there isn't really an algorithm for it. But the building blocks, you know, that are in place for 2025 FRE growth, we are very optimistic about between base management fees, the sort of structural embedded up work ramp, the full-year benefit of the flagship vehicles we've activated this year, which we talked about, additional drawdown funds to be activated, new raises underway, you know, continued expansion and broadening of our perpetual strategies, including BXPE, significant momentum and credit insurance management fees you know up 18% year-to-date. And fee-related performance revenues which you touched on you know the direct lending BDCs just steadily expanding earnings power. BREIT sort of a bit of a sleeping giant in terms of this embedded incentive fee earnings power there, fee related performance revenue earnings power, and then BXPE, which I mentioned, continued to scale. And then in credit insurances generally, you know, year-to-date, FRE has been up 26%. So we think about the drivers, I think less in terms of equations and more around across different building blocks across the overall business, you know, really good I think near and medium term and longer term momentum and path forward. So I would really frame it that way rather than sort of a net flow or kind of quarter-to-quarter sort of an algorithm around that."
},
{
"speaker": "Steven Chubak",
"content": "No, it's a very helpful context. Thanks for taking my question."
},
{
"speaker": "Operator",
"content": "We'll go next to Ken Worthington with JPMorgan."
},
{
"speaker": "Ken Worthington",
"content": "Hi, good morning. Thanks for taking the question. So lots of areas and elements in Blackstone are performing well or recovering. Secondaries continues to lag and we witnessed IRRs in SP 9 and for three SP8 all fell this quarter by a couple percentage points and returns and aggregate and secondaries for 2023 and ‘24 are well below your hurdle rates. So help us understand why performance here continues to lag. Is the path forward to better results just a function of time? And if that's the case, when do we see it? Or is there really like a different bigger issue here?"
},
{
"speaker": "Jon Gray",
"content": "Oh, I would say we feel great about our secondary business. We were today at $82 billion of AUM. If you look in our filings here and you look at the SP funds, their net return since inception, high teens returns are higher in the flagship private equity vehicles. So we have extremely happy customers. In the near-term, yes, you know, that business reports on a lag of a couple quarters. So you're seeing what we’re challenging reports that come in the last few quarters. There's been modest growth in terms of appreciation there. But I would say the overall sort of embedded discount in buying funds at attractive prices, particularly what we focus on, which is eight year old funds on average. And being able to show up and we own today, I think interest in 4,000 different funds to give a holistic solution to sellers, do it across real estate and private equity and infrastructure and credit. I think it puts us in a really unique spot. So I would say near-term, there's a little bit of, you know, a slowdown in performance. But when you look at this business, what we've done for the customers, they're very pleased with it. And I feel quite good as we go out to raise the next vintage."
},
{
"speaker": "Michael Chae",
"content": "Yes, Ken, I'll just add to that on a couple things. One, just to reframe what John said or reiterated, the investment for us has been outstanding. I think if you did a channel check, you would hear that. I think on the recent performance, just to add to what Jon said, I think there are two factors which are kind of the key elements of the math in the short-term of the secondary fund returns. One is the immediate gains from buying new deals at a discount. That volume was lower, as you know, last year and early this year. It's definitely accelerating now. That will help returns. And then in terms of the underlying performance of the funds themselves, and Jon referenced this, the nature of secondary buyers is they tend to be more mature funds. So yes, in the period of the last couple of years or so, and even more recently, the performance of some of these more mature funds across the industry, naturally during this recovery, you know, lags. And so that's being sort of transmitted as well, as opposed to say, you know, our latest corporate private equity fund with a younger portfolio, and you see the performance that it's delivered, you know, in recent quarters. So those are really the two factors. They're structural, but they also have to do with structural in the context of where we are in the cycle. And overall, SP has been through these cycles. Their investment performance delivery has been outstanding."
},
{
"speaker": "Ken Worthington",
"content": "Okay, great. Will stay tuned. Thank you so much."
},
{
"speaker": "Jon Gray",
"content": "Thanks, Ken."
},
{
"speaker": "Operator",
"content": "We’ll go next to Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Okay, thank you very much for the update and taking my question this morning. I may be a big picture one on wealth management. Obviously you have a tremendous first mover advantage and a great brand. How do you sort of see the platform evolving here just in terms of impact of rising competition and maybe what you're seeing in terms of investor demand as interest rate expectations shift? Thank you."
},
{
"speaker": "Steve Schwarzman",
"content": "Thanks, Bill. I would start with, we definitely have a first mover advantage. The $250 billion speaks to our scale and is much larger than others. It speaks to the fact that we started here earlier than others and we built up incredible relationships with financial advisors, as well as their underlying clients. And I think that's very important. We had a bunch of them in town the last couple of weeks and the goodwill towards the firm is extraordinary, particularly because of the performance, both of the drawdowns and more recently, of course, because of the perpetuals, how BREIT has delivered, how BCRED has delivered. how BXP has started. This builds up a lot of goodwill with underlying customers. I'd also point out that if you look at our institutional investors, they're now 30%, 33% allocated to privates. In the $80 trillion wealth space, they're probably allocated 1% to 2%. It is early days here, even earlier outside of the United States. So if you said, you know, what do we see here? We see an enormous opportunity with our existing sort of flagship products. We talked about going into infrastructure, another version of credit. I think you'll see us put more people on the ground around the world. We think the benefits of alternatives will continue to grow. We think these semi-liquid structures, which have reporting that's more timely, in many cases are more tax efficient. They provide semi-liquidity as well. This works for advisors and their underlying customers. So I would say, yes, there will be more competitors moving into the space, but the overall market is very, very large. I feel like given our brand, our reach, we'll get shelf space, which is different, as you know, versus, let's say, traditional institutional private equity, where there you can have an unlimited number of participants. In this world, I think it's smaller, a smaller number of groups will be able to play. Our first mover advantage, the performance we've delivered, the brand, all of that is super helpful in this context. And I would say one other thing that I just thought about that's worth noting is as base rates come down, that makes investor’s enthusiasm for these products go up. When you were earning 6% in a money market fund, there wasn't much incentive to think about other things. As the Fed brings rates back in at some point into the 3s, I think the attractiveness of trading some near-term liquidity for higher returns goes up. So I think performance improving in a better environment, these products showing how they weathered a storm, and the lack of return from short-term cash, I think all of that should grow and we would expect as we move forward the momentum will accelerate in private wealth."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our last question from Crispin Love with Piper Sandler."
},
{
"speaker": "Crispin Love",
"content": "Thanks, good morning. Got just a big picture question here. So just from your seat, what are you seeing with regards to M&A and IPO activity and the IPO pipeline? And do you see a scenario where there are less IPOs, companies staying private longer? And what could that mean for you? Are there both positive and negative implications there for Blackstone in this type of environment? Thank you."
},
{
"speaker": "Jon Gray",
"content": "You know, I'm a believer that the environment's falling into place, both for more IPOs and more M&A. On the M&A front, in terms of the private side, certainly debt cost of capital coming down makes a huge difference. If you looked when we bought Emerson Electrics, Copeland business, you know, when we bought that, we were struggling to get any debt capital cost 13%, 14%. That they doing transactions very difficult. As debt cost capital comes down. People can borrow more and it allows the private market to become much more robust. As stock prices go up, obviously strategic acquirers become more active in M&A. On the IPO front, that's obviously been the laggard. We've had two very slow years in ‘22 and ‘23. ‘24, you've watched the momentum build up. And as I said on TV earlier, as the price of the public market goes up, it's like a magnet pulling private companies into the market. And so I think you'll begin to see more you've seen some sponsor IPOs come out that have done quite well overall I think IPOs in the U.S. are up something like 30% from IPO to today that will get people investors more motivated to invest in the IPOs. And when we just talk about what's happening in our firm, I walked into a meeting yesterday and we were talking about a potential IPO and we've really gone from sort of this theoretical to the practical. What's the right size? Should we do it in February or April? So my expectation is the IPO market, which is historically cyclical will pick back up. You know, the private market has grown. There may be companies that stay in continuation vehicles. So there will be some of that, but I think we will see a much better IPO market in 2025. And obviously for our business realizations, DPI, that's a very good thing."
},
{
"speaker": "Crispin Love",
"content": "Thank you, Jon. I appreciate the color."
},
{
"speaker": "Operator",
"content": "With no additional questions in queue, I would like to turn the call back over to Mr. Weston Tucker for any additional or closing remarks."
},
{
"speaker": "Weston Tucker",
"content": "Great. Thank you, everyone, for joining us today, and we look forward to following up after the call. Have a great day."
},
{
"speaker": "Operator",
"content": "Good-bye."
}
] |
bx | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Blackstone Second Quarter 2024 Investor Call. Today's call is being recorded. At this time all participants are in a listen-only mode. [Operator Instructions]. At this time, I'd like to turn the conference over to Weston Tucker, Head of Shareholder Relations. Please go ahead."
},
{
"speaker": "Weston Tucker",
"content": "Great. Thank you and good morning and welcome to Blackstone's second quarter conference call. Joining today are Steve Schwarzman, Chairman and CEO; Jon Gray, President and Chief Operating Officer; and Michael Chae, Chief Financial Officer. Earlier this morning we issued a press release and slide presentation which are available on our website. We expect to file our 10-Q report in a few weeks. I'd like to remind you that today's call may include forward-looking statements which are uncertain and may differ from actual results materially. We do not undertake any duty to update these statements. For a discussion of some of the factors that could affect results, please see the Risk Factors section of our 10-K. We'll also refer to non-GAAP measures and you'll find reconciliations in the press release on the shareholders page of our website. Also note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Blackstone fund. This audio cast is copyrighted material of Blackstone and may not be duplicated without consent. So quickly on results, we reported GAAP net income for the quarter of $948 million. Distributable earnings were $1.3 billion or $0.96 per common share and we declared a dividend of $0.82, which will be paid to holders of record as of July 29th. With that, I'll turn the call over to Steve."
},
{
"speaker": "Steve Schwarzman",
"content": "Good morning and thank you for joining our call. On our last several earnings calls, we spent a good deal of time talking about how we saw inflation, compared to many other market participants. We took a strong view that we were seeing different outcomes with inflation moderating more quickly, in part because of our unique position in the real-estate area and our understanding of the shelter component of the Consumer Price Index. As a result of our convictions, we decided to adopt a more aggressive approach to new investments. I'm pleased to report that in the second quarter we deployed $34 billion, the highest level in two years, and nearly $90 billion in the last three quarters since the 10-year treasury yield peaked. With inflation continuing to recede, we expect the Fed to begin cutting interest rates later this year. This should be very positive for Blackstone's asset values and provide the foundation for a significant realization cycle over time. As the largest alternatives firm in the world, with nearly $1.1 trillion of AUM, the real-time data collected across our global portfolio provides insights that help us decide in which areas to concentrate our investments. This data also alerts us to major paradigm shifts, which is essential for any top-performing asset manager. Our firm has demonstrated this foresight repeatedly since our founding, including the decision to extend our private equity business into real estate in 1991 when values collapsed following the savings and loan crisis, by significantly expanding our credit platform in 2008 in advance of the extraordinary investment opportunities that arose from the global financial crisis. Being the first investment alternatives firm, to start and develop a dedicated private wealth business in 2011 and introducing the first large-scale perpetual product for that channel in 2017 and our decision later the same year to create a perpetual infrastructure strategy for institutional investors, which now anchors an overall infrastructure platform across Blackstone of over $100 billion. This demonstrated ability to be in the right place at the right time continues on an accelerated basis today. This includes our investments and innovation in all types of private credit, where we're one of the world's largest managers; in global logistics as the largest private owner of warehouses in the world; in the energy transition field, where we own the largest private renewables developer in the United States. In India, where we believe Blackstone is the largest alternatives investor in what has become the fastest growing major economy, and of course in data centers, where we own the fastest growing platform in the world. I'd like to take a moment to discuss what Blackstone is doing today in Artificial Intelligence, specifically in data centers, which is an essential part of that breakthrough area. AI is widely acknowledged as having the potential to be one of the greatest drivers of transformation in a generation. I have personally been active in this field since 2015. I believe the consequences of AI are as profound as what occurred in 1880 when Thomas Edison patented the electric light bulb. While it took years to develop commercially viable products, the subsequent build out of the electric grid over the following decades has parallels to the creation of data centers today to power the AI revolution. Current expectations are that there will be approximately $1 trillion of capital expenditures in the United States over the next five years to build and facilitate new data centers, with another $1 trillion of capital expenditures outside the United States. The need to provide power for these data centers is a major contributor to an expected 40% increase in electricity demand in the United States over the next decade compared to minimal growth in the last decade. We believe these explosive trends will lead to unprecedented investment opportunities for our firm. Blackstone is positioning itself to be the largest financial investor in AI infrastructure in the world as a result of our platform, capital and expertise. Our portfolio today consists of $55 billion of data centers, including facilities under construction, along with over $70 billion in prospective pipeline development. Our largest data center portfolio company, QTS, has grown lease capacity 7x since we took it private in 2021. Through QTS and our other holdings, we have a robust ongoing dialogue with the world's largest data center customers. We're also providing equity and debt capital to other AI-related companies. For example, in the second quarter, we committed to provide AI-focused cloud service provider, CoreWeave, with $4.5 billion of a $7.5 billion financing package, the largest debt financing in our history, and we're now focusing on addressing the sector's power needs in many differentiated ways. With large-scale platforms in infrastructure, real-estate, private credit and renewable energy, we are extremely well positioned to be the partner of choice in this rapidly growing area. In another important area where Blackstone, once again, has been in the right place at the right time, is real-estate. During the global financial crisis, most competitors were forced out of business or delivered mediocre results. In fact, sometimes losing money for their customers, where Blackstone, for our investors, ultimately doubled their money. How did we do it? We owned the right assets in the right sectors with the right capital structures, enabling us to emerge from the crisis as the clear market leader. As a result, institutional limited partners and subsequently individual investors allocated significant capital to Blackstone real-estate in contrast to most other real estate managers. With that capital, we repositioned our portfolio over time by selling US office buildings and instead bought warehouses, rental housing, and eventually data centers. These three sectors comprised approximately 75% of our global real-estate equity portfolio today compared to 2% in 2007. This repositioning drove the outperformance and extraordinary growth of our real-estate business over the last decade and a half. Real-estate markets, of course, are cyclical, and over the past 2.5 years, the increase in interest rates and borrowing costs has created a more challenging environment. Even through this period, Blackstone real estate has delivered differentiated performance. BREIT for example, has generated a cumulative return of 10% net in its largest share class since the beginning of 2022 and 10% plus net returns annually since inception 7.5 years ago, more than double the return of the public-REIT market. Nearly 90% of BREIT's portfolio is in warehouse, rental housing, and data centers, with data centers alone contributing almost 500 basis points to returns in the last 12 months. The performance BREIT has achieved is the key reason it is 3x larger today than the next five largest non-traded REIT’s combined. Now the cost of capital has begun to decline, which would be further helped by Fed cuts later this year. We believe creating the basis for a new cycle of increasing values in real estate. At the same time, new construction for most types of real-estate is declining dramatically down 40% to 70% year-over-year, depending on the asset class. Looking forward, we are confident the outcomes experienced by our investors in this cycle will further reinforce our leadership position and will result in higher allocations to Blackstone from both institutional and private wealth channels in the future. Real-estate is one of the largest asset classes in the world, and having the largest business when the cycle is turning should be very advantageous for our shareholders. Blackstone is the reference firm in the alternatives industry, and for nearly four decades, we've been an essential partner to our investors helping them navigate a dynamic world. The Blackstone brand engenders deep trust with our clients, allowing us to innovate and build leading businesses across asset classes. We now have 75 individual investment strategies, and we are working on many more currently. Our near-term plans include launching several new products in the private wealth channel, the global expansion of our infrastructure platform, further deepening our penetration of the private credit and insurance markets, and expanding our business in Asia. Our firm is as innovative today as at any point in our history. Innovation in finance done correctly is essential to create the virtuous cycle of satisfied investors who provide more and more capital for future growth. I have great confidence that we are firmly on this path. And with that, I'd like to turn it over to Jon."
},
{
"speaker": "Jon Gray",
"content": "Thank you, Steve, and good morning everyone. In January, we highlighted three powerful dynamics emerging in our business. First, that investment activity was picking up meaningfully across the firm. Second, that commercial real-estate values were bottoming; and third, that our momentum in private wealth was accelerating. Since then, each of these dynamics has progressed in a very positive way, starting with investment activity. We deployed $34 billion in the second quarter, up 73% year-over-year, and committed an additional $19 billion to pending deals. Activity was broad-based across the firm. BXCI, our credit and insurance business, had one of its busiest quarters ever with $21 billion invested or committed, including in global direct lending, along with infrastructure and asset-based credit. In private equity, new commitments included two take-privates in Japan, a music royalties business in the UK, and a fast-growing insurance broker in India. Back in the US, we bought Tropical Smoothie, a franchisor of fast casual cafes. This acquisition launched the investment period for our corporate private equity flagship, for which we've raised more than $20 billion to-date. In real-estate as I said, we made the call in January that values were bottoming and the pillars of recovery were coming into place. What did we do with our conviction? We deployed nearly $15 billion in the first six months of the year in real-estate, approximately 2.5x the same period last year. Since January, Green Street's index of private real-estate values has had six consecutive months of flat or increasing values for the first time in over two years. In our own portfolio, we're now seeing more bidders show up to sales processes for single assets driving price improvement. Overall, the cost of capital has declined significantly, with borrowing spreads and base rates moving lower, while the availability of debt capital has increased significantly. At the same time, new construction starts are falling sharply and are at or near 10-year lows in the U.S. for both warehouses and apartment buildings, our two largest areas of concentration. For a market driven by supply and demand, this is very positive for long-term values. Nevertheless, the office sector remains under substantial pressure, with more troubled assets likely to emerge. For Blackstone, as we've discussed, we have minimal exposure to traditional U.S. office in our expansive equity portfolio. Exposure is higher in our public mortgage REIT, creating some challenges, although its focus on senior loans has been an important factor in navigating the sector's dislocation. With the vast majority of our global real-estate portfolio concentrated in logistics, rental housing and data centers, Blackstone is in a very differentiated position. Moving to our private wealth business, where our momentum has been accelerating. We raised $7.5 billion in the channel overall in the second quarter. In the perpetual vehicles, we raised over $6 billion in the second quarter, and nearly $13 billion in the first half of the year, already exceeding what we raised from individuals in all of 2023. BCRED led the way with $3.4 billion raised in the quarter, the highest level in two years. BXPE raised $1.6 billion in the quarter, reaching $4.3 billion in its first six months. And BREIT is seeing encouraging signs on the new sales front, raising $900 million in Q2, the best quarter in over a year. The vehicle has delivered six straight months of positive performance, and has fulfilled 100% of repurchase requests every month since February. Requests in June were down 85% from the peak last year, down 50% from May, and have declined further month-to-date in July. As we've been saying for some time, we believe flows in the wealth channel ultimately follow performance. We built the leading platform in our industry with over $240 billion and three large-scale perpetual vehicles. We have more in development, including two we plan to bring to market by early next year. First, an infrastructure vehicle that will provide investors access to the full breadth of the firm's strategies in this area, including equity, secondaries and credit. And second, a vehicle that will invest across our expansive credit platform. Our commitment to the $85 trillion private wealth market is stronger than ever. Multiple other areas of the firm are showing strong momentum today. Our credit and insurance business is thriving in an environment of higher interest rates and accelerating demand for both investment-grade and non-investment-grade strategies. Our performance has been outstanding, with minimal defaults of less than 40 basis points over the last 12 months in our non-investment-grade portfolio. Our scale allows us to focus on larger investments, where competitive dynamics are more favorable, and where the quality of borrowers and sponsors is higher. In our nearly $120 billion global direct lending business, our emphasis on senior secured positions with average loan-to-values of 44% provides significant equity cushion subordinate to our loans. We're the sole or lead lender in approximately 80% of our U.S. portfolio, helping us to drive document negotiations and control the dialogue with borrowers if any challenges arise. We believe our scale, careful sector and asset selection, and deep experience will differentiate us in a world of greater performance dispersion in credit. In our investment-grade focused credit business, our goal is to deliver higher yields to clients, primarily insurers, by migrating a portion of their liquid portfolios to private credit. We place or originated $24 billion of A-rated credits on average in the first half of 2024, up nearly 70% year-over-year, which generated approximately 185 basis points of excess spread versus comparably rated liquid credits. Our insurance AUM grew 21% year-over-year to $211 billion, driven by strong client interest in our asset-light open architecture model. We have four large strategic relationships and 15 SMAs today, and we expect our business to grow significantly from here. Moving to infrastructure, our total platform across the firm now exceeds $100 billion, as Steve noted, including our perpetual BIP strategy, infrastructure secondaries, and other infrastructure equity and credit investments. We built this platform from the ground up to become one of the largest in the world. BIP specifically reached the $50 billion milestone, including July fundraising, up 21% from year end 2023. Performance has been exceptional. With the commingled BIP strategy generating 16% net returns annually since inception, beating the public infrastructure index by nearly 1,100 basis points per year. We are well positioned to address the massive funding needs for our infrastructure projects globally, including digital and energy infrastructure. Just last week, we agreed to invest nearly $1 billion in a portfolio of solar and wind projects in the U.S. alongside NextEra, the largest public renewables developer in the country. A final comment on our drawdown fund business, where there are a number of initiatives we're quite excited about. We've launched or expect to launch fundraising in the next few quarters for the new vintages of multiple strategies. These include the successors to our $5 billion Life Sciences Fund, $9 billion private credit opportunistic strategy, $22 billion private equity secondaries fund, and $6 billion private equity Asia fund. All have strong track records, and we expect the new vintages to be at least as large as, and in most cases, hopefully larger than the current funds. While the fundraising environment has been challenging, we're seeing more receptivity from LPs today as markets improve. Importantly, when we meet with our clients around the world, what we consistently hear is that they are holding or increasing their allocations to alternatives and to Blackstone. In closing, our firm is emerging from this multiyear period of higher cost of capital, even stronger than before, and we're sticking with our model of being a third-party asset manager, relying on our track record, our people, and the power of our brand to grow. With that, I will turn things over to our very capable CFO, Mr. Chae."
},
{
"speaker": "Michael Chae",
"content": "Thanks, Jon, and good morning everyone. The firm delivered steady financial results in the second quarter, with positive momentum in fundraising and deployment as you've heard today. I will first review results, and we'll then discuss investment performance and the outlook. Starting with results, the firm's expansive range of growth engines continues to power AUM to new record levels. Total AUM increased 7% year-over-year to $1.1 trillion, with inflows of $39 billion in the quarter and $151 billion over the last 12 months. Fee-earning inflows were also $151 billion for the LTM period, including $53 billion in the second quarter, the highest level in two and a half years, lifting fee-earning AUM by 11% to $809 billion. We activated the investment periods for our corporate private equity and PE energy transition flagships in the second quarter, which along with BXPE and Private Wealth, were in fee holidays as of quarter end, representing $27 billion of fee AUM in aggregate. Notwithstanding the temporary impact from these fee holidays, management fees increased 5% year-over-year to a record $1.8 billion in the second quarter. Notably, Q2 represented the 58th consecutive quarter of year-over-year growth in base management fees at the firm. Fee-related earnings, the comparison of FRE to prior periods was impacted by a decline in fee-related performance revenues in the real estate segment, including from BREIT, as its positive year-to-date appreciation came in modestly below the required hurdle. These revenues carry favorable margins, and their decline impacted the firm's FRE margin in the second quarter. These factors are partly offset by the steadily growing contribution from our direct lending business, with fee-related performance revenues in the credit and insurance segment rising 24% year-over-year to $168 million. Distributable earnings were $1.3 billion in the second quarter or $0.96 per share, up 3% year-over-year. DE was underpinned by the firm's steady baseline of fee-related earnings, with Q2 representing the 11th consecutive quarter of FRE over $1 billion. Net realizations were $308 million in the second quarter, up year-over-year, but still reflective of a backdrop that is not yet robust as it relates to scale dispositions. That said, we executed the sales of a number of public and private holdings in the second quarter, concentrated in our Asia private equity business, including a leading healthcare services company in Korea, the IPO and subsequent sale of stock of one of the largest housing finance platforms in India, and the sale of stock of an India-based technology company. Moving to investment performance, our funds generated healthy overall appreciation in the second quarter, led by strength in infrastructure, private credit and life sciences. Infrastructure reported 6.3% appreciation in the quarter, and 22% over the last 12 months, with broad gains across digital transportation and energy infrastructure. Our data center platform was again the single largest driver of appreciation in our real estate and infrastructure businesses, and for the firm overall in the second quarter. In credit, we reported another outstanding quarter against a continuing positive backdrop of private debt market fundamentals. The private credit strategies generated a gross return of 4.2% in the quarter and 18% for the LTM period. The default rate across our 2000-plus non-investment grade credits was less than 40 basis points over the last 12 months, as Jon noted, with no new defaults in private credit in the second quarter. Our multi-asset investing platform, BXMA reported a 2.1% gross return for the absolute return composite, the 17th consecutive quarter of positive performance, and 12% for the last 12 months. BXMA has done an extraordinary job delivering resilient all-weather returns over the past several years through volatile equity markets and the longest and deepest drawdown in bonds on record. Since the start of 2021, the absolute return composite, net of fees, is a cumulative 27% or nearly double the traditional 60/40 portfolio. The corporate PE funds appreciated 2% in the second quarter and 11% for the LTM period. Our operating companies overall reported stable mid-single digit year-over-year revenue growth, along with continued margin strength. In real estate, values were stable overall in the quarter, supported by strength in data centers and global logistics. This was offset by declines in our office portfolio, including Life Sciences Office and certain other factors. One final highlight on investment performance. Our dedicated Life Sciences business delivered a standout second quarter. The funds appreciated 11.9% and a remarkable 33% for the LTM period after achieving positive milestones for multiple treatments under development, including for stroke prevention, cardiovascular disease and rare forms of epilepsy in children. The growth and performance of this business is yet another example of the firm's ability over many years to innovate and translate megatrends into large-scale businesses for the benefit of our investors. Turning to the outlook, we're putting in place the foundation for a favorable step-up in earnings power over time. First, in terms of net realizations. We expect a near-term lag between improving markets and a pickup in these revenues as we stated previously. In the meantime, the firm's underlying performance revenue potential has continued to build, with performance revenue eligible AUM in the ground reaching a record $531 billion at quarter-end. Meanwhile, net accrued performance revenue on the balance sheet, the firm's store value, grew sequentially to $6.2 billion or $5.08 per share. As markets heal and liquidity improves, we are well positioned for a significant acceleration in net realizations over time. In terms of FRE, we anticipate a material step up in FRE in the fourth quarter, with multiple drivers of note. First, with respect to management fee holidays, the corporate PE and energy transition flagships will exit their respective fee holidays in the coming months and will generate full management fees in Q4. BXPE exited its fee holiday this month. Second, in terms of fee-related performance revenues, Q4 includes a scheduled crystallization for the commingled BIP infrastructure strategy with respect to three years of significant accrued gains, as well as BXP's first crystallization event with respect to full year 2024 gains. Looking forward to 2025, we will see the full year benefit of the flagship vehicles that were activated in 2024. We also expect to raise multiple other flagships throughout the course of 2025, including Life Sciences, private equity secondaries, private equity Asia, and other major strategies. In addition, we expect the continued expansion of our platform of perpetual strategies, which has grown by 2.5x in the past three years. And importantly, our credit insurance business is on a strong positive trajectory, with segment FRE increasing nearly 30% year-over-year in the second quarter. The dual engines of performance and innovation at Blackstone continue to drive the firm forward. In closing, the firm is exceptionally well positioned against today's evolving backdrop, with powerful structural tailwinds and multiple engines of growth. Our long-term capital provides the flexibility and firepower to invest, and the patience to sell assets when the time is right. We are very optimistic about the future of Blackstone. With that, we thank you for joining the call. I would like to open it up now for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll go first to Craig Siegenthaler with Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "Good morning, everyone. So, my question is on investing. It was nice to see the sharp pick up in both deployments and commitments in the quarter. And with the credit piece more steady, we wanted to get your perspective on the two equity businesses, real estate and private equity. So, do you think we'll likely see further progress in the second half, or is a $24 billion deployment and $19 billion commitment run rates driven by upticks in P [ph] in real estate, really a good run rate going forward, just given the stronger activity levels that you already achieved this quarter?"
},
{
"speaker": "Jon Gray",
"content": "So Craig, it's a good question. I think it's hard to put an exact number, but there are some, I think, very positive signs. The fact that we have $19 billion committed at the end of the quarter is a good forward indicator of a lot of activity. I would say that just the volume of what we're seeing across our business, our equity strategies, is picking up. We did this last quarter, our first growth deal in a while, buying an ERP software business in Israel. We're seeing good activity in our secondaries business, that has clearly picked up year-on-year. I think double the activity over last year's level. Infrastructure quite busy. Real estate a little more episodic, but we are definitely leaning in as we've talked about, and then private equity, broad based global. We bought a couple of companies in Japan. We bought an insurance brokerage in India. We bought some software and online platforms in Europe. We bought a fast food business here in the United States. And I would say by virtue, and I said it last quarter, sort of my briefcase indicator continues to be getting full and indicates that there should be increasing solid levels of transaction activity. So I think the fact that we're seeing rates coming down, the market's being more conducive, more people are thinking about selling assets. I think as the IPO market reopens, we should see more. It's hard to say it's a straight line, but the overall trend lines on investing are positive."
},
{
"speaker": "Craig Siegenthaler",
"content": "Thank you, Jon."
},
{
"speaker": "Operator",
"content": "We'll go next to Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Jon Gray",
"content": "Good morning, Mike. Mike, are you with us?"
},
{
"speaker": "Operator",
"content": "Please check your mute function. We're unable to hear you."
},
{
"speaker": "Jon Gray",
"content": "Let's move on in the queue."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "Hey, good morning, everybody. Hey Jon, so maybe just building on your point around deployment activity picking up, I was hoping we could go in on what that could mean for real estate fundraising. Obviously, it's been an area of somewhat of a challenge, but as deployment ramps, and you guys are making nice progress on BREP X, I believe, and other areas as well. So what areas do you think will be the soonest to come back when it comes to real estate fundraising and your broader outlook there over the next 12 to 18 months?"
},
{
"speaker": "Jon Gray",
"content": "Well, obviously the sentiment for investors on real estate has been pretty negative given what's happened in much of their portfolios. We have been an outlier. We've raised over $8 billion for our latest opportunistic European fund. We've raised now a little over $5 billion for our latest real estate debt fund. You know, I think they are going to be a little more cautious going into open-ended funds until they see more of a pickup. I think it is an area that's probably a little more muted for a period of time, just because of investor caution, but we've seen this before. If you went back to the financial crisis, people wait for the numbers to get better, to feel better about a sector, and then they start to jump in. I will say the tenor of the conversations around real estate have improved. I think people are recognizing that prices have reset and that it's an interesting time to get back in. And I think one of the really important things, and Steve pointed this out in his remarks, is the differentiation of our performance. The fact that we're three-quarters allocated to logistics, rental housing and data centers, which looks very different than other investors. And I think like the financial crisis, it may take a bit of time, but when people see the dispersion in performance and how we've done, I think we'll see significant capital moving in our direction. So the path of travel here I think for us is good, but in real estate I think it'll take a little bit of time just because of the experience investors have had in the sector."
},
{
"speaker": "Michael Chae",
"content": "And I'd just add, Alex. This is Michael. In terms of the breadth drawdown area, obviously, I think our timing was fortuitous in terms of being able to raise those funds over the last two or three years and now being in a really amazing position with $60 billion of dry powder. And so we're in a good position where subject to finishing the Europe drawdown fundraise where we have a lot of dry powder to invest from those opportunistic vehicles."
},
{
"speaker": "Alex Blostein",
"content": "Yep. Thanks so much."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Glenn Schorr with Evercore ISI."
},
{
"speaker": "Glenn Schorr",
"content": "Hello there! Good morning."
},
{
"speaker": "Jon Gray",
"content": "Morning."
},
{
"speaker": "Glenn Schorr",
"content": "Curious if we can get a little update on the bank partnerships and asset-backed finance. There was another deal announced today outside of you guys. But there's been a tremendous amount of news flow in that space and the asset-backed opportunity might be multiples larger than what we've seen in middle market lending. So I wonder if you could help frame the opportunity and remind us what you have on the ground already."
},
{
"speaker": "Jon Gray",
"content": "Well, I think it is a big area of opportunity, because I think you can offer clients higher returns in investment-grade private credit, particularly in the asset-backed sector, because you are able to take out a lot of the distribution costs in an ABS transaction and so we've seen a tremendous amount of interest in this area. In fact, we talk about 15 SMAs with insurance companies away from the big four strategic partnerships and virtually all of those have some piece of asset-backed finance. It could be fund finance, it could be transportation, digital; it could be green energy, it could be residential. We're just seeing a tremendous amount of interest in this area. We've been building up the number of platforms. We have partnerships, flow agreements with banks. We've been making some smaller strategic investments from our partners as you know. We have a balance sheet light approach to this. But I think that market is something like a $5 trillion market, and the penetration remains very low and we have seen a big pickup in terms of our volumes in this area and I would expect you'll see more. I would also point out that the build-out of the AI infrastructure which Steve’s dwelled on, and I think is really important, much of that will be in asset-backed finance. And so if you think about financing data centers and financing the power that's going to support that, it will be ABF. And the fact that we have an enormous equity business that invests in scale in both of these areas and have a lot of expertise, makes credit investors and insurance companies particularly want to allocate more capital. So it feels to us like a very big market, early days in terms of penetration, and because these are long-duration assets, I think the holders really appreciate additional spread, and the dialogue in this area is as good as anywhere at the firm today."
},
{
"speaker": "Glenn Schorr",
"content": "Thanks Jon."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Crispin Love with Piper Stanler."
},
{
"speaker": "Crispin Love",
"content": "Thanks. Good morning, everyone. I appreciate you taking my question. Just a big picture question on the election, just with the U.S. election rapidly approaching. Can you speak to what you expect to be the biggest impacts due prior to the election, and then how that could impact near-term deployment and realizations? And then how you would also expect the differences between former President Trump or President Biden or perhaps another Democrat occupying the White House to impact Blackstone and the environment over the intermediate term and beyond, and how that could change your activity, just depending on what we see in November?"
},
{
"speaker": "Jon Gray",
"content": "You know, I think on the pre-election side, I think investors, frankly, are more focused on what's happening with the economy and in particular with inflation. I know there will be a lot of press coverage of course, rightfully on how the Democrats, Republicans are doing, how things look. But I think if we get good prints on inflation that gives the Fed more air cover to cut rates, that will be more determinative of how markets perform. So I think that is really the key thing to keep your eye on, even though there will be a lot of press focus on the election itself. I think post-election, you could see some very different policies. I would just back up and say look, we've operated in blue environments and red and purple environments, and the constant for us is delivering great returns for our customers and that's what we focus on. And we focus on a lot of these long-term trends that we've talked about, what's happening in digitalization, what's happening in power, in life sciences, the growth of the alternatives business, private credit. We think those are the long-term determinants of value. That being said, what happens here, there will be differences. There'll be differences in the regulatory front. Certainly if you had a Republican administration in areas like antitrust, you would see a different posture I would believe. On energy, you could see, obviously, a different approach on hydrocarbons versus renewables, and you have to factor that into investing. And you could see a very different policy in terms of tariffs broadening out and maybe being certainly higher, and you have to think about that in terms of manufacturing businesses. So the good news is, I think we have a pretty good sense of what that may look like, and we're really focused on the long-term in some of these big sectors where we think there are huge opportunities. And regardless of which side wins, I think those things will be really the critical item in terms of driving higher returns."
},
{
"speaker": "Crispin Love",
"content": "Thank you, Jon."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "All right, great, thanks. Good morning, folks. Maybe a question for Michael on FRE margin. Obviously, as you're scaling or I should say, as you are building the base management fees with the funds coming off holiday and new funds coming into market in ‘25 and obviously on the deployment on the credit side. As you think about ‘25 from an FRE margin perspective, I know Michael you've said you certainly want to scale the FRE margin over time. But should we be set up for a step-up in the FRE margin in ‘25, excluding the impact of whatever happens with fee-related performance fees? And then if you could just remind us of what the – what do you think the comp ratio overall on FRE per is maybe that depends by product. But I have a few questions in there, but basically FRE margin ex-FRE per is the base question."
},
{
"speaker": "Michael Chae",
"content": "Sure. Hey Brian. Look, I think the underlying sort of trajectory and the baseline for margins, certainly ex-FRE per, is one of stability in the near term, and we think operating leverage over the long term. I think you note correctly the two sort of key variables in the near term, fee holidays and that level of sensitivity to fee-related performance revenues on fee holidays, corporate private equity energy transition, both activated in this quarter, as I mentioned. We'll have some other funds that'll be in holiday proportions in the second half. So we'll come through that in the latter part of the year and into next year. Then second, that level of sensitivity to fee-related performance revenues. So core plus fee-related performance revenues do carry higher incremental margins generally as do direct lending incentive fees. On the other side for infrastructure, Q4 represents its first large crystallization. As we've been building and scaling out that business, it carries with it a modestly lower effective margin at this stage of its development. But of course, it's been performing extraordinarily well, and that's very positive for FRE on an absolute dollar basis. So overall, in the near term, we'd expect full year margins to be sort of in a reasonable range relative to last year, where it falls within that function of the factors I mentioned that you cited. Then longer term, that sort of picture of stability and over time of operating leverage. So, I think you framed the picture right. I think you alluded to the right couple of variables, and both the near term and into 2025. Obviously, on a long-term basis we're very comfortable and optimistic about it."
},
{
"speaker": "Jon Gray",
"content": "Thanks, Brian."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Ken Worthington with JPMorgan."
},
{
"speaker": "Ken Worthington",
"content": "Hi. Good morning. Thanks for taking the question. In terms of the secondary business, there's been an overwhelmingly positive course of commentary from the industry at large. Two things, maybe can you talk about deployment opportunities and the competitiveness of private equity secondaries these days? And then your secondary returns in your investment performance table has trailed private equity and other asset classes in recent years, I think in ‘23 up 2.5%, and in ‘24 up 3% to-date. As you go into flagship secondary fundraising, what anchors your confidence in being able to raise more money in the next vintage, and are returns a factor here?"
},
{
"speaker": "Jon Gray",
"content": "So a couple of things on the secondaries business. One, I would say is that if you just look at what's happening in alternatives, the growth in alternatives, which has been a double-digit grower now for a long period of time, what we've seen is the need for liquidity as an asset class grows. So that's why secondaries business continues to grow, and our business, which we started with 10 years ago at $10 billion has grown eightfold. So there's a need for liquidity. Even today, if you look at the volume of secondaries that trade, it's 1% to 2% of the underlying NAV in funds, which is very low for most asset classes in terms of liquidity. So there is, as alternatives grow, the fact that this sector, there's not enough liquidity today in the sector, and the sector is growing. It creates a secular opportunity. Also, as you know, in the institutional market what we've seen is a bunch of clients are over their targets, and that's creating a deployment opportunity. So I think we as the largest player in the space feel very good. When you comment on returns, if you look at those overall, they've been remarkably strong. Yes, in recent quarters not as strong, but since inception, mid-teens or higher returns, latest funds, high-teens net returns. So when we think about going back out to raise our next flagship fund, our confidence level is extremely high. Our last vintage, I think, was $22 billion for our private equity secondaries business. The team there, Verdun Perry has done an incredible job. Our expectation is we would raise something larger. So it feels like a segment that is well-positioned, that there is a bit of structural inefficiency that's allowed you to generate attractive returns. Clients are beginning to really recognize that the risk return is favorable, and we think it can continue to be a real growth driver here at Blackstone."
},
{
"speaker": "Steve Schwarzman",
"content": "Just to add onto and reinforce Jon's point. First of all, on the long-term track record, as Jon said, you can see in the investment record, 14% across the business. And in the two most recent sort of invested funds, 24% and 21% net. I would say in the last year or so, the return versus private equity, first of all there is as you know, a lag on the reporting of the secondary business relative to the underlying GPs. Moreover, I'd say the nature of the secondaries business is portfolios that tend to have more mature investments. So I think in terms of the cyclical rebound in returns, that will also lag and be more muted to some degree than the overall market, and what you'll see in our own private equity business. There's also a variable around the sort of the level of deal flow, a year ago and the benefit that comes from buying those funds at a discount to the fund returns in the short term. But long-term overall, it is an outstanding track record."
},
{
"speaker": "Ken Worthington",
"content": "Great. Thank you."
},
{
"speaker": "Jon Gray",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll go next to Dan Fannon with Jefferies."
},
{
"speaker": "Dan Fannon",
"content": "Thanks. Good morning. Jon, I was hoping you could expand a bit more on the fundamentals you're seeing in real-estate, which is obviously fueling some of the confidence around your accelerating deployment. I think you mentioned more buyers out in the market, but hoping to get a little more context around the broader real-estate environment."
},
{
"speaker": "Jon Gray",
"content": "So what we said on real-estate, and you guys know, because we've been certainly talking about it for some time, is there are a couple of, I'd say very positive signs that are emerging in the overall real-estate picture. Office, as we've said, is more challenged. Vacancy rates in office today are sort of mid-20s, and it's going to take a while to work through that. In the other sectors, the fundamentals are better. If you think about apartments and logistics in the U.S. 5%, 6% vacancy. Demand has softened a bit, but pretty steady I'd say in both of those areas. Very positively supply has come down 50%-ish in multifamily starts, 75% from the peaks in warehouse starts, so that's very good long term. But the near-term thing that has really impacted price and transaction volume has been cost and availability of capital. So, if you went back to the fall, the tenor was 80 basis points higher than it is today. Spreads were probably 100 or more basis points wider, and the CMBS market was basically closed. That's changed pretty significantly, and the result of that is, in those sectors where we have our greatest exposure, which would be logistics and rental housing, we see 2x, 3x more bidders showing up to buy assets. So I think that is clearly a positive. We have said we don't see some sort of rocket ship V-shaped recovery here. But we definitely have seen, if you look at the Green Street Property Report, six quarters, as I noted, where things have been flat and rising, and the sentiment's improving. So you've got a better cost of capital environment. You've got decent fundamentals, in that sense, the groundwork. And if you went back to the financial crisis of course, we started deploying in the summer of ‘09. There were still plenty of negative headlines from troubled deals for the next couple of years, and it was a great deployment period for us. There's some similarities we're seeing today. The sentiment, we think, will stay negative because there still will be some troubled assets to work through the system. But on the ground prices have cleared, and some of these headwinds have gone away, and that creates a favorable environment, and what we're doing now is seed planting for the future. So these huge public to privates we've done in the U.S., the big push in European logistics, we think this will pay real dividends for our investors over time."
},
{
"speaker": "Dan Fannon",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "We'll go next to Benjamin Budish with Barclays."
},
{
"speaker": "Benjamin Budish",
"content": "Hi. Good morning, and thanks for taking the question. I wanted to ask maybe a specific one on BPP. If you could give an update on sort of what's happening there with the redemption queue, and then it sounds like based on your optimism around, real-estate performance and inflows potentially picking up over the near to medium term, how should we think about the sort of inflows and outflows of that fund evolving over the next, say, six to 12 months? Thank you."
},
{
"speaker": "Jon Gray",
"content": "Yeah. In our Core+ institutional business, we've seen a little bit of a pickup. It's still single digit in terms of the redemption queue across our BPP product line. I think, as you know in this, different than what we have in our individual investor vehicle, that it's based on new capital coming in, in terms of providing liquidity over time, and the institutional investors have a recognition that it takes time in a period of like this to get liquidity. As I said earlier on fundraising, my expectation would be open-ended funds will take some time before investors feel a little more confident. We're starting to see some interest, particularly folks thinking about could they buy in at a little bit of a discount and so forth. But I think it's a question of working our way through the cycle. Again here, I think we've done a very nice job on how we've set these portfolios up for success over time in terms of the portfolio positioning. But I would say my expectations on inflows here would be a little bit muted over the near term. But as fundamentals, certainly as real-estate starts to deliver more positive performance, we can see the shift and that's exactly what happened. If you went back to the post-financial crisis period, interestingly what you see in that case is people want to get deployed and then they pull their redemptions from the queue. So in many cases, they get in the queue thinking about, well maybe I want liquidity. Then when the world turns, they pull that back. So, I think that could happen over time as well, and it is obviously a tie here to what happens in the cycle."
},
{
"speaker": "Benjamin Budish",
"content": "Got it. Thank you, Jon."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Brennan Hawken with UBS."
},
{
"speaker": "Brennan Hawken",
"content": "Good morning. Thanks for taking my questions. So, was curious, given the tightening of redemption limits that we saw at SREIT during the quarter, can you speak to the impact that you saw in the wealth market on the back of that? I mean, totally appreciate that BREIT is dramatically better positioned and you all actually allowed for more redemptions when above the limit and a clear sign of strength. So it's not really about BREIT specifically, but more about what SREIT, that impact that had on that market and maybe risk appetites. Thanks."
},
{
"speaker": "Jon Gray",
"content": "As you noted, there was a short-term impact in May in BREIT specifically as investors got nervous. We were able to assure investors that we managed the liquidity in a very differentiated way, and then we saw in June redemption specifically in BREIT come down pretty sharply 50% from May levels. As I noted in my remarks, month-to-date so far, they've come down additionally. We have not seen a dramatic change or frankly much of a change in terms of sentiment or what's happening in the private wealth channel. I think in real estate specifically, investors are still waiting and seeing here a bit, although we pointed out in the quarter, we had our best inflows in BREIT in a year. BCRED had its best quarter in two years in fundraising and BXPE has continued to raise significant money, and that has been a very successful launch in the first six months. Ultimately, this is about performance. That's what matters. That's what drives things. It's the same story as our institutional business. We are relentless in focusing on where we invest capital, how we manage the assets and how we deliver returns. If you look at BREIT since inception, remarkable double-digit net returns over 7.5 years, more than double the public REIT index. You look at the double-digit net returns in BCRED, the strong start for BXPE, this is what ultimately matters to our underlying clients, and this is what we've got to do. I think, frankly, getting through this downturn period and people seeing the semi-liquid structure work, I think will give additional confidence. So, as long as we continue to execute, I think that's the key in this private wealth channel. I feel good about our ability to do that. So our confidence in the channel remains extremely high."
},
{
"speaker": "Brennan Hawken",
"content": "Great. Thanks for that color."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go next to Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Okay, thank you very much. Maybe to pick up on the retail discussion, you were obviously very early and very prescient in terms of building the platform. However, the last number of years has been a very big pickup of focus and new players into that. So, I was wondering, as you look ahead, how you sort of see the evolution of the wealth management opportunity, certainly a big denominator. But how do you think the competition shakes out and how are the conversations with the financial advisors and intermediaries playing out in terms of how they are allocating to the bigger brands? Thank you."
},
{
"speaker": "Jon Gray",
"content": "Thanks, Bill. It's definitely an area of large-scale opportunity, and everybody in the industry is recognizing this now. I think credit to our firm to get into this well before other people, to focus on financial advisors and their underlying clients, to build out now a 300-plus person global team led by Joan Solotar that's focused on serving individual investors and also innovating, creating these perpetual products that brought costs down very significantly from what had existed historically in non-traded REITs, non-traded BDCs, and really innovating to create things that would work from a cost structure, tax standpoint, liquidity standpoint. So I think we will see more competitors move into the space. The advantage we have is our brand. I touched on it at the end of my remarks, but I think that is perhaps the most powerful asset of our firm along with our people. Investors know us, trust us, because we've done such a great job investing capital for four decades. The relationship and reservoir of goodwill we have with individual investors in in the products, in the results we've delivered in BREIT and BCRED, and in the drawdown funds that we have sold into the channel have built up a lot of positive feelings. So I think others will show, but we're continuing to innovate here. We talked about in the remarks, new products in infrastructure and multi-asset credit. I think the one advantage I'd say in this market versus the institutional market, there you can have thousands and thousands of individual private equity firms or real-estate firms, credit firms. I think when you get to private wealth, the brands are going to matter, the scale, the ability to service. I think it'll be a smaller number of players in that segment. It'll grow over time, but it requires something different. We have a pretty meaningful first mover advantage, $240 billion of total assets. We are absolutely committed to delivering great performance and great service to the underlying customer. So, we recognize it's going to be more competitive. Others will try to do things in the marketplace. We respect them, but we really like our first mover position in this very large and growing market."
},
{
"speaker": "Bill Katz",
"content": "Thanks Jon."
},
{
"speaker": "Operator",
"content": "Thank you. We'll go ahead to Patrick Davitt with Autonomous Research."
},
{
"speaker": "Patrick Davitt",
"content": "Hey. Good morning, everyone. Most of mine have been asked. I guess, the gross to net flow GAAP in AUM was fairly dramatic for a low realization quarter. So to what extent is that a result of the assets moving between strategies and/or funds? And if so, could you give the volume of that rotation that was included in gross flows, if any? Then taking a step back, is this a trend we should expect more of on a go-forward basis, or do you think 2Q was uniquely large? Thanks."
},
{
"speaker": "Michael Chae",
"content": "Yeah, I think Patrick, there has been over time a bit more of that dynamic that involves to some degree the open-ended funds and the nature of how those work. There have been some shifts in terms of allocation of capital between businesses that cross segments. Also, we had in the second quarter that the move from a reporting standpoint, a couple of businesses between credit and BXMA. So that's been – the nature of the business involves more of that, but it’s not – I think it's not going to be dramatically different over time."
},
{
"speaker": "Patrick Davitt",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take our last question from the line of Arnaud Giblat with BNP."
},
{
"speaker": "Arnaud Giblat",
"content": "Good morning. A quick question on the wealth channel. I'm just wondering if you could share with us why you think the European semi liquid products lag so much versus the U.S. products? And do you think that a refresh of the rules with the new ELTIF 2.0 rules are likely to offer material opportunity to grow in the European wealth channel?"
},
{
"speaker": "Jon Gray",
"content": "So we love Europe. I'll be there next week, but it is harder on the regulatory front. If you look at the European Union, you have a completely different set of rules for private wealth products, almost by country, and some of the rules, I do believe, need to be updated. The definitions of who can invest, the term professional investor, which is technical. There are a lot of limitations by country, and the structures you can use are very different. So you have to attack Italy different than Switzerland and Spain or Germany. We built up a lot of capabilities. We're having some success today with our European direct lending platform, although it's still small. I think European investors ultimately will want the same thing as U.S. investors. They tend to be a little more risk averse as you know, but I think their desire for strong returns in a product that's designed and works for them will be high. We're a persistent bunch. We're going to stick at it in Europe. We do want to work with the regulators to try to make this a little bit more of a user-friendly environment. The distributors, the big financial institutions recognize this as well. So I think it's a long-term process. I think it can change. We've seen some changes in places like Japan that were conducive to selling some of these private wealth products. I think we will over time hopefully see changes in Europe, because I think the products make a lot of sense for customers. So, we'll stick at it, and it's probably going to take some time."
},
{
"speaker": "Operator",
"content": "Thank you. That will conclude our question-and-answer session. At this time I'd like to turn the call back over to Weston Tucker for any additional or closing remarks."
},
{
"speaker": "Weston Tucker",
"content": "Thank you everyone for joining us today, and look forward to following up after the call. Have a great day."
}
] |
bx | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day. And welcome to the Blackstone First Quarter 2024 Investor Call. Today's conference is being recorded. At this time, all participants are in a listen-only mode [Operator Instructions]. At this time, I'd like to turn the conference over to Weston Tucker, Head of Shareholder Relations. Please go ahead."
},
{
"speaker": "Weston Tucker",
"content": "Thanks, Katie, and good morning, and welcome to Blackstone's first quarter conference call. Joining today are Steve Schwarzman, Chairman and CEO; Jon Gray, President and Chief Operating Officer; and Michael Chae, Chief Financial Officer. Earlier this morning, we issued a press and slide presentation, which are available on our Web site. We expect to filed our 10-Q report in a few weeks. I'd like to remind you that today's call may include forward looking-statements, which are uncertain and may differ from actual results materially. We do not undertake any duty to update these statements. For discussion of some of the factors that could affect results, please see the risk factors section of our 10-K. We'll also refer to certain non-GAAP measures and you'll find reconciliations in the press release on the shareholders page of our Web site. Also note that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Blackstone fund. This audiocast is copyrighted material of Blackstone and may not be duplicated without consent. So on results quickly, we reported GAAP net income for the quarter of $1.6 billion, distributable earnings were $1.3 billion or $0.98 per common share and we declared a dividend of $0.83, which will be paid to holders of record as of April 29th. With that, I'll turn the call over to Steve."
},
{
"speaker": "Steve Schwarzman",
"content": "Good morning, and thank you for joining our call. Blackstone reported strong results for the first quarter of 2024, including healthy distributable earnings of $1.3 billion as Weston mentioned, underpinned by the highest fee related earnings in six quarters. On our January earnings call, following a volatile multi-year period for global markets, we noted an improving external environment and shared our view that 2023 would be the cyclical bottom for our firm. While changing market conditions take time to translate to financial results, including realizations and performance revenues, we are seeing positive momentum across many key forward indicators at our firm. Inflows were $34 billion in the first quarter and $87 billion over the past two quarters. We invested $25 billion in quarter one and $56 billion in the past two quarters with a strengthening pipeline of new commitments. We’re planting the seeds of future value and what we believe is a favorable time for deployment. At the same time, our fundraising in the Private Wealth channel meaningfully accelerated in the first quarter. Sales for our perpetual life vehicles increased more than 80% from the fourth quarter to $6.6 billion. We've stated before that short term movements in stock and bond markets impact capital flows in this channel. But ultimately, flows follow performance as well as innovation as we're seeing now. We've delivered 10.5% net returns annually for BREIT's largest share class over more than seven years and 10% for BCRED over three plus years. And we continue to successfully launch new strategies, including our private equity vehicle, BXPE, in the first quarter. With $241 billion of AUM in Private Wealth at Blackstone, we have the leading platform in our industry by far. We've established a significant first mover advantage with the number one market share for each of our major season products, along with a high percentage of repeat business across strategies. Blackstone is built on long term investment performance. We've achieved 15% net returns annually in corporate private equity and infrastructure since inception, 14% in opportunistic real estate and secondaries, 12% in tactical opportunities and 10% in credit. In the first quarter, our funds reported steady appreciation overall, highlighted by strength in infrastructure, credit and our multi-asset investing platform, BXMA. Our portfolio is in excellent shape, and our limited partners continue to benefit and we've positioned their capital, emphasizing new neighborhoods, such as digital infrastructure, logistics and energy transition. The firm's thematic approach to deployment is informed by the real time data and insights we gather from our global portfolio, which helps us to identify trends early and build conviction around our ideas. Blackstone is the largest and most diversified firm in the alternatives area with over $1 trillion of assets under management and we believe our knowledge advantage consequently is a unique asset in our industry. For example, digital infrastructure, one of the firm's highest conviction investment themes today, is a powerful example of this knowledge advantage at work. Just as we recognized the rise of e-commerce nearly 15 years ago and started buying warehouses, we anticipated a paradigm shift around demand for data centers, driven by growth in content creation, cloud adoption and most importantly now, the revolution underway in artificial intelligence. Others now know that AI requires exponentially more computing power and capacity than was previously imagined. On a personal basis, in less than two weeks, I am participating in the dedication ceremony for the Schwarzman College of Computing at MIT, which will be heavily focused on this area. What has Blackstone done with our conviction? We identified QTS, the fifth largest US data center REIT as a well positioned but poorly trading public company with tremendous long term potential. Our BREIT, BIP Infrastructure and BPP perpetual strategies acquired the company for $10 billion in 2021, and its lease capacity has already grown sixfold in less than three years. Today, QTS is the largest data center company in North America. We are building a variety of other center platforms around the world as well. In total, Blackstone vehicles now own $50 billion of data centers globally, including facilities under construction. And there is an additional $50 billion in prospective future development pipeline. Blackstone is highly differentiated in our ability to conceptualize the new business area and transform it into a $100 billion potential opportunity. We are also actively investing in other companies in AI related areas. We're buying as well as financing several firms that design, build and service data centers. We recently financed a cloud infrastructure business supporting AI development. And now we've transitioned to addressing the sector's growing power needs, leveraging our sizable energy infrastructure platform, which includes the largest private renewables developer in North America. There are several other powerful megatrends that we expect to drive the firm forward, both in terms of where we invest and where we raise capital. The most compelling of these today include the secular rise of private credit, where we have one of the world's largest platforms; infrastructure, energy transition, life sciences and the expansion of alternatives globally and particularly in Asia. In each of these areas, we've established leading platforms with tremendous momentum. Looking forward in 2024, the market environment will remain complex. The economy is stronger than expected but is starting to slow a bit. In terms of inflation, despite the recent US CPI readings, we are seeing a decelerating wage growth and minimal input cost increases across many of our companies. In real estate, we see shelter costs moderating, contrary to government data. We believe inflation will trend lower this year, although, the pace of decline has slowed recently. Geopolitical turbulence, including wars in the Middle East and Ukraine, adds further uncertainty to the business environment. And 2024 is a major election year as we all know with nearly half of the world's population going to the polls, which injects unpredictability around the future of important policies that impact the global economy. Blackstone is well positioned against this evolving backdrop. Our portfolio is concentrated in compelling sectors and we have the industry's largest dry powder balance of nearly $200 billion to take advantage of opportunities. Our long term capital provides the flexibility and firepower to invest while affording us the patience to sell assets when the time is right. The firm itself could not be in a stronger position with minimal net debt and no insurance liabilities, allowing us to distribute $4.7 billion to shareholders over the past 12 months through dividends and share repurchases. And we are in the early days of penetrating markets of enormous size and potential. With that, I'll turn it over to John."
},
{
"speaker": "Jon Gray",
"content": "Thank you, Steve, and good morning, everyone. We are pleased with the firm's performance in the first quarter and the momentum building across our business. This momentum is underpinned by three key developments; first, the transaction environment has strengthened; secondly, in private credit, demand from both investors and borrowers is expanding; and third, our private wealth business is reaccelerating. I'll discuss each of these areas in more detail, starting with the transaction environment. The market backdrop has become more supportive. The 10 year treasury yield is still down from its October peak despite the recent run-up. Borrowing spreads have tightened significantly and the availability of debt capital has increased significantly. We're also seeing M&A activity and the IPO market restarting. As we've stated before, the recovery will not be a straight line but we're not waiting for the all-clear sign to invest. We deployed $25 billion in the first quarter and committed an additional $15 million to pending deals, including subsequent to quarter end. We were most active in our credit and insurance area, which I'll discuss further in a moment. In real estate, we shared our view in January that commercial real estate values were bottoming, providing the foundation for an increase in transaction activity. This has coincided with several major investments by Blackstone. Just last week, we announced a $10 billion take-private of a high quality rental housing platform, Air Communities, which follows our announcement in January to privatize Tricon Residential. Rental housing remains a major investment theme for us given the structural shortage in this space. US is building roughly the same number of homes today as in 1960 despite having almost twice the population. We are also quite focused on European real estate where we've now raised $7.6 billion for our new flagship vehicle as of quarter end. In private equity, we closed the acquisition of Rover in the first quarter, a leading digital marketplace in the pet space, along with an online payments business in Japan and a healthcare platform in India. The economy in India, which I visited two weeks ago, remains incredibly strong. We're fortunate to have what we believe is the largest private equity and real estate platform in that country. Back home, our dedicated life science business announced a $750 million collaboration with Moderna to support the development of mRNA vaccines for influenza. And our growth equity fund invested in 7 Brew, an innovative quick service coffee franchisor. As Steve highlighted, we are planting the seeds of future realizations. Turning to the second key development, our expansion in private equity credit. There is powerful innovation underway in the traditional model of providing credit to borrowers. Our corporate, insurance and real estate debt businesses comprise over 60% of the firm’s total inflows in the first quarter and nearly 60% of deployment. We continue to see strong interest in non-investment grade strategies, such as opportunistic, direct lending and high yield real estate lending. We're also now seeing a dramatic increase in demand from our clients for all forms of investment grade private credit, including infrastructure, particularly in energy transition and digital infrastructure, residential real estate, commercial and consumer finance, fund finance and other types of asset based credit. In our investment grade focused business, we believe there is a massive opportunity to deliver higher returns to clients with lower risk by moving a portion of their liquid IG portfolios to private markets. Alternatives have taken meaningful share of public equity portfolios over the past 30 years but little on the fixed income side. In the insurance channel, this migration has been underway and we've created a capital light, open architecture model that can serve a multitude of limited partners. Worth noting we crossed the $200 billion AUM milestone in insurance this quarter, up 20% year-over-year. In addition to our four largest clients, we now have FMA relationships with 14 insurers, which continue to grow in number and size. We placed or originated $14 billion of A-rated credits on average for them in the first quarter, up 71% year-over-year and nearly $50 billion since the start of 2023. These credits generated approximately 200 basis points of excess spread over comparably rated liquid credits. In addition to insurance clients, pension funds and other LPs see the value we're creating in private credit, and there's been a strong response to our product offerings. With nearly $420 billion in BXCI and real estate credit, we're extremely well positioned to directly originate high quality assets on behalf of a much larger universe of investors. We've also established numerous origination relationships as well as bank partnerships, most recently with Barclays and KeyBank in areas like consumer credit card receivables, fund finance, home improvement and infrastructure credit, and we plan to add more. These arrangements are a win-win. They create more flow for our investors who want to hold these investments, these assets long term, and they help our partners better serve their customers. We expect our credit and insurance platforms to grow significantly from here. Moving to the third key development, the reaccelerating trends in our private wealth business. In January, we noted our momentum building as market volatility receded. And with the launch of BXPE, we now offer three large scale perpetual vehicles, providing individual investors access to even more of the scale and breadth of Blackstone. Our sales in the wealth channel were a robust $8 billion in the first quarter, including $6.6 billion for the perpetual strategies, as Steve noted. Subscriptions for the perpetuals increased 83% from Q4 and marked the best quarter of fundraising from individuals in nearly two years. BCRED led the way, raising $2.9 billion. BXPE has received very strong investor reception, raising $2.7 billion in its debut quarter, and we plan to expand to more distributors over the coming months. Over 90% of advisers that have transacted with BXPE have previously done so with BREIT or BCRED, illustrating the affinity for our products and the power of the Blackstone brand in this channel. At the same time, BREIT has successfully navigated a challenging two year period for real estate markets. Its semi-liquid structure has worked as designed by providing liquidity while protecting performance. BREIT has delivered double the return of the public REIT index since inception over seven years. This outperformance continued with strong results in Q1, underpinned by outstanding portfolio positioning that includes growth in its data center exposure. Repurchase requests in BREIT have fallen 85% from the peak to the lowest level in nearly two years and the vehicle is no longer in proration. We're now seeing encouraging signs in terms of new sales while repurchase requests are continuing their decline in April as well. We are confident in the recovery of BREIT flows over time given performance. When looking at the $80 trillion private wealth landscape overall, allocations remain extremely low, and we expect a long runway of growth ahead. In closing, the firm is exceptionally well positioned, supported by both cyclical and secular tailwinds, that's why we believe the future is very bright for Blackstone. With that, I'll turn things over to Michael Chae."
},
{
"speaker": "Michael Chae",
"content": "Thanks, Jon, and good morning, everyone. Firm delivered strong results in the first quarter, highlighted by the reacceleration of fee related earnings. I'll first review financial results and will then discuss investment performance and the forward outlook. Starting with results. Fee related earnings increased 12% year-over-year to $1.2 billion or $0.95 per share, the highest level in six quarters and the third best quarter in firm history, powered by double digit growth in fee revenues, coupled with the firm's robust margin position. With respect to revenues, the firm's expansive breadth of strategies lifted management fees to a record $1.7 billion. Notably, Q1 reflected the 57th consecutive quarter of year-over-year growth of base management fees at Blackstone. Fee related performance revenues doubled year-over-year to $296 million generated by multiple perpetual capital vehicles in credit and real estate, including a steadily growing contribution from our direct lending business, scheduled crystallization in our European BPP logistics strategy and BREIT. The setup for these high quality revenues is favorable in 2024 and beyond, which I'll discuss further in a moment. With respect to margins, FRE margin was 57.9% in the first quarter, in line with full year 2023. Distributable earnings were $1.3 billion in the first quarter or $0.98 per common share, stable year-over-year and underpinned by the growth in FRE. Net realizations remain muted at $293 million. And going forward, we expect a lag between improving markets and a step-up in net realizations. In the meantime, the firm's strong underlying FRE generation has supported a consistent and attractive baseline of earnings with Q1 representing the 10th consecutive quarter of FRE over $1 billion. We did execute a number of sales in the quarter, including a stake in one of the largest cell tower platforms, public stock of the London Stock Exchange Group and the sales of certain other public and private holdings. We also closed or announced several dispositions in our real estate and infrastructure perpetual vehicles, which as a reminder, do not earn performance revenues based on individual asset sales but on NAV appreciation. These included a trophy retail asset in Milan for EUR1.3 billion, representing the largest real estate single asset sale ever in Italy, portfolio of warehouses in Southern California and a prime office building in Seoul. Each of these sales generated a substantial profit individually and in aggregate, a gross multiple of invested capital of approximately 2 times. These dispositions exemplify the significant quality and embedded value within the firm's investment portfolio. Turning to investment performance. Our funds generated healthy overall appreciation in the first quarter, as Steve noted. Infrastructure led the way with 4.8% appreciation in the quarter and 19% over the last 12 months with broad gains across digital, transportation and energy infrastructure. The QTS data center business was the single largest driver of appreciation for BIP, BREIT and BPP US and for the firm overall in Q1. The comingled BIP vehicle has generated 15% net returns annually since inception, powering continued robust growth with platform AUM increasing 22% year-over-year to $44 billion. The corporate PE funds appreciated 3.4% in the quarter and 13% for the LTM period. Our operating companies overall reported healthy, albeit decelerating, revenue growth along with margin strength. In credit, we reported another outstanding quarter in the context of strong fundamentals and debt marks generally and tightening spreads with a gross return for the private credit strategies of 4.1% and 17% for the LTM period. The default rate across our nearly 2,000 noninvestment grade credits is less than 40 basis points over the last 12 months with zero new defaults in our private credit business in Q1. Our multi-asset investing platform, BXMA, reported a 4.6% gross return for the absolute return of composite and 12% for the last 12 months, the best quarterly performance in over three years and the 16th quarter in a row of positive returns. Since the start of 2021, the composite has delivered nearly double the return of the 60-40 portfolio net of fees, a remarkable result in liquid markets. Finally, in real estate, the Core+ funds appreciated 1.2% in the first quarter, while the BREP opportunistic funds appreciated 0.3%. These returns include the negative impact of currency translation for our non-US holdings related to the stronger US dollar, equating to 20 and 60 basis points impact on each strategy respectively. As Jon noted, we see a recovery under way in commercial real estate, and in our portfolio cash flows are growing or stable in most areas. Overall, strong returns lifted net accrued performance revenue on the balance sheet, affirmed store value sequentially to $6.1 billion or $5 per share. Meanwhile, performance revenue eligible AUM in the ground increased to a record $515 billion. The resiliency and strength of the firm's investment performance over many years and across cycles powers the Blackstone innovation machine and provides the foundation of future growth. Moving to the outlook, where several embedded drivers support a favorable multiyear picture of growth. First, the firm has raised approximately $80 billion that is not yet earning management fees and new drawdown fund vintages that haven't yet turned on along with certain other funds. These will commence when investment periods are activated or capital is deployed depending on the strategy. We plan to activate our corporate private equity flagship this quarter, which has raised over $19 billion to date, followed by an effective four month of fee holiday. We expect to activate several other drawdown funds over the balance of the year followed by respective fee holidays. Second, our platform perpetual strategies has continued to expand, now comprising 45% of the firm's fee earning AUM. As a reminder, our private wealth perpetual vehicles, including BREIT and BCRED, generate fee related performance revenues quarterly as will BXPE starting in Q4 of this year. Our institutional strategies, BPP and real estate and BIP and infrastructure, generate these revenues on multiyear schedules with a sizable crystallization for the comingled BIP vehicle scheduled to occur in Q4 of this year with respect to three years of accrued gains. Third, our investment grade focused credit business is on a strong positive trajectory, as Jon highlighted, and we expect $25 billion to $30 billion of inflows again this year from our four major insurance clients [alone]. In closing, the firm is moving forward in a position of significant strength. Our momentum is accelerating in key growth channels and our underlying earnings power emerging from this period of hibernation continues to build. We have great confidence in the outlook for the firm. With that, we thank you for joining the call. I would like to open it up now for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We'll go first to Michael Cyprys with Morgan Stanley."
},
{
"speaker": "Michael Cyprys",
"content": "I wanted to dig in on infrastructure, the platform continues to build, I heard $44 billion AUM, strong returns, 15% net. Maybe you could just update us on the platform build-out, the initiatives here that can help accelerate growth. It seems like there's a tremendous market opportunity out there. Just curious what you see as the gating item on seeing this business multiples of the size, maybe talk about some of the steps you're taking around expanding your origination funnel and infrastructure and as well as expanding the vehicles for capital raising across the return spectrum and customer sets globally?"
},
{
"speaker": "Jon Gray",
"content": "Infrastructure is clearly an area with a lot of potential for us. As a reminder, our program is less than six years old at this point, and we're already at $44 billion. The key, like building everything we do is delivering performance for the customers. Sean Klimczak and the team have delivered 15% net returns since inception in an open ended vehicle, which is different than many of the other players in the space. We think that is a very powerful model because it allows us to partner with other long term holders and it matches the duration of the capital to long duration infrastructure. We positioned the business in three big areas; transportation infrastructure, coming out of COVID; energy and energy transition, obviously, a very important area today for a whole host of reasons; and then digital infrastructure, which Michael pointed out, has been the biggest driver of value both in real estate and in infrastructure and across the firm in this most recent quarter. So we think we've done a really exceptional job deploying the capital. We have a lot of clients who are quite pleased. I think the base business can grow. And I think there are opportunities geographically to expand this. Our current fund is focused primarily on the US but we've done a number of large things in Europe. And I think there's opportunities in infrastructure in both Europe and Asia over time, and it's an area that we have real strength. I would add to the mix, infrastructure credit, something we're doing as well. And interestingly, when you think about what we're doing for insurance clients, what we have in infrastructure and things like digital infrastructure, green energy, it's very helpful for investment grade debt as well given our insights and relationships. So this is an area where we're still seeing investors showing a lot of enthusiasm. I think it will continue to be a growth area on the back of what we built. I think we can create other products. And we see this growing to be, I think, as we've talked about in previous calls, a triple digit AUM business."
},
{
"speaker": "Michael Chae",
"content": "And Jon, I'd just add on, and I think you might agree that, I think if you step back, Mike, you could analogize it’s sort of the multi decade growth path of real estate, that business overall with respect to another area of relapse that's infrastructure, and that is geographic/regional expansion, expansion up and down the risk return spectrum, cross asset classes between equity and debt and also serving different customer channels, whether it's retail insurance or institutional. So that's another way to dimension it."
},
{
"speaker": "Operator",
"content": "We'll go next to Craig Siegenthaler with Bank of America."
},
{
"speaker": "Craig Siegenthaler",
"content": "My question is on real estate. So with deployments picking up with both the Tricon and Apartment Income take privates, and John, I heard your comments earlier this morning, but it sounds like the Blackstone house view is that the work from home and interest rate hit are now baked into cap rates. So given all this, can you comment on where we are in the investing cycle, be it dry powder at BREP, BPP and BREIT? And I also wanted your perspective on returns now that BREIT is back above its [prep] putting 2Q in a better position for [FRPR]?"
},
{
"speaker": "Jon Gray",
"content": "As we've talked about and you noted, there have been two big headwinds here. One in the office sector, specifically in the US where we have very little exposure, the impact of remote work and also capital needs in older office buildings. The second thing has just been the movement upward in interest rates and the rise in spreads that happened. And both of those, I believe, peaked back in October and that has really worked its way through the market. Interestingly, of course, there'll still be plenty of challenging headlines from assets that were financed in a different environment as they work their way through the system, and that's sort of -- it's almost as if something happened to a ship at sea and then it comes ashore. We saw this after the financial crisis where real estate values bottomed in that summer of '09 but you had negative headlines in real estate for the next three years. We spent a lot of that time, of course, deploying capital into that dislocated period where people were still cautious. What gives us confidence as we look forward here is one is this reduction in cost of capital. We've obviously seen spreads tighten a fair amount, probably 125 basis points in CMBS in the first quarter and through the end of the fourth quarter last year. We also saw CMBS issuance go up fivefold versus the first quarter of 2023. So that -- and the fact that the Fed at some point here will be bringing rates down, and that's important as well. The other thing I'd add is on the supply front. We've seen in logistics an 80% decline in new starts. We've seen in multifamily a 50% decline in peak starts -- from peak starts as well. And so that starts to lay the groundwork. In terms of timing, I would think about this period of time is a time of seed planting that you want to be investing into this dislocation because there's a lot of uncertainty, there maybe [fore sellers], there maybe public companies trading at discounts. And then over time, as things start to normalize, you start to accelerate on the realization. But first, I think it's the deployment period then the realization period as you move out similar to that post GFC period, that's certainly the way we're playing it. And in terms of capital, we obviously have a very large $30 billion global fund. We said we've raised over 7.5 in Europe, we have most of our $8-plus billion Asia fund still uninvested. So a lot of opportunistic capital to deploy. So we're forward leaning as it relates to deployment, even though we recognize there's still going to be a lot of assets from the previous period working their way through the system."
},
{
"speaker": "Operator",
"content": "We'll go next to Alex Blostein with Goldman Sachs."
},
{
"speaker": "Alex Blostein",
"content": "My question is around BXPE. Really strong momentum out of the gate, obviously, $2.7 billion that you guys highlighted this quarter and over the last couple of months. What's the vision for this product, I guess, in terms of both capacity and maybe the appropriate size for the strategy as well as the pace at which you feel comfortable taking in inflows? And I don't want to draw too much parallel with BREIT, obviously, very different product, very different customer base. But thinking of that one, I think, peaking at north of $70 billion, how are you thinking about the size and opportunity for BXPE?"
},
{
"speaker": "Jon Gray",
"content": "Well, I think it's a great question, Alex. One of the things we did when we designed BXPE was to make the platform as broad as possible so that we could scale the product and we could be flexible on behalf of investors in terms of where we deployed it. So control large scale private equity is part of it; US, Europe, Asia is part of it; Tactical Opportunities, more hybrid equity, part of it; life sciences growth, part of it; secondaries, infrastructure, some opportunistic credit. It's a very broad platform and it enables us to deploy a lot. One of the advantages of Blackstone is just our scale and the amount of deal flow we see across all these different areas. And particularly our connectivity with many other sponsors in the private equity space through our secondaries, our credit business, our GP stakes business, we can be great partners to those folks. Obviously, we can manufacture a lot of transactions ourselves. So we think the potential scale here is quite large. You pointed out BREIT scale, we're over $30 billion of equity, nearly $60 billion of assets in BCRED. We think this can grow a lot. The key is we have to deliver strong performance to the underlying customers. We have to be disciplined in how we deploy capital and thoughtful. I think we've been doing that. I think we'll continue to do that. And that's what gives us a lot of confidence, which is investors want exposure to private equity, individual investors want a little bit of a different structure, and that's why I think BXPE is so attractive. So I think as we come out of this period over the last two years where there's been a lot of caution and negativity, as market sentiment improves, as we show the strong performance from our other individual investor products, I think there's a potential here of pretty good size. Again, we've got to do a good job deploying capital but I've got a lot of confidence, particularly given the breadth of the platform. So the short answer is I think this can grow to be much larger than it is today."
},
{
"speaker": "Operator",
"content": "We'll go next to Dan Fannon with Jefferies."
},
{
"speaker": "Dan Fannon",
"content": "Michael, last quarter, the message for this year on margins was stability. The first quarter was flat with last year. As you think about the momentum in the business that you highlighted and the prospects for growth and growth in AUM, how are you thinking about margins as you think about the rest of the year?"
},
{
"speaker": "Michael Chae",
"content": "I think my message is consistent. First of all, in terms of the actual result, as you noted in the first quarter, quite stable, quite consistent, quite in line with both the first quarter a year ago and the full year 2023. I think, as always, we guide people to look not at individual quarters but at sort of the -- on a full year basis. And I think on that basis, we would again encourage people to think about this as -- reinforce margin stability as a guidepost. And then, again, consistent with our message over a long time, on a longer term basis, we do think there's operating leverage built into our model. We obviously actively manage our cost structure. And we think long term, there is a -- it's a robust margin position that we’ll scale and leverage over time. So back to where we started, I would reinforce margin stability as the message and over the long term, feel optimistic about the ability to increase that."
},
{
"speaker": "Operator",
"content": "We'll go next to Glenn Schorr with Evercore ISI."
},
{
"speaker": "Glenn Schorr",
"content": "I got a question to peel back the onion a little bit on this commentary on bank partnership. So when we watch you do something like Barclays where you've taken a credit card book and give to your insurance clients, that makes sense to us, that's like a cash transaction, it's tangible. So we read a little more about the rising of synthetic risk transfer trends. And I'm just curious, that's something that's obviously harder for us to follow. It gives us shivers. It reminds us about 16 years ago. Curious of your thoughts on how much SRT is going on in the industry, how much you do, and maybe you can talk about what type of partnerships you envision going forward?"
},
{
"speaker": "Jon Gray",
"content": "SRTs are an area we're very active. I think we're the market leader today in terms of working with our bank partners. For them, these are capital relief transactions, as you know, where you're sharing in or taking first loss positions. We've been doing this with a variety of banks who are highly creditworthy institutions. One of the advantages we have is the strength we have across asset ownership and also corporate and real estate credit. So if we do these with bank partners, we can go through them in detail. The most active area has been subscription lines to date, which as you probably know, subscription lines to private equity firms have had virtually no defaults over the last 30, 40 years. So we like that area. When we work in investment grade or noninvestment grade, much of it's been around revolvers, which historically have had much lower loss ratios. And we were able to go through these portfolios and look at the credits we're taking. We do this, of course, not as Blackstone but on behalf of our investors in various vehicles and funds. The returns -- we've been doing this, by the way, for a number of years. And I just think our ability to look at the underlying credit as opposed to just make a macro call is our competitive advantage and our ability to do this and scale with the bank. So I see this as a win-win. It helps banks with some of the Basel pressure, balance sheet pressures they have and we're able to generate favorable returns. So I think this is a very good thing for the system overall. I think we're doing it in a quite responsible way. Our team is very experienced in how they execute these transactions."
},
{
"speaker": "Operator",
"content": "We'll go next to Crispin Love with Piper Sandler."
},
{
"speaker": "Crispin Love",
"content": "So in recent weeks, there's definitely been a shift in the rate outlook as we're likely in a higher for longer scenario, which is very different than just three months ago. So can you just talk a little bit about how that might impact your outlook for investment activity and putting dry power to work going forward and then just how it might shift the areas where you're most excited about deploying capital?"
},
{
"speaker": "Jon Gray",
"content": "Well, I do think it extends the investment window a bit for our $191 billion of dry powder. I think as people were getting closer to anticipating rate cuts, you saw big rallies in both equity and debt markets and that can make it a little bit tougher to deploy capital. In some ways, it's helpful for financings but it also can drive prices up. From our perspective, because we're buying assets so often for longer periods of time, the fact that a rate cut may happen 90 days or 180 days later is not really a long term negative and if anything, allows us to get into some assets at more favorable pricing. So the way I would think about it is it extends out to deployment period. It may slow some of the realizations and push them out a bit as well. But when we think about delivering value for our customers, we see it as a positive. Obviously, for businesses like our credit business, which is mostly floating rate, it enhances returns for our underlying customers. I do think it's important to note that unlike October and the end of the summer when rates moved and spreads really gapped out, we haven't seen that accompanying change. So market seem to be in a much healthier spot. But I do think it probably prolongs the investment window here. And as we keep saying, we're not going to wait for the all-clear sign. You saw a big ramp-up. We had $25 billion of deployment in the quarter. And I think in terms of commitments and then as of quarter end-plus beyond the quarter end, we have another $15 billion that's committed. So you're seeing us move. We did our first deal in growth in quite some time. Real estate, we've talked about, we’ve obviously accelerated there. In our secondaries business, the pipeline of deals we're looking at is about 2x where it was 90 days ago. So we're seeing a pickup in activity. It won't be everywhere. But I do think it creates more of a chance for us to deploy capital at prices we find attractive."
},
{
"speaker": "Operator",
"content": "We'll go next to Brian Bedell with Deutsche Bank."
},
{
"speaker": "Brian Bedell",
"content": "Maybe just to add on to that question on that pace of deployment in two specific areas, real estate and credit. Just going back to the comment you just made, Jon, about extending the period. But does that make you sort of more excited about potential opportunities given that’s extension of the period that could depress prices in real estate? And with massive dry powder, especially in real estate, could that bring that level of deployment back up to sort of prior year levels in the mid to high $40 billion ranges? And then just secondarily in private credit, a little different dynamic with less dry powder but more fundraising. So I guess, same question there or do you think you can get up to sort of similar types of record levels in the mid to high $40 billions in like on, say, for 2024 for deployment?"
},
{
"speaker": "Jon Gray",
"content": "Brian, it's hard to put numbers on things, so I'll talk about it directionally. I do think when rates go up, the market tends -- the public markets tend to move much more than what we see in the private market. So for real estate, I do think that creates more opportunity for scalable deployment as some of those stocks move on, particularly if the debt market hangs in there. And so that disconnect can create opportunity. We've seen a pickup in Europe in real estate as well, some of that relating to distress, and there's very negative sentiment, even though the fundamentals on the ground are actually pretty good in our chosen sectors. And we're seeing overall in Europe, I think there, we'll see rates come down more quickly than the US, which is helpful. So short answer, yes, it should help real estate deployment. On private credit, we've got a lot of momentum, particularly in the investment grade and asset based -- asset backed area, that's where we're probably most active right now. The need for capital around digital and energy infrastructure, enormous. The needs for power tied to digital infrastructure but also electrification of vehicles, reshoring, very significant. And there's going to be a huge need for capital. So we see that almost regardless of the interest rate environment. I do think on the direct lending side, we've seen some spread tightening. Rates coming down will be helpful to see deal activity and I think at that point, we'll see a pickup. But regardless, our pipeline and credit both on the investment grade and noninvestment grade size has accelerated. So it's hard to say exactly how this happens but we feel good about the momentum and deployment. And I use my very scientific briefcase indicator, how many investment memos I'm taking home over a weekend, and it’s definitely been trending up. So I think that bodes well. It's hard to predict exactly how it manifests itself. But it feels like, certainly, this will be a more active year than last year for deployment."
},
{
"speaker": "Operator",
"content": "We'll go next to Ken Worthington with JPMorgan."
},
{
"speaker": "Ken Worthington",
"content": "Looking into BPP, net accrued performance revenue, $73 million. I assume, down on this quarter's crystallizations. But IRRs are down to 6%, which I think is below the hurdle rate there. I know BPP is a collection of front end investments, like BioMed and Mileway. What needs to happen here for returns to recover and accrued performance fees to build into what I think are big crystallizations anticipated for next year?"
},
{
"speaker": "Jon Gray",
"content": "So Ken, you pointed it out correctly. It's a bunch of different vehicles with different hurdle rates and different performance, some of which obviously are at higher levels, some at lower levels. It feels to us, as we've been talking about, that real estate has moved towards this lower ebb. And it's fortunately a cyclical business, right? When you stop building new supply, as the cost of capital comes down, you get a recovery, and if you look back over time to the early '90s after the 2001 downturn, certainly after the GFC. The great thing is these are long duration vehicles. The capital is going to stick with us for quite some time. And ultimately, we'll get other opportunities when these crystallization events come up. And so I would say the fact that we think we're positioned in some really good sectors, really good geographies, we have big exposure to logistics, in Europe in particular. We've got some really high quality -- we have data centers in some of our investment vehicles here as well. I would say, overall, it's a combination of the quality of what we own and the sentiment in the sector improving. And when that happens, we'll get these unrealized performance fees that happen on a regular basis. So to me, it's a matter of time. It goes to the larger issue of a large portion of our earnings in hibernation, the fact that we're still able to earn $0.98 even though incentive fees are well off what we think their long term potential are, realizations in our opportunistic funds and private equity funds below potential. I think there's a lot of embedded upside in this firm, and you pointed out to one area of BPP. It's hard to put an exact date because it's going to be a function of sort of the pace of the recovery. But we're pretty confident that commercial real estate over time recovers and that foundation is starting to come into place."
},
{
"speaker": "Operator",
"content": "We'll go next to Ben Budish with Barclays."
},
{
"speaker": "Ben Budish",
"content": "I wanted to follow up on, I think, Dan's question earlier on the margins. Just a couple of kind of housekeeping items maybe for Michael. On the fee related performance comp ratio, it looks like that has been sort of trending -- it was a bit lower in the quarter than we expected, and it looks like it's been a little bit volatile over the last like year or so versus sort of 40% range we tend to expect. So any color there? And then sort of on the same lines, the stock based comp stepped up a little bit in the quarter. Just curious how we should be thinking about that trending throughout the rest of the year."
},
{
"speaker": "Michael Chae",
"content": "I think on the margins on the fee related performance revenues, there is variability over time. But I think it's important to point out, as a practical matter, we think about sort of fee revenues and comp holistically on a business by business basis. And so -- and that gives us the ability, I think, to manage that, I think, thoughtfully over time. So you'll see variability over the long run for BREP margins where some are aligned with the firm margin overall. But in the near term, you will see that move around based on the fact that we manage things holistically, I think, for the benefit of the firm and shareholders. On equity based comp, I think when you step back, there is seasonality in the first quarter around that line item. And sort of movements between, say, Q4 of last year and Q1 are affected by that as well as other puts and takes. But if you sort of step back and look at the kind of growth trajectory. In Q1, it grew about 19% year-over-year. That's lower than the 2023 overall growth rate, which was 23%. That, in turn, was about half the growth rate of 2022 overall. And so we do expect -- you are seeing this move lower over time given sort of stable grant levels and we think that's positive."
},
{
"speaker": "Operator",
"content": "We'll go next to Steve Chubak with Wolfe Research."
},
{
"speaker": "Steve Chubak",
"content": "So it was encouraging to hear the positive commentary on private credit deployment despite the reopening of public or syndicated markets. But given the increased competition for deals, you know that credit spreads are tightening, high levels of credit dry powder. Curious if you're seeing any tangible signs or evidence of credit underwriting standards potentially growing more lax and how that could dampen the pace of deployment across the credit platform?"
},
{
"speaker": "Jon Gray",
"content": "It’s a good [Technical Difficulty]…"
},
{
"speaker": "Operator",
"content": "Please standby as we reconnect our speakers."
},
{
"speaker": "Jon Gray",
"content": "And obviously, at very high multiples. Today, in the first quarter on our direct lending, the average loan to value was 44%. And now part of that, of course, is driven by the fact that interest costs to have coverage given the high base rates, there's only so much debt you can bear. So we're definitely not seeing reckless levels in any way in terms of what we've seen in terms of loan to value. Spreads have come down but on direct lending today are probably 500 over, still pretty good by historic standards. Interestingly, liquid markets have tightened far further. So if you look at investment grade or high yield, we've seen much more movement there. So we still see this as a sector where the risk return for lending money is quite favorable. If you're earning 500 over a base rate today, that's 5.5 plus upfront fees, you're earning 11.5% on an unleveraged basis if you put a little leverage better than that. So the risk return to us still feels compelling. Some sponsors [Technical Difficulty] risk for the common equity, not the capital structure. So overall, we have not seen signs of excess. And there's pretty good discipline in the market and that gives us a lot of confidence."
},
{
"speaker": "Michael Chae",
"content": "Jon, I'll just chime in on that. Two things, one, to put a fine point on Jon's point about 44% loan to values, what that obviously means is, because these are mostly sponsored transactions with new equity being invested, that 56% of the capital structure on a new deal is being put up with cash equity junior to this debt from high quality sponsors. So that is sort of another dimension too that we think the risk reward here. And then on default rates, as I mentioned in my remarks, less than 40 basis points for our business in the first quarter. There is -- we are demonstrating -- because I think a couple of years ago, there were some concern in the marketplace about what would happen with the default rates for folks like us. There is differentiation, there is outperformance depending on the borrower selection and the individual private credit player. And so we're operating at a fraction, I think, of the overall market default rate, which is normalizing. So I think we feel really -- and that's while being a leader in deploying capital in private credit."
},
{
"speaker": "Operator",
"content": "We'll go next to Brennan Hawken with UBS."
},
{
"speaker": "Brennan Hawken",
"content": "Just two on real estate, one housekeeping and one sort of more forward looking. Could you touch on the impact of the rate hedge in BREIT in the first quarter and April to date? And then more on the forward looking side, appreciate the comments on supply and real estate. But given that rates have actually started to back up and sure long rates are a little off the peak but not by much. What drives the confidence in real estate bottoming, wouldn't we need the cap rates to move up as much as base rates or close to as much as base rates have moved up in order to draw that demand into the market?"
},
{
"speaker": "Michael Chae",
"content": "Brennan, first, just on the data question in terms of the impact of the swaps, it was about 1 point out of the 1.8% net performance for BREIT."
},
{
"speaker": "Jon Gray",
"content": "And then on cost of capital, certainly a rising 10 year, not helpful, but I think it's important to put it into context. As you noted, it's lower than it was in October but also debt capital being so important. So if you went back to October, it was extremely difficult to borrow money. Spreads were much wider and banks were very reluctant to lend in the space. In the first quarter, as I noted, we've seen a fivefold increase in CMBS issuance. So the fact that debt capital is more available and the cost is meaningfully lower because of the spread not as much the base rates, that's a helpful sign. So it is more positive than it was six months ago. Backing up 10 year treasury, as I noted, not helpful. But the fact that overall, it does feel to us at some point here the Fed is going to bring rates down, there will be some downward pressure, that should be helpful. But the cost of capital overall coming down is helpful. And that's why we're seeing, even today, despite the backup in rates more folks showing up to buy assets than certainly we saw six months ago."
},
{
"speaker": "Operator",
"content": "We'll go next to Bill Katz with TD Cowen."
},
{
"speaker": "Bill Katz",
"content": "Just coming back to the opportunity in global wealth management. I was wondering if you could talk a little bit about where you're seeing the volume coming from, to the extent you get that kind of granularity from the distributors? And then secondly, just given the tremendous focus on many of your peers into the space, also wondering how you sort of see the competitive environment unfolding as we look ahead?"
},
{
"speaker": "Jon Gray",
"content": "So Bill, we see demand pretty broad based. Obviously, we have a lot of strength in US with the biggest distribution partners. We've been at this, as a reminder, for a very long time. We've got a lot of relationships with financial advisers and their underlying customers. The performance of our drawdown funds, the performance of BREIT, of BCRED, has created a lot of goodwill that we're able to tap into. And so I would say it's broad based in the US. We are seeing strength overseas as well. Japan is a market where we certainly have seen more openness to our products and we've had success there. Historically, some of the markets more tied to China, Hong Kong, Singapore are a little slower today, but we've had strength in those markets over time also. And Europe, I'd say, is an emerging market as is Canada. So I think it's a global story. It's still primarily US but it's growing. And within the US, what's interesting is we're still -- if you look at the penetration of financial advisors, still in the very early days. Really a small percentage are allocating to alternatives. And we think that can broaden quite significantly as these products deliver for clients as they begin to recognize the benefit of alternatives trading some liquidity for higher returns. So we think there's a lot of room to grow. And the fact that we have 300 plus people on Joan Solotar's team, we've got this very powerful brand, we've had strong performance. All of that, I think, bodes well for us and makes us a differentiated player in this space."
},
{
"speaker": "Operator",
"content": "We'll go next to Brian McKenna with Citizens JMP."
},
{
"speaker": "Brian McKenna",
"content": "I believe you've recently hired a senior data exec to leverage AI across your private equity portfolios. So can you talk about your approach to leveraging data and AI across your portfolios and what that might mean for additional value creation over time? And then can you also talk about how you leverage data on the deployment front? I'm assuming a lot of the data you have across the entire platform gives you insight into emerging trends globally. And so how does all of this translate into where you ultimately invest?"
},
{
"speaker": "Jon Gray",
"content": "So AI is obviously hugely important for our business, for the global economy. I would just frame this by saying, we set up our data science business back in 2015. We've got more than 50 people on that team today. We have focused historically on predictive AI, which is basically numbers in, numbers out. So you could look at a company and you could look at their pricing history and you could do much more sophisticated revenue management than human beings could do, similarly in terms of staffing. And we've been using that as a tool for investing for quite some time now and we'll continue to do this. And we've been pushing it out to some of our portfolio companies. I would point out also that Steve personally with his investments at MIT and Oxford has been a leader thinking about AI. And that has, I think, pushed the firm to try to do more in this space because we had more recognition something profound was happening here. I would say on the generative AI front, it's still very early days in terms of applications. The ability to take language and put that into the machine, produce language or videos, I think it will have a powerful impact, but that's going to take a bit of time. And what I think it will do most is impact customer engagement for many of our companies. I think it will also, on the content side, help in software development and media development. And we're working by hiring data scientists working with our teams, we hired a senior executive recently. But I'd still say on the generative side, it's early days. Now on the investing overall, what we've tried to do is focus on the infrastructure around AI and that is primarily data centers. And by going out there and investing in $50 billion of data centers that we own or have under construction and another $50 billion in development pipeline globally, which Steve talked about that really is the infrastructure. We're also spending a lot of time on power, which is a key necessity to build these data centers. And then we've made a number of investments around cloud companies, contractors building these, the whole ecosystem. So as a firm, we're trying to spend a lot of time. It's early days for us. The biggest impact has been around the infrastructure. But we're working hard to find ways to help our companies be more competitive, and we're certainly trying to make our investment process better. So an area definitely worth focusing on."
},
{
"speaker": "Operator",
"content": "We'll go next to Patrick Davitt with Autonomous Research."
},
{
"speaker": "Patrick Davitt",
"content": "So there's been increasing regulatory focus on the more illiquid stuff, the ABS that you and others are originating for insurance balance sheets and to what extent those should have a higher risk weighting. I know insurance regulators work very slow. But what are you hearing from your 18 big insurance clients on that issue and are you seeing this concern factor into new business conversations with that channel at all?"
},
{
"speaker": "Jon Gray",
"content": "So I think there's a lot of discussion around these areas. A lot of the focus has been around securitizations or synthetic securitizations, creating different ratings than a direct rating. A lot of the activities, though, that we've been talking about here have been literally doing private assets investment grade, and very similar to what insurance companies have been doing in commercial mortgages and private placement debt for decades. What we're really doing is taking that model of senior, what we believe safe debt on average A rated in infrastructure, in all forms of asset based finance, in residential finance and putting that directly on insurance company balance sheets. And I think regulators and participants see that as generally a good thing because it's generating higher returns. There's a little less liquidity. Although I would point out when you look at things like ABS bonds, there's not a lot of liquidity as it is, but there is a little less liquidity. But the risk profile of the assets is very much in line, if not safer, than what our clients have done historically. So I think there's going to be more scrutiny. As you know, in the insurance space, we made a conscious choice. We're not an insurance company. We really see ourselves more like BlackRock or PIMCO, what they do for liquid assets for insurance companies, we're doing a similar dynamic for insurance companies and private assets. And we think what we're doing is very sound, it saves, it generates, on average, 200 basis points of higher return than comparably rated liquid assets. We think this is a good thing for policyholders. So we think there will be a lot of dialog with regulators, but the activities we're focused on, we think will be well received over time."
},
{
"speaker": "Operator",
"content": "With no additional question in the queue, I'd like to turn the call back over to Mr. Tucker for any additional or closing comments."
},
{
"speaker": "Weston Tucker",
"content": "Thanks, everyone, for joining us today and look forward to following up after the call."
}
] |
bxp | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day. And thank you for standing by. Welcome to BXP's Q 4 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference call is being recorded. I would now like to hand the conference call over to your first speaker, Helen Han, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Helen Han",
"content": "Good morning and welcome to BXP's fourth quarter 2024 earnings conference call. The press release and supplemental package were distributed last night, and furnished on Form 8-K. In the supplemental package, BXP has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors.bxp.com. A webcast of this call will be available for 12 months. At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Although BXP believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that expectations will be attained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday's press release and from time-to-time in BXP's filings with the SEC. BXP does not undertake a duty to update any forward-looking statements. I'd like to welcome Owen Thomas, Chairman and Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchie, Senior Executive Vice President, and our regional management teams will be available to address any questions. We ask that those of you participating in the Q&A portion of the call to please limit yourself to only one question. If you have an additional clarity or follow-up, please feel free to rejoin the queue. I would now like to turn the call over to Owen Thomas for his formal remarks."
},
{
"speaker": "Owen Thomas",
"content": "Thank you, Helen. Good morning and happy Lunar New Year to all of you. Our results in the fourth quarter demonstrated strong performance given our execution and the property and capital market recovery that is underway. Our FFO per share was in line with our forecast and market consensus for the fourth quarter. We completed over 2.3 million square feet of leasing in the quarter, which was the most quarterly leasing we have experienced since the second quarter of 2019. It was 130% of our long-term average leasing for the fourth quarter and our fifth largest quarter of leasing ever. Over the last few months, we have made several significant leasing announcements with important clients such as Bain Capital, Ropes & Gray, McDermott Will & Emery, and KnitWell. We leased over 5.6 million square feet for all of 2024, which was 35% greater than 2023, and the average term for over 291 leases completed in 2024 was just under 10 years. Though the fourth quarter is usually our most productive leasing quarter due to year end seasonality effects, momentum is clearly building in the market and our leasing results. As I discussed at some length last quarter, the most important market forces impacting BXP, corporate earnings growth, return to office behavior and outperformance of premier workplaces continues to work in our favor, serving as a tailwind for BXP's performance. The one critical factor with a more uncertain trajectory is interest rates. Inflation measured at CPI has risen the last three months to 2.9%, stubbornly above the Fed's 2% target and the December employment release indicated new job creation was well in excess of market expectations. As a result, the Fed has become more cautious lowering its forecast of Fed's fund rate cuts in 2025. And in the fixed income markets, long-term interest rates are up nearly 100 basis points since the Fed's first rate cut in September last year. Notwithstanding these uncertainties, short-term interest rates should remain lower in 2025 than 2024, which would be a positive for our and our clients' cost of capital. One question we frequently receive is to project the impact of the new federal administration's policies on BXP's activities. Though, we are in the early stages of the new administration executing its plan, we do believe many of the articulated policies are business-friendly, particularly lower taxes and less regulation, which will be positive for our clients, building their confidence, and as a result, stimulating leasing activity. Regarding efficiency initiatives, even if the federal workforce is rationalized and the GSA reduces space requirements, having federal workers returning to their offices should be a significant positive for BXP's business in the Washington, D.C. region. BXP has limited exposure to GSA leases and is therefore not directly impacted by a reduction in GSA space requirements. More street life would be a positive for the urban environment and local retailers in Washington, D.C. And many of our users are government contractors who would be more likely to return to their offices in line with their government clients. An area of concern with the new administration's policies, the potential impact to interest rates, given that new tariffs that's implemented could be inflationary, and larger fiscal deficits resulting from tax cuts could lead to higher long-term treasury yields in the debt markets. We are shocked by the devastation of the recent fires in L.A. and empathetic to all those impacted. It is too early to fully understand the future impact of this tragedy on the L.A. office market. But we are aware of a significant office sale process that is progressing with no apparent pricing impact post the fire incident. As discussed repeatedly in the past, BXP competes primarily in the premier workplace segment of the office sector which continues to materially outperform the broader office market. Premier workplaces are defined in CBRE's research as the highest quality 7% of buildings representing 13% of total space in our five CBD markets. Direct vacancy for premier workplaces is currently 13.2% versus 18.8% for the broader market. Likewise, net absorption for premier workplaces has been a positive 8.8 million square feet over the last three years versus a negative 15.6 million square feet for the broader market. Asking rents for premier workplaces are more than 50% higher than the broader market, up from approximately a 40% premium three years ago. Regarding the real estate private equity capital markets, office sales volume in the fourth quarter demonstrated a continued acceleration of deal activity. Specifically, significant U.S. office sales volume was $15.3 billion, 80% greater than the third quarter of ‘24 and 59% above the fourth quarter a year ago. Lower short term interest rates, increased leasing activity for certain assets and locations and better access to debt financing continue to be the drivers. So there were limited premier workplace sale transactions this past quarter in our core markets. Notable deals include Norges purchased the 50% interest that did not already own and a portfolio of eight assets located in Boston, Washington, D. C. And San Francisco from NBIM. Pricing was on average approximately $500 a square foot for a portfolio that is 88.5% lease. A non-US investor purchased a 11% minority interest in One Vanderbilt next to Grand Central in New York City for $2,700 a square foot and a 4.3% reported cap rate. Moving to BXP's capital allocation activities and new investments, we commenced an exciting new office development in Washington, D.C. Specifically, we acquired 725 12th Street, a vacant office building from its lender for $34 million or $112 a square foot. The site is very well-located, immediately adjacent to Metro Center, Washington, D.C.'s busiest transit stop where four train lines converge. Concurrent with the acquisition, we secured a long-term pre-lease commitment from McDermott Will & Emery for 152,000 square feet to anchor a new premier workplace development on the site. Further, we have a letter of intent with another anchor client to lease substantially all of the remaining space. Our development plan is to demolish the existing building, reuse the below grade parking structure, and rebuild a new 320,000 square foot premier workplace with market leading amenities and unique entry meeting and outdoor spaces for our two anchor clients. We expect the full development budget including land acquisition and capital costs will be approximately $350 million and our projected initial cash development yield for the project is over 8%. The development has commenced with our acquisition in December and we expect to deliver the building in late 2028. 725 12th Street is a great example of how BXP is uniquely able to create an accretive investment opportunity in the current market environment. The existing building was empty and its loan in default creating a discounted acquisition opportunity. Industry leading clients want and will pay for new premier workplace space fulfillments notwithstanding high levels of vacancy in existing buildings and BXP has the unique ability to execute given our relationships with lenders and owners, trusted reputation and experience with industry leading clients both in Washington DC and around the US, access to the capital markets needed to fund the development and a market leading execution team to design and construct the new building. Well done team BXP DC. Continuing with new development I described last quarter our 940,000 square foot 343 Madison project in Midtown with direct lobby escalator access to Grand Central Madison Concourse and located two blocks south of JP Morgan's new headquarters building. We are in active conversations with several potential anchor clients ranging from 150,000 to 400,000 square feet. 343 Madison is the only immediately actionable office development site in close proximity to Grand Central Terminal, widely viewed as the most in-demand office sub-market in the U.S. We expect to launch this $2 billion project in 2025, where, as a reminder, BXP owns a 55% interest. We also expect to launch two new residential developments in 2025, where BXP will serve as a developer and a minority owner of the project. One of these projects is in suburban Boston at 17 Hartwell Avenue in Lexington on a site we already own that is being re-entitled, and the other project is in the New York region. More details will be forthcoming when we launch these projects later this year. BXP, along with three partners, was also awarded by the State of New York a project known as Site K, located at 11th Avenue between 35th and 36th Streets, directly across from the Javits Convention Center and adjacent to our 3 Hudson Boulevard commercial site in New York City. The plan is to build approximately 1,350 residential units with an affordable component and a 450-room hotel and two separate towers over a five-story podium. We are very pleased and honored to have been selected by New York State in this highly competitive RFP process. The project is several years away from construction commencement, given the entitlement, pre-development and design work that needs to be completed. BXP also delivered into service two projects this past quarter ahead of schedule. In October, we completed 300 Binney Street, a 240,000-square-foot office-to-lab conversion project fully leased to the Broad Institute on a long-term basis, where we were able to achieve a first-year cash development yield on incremental capital of 14.5%. We also fully delivered into service Skymark; a 508-unit luxury residential high-rise development located Reston Town Center. The lease-up of this project is well ahead of schedule, having leased over 50% of the units at above pro forma rents only six months after opening. We are in active negotiations for the disposition of three land sites and are preparing to put into the market an operating property. In the aggregate, these sales, if successful, will generate approximately $200 million of net proceeds, although it is possible one of the land sale closings gets pushed to 2026. We remain active evaluating our non-producing assets, both sites and buildings taken out of service, to generate more monetization activity. Notwithstanding the development deliveries we completed in the second half of 2024, BXP continues to execute a significant development pipeline with seven office lab, retail, and residential projects underway as of the end of the fourth quarter. The largest of which is 290 Binney and Cambridge fully leased to AstraZeneca and expected to deliver in the second quarter of 2026. These projects aggregate approximately 2.3 million square feet and $2.1 billion of BXP investment with $1.2 billion remaining to be funded. So in conclusion BXP is clearly gaining momentum in both leasing and new investment activity due to more favorable market conditions and our strategy of commitment to both our clients and the premier workplace segment of the office industry, our access to public and private debt and equity capital markets and a leading market presence in our core cities. We will build on this momentum and the constructive environment for our business to lay the foundations for additional growth in the years ahead. Let me turn over our report to Doug."
},
{
"speaker": "Doug Linde",
"content": "Thanks Owen. Good morning, everybody. So as Owen said BXP's regional leasing teams had an outstanding fourth quarter and we greatly exceeded our 2024 baseline leasing expectation of three 3.5 million square feet. We did a significant amount of future year expiration leasing during the fourth quarter which followed a pattern that we set over the last 12 months. This has had the effect of dramatically reducing our 2026 and 2027 expirations. During the last 15 months, our 2026 expirations were cut by more than 1.5 million square feet. So as of 12/31/24, 2026 expirations sit at 1.86 million square feet, 3.8% of our portfolio and 2027 sits at 2.2 million square feet, 4.4% of the portfolio and the largest expiration we have in 2026 is 134,000 square feet and the largest expiration we have in 2027 is 143,000 square feet. We are today in renewal or replacement client discussions on more than 500,000 square feet of the 2026 expiration. ‘26 and ‘27 will be exceptionally low rollover years for BXP. Why am I emphasizing this? Because if we continue to lease two to three million square feet of vacancy and expiring space in ‘26 and ‘27, there will be a material improvement in our occupancy. 490,000 square feet is 100 basis points. Mike thought I should just stop right there today, but I'm going to keep going. Our in-service properties finished the year at 87.5% occupancy. A 50 basis point increase from last quarter and slightly ahead of the estimate we provided on our last call. Remember, our occupancy reflects the square footage of space where we are recognizing GAAP revenue. Our leased square footage includes the addition of any spaces that have been leased but have yet to commence GAAP revenue. At the end of the fourth quarter, we were 89.4% leased. Our focus is on leased square footage since it captures all of our future revenue and eliminates the variability of the timing of completion of tenant improvements which governs GAAP revenue recognition and occupancy. We start ‘25 with our leased square footage as I said at 89.4%. We've just completed our bottom-up leasing projections which emanate from the regions. A little help from me as well. And the goal for our in-service and 2025 development deliveries is just over 4 million square feet. So that's our goal for ‘25. In ‘24, we completed leasing on about 1.5 million square feet of vacant space. Our ‘25 estimate includes the execution of about 2 million square feet of currently vacant space and 1.3 million square feet of leasing on known ‘25 move outs and 2025 explorations where we would believe we will be successfully renewing our clients. The remainder of the leasing will be on future year explorations, the 500,000 square feet I talked about earlier. Our current pool of leases in negotiation is about 1 million square feet. It covers 280,000 square feet of currently vacant space, 325,000 square feet of ‘25 explorations, 75,000 square feet of ‘25 renewals with the remaining transactions involving spaces with explorations after ‘25 and as Owen said our second lease at 725 12th Street. There's another 1.6 million square feet of active pipeline transactions which include 550,000 square feet of vacant space. These are deals that are not in LOI states but where we have good clarity. We're off to a good start in ‘25. So, we have 3.1 million square feet of contractual expirations in ‘25. If we achieve our budget of 2.3 million square feet of leasing of vacant and ‘25 expiring space square footage, our net lease pickup would be about 40 basis points. The one adjustment to this number will be the impacts from changes to the portfolio, which will cause some quarter-to-quarter fluctuations, but will even out by the end of 2025. Right now, we expect to take about 825,000 square feet of space out of service, which is currently 62% leased, and we're adding our three developments, 651 Gateway, Reston Block B, and 360 Park Avenue South, which will all be in the in-service portfolio by the end of the year, and they are currently 23% leased. I guarantee they'll be a lot higher before we get to the end of the year, though. In 2025, we're taking a few suburban office assets out of service. This follows the path we took in 2024. We are taking action where we have higher and better use for our assets. There's pent-up demand for residential development and acknowledgement by local governments that affordable housing is a critical component to a successful economy and development economics that can actually work for six-frame construction today. This is leading to a change in attitude towards the permitting of additional housing in some of our communities. We have been working in many of our markets for more than 25 years and have established constructive relationships in these towns and counties. We are working with the local communities to rezone commercial office to for rent and or for sale housing. 17 Hartwell Avenue, as Owen said, is the first example of this. This is a building in Lexington that we took out of service in 2024 and where we have received the entitlements for a 312-unit project in late December. We expect to be under development in early 2025. We have also entitled the site in Shady Grove, Maryland for townhouses and have executed an agreement to sell the first space to a townhome developer. We've done the same thing in Herndon, Virginia, where we have rezoned land holding two existing office buildings for a 359-unit rental project and a townhouse development and we have already executed an agreement to sell the townhouse development sites. This is what we expect to accomplish with the buildings that we are taking out of service in ‘25. Our office markets have either stabilized or are improving. Sublet additions have tailed off, leasing activity has picked up in every market and the negative absorption spigot appears to have stopped in Boston, San Francisco, Northern Virginia and the District of Columbia already seen in Midtown Manhattan over the last year. Our two largest property concentrations, the Back Bay of Boston and Midtown Manhattan, continue to be the strongest markets in our portfolio. Availability is sparse, rents are increasing and concessions remain constant. While there's no meaningful job growth in office using jobs across the US economy, the pace of job reductions has slowed. There are still technology companies that are reducing headcount but there are others that are short of space and increasing their footprints. We are witnessing space utilization growth in pockets of industries though they vary by market. Take the legal industry as a case in point. There are law firms in New York and Boston that are expanding while at the same time law firms in Washington DC and San Francisco continue to reduce but upgrade their footprints. The improvement in business sentiment, the anticipation of deal activity and a more robust capital raising environment are improving the confidence of our existing and potential customers. When our clients are confident, they are more constructive about making long-term real estate commitments. While we don't think that ‘25 is going to be characterized by a dramatic pickup in market leasing absorption, we are certainly on the right track and our data on premier space illustrates the activity continues to migrate to the best assets. As Owen said, there's no better example of this than the transaction that he described at 725-12. When we began our pursuit of this opportunity, we identified eight buildings to find its class they premiere by the brokerage community in DC, including one new development under construction that could accommodate 150,000 square foot clients. Were they trophy? Did they have availability at the top of the building? Were they amenity rich? Well, none of these buildings were deemed to be acceptable by our client. In order to bridge the delivery of the new development, the client also executed a short term extension at 500 North Capitol, a JV asset owned by BXP rather than relocate when their existing lease expired to the existing inventory in the market. The bifurcation is real. BXP's activity for the fourth quarter was not dominated by any region. We completed 680,000 square feet in Boston, 577 in New York, 571 on the West Coast and 494,000 square feet in DC. 320,000 square feet was on currently vacant space, 626,000 involved ‘24 and ‘25 expirations and 1.2 million involved lease extensions for the space that we were scheduled to expire post-2026. 152,000 square feet was for the new development at 725-12. The activity includes about 312,000 square feet of leasing on existing vacant space. Across the portfolio, the deals were executed this quarter had a markdown of about 5% with a 3% increase in Boston, a 5% decrease in New York, a 10% decrease in D.C., and a 14% decrease on the West Coast. Pretty consistent with what you saw in our supplemental for the leases that hit revenue this quarter. The bifurcation of client demand between the East Coast and the West Coast continues to exist, and there are actions of the clients in these respective markets that are also different. There is little large block availability in the Back Bay of Boston or in the Park Avenue sub market in New York. The lease extensions we completed with Ropes & Gray at the Prudential Center this quarter begins in 2031. You may recall that we did an early extension with Bain Capital earlier this year and another with MFS at 111 Huntington Avenue in ‘23. At the moment, the rents necessary to justify new construction in Boston are considerably higher than the rents embedded in extensions. Our large clients recognize that if they want to remain in the Back Bay long term, there are few alternatives to remaining in place. This quarter, we did two other larger renewals in Boston, one at 200 Clarendon and the other at Atlantic Wharf. These clients had the options to go to vacant space and the greater CBD market, but that would have meant significant changes in quality and location. Our Boston CBD portfolio availability is as tight as it has ever been. We do have some work to do, however, in our urban edge portfolio, which is where we have our largest concentration of vacant space, large known expirations and life science availability. These markets are focused on traditional technology and life science clients, life science tenant clients, and that demand growth continues to be weak. Traditional life science demand is weaker than office demand. We are in discussions with a few life science companies that are looking exclusively for office space as they focus their capital on acquiring de-risked products that are in trials rather than pure drug discovery and therefore don't need lab infrastructure. There is considerable lab sublease space available and the economics of these offerings make it very difficult for new developments with Shell Lab to compete even if we provide a significant tenant improvement allowance. Our availability in Midtown Manhattan is almost none but we have a concentration in Midtown South. We have 350,000 square feet of availability at 205th Avenue where we are in lease negotiations with a non-technology client for 244,000 square feet. At 360 Park Avenue South, demand is picking up and there has been some improvement in small tech tenant inquiry but overall tech demand in ‘25 is still less than 40% of what it was pre-COVID. We are in lease with another single floor tenant at 360 Park Avenue South. During the quarter, we leased about 200,000 square feet to financial firms in the Park Avenue submarket at the General Motors Building, 599 Lex and at 510 Madison Avenue. Each of these clients experience growth in their footprint. There is no question that the activity we have seen at 599 Lex is a direct result of the lack of availability on Park Avenue. Our largest Midtown opportunity in ‘25 is at 510 Madison. We are finishing it up in a many upgrade and have about 100,000 square feet of availability on 11,500 square foot floors. The big news is that the small floor leasing market this quarter was made by CBRE who took multiple small floors at Lever House earlier this month at rents that position our offering at 510 Madison as a great value in the market. There is a sparse selection of large block space availability in the Park Avenue area, which pretends well for our ability, as Owen said, to get a commitment at 343 Madison, where the rents necessary to support new construction are only a slight premium to current market rents, and we're leasing at rents that will be starting in 2029 and 2030. The leasing excitement on the West Coast in ‘24 continues to be growth from AI organizations in the city of San Francisco. At this point, we're not sure what defines an AI company, since it seems that even established technology companies are describing their proprietary large-language model computing power and storage of data, and there are a number of organizations that are working on industry-specific solutions that rely on new training models. The critical point is that the technology ecosystem in the city of San Francisco and the peninsula is where the bulk of these businesses are operating and growing. In addition, the cost of office real estate is significantly cheaper, the cost of housing is cheaper, and there is more available talent, and there has been in the last decade in the Bay Area. Our largest availability in our CBD portfolio wide is in San Francisco. Many of our traditional office users have continued to rationalize their space in the city, which has led to little, if any, growth in the traditional San Francisco CBD market. Mayor Lurie is just weeks into his new job, and one of his priorities is bringing workers and shoppers and visitors back to the CBD. View spaces in short supply, but spacing the lower sections of buildings is widely available and very competitive. We completed a new amenity center and a market area center in December, and are now focused on increasing occupancy there and at 680 Folsom Street, where we also have a large block and are finishing up a new amenity offering as well. Before I hand the call over to Mike to discuss ‘25 earnings guidance, I want to reiterate my comments at the top of my remarks. We accomplished a lot of leasing and a lot of early in the rules in ‘24. We expect ‘25 will be a year of modest lease square footage increases as we focus on leasing vacant space and known expirations. When we get to ‘26 and ‘27, there is going to be very little expiration headwinds. If we lease at a pace anything like ‘24 and what we hope to accomplish in ‘25, we will see our lease percentage accelerate. Mike, time to talk about the quarter and guidance for ‘25."
},
{
"speaker": "Mike LaBelle",
"content": "Excellent. Thanks Doug. Good morning, everybody. So this morning I plan to cover the details of our fourth quarter and full year ‘24 performance. And I'm going to spend most of my time describing our ‘25 initial earnings guidance that was included in our press release with additional details in our supplemental financial package. For 2024, we reported total consolidated revenues of $3.4 billion and full year FFO of $1.25 billion or $7.10 per share. We continue to grow our portfolio and saw revenue increase by 4% in 2024, primarily from bringing new developments into service. Our fourth quarter FFO of $1.79 per share was in line with the midpoint of the guidance we provided last quarter, and our portfolio performed consistent with our expectations. As Doug mentioned, our occupancy climbed this quarter by 50 basis points to 87.5%. Our Premier Workplace CBD buildings that contribute nearly 90% of the company's revenues continue to outperform and are 90.9% occupied and 92.8% leased. Our CBD occupancy improved by 80 basis points in the fourth quarter with positive absorption in Boston, New York City, and Seattle. We also recorded 2024 full year AFFO, which we refer to as FAD in our supplemental, of $894 million, which exceeds our dividend payout by over $200 million. While not impacting our FFO, we recorded non-cash impairment charges totaling $341 million this quarter related to three of our unconsolidated joint ventures. The charges all relate to assets located on the West Coast and include our interest in Colorado Center, Gateway Commons, and Safeco Plaza. With that, I will turn to our 2025 guidance. On a high level, our 2025 guidance can be summarized as follows. Growth from a full year of contribution of development deliveries, higher fee income, and relatively flat 2025 same property portfolio of NOI compared to 2024. These items will be offset by lower termination income, lower interest income from utilizing our cash balances to pay off debt and fund our developments, and a loss of NOI from taking buildings out of service for future development. I'll start with the growth from our development activities. In 2024, we delivered two fully leased properties. 300 Benny Street in Cambridge and Dick's House of Sport at the Prudential Center in Boston. We also delivered Skymark, our multifamily project in Reston that is currently in lease up and 54% lease today. As Owen mentioned, it's exceeding our expectations on both absorption pace and rental rates. Our life science deliveries at 651 Gateway in South San Francisco and 103 and 180 CityPoint in Waltham continue to be in lease up with minimal projective contribution to our earnings in 2025. 651 Gateway will be delivered into service and we will cease interest capitalization in the first quarter of 2025. And lastly, our 360 Park Avenue South development in Midtown South opened in late 2024. We have four floors occupied and are seeing a meaningful pickup in leasing activity. We will complete incremental leasing in 2025, but the revenue commencement will likely be either late in the year or in 2026. We expect the NOI for 360 Park will have significant growth in 2026 as we gain occupancy from new leasing. 360 Park will be delivered into service and we will cease interest capitalization in the third quarter of 2025. Overall, the incremental contribution to our NOI from our developments in 2025 is expected to be $19 million to $22 million. Our same property portfolio is the largest contributor to our earnings and generated approximately $1.9 billion of NOI in 2024, including our share of joint ventures. Doug described in detail our lease expirations over the next 12 months and the expectation that we will grow our lease percentage as we execute our leasing plan for 2025. As , there is a lag between signing a lease, achieving occupancy, and generating GAAP revenue. In the first half of 2025, we have several larger expirations that will impact our occupancy. These include 350,000 square feet at 205th, whereas Doug described we're negotiating a replacement lease for occupancy in 2026. We also have 480,000 square feet in two uncovered expirations in suburban Boston. This totals 1.6% of the portfolio and is expected to result in our occupancy declining slightly in the first six months of 2025. We do have signed leases totaling 860,000 square feet that will take occupancy spread relatively evenly across 2025. Our leasing plan results in our occupancy remaining relatively stable and averaging 86.5% to 88% during the year. Our same property NOI is also anticipated to be stable and we project ‘25 same property NOI growth of negative 1% to positive 0.5% from 2024. Our 2025 same property NOI on a cash basis will actually increase by up 1.5% from 2024 as we have free rent burning off that will increase our cash flow from the portfolio. Turning to our fee income which we expect to be higher in 2025 from earning leasing commissions on our joint venture properties this is primarily at 205th and 360 Park Avenue South in New York City and will also generate incremental construction management fees as we construct the tenant improvements for AstraZeneca at 290 Binney Street in Cambridge. Our projection for fee income in 2025 is $32 million to $38 million, an increase of $7 million at the midpoint from 2024. Our termination income was higher than typical in 2024 and totaled $16 million or $0.09 per share. In 2025, we're projecting a more normalized $4 million to $8 million of termination income so this results in a $10 million projected revenue decline in 2025 at the midpoint of our guidance. As we described on our call last quarter, we project our net interest expense will be higher in 2025 as we will be carrying lower cash balances resulting in lower interest income. At yearend, we reported cash balances of $1.3 billion. At the beginning of January, we utilized $850 million of available cash to pay off an expiring senior unsecured note. We are also forecasting approximately $700 million of development spend in 2025. Overall, we project our average cash balance will be $800 million lower on average in 2025 reducing our interest income by approximately $35 million year-over-year. Our consolidated interest expense is expected to be relatively flat in 2025 versus 2024 assuming no Fed rate cuts and with 12% of our debt portfolio floating, we will benefit if the Fed cuts rate this year and that is reflected in the low end of our interest expense guidance. Overall, we project net interest expense of $610 million to $625 million in 2025, an increase of $33 million from 2024 at the midpoint. Lastly, and as I described last quarter, we have taken Reston Corporate Center, the buildings at Reston Corporate Center, out of service upon the expiration of the full building lease on 12/31/24. This is the location for the next phase of our highly successful Reston Town Center development that we anticipate will encompass 2.3 million square feet of new mixed-use development, including both multifamily and commercial space. The ability to increase the density by nearly 10 times on this site will create significant future value and earnings over time. The buildings generated $11 million or $0.06 per share of NOI in 2024 that we will lose in 2025. So, to sum all this up, our initial guidance range for 2025 FFO is $6.77 to $6.95 per share, representing a decline of 2% at the high end from 2024. At the midpoint, the decline is comprised of higher net interest expense of $0.20, lower same property NOI of $0.03, lower termination income of $0.06, higher G&A of $0.04, and the loss of $0.06 from pulling Reston Corporate Center out of service. These are projected to be partially offset by higher NOI from our developments of $0.11 and higher fee income of $0.04. Again the modest decline in 2025 FFO is primarily due to lower interest income from lower cash balances as we fund our development pipeline that will generate future growth, pulling buildings out of service for future development as well as decline in non-core termination income. We have not included any incremental acquisition activity in our guidance, so we are actively looking for opportunities. Looking forward to 2026, we see an opportunity to demonstrate meaningful growth in our portfolio. We have very limited lease expirations and project positive absorption in the in-service portfolio, and we have embedded growth opportunity in the development pipeline through the delivery of a fully leased 290 Binney Street in mid-2026 and the lease-up of the available space in our 2024 and 2025 development deliveries. You can hear about all of this and more at our Triennial Investor Conference we will hold this fall on September 9th in New York City. The conference will be a deep dive into our portfolio and our future outlook and will include presentations from our regional teams offering an opportunity for investors to see the depth of our company. We will send out Save the Dates soon and we look forward to hosting all of you. That completes our formal remarks. Operator, can you open the lines for questions?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] I share our first question. It comes from the line of Steve Sakwa from Evercore ISI."
},
{
"speaker": "Steve Sakwa",
"content": "Yes, thanks. Good morning. Doug, you provided a litany of information. I'm not sure that I was able to transcribe it all 100% accurately, but high level, when you sort of look at the rollover this year, just help me think through kind of your retention ratio and given to no move out. So like what you expect to retain of the expiring spaces here and then I guess what is your broad expectations for I’ll call new leasing activity on vacant space."
},
{
"speaker": "Doug Linde",
"content": "Okay. I'm going to answer your question circuitously. In a year when we have very large lease expirations, so we have a 350,000 or 400,000 square foot lease expiring, highly unlikely that we've retained that organization. When we have a year when we have the multitude of our leases expiring that are between 40,000 square feet and 5,000 square feet, we're probably retaining a very high percentage of those tenants. So as I look forward into what we have remaining in 2024 that are ‘25 that are known expirations, all of the large ones we've already sort of quote unquote acknowledge are going to be known vacancies. And we are now leasing that space to other customers. So the obvious example that we're going to talk about on the call was 200 Fifth Avenue, we have a 350,000 square foot lease expiring, and we were in negotiation on a 240,000 square foot replacement tenant on that, right? So that's, I think that's sort of the way that works. In a quote unquote non-large lease expiration year, generally we are quote unquote renewing somewhere between 45% and 50% of our existing tenants. Some of those are actually growing so we may actually be picking up additional square footage there, but that's sort of what our quote unquote known retention rate is. If you look at 2025, what we are looking at this year is that we will cover somewhere in the neighborhood of three plus or minus million square feet of vacancy and known leasing expirations of tenants that are expiring plus the renewals of the smaller tenants that are sort of moving forward through the normal process. So we have a whole host of those. So as I describe sort of what we're currently working on today, in the year we're covering some vacant space. We have leases on known expirations and then I said we have about 75,000 square feet of leases in progress on just sort of normal as ordinary sort of ordinary course of business expirations that are occurring on a day-to-day basis in the portfolio. So as I look into ‘26 and ‘27, those numbers are exceedingly low and the bulkiness is also low, right. If I start with 1.8 million square feet today, which is the number in the supplemental on a 100% basis and I have 500,000 square feet that I'm actively working on that I expect to get done in 2025, that means when we get to this point in 2026, my known expirations for ‘26 are going to be under 1.3 million square feet. If I lease on a sort of average year somewhere in the neighborhood of 2 to 3 million square feet of vacant and renewals, I'm picking up occupancy in a meaningful way and that pattern will also move forward into 2027. That was my point of my sort of initial remarks."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Andrew Berger from Bank of America."
},
{
"speaker": "Andrew Berger",
"content": "Hey, good morning. This is Andrew. I'm for Jeff. I appreciate all the detail. So Doug, you mentioned that Back Bay Boston and Midtown Manhattan are the strongest markets and obviously it sounds like there's a lot of great activity that's reflected by the volumes. You also mentioned though that concessions are flat and I'm just curious with all this activity, what does it take to really become more aggressive and start to reduce concessions?"
},
{
"speaker": "Doug Linde",
"content": "So I'm going to give you a quick answer and then I'll ask Hilary and I'll ask Bryan to comment on it. So my quick answer is inflation is real in terms of what happened over the last five years. So the cost of building anything probably went up somewhere between 45% and 55%. So just assume 50%. So the cost for a one of our clients to move into new space or rebuild their space is materially higher. So the contribution that we are giving them on sort of a real basis is it makes up a smaller portion of what they actually have to spend. But Hilary and Bryan, why don't you sort of talk about the stickiness of concessions in your market. Hilary?"
},
{
"speaker": "Hilary Spann",
"content": "Sure. Yes. Hi, this is Hilary. I would say that in discrete instances in Midtown on the Park Avenue corridor, there are some reductions in concessions, but that is in a very defined geographic area more broadly, even on the margins of the Park Avenue sub-market, there is availability in buildings and folks have choices about where they want to go. And so the concessions are sticky because the availability levels are elevated outside of the Park Avenue sub-market. And so that's part of the reason that I think you've seen the overall statistics reflect sort of a flattening but not radical decline in concessions given in New York. Bryan?"
},
{
"speaker": "Bryan Koop",
"content": "Yes, I'd say that Doug was spot on with the inflation comment. And then also we are definitely feeling, let's say, some flattening on the concessions regarding TI in the Back Bay. However, our downtown market is not in that position and it can be used in negotiations. But it's definitely firmed on TI. Very noticeable. For Back Bay only, though."
},
{
"speaker": "Operator",
"content": "And I share our next question comes from the line of Alexander Goldfarb from Piper Sandler."
},
{
"speaker": "Alexander Goldfarb",
"content": "Hey, good morning down there. So question for you guys, you've outlined a pretty solid outlook sort of tail end of this year into ‘26 and ‘27, as far as addressing a lot of leasing exposure. And it sounds like, I know you're not giving guidance for the next few years, but sounds like all else equal, we should see a meaningful pickup at FFO. What are the risks or offsets? Like, for example, acquisitions that maybe dilutive or taking buildings out of service for redevelopment like what would stop you guys from or what would stop FFO from really accelerating tail end of this year into next?"
},
{
"speaker": "Doug Linde",
"content": "So let me, I’m going to give you half the answer and I'll let Mike give you the other half of the answer. So on my half of the answer, I believe if you look at our NOI from our same property portfolio in our development there will be meaningful increases in the contribution from those quote-unquote assets as we move into 2026 and 2027."
},
{
"speaker": "Mike LaBelle",
"content": "So I mean I think on the other side of things there's where interest rates going. So we're a short-term long-term interest rates going what does that mean for our interest expense based as we refinance bonds that are expiring every year and that is offset by what is likely to be somewhat lower floating rates on the 12% to 15% of our debt portfolio that's floating."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of John Kim from BMO Capital Markets."
},
{
"speaker": "John Kim",
"content": "Thank you. Doug mentioned life science tenants looking for office space exclusively, and I'm wondering if you could provide any commentary on how widespread you think that is. Either by geography or stage of the companies. And if you believe this is a reflection of AI and its impact on the biotech sector."
},
{
"speaker": "Doug Linde",
"content": "Okay, so I'll try to give you a perspective on that, and then I'll let Rod give you a perspective as well. And Bryan, if you have anything else you want to add as well. So what I believe is going on right now is that there is a bunch of money that is being raised in the life science sector that are looking for opportunities to take advantage of trials that have already started and shown some efficacy. And they are instead of, quote unquote, starting with a brand new idea, looking sort of for that later stage, quote unquote, proven kind of a product to move forward. And there are management teams that have been able to figure out how to raise capital to do those things. And they are the companies that we are seeing right now, certainly in suburban Boston, as the preponderance of the, quote unquote, expansion and growth relative to life science. What we have not seen is significant numbers of incubator kinds of companies going to the point where they are now ready to move into a more permanent kind of a space because they have been given capital by their VCs in order to go to the next level in the same way that was happening in ‘18, ‘19 and ’20, right. That's where all of the demand was coming from. So I'd say there's sort of that shift. And Rod, you may want to comment on what you're seeing in the South San Francisco market."
},
{
"speaker": "Rodney Diehl",
"content": "Thanks, Doug. So I think it's important to keep in mind that our office buildings in South San Francisco have always catered to the office component of the life science business that was around down there. And that's still the case. We actively are in negotiations now with a larger lab tenant that's specifically looking for more office space. So that is definitely part of it. I don't know if it's attributable to the AI piece as your question came through, John, but there's a mix of office users that are life science tenants. That's very typical in our market."
},
{
"speaker": "Doug Linde",
"content": "Bryan?"
},
{
"speaker": "Bryan Koop",
"content": "Yes. In Boston, I'd say we've seen a little bit of evidence, let's say three to four situations that are indicative of what Doug and we've discussed here, but not enough to say it's a big trend. And it's only in the urban edge market."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Nick Yulico from Scotiabank."
},
{
"speaker": "Nick Yulico",
"content": "Good morning, Mike. I had a question on the occupancy guidance. So the midpoint assumes you're roughly flat from where you ended Q4. But that guidance doesn't include the developments being put into service. So I was hoping you can quantify how much the developments will drag occupancy this year. The reason I'm asking is I think you'll be reporting an in-service occupancy number through the year that actually includes those developments being added in. So it'd be helpful to know that. Thanks."
},
{
"speaker": "Mike LaBelle",
"content": "Sure. I'm happy to answer that, Nick. I think in our supplemental, what we provide is what the in-service occupancy is at the end of the year. And then we guide to what we expect the occupancy to be in those buildings for 2025 as a way to help you kind of determine where the same store is going, where the portfolio NOI is going. But you're right in 2024 we had some negative impacts because we brought 103 CityPoint online in the fourth quarter and we brought 180 CityPoint online in the third quarter and that was not part of our original kind of guidance for the in-service portfolio. At the end of the year we're at 87.5% occupied. We're going to remove Reston Corporate Center from service. It's fully leased. It's not a big impact. It's only down about 10 basis points so we'll start it at 87.4% net of that. If you look at the developments that are delivering as I mentioned on my notes 651 Gateways coming in Q1 and then 365 Park and Block D will come in Q3. Right now they're 21% occupied, if they don't achieve any more occupancy, it's going to have a negative impact of 70 basis points roughly on our occupancy. Now, as Doug mentioned, we've got some activity there, especially at 360 Park. So we do think we're going to have a little bit more occupancy there, but they're certainly not going to be fully leased. Doug also mentioned that we're going to remove some other buildings from service in the suburbs. So there's a couple of buildings in suburban Boston we're thinking about and suburban, in Princeton that we're thinking about. And if we were to do that, because we have a higher and best use for those assets to build residential developments, that actually goes the other direction and could help us by close to 90 basis points. So as Doug mentioned, kind of a net of these two things is not going to be that impactful. But at this point, we haven't determined, right, to take those buildings out of service."
},
{
"speaker": "Doug Linde",
"content": "Yes, let me just comment on our development pipeline and sort of what's going on in there and where I think you'll start to see some progress and where you won't see some progress. So the building that probably sees the most relative progress during the year in terms of its lease square footage is probably 360 Park Avenue South, knock on wood. However, you can sort of talk about the activity we're seeing there. And then we're actually seeing some leasing activity at 180 CityPoint. Again, it's a lab building where we're talking to lab tenants about office space. And therefore, we're going to likely be building out office space, not lab space. And then we're also not going to be building out a lab infrastructure in that space. So we're not going to be spending the same capital. And then Jake, you may want to comment on sort of what we're also doing and seeing at Reston Block B. So in all three of those particular situations, I believe you will see a meaningful increase in occupancy during 2000, sorry, lease percentage in 2025. The occupancy won't hit until 2026. Where we're going to have, I'd say a more of a challenge are at 651 Gateway, which is the building we have with ARE where there's very little activity right now. And then at 103 CityPoint, which is the second lab building that we have in the Waltham Submarket. But Jake, why don't we start with you and talk about Block D, and then Hilary can talk about 360 Park Avenue South, and Bryan can talk about 180 CityPoint."
},
{
"speaker": "Jake Stroman",
"content": "Yes, sure, thanks Doug. I will just say that we've seen a pretty meaningful uptick in activity across the Reston Town Center Market, and in particular the 75,000 square foot Block D development that we just delivered. And we have a few clients and proposals and prospects that we're discussing, taking the majority or all the space with. So very good activity, and hope to have better news to deliver here in the coming quarter or two."
},
{
"speaker": "Doug Linde",
"content": "Hilary?"
},
{
"speaker": "Hilary Spann",
"content": "Thanks Doug. At 360 Park Avenue South, as Doug mentioned earlier, we have one lease out for a full floor at that building. So that will be the fifth floor that we've leased there. And we have three or four other proposals that we're actively trading that are roughly the same size, one floor to two floors. That's really where the demand sweet spot seems to be in that sub-market. And as a reminder, the floor plates there are about 23,000 square feet. So call it 20,000 to 40,000 square foot tenants. The larger tenant demand has remained muted in Midtown South. And so if we continue to see 20 to 40s, we expect that we'll have very good leasing activity throughout the course of the year and that the building will continue to lease up a pace. But there is still the outside chance that we'll get a larger tenant; in which case I think that it could fill up quite quickly. So we'll just have to see how it plays out with regards to the tenant size demand. But we are in active discussions with several tenants and out to lease with one in particular for a full floor."
},
{
"speaker": "Doug Linde",
"content": "Bryan?"
},
{
"speaker": "Bryan Koop",
"content": "180 CityPoint has noted probably the highest probability of getting some lease up there. And we started seeing some pickup in the fourth quarter. And I'd say that they were from clients that had been in the market for over a year and really gain confidence in the fourth quarter that we're seeing. So that building is excellent. It's the best product in the market for life science and the description that we have about a couple deals looking at it for life science but office is hopeful. 103, a little bit more challenging, it's GMP building and that zone is a little bit more quiet although we're still optimistic about that for a possible lease this year."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Michael Goldsmith from UBS."
},
{
"speaker": "Michael Goldsmith",
"content": "Good morning. Thanks a lot for taking my question. Doug, in the past you commented that 3 million square feet of leasing equates to flat occupancy. You talked a lot about if they've done a nice job of cutting back on some of the future exploration. So is there a nice, hard and fast rule, how we should think about going forward, or is it still 3 million equates to flat occupancy from here? Thanks."
},
{
"speaker": "Doug Linde",
"content": "Yes, so in 2025, 3 million is flat occupancy. 3 million in 2026 is a meaningful increase in occupancy. Again, our portfolio is 49 million square feet. So 490,000 square feet is 100 basis points. So if we have under 2 million square feet expiring and we do 3 million square feet of leasing on vacant and expirations, that would mean a pickup of a material amount. I'm doing the math for you. I'm not suggesting I'm giving you a projection for ‘26."
},
{
"speaker": "Operator",
"content": "And I show a next question comes from the line of Floris Van Dijkum from Compass Point LLC."
},
{
"speaker": "Floris Dijkum",
"content": "Hey, thanks, guys, for taking my question. Question on capital allocation. Owen as you think about where you're deploying your capital, obviously the transaction in DC at 725-12 was very interesting. How do you think about -- how many other types of transactions like that are in the markets? What kind of -- what markets are you looking at? Or which markets you think are going to be the most active for you in ‘25 and maybe also touch on the sellers or who you're getting this product from, if you could."
},
{
"speaker": "Owen Thomas",
"content": "Yes. Okay, Floris, so I would break it first between development and acquisitions. So on development, the only market where development is really supported by current market rents is in Midtown, New York. And so we have, as I mentioned in my remarks, and you're aware of 343, Madison, which we have, which we expect to launch this year. We are speaking to several anchor clients for that. And given the yield that we project, we think it's a very appropriate and strong allocation capital decision for the firm. Also in DC, as I mentioned in my remarks, I think our team did a magnificent job of creating a very accretive new development opportunity, given the dynamics in DC. There’re clients that want to be in premier space, number one. Number two, they were able to identify a building where the loan was in default and buy the loan at an interesting price. So we got a good land basis and all the math worked and they were able to de-risk the project from a leasing standpoint, given all of their relationships in the market and the interest by clients there in premier workplaces. We also have a great site in the Back Bay of Boston. Right now, I don't think market rents support that development, but it's getting closer because again, as Doug said, the Back Bay of Boston and Midtown New York are the two strongest markets we're in. And my expectation is that's probably the next site that we control that will pencil from an office standpoint. And then just to finish the remarks on development, if other teams in other regions can replicate what our DC team did with the clients in the buildings that they created, we're going to want to do that. So that's the development answer. And then on the acquisitions answer, we continue to be in the market looking for buildings that are either currently premier workplaces or ones that we can make into premier workplaces. And again, we have looked at a lot of different deals and we continue to be out in the market. And as Mike said, he didn't put anything in his projections for next year about new acquisitions, but we're hoping that we're going to, this cycle, we're going to be able to identify accretive acquisition. That's certainly been our history. Anytime there's a down tick in real estate and specifically office real estate, BXP has been able to add great properties at accretive yield to its portfolio. And I fully expect that to happen again, this cycle. But there's nothing right now that's specific that we could point to that, I think we will get done in the near term. But that doesn't mean later in the year something that's of interest won't present itself."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Michael Griffin from Citi."
},
{
"speaker": "Michael Griffin",
"content": "Great. Doug, maybe going back to your assumptions around vacancy leasing for the year. As I look in the portfolio, kind of stands out from a vacancy perspective as still San Francisco. So, suffice it to say, do you really need to see demand accelerate in that market for vacant space and thinking about, 680 Folsom, 535 Mission, as two examples of high quality properties there that could see some leasing. Or do you have enough demand from your portfolios in New York, Boston, DC to be able to hit that vacancy leasing goal? Thanks."
},
{
"speaker": "Doug Linde",
"content": "Sure. So I'm going to let Rod talk about what's going on in San Francisco and sort of what our expectations are there. But we need all of our markets to perform from an increase in available space being leased to new clients, right? That's the mandate across the entire portfolio. And everybody has to, all the reasons have to pull their part. Obviously, we have lower expectations and higher expectations, depending upon the particular property, as well as the particular sort of environment of what the demand might be for that. In San Francisco, we've done a really good job, actually, of leasing available space at 535 Mission, because of, interestingly, the sort of demand that it is apt to capture end and the success that building has had in grabbing that demand. We need to do more of that. We also need to do more leasing at a market-era center, and we need to do more leasing at 680 Folsom. And Rod can talk about some of the things that we are doing to accelerate our activity in those properties. Rod?"
},
{
"speaker": "Rodney Diehl",
"content": "Yes. Well, you hit on 535, which has had really great leasing experience in ‘24, and we've got a good pipeline of deals we're talking to there still. And our strategy, both at 535 and in Embarcadero and at 680 Folsom, is centered around an amenity-based offering first in a premier workplace environment. So we just finished this fantastic amenity center in Embarcadero center called The Mosaic. It's gotten great reviews, and it's a super great draw for bringing new clients in. It's something that not every other building is offering. I certainly don't think at the quality. So we're doing that at Embarcadero. We have a similar type of focused amenity offering under construction now at 680 Folsom. We've done some remodeling to the lobby, and we're going to add another portion on the ground floor, which will be a tenant amenity. So that's going to definitely get some traction. We're also going to enhance the roof deck. We have a capital plan in place that's going to be completed this year on the roof deck of 680 Folsom, which, again, is going to be a nice way to differentiate that building. So I think we're positioning all these buildings for success. We have a great spec suite program in all the buildings that we've used over the years, and it's when you go down a list of deals that we did last year, many of them are in those spec suites. So it's not the only focus, but it's certainly an important focus, and we're going to keep doing that. And I'll just close on the point that San Francisco had positive net absorption for the fourth quarter. That hasn't happened in a long time, so it's a good sign, and we feel it in our activity, and so we're optimistic we're at it, and we're going to have a good year."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Richard Anderson from Wedbush Securities."
},
{
"speaker": "Richard Anderson",
"content": "Thanks. Good morning. So at the outset, you talked about your lack of exposure to the GSA leasing business, but perhaps defense contractors follow the Trump five-day RTO approach to government workers. Then you have Amazon, JP Morgan, Salesforce. I'm wondering how critical this is into your old leasing outlook for ‘26 and ‘27 in terms of return to office. Is it enough to be two or three days a week for you to have a successful negotiating platform, or do you need that to kind of ramp to a full week eventually over the course of the next few years, and whether or not you can comment on the conversations you're having with your tenants about what their plans are for return to office over the next few years? Thanks."
},
{
"speaker": "Doug Linde",
"content": "Yes. The return to office is clearly accelerating, and it's helping our leasing activity. I think it's varied a bit by industry, and therefore we see it a little bit differently by region, because different industries have different concentrations in different regions. So it's a big plus. Look, we have always said return to office is important to leasing. But also corporate earnings growth as a proxy for corporate health is actually even more important. And that's also a positive. So I would put both of those in the same category when you think about the health of the client base that we serve. In terms of number of days in the week, I mean, look, I think even for clients that are only coming in two or three days a week, they want everybody in the office on the same days because that's why they're there is to collaborate. So it's hard to save space. People aren't allocating, okay, you come in Monday, Tuesday, and this group comes in Thursday, Friday. So I don't think necessarily going from four days to five days increases space demand under that logic."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Blaine Heck from Wells Fargo."
},
{
"speaker": "Blaine Heck",
"content": "Hey, thanks. Good morning. Related to the earlier question on concessions and increasing costs, I'm wondering whether you've noticed a change in tenants' willingness to move and upgrade their space, given the higher costs to move and higher costs to build out their space over and above what you've given them in TIs, and whether that's driven more of a preference to renew in place because of those cost pressures, maybe even slowing the flight to quality. And if so, how does that factor into your leasing strategy?"
},
{
"speaker": "Doug Linde",
"content": "Yes, so I'm going to give you a response on that, and then I'll let the region's going to sort of chime in. My sense from what I have been seeing is that most of our clients have said, we have to rebuild our space because we have to be competitive with our offering to our employees. And interestingly, if you have older space, call it 10-plus-year-old space, the brain damage associated with staying in place and renovating it is not something that is very attractive to many of our clients. And unless they are forced to do that, they would prefer to move. In many cases, they would prefer to move within our buildings if we had space available to them. But in many cases, we can't do that. And so they are going ahead and spending the money. And right now, again, and as Owen sort of talked about earlier, the confidence that our clients have based upon the economy is giving them, I'd say, the conviction that it's a good time to be making that capital allocation to their space. So, maybe Hilary and Rod, you can start. And then Bryan talked about sort of the CBD location and then perhaps Jake, you talk about what's going on in Reston. Rod?"
},
{
"speaker": "Hilary Spann",
"content": "This is Hilary. I would entirely agree with the comment around the difficulty regarding renovating in place. We've seen clients be very reluctant to do that. I think that there is a lot of confidence in the New York market around the direction of the economy, and for the client base in BXP's New York portfolio around their business models and their future, and so what we are seeing a lot of is clients expanding in our buildings, taking new space and building that space out. We're also seeing new demand coming into the portfolio, and of course that tendency is generally always a full new build. So I think it's much more of a case where the demand drivers are expansion of the economy and expansion of the business units, and they want fresh new space that will help them compete for employees and will help them compete for clientele. So that's the trend that I see in New York."
},
{
"speaker": "Doug Linde",
"content": "Rod?"
},
{
"speaker": "Rodney Diehl",
"content": "I would just add that I think what we are not seeing is the short-term renewals that we saw early in emerging out of the pandemic. Most of our clients are confident in what the future looks like and are not asking for short-term renewals. I mean, I think in those cases, it's tough. If somebody is willing to just do a one- or two-year extension or three-year even, then it's hard to pull a tenant like that out of a building, but most of the people we're talking to are willing to make long-term commitments 10-plus years. So I think that they're doing exactly what you said, Doug, which is they're looking to build a better offering for their employees to come back and entice them back. And we're seeing that across all of our existing tenants and then the ones that we're trying to pull out of other buildings, definitely."
},
{
"speaker": "Doug Linde",
"content": "And, Jake, comment on sort of the opportunities that the two tenants that we're talking to about Reston next have to stay where they want, where they are, and what they're doing."
},
{
"speaker": "Jake Stroman",
"content": "Yes, sure. I mean, again, we are having very interesting and productive conversations with lots of clients in the Northern Virginia market. Over half of our holdings in the D.C. region are in Reston Town Center, which is what I would say is the home to the who's who of the defense and cybersecurity community. And these are groups that can pay market-leading rents and are seeking trophy quality product in a mixed-use environment. And a lot of that is just because they want to attract and retain and motivate their employee base. So we're seeing lots of inbounds in that regard, and so it's exciting for the future of Reston Town Center."
},
{
"speaker": "Doug Linde",
"content": "But, again, just to sort of keep going on this, Jake, the two tenets that we're actually talking to you about Reston Next, have the ability to stay where they are and pay rent that is significantly lower than what we're charging at Block B, correct?"
},
{
"speaker": "Jake Stroman",
"content": "Absolutely. And in each case, the landlords would happily accept renewals with these clients. But these clients want change. They want to motivate their employees to continue to come to work and do the important work that they do to generate revenue forms. So they're looking to change up their environments and move to these mixed use environments that are more exciting and provide a better ground floor plan for their employees and more excitement and more amenities. And we're seeing that in spades in Reston."
},
{
"speaker": "Doug Linde",
"content": "Bryan?"
},
{
"speaker": "Bryan Koop",
"content": "Yes, ours is a little bit more varied. I'd say in at least two to three significant renewals, we had situations where we had clients that their initial space was well ahead of its time and how they work today isn't that much different than how it was when they did the original lease. But I would say that's just an example of three extraordinarily good, thoughtful plans from previously. And in those cases, they did some fresh up, they did some adding of some amenities, but nothing significant. But they're exceptional spaces to begin with and really thoughtful. On the new side, we're definitely seeing the willingness of the clients to add additional dollars of their own on top of tenant finish that we may provide to really create a great space. And I would also say that the amount of interest in seeing new space and examples of it is far more than I've ever seen. We just redid our own space on low 16. And it's incredible the response we've had from our own people, but we have probably at least a tour a day of clients coming to see it. I've never seen a situation where the clients want to talk to us this much about how we see trends and how we see future layouts."
},
{
"speaker": "Owen Thomas",
"content": "Yes, I would just add to this conversation from BXP standpoint, we're eating our own cooking. The Boston region and the San Francisco region were in space they had been in for well over a decade. And in the last six months, they've both moved. Here in Boston, it proved tower to a lower floor and in Embarcadero Center to a lower floor. And there is no doubt that the new build out has created a lot of energy and enthusiasm for our teams. And so we're experiencing this phenomena that you're hearing about firsthand."
},
{
"speaker": "Operator",
"content": "And I show our next question. It comes from the line of Caitlin Burrows from Goldman Sachs."
},
{
"speaker": "Caitlin Burrows",
"content": "Hi, everyone. You mentioned earlier that the negative absorption spigots seem to have stopped in a few markets. And you did mention positive absorption in San Francisco in 4Q. But then you also mentioned that law firms in San Francisco are still reducing their footprint and others are rationalizing space. So it just makes it seem difficult that absorption would consistently increase, if that's what you're seeing from the tenants. So I'm wondering if you can give some details on what gives you confidence that absorption will continue to be positive in San Francisco. And is the demand there to then take advantage of the amenities that you're creating that you went through before?"
},
{
"speaker": "Doug Linde",
"content": "Rod, you want to take that?"
},
{
"speaker": "Rodney Diehl",
"content": "Yes, I mean there's no question that some of the existing, I would say, traditional tenants are still, in some cases, rightsizing. We've experienced it with some of our own law firm clients. I think you have to just add into that, the growing demand that is coming from these new technology companies. You can say it's AI, or you can just say it's the new wave of technology companies, which has traditionally brought the Bay Area and San Francisco in particular out of these down cycles. So we're seeing it. We're seeing lists of companies, names I've never even heard of, that are out in the market. And I think you can point to, obviously, the bigger AI deals with open AI and anthropic and scale AI and some of these others that have done deals as examples of tenants that are going to use space. And so we're going the right direction, and I think it finally showed up in another. So we'll see what happens, but it feels different than it did a year ago. I can tell you that much, Caitlin, for sure."
},
{
"speaker": "Operator",
"content": "Our next question. It comes from the line of Upal Rana from KeyBanc."
},
{
"speaker": "Upal Rana",
"content": "Great. Thank you. So the Biogen announced some layoffs to their research department last week, and they are your third largest tenant, and I was wondering if there was any potential impact for BXP, given they do only have about two and a half years left on their term, and is there any read-through on life science broadly on this announcement? Thanks."
},
{
"speaker": "Doug Linde",
"content": "So I think, look, Biogen is a company that has gone through many fits and starts over the decades that it has been in Kendall Square. We have one building with them, which is a lab building, that least expires in the middle of 2028, and that's basically in the midst of the next election cycle. There's so much that's going to happen between now and then. I can't even contemplate what the world will look like for lab space in Kendall Square, but it's the one location on the globe that I would rather have more than less lab space. And so to the extent that Biogen makes a decision to downsize or they grow, we'll be ready to capture whatever the opportunity is in that building. And again, it's the only building that we have with Biogen. The other building that we have is already been basically master leased to another organization and Biogen has not been in that building for the last 15 years."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Dylan Burzinski from Green Street."
},
{
"speaker": "Dylan Burzinski",
"content": "Appreciate you taking the question, guys. Just going back to some of your comments on sort of the concessionary environment remaining elevated to what it once was. I guess in some of your tighter markets, at least within your portfolio, such as Boston and New York, are you guys starting to be able to push face rent so that on a net effective basis, we're starting to see incremental improvement? And then I guess as you sort of think about the next two years, right, going in ‘26 and ‘27, you guys mentioned being able to likely pick up significant occupancy. I mean, should we also expect you guys to be able to push net effective rent growth quite significantly in those years? Or can you sort of put some guardrails around that for us?"
},
{
"speaker": "Doug Linde",
"content": "So unequivocally in the Midtown market and in the greater Boston Back Bay market, we, our rents are higher in 2024 than they were in 2023. And for the modest amount of space that we have available, they will be higher in 2025. In the Midtown Park Avenue market, same phenomenon, except the increase has been much larger. I mean, the increases are double digit in terms of what we have seen between ‘23 and ‘24 and what we probably will see in ‘25 to ‘26. I do not want to make a suggestion that we're going to see a groundswell of rental rate increases across all of our markets in the entire portfolio. I think those particular markets are unusual because of what we discussed earlier in the call relative to the minimus amount of large block availability and the fact that we're getting closer and closer to new construction pricing in Boston. We're not quite there yet and then obviously and we are where we are in Midtown Manhattan. But it's a very constructive environment in those marketplaces. It's not as constructed elsewhere."
},
{
"speaker": "Mike LaBelle",
"content": "I just think the one thing I would add Doug is that there's no new development because it's going to be coming in ‘26 and ‘27 in these markets. So from a supply perspective there's nothing to for those clients to look at so that will benefit us."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Michael Lewis from Truist Securities."
},
{
"speaker": "Michael Lewis",
"content": "Thank you. So you hit this topic of concessions and CapEx from a few different angles. When we put together the increased leasing volume as we get the occupancy back up and the higher cost, I don't think you give guidance for FAD but should we expect FAD and cash flow to be under pressure in the near term at least until you kind of stabilize the occupancy or is that not the case?"
},
{
"speaker": "Mike LaBelle",
"content": "I'm not going to give a projection for ‘26 and ‘27 for FAD. I think for 2025 I feel pretty good about it. I think it will probably be a little bit lower than this year in line with kind of the FFO drop that we had this year. We do have free rent that is burning off so as I mentioned the cash flow from the portfolio is increasing. I don't expect our CapEx and TI to be significantly different than they were in ‘24, TI could be a little bit higher than it was in 2024, but I don't expect a meaningful change."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Omotayo Okusanya from Deutsche Bank."
},
{
"speaker": "Omotayo Okusanya",
"content": "Yes, good morning. Just a very quick one, in regards to all the leasing activity kind of leasing up on the early renewals of leases that are going to be expiring in next year or a year or two and reducing leasing risk in ‘25 and ‘26, just curious how you think about balancing the certainty of renewal today versus maybe, again, waiting six to nine months where the leasing environment may feel a little bit better. And maybe we can kind of get better economics from a renewal. I am just kind of curios how you think through those two things to make the ultimate decision to kind of renew a little bit earlier."
},
{
"speaker": "Doug Linde",
"content": "So the BXP mentality is that we are not market timers. We would never have been, and we never will be. And if we have a client that wants to engage, we will constructively attempt to do a renewal with that client. I mean, the fact of the matter is, and everyone understands this, downtime is a cost of any transaction. And to the extent that you can eliminate downtime between a lease if the tenant were to leave or the tenant were to stay, that's a value, and that value can be split in a way with the renewal that it cannot be split with waiting for the next best tenant. And so from our perspective, we try and be commercial and thoughtful, and we try and work with our clients. And if our clients are interested in renewing, we do everything we can to renew them. Obviously, we have to be cognizant of what we think the market conditions are and where we think market rents are and where they might be going, but we never are going to be greedy, and we are never going to try in a market time."
},
{
"speaker": "Operator",
"content": "And I show a last question in the queue comes from the line of Jamie Feldman from Wells Fargo."
},
{
"speaker": "Jamie Feldman",
"content": "Great, thanks for taking a follow-up from our team. So we want to get your thoughts on how the rest of this office recovery may play out. The Park Avenue recovery was pretty unique this cycle with JP Morgan and Citadel's investments in leasing there. It's also encouraging to hear you say the Back Bay is tightening also. But do you think other sub-markets across your portfolio are structured to tighten up in the same way as the cycle continues, or do you think it will be more about filling specific buildings rather than sub-markets tightening in the future? And against that backdrop, can you also comment on the impairments taken in the quarter? Are these signals you don't expect these sub-markets to get better? Are they building specific, or are they a function of JV accounting rules? We found the Santa Monica impairment particularly interesting since our local market contacts indicate local schools are looking at the office campuses there as potential relocation options."
},
{
"speaker": "Owen Thomas",
"content": "I'll take the first part of that Jamie and I'll turn it over to Mike for the impairments. Look, the office market is recovering. It's recovering because of what we've been talking about on this call which is increased corporate confidence as well as return to office behavior. It's certainly the most acute in our portfolio in Midtown and in the Back Bay, but there's clearly spillover benefits. I mean Doug talked about the action that we have at 599 Lex. That's a spillover from Park Avenue. There's leasing going on Third Avenue. There's leasing going on Sixth Avenue. So it depends on the strength of the market, but there's clearly benefits away from these two markets that we're talking about. So look, how does it all shake out at the end of the day? It's hard to actually forecast. I do think there's probably some reduction in overall office demand because of the remote work phenomena. What percentage that is? I don't know, but don't forget you have that impact, but you also have a growing economy. So all these companies are growing. They're adding employees and at some point, the growth will make up for all of that. So I think those are the forces that you have at work and as we've been talking about over and over again, BXP is positioned as the premium office provider in the market and we're seeking to have clients that are leaders in their industries that will pay the premium rent that we're seeking and that segment of the office industry is outperforming materially the rest and that's one of the keys to our stability that we've experienced about this whole office phenomena."
},
{
"speaker": "Doug Linde",
"content": "Yes. And before Mike talks about the impairment, Rod, you can just -- you should comment on sort of what the activity level is for these schools and also whether they're really able to take space in the current configurations and for how long they're looking to sort of do these transactions and how that's sort of playing out in the West Valley market."
},
{
"speaker": "Rodney Diehl",
"content": "Yes, okay. So it's true there are schools that are in the market that are looking for some temporary space. We're talking with one of them. We've actually got a space in one of our buildings that is a sub lease space that this particular school is going to be occupying. So it's a temporary deal until they can figure out what they're going to do with a rebuild. Obviously, this is all pretty fresh and there's been just a lot of chaos down there and so we're doing our best possible to help the community. We've done it with this effort with the school. We also housed over 450 firefighters from Oregon and Utah at our Santa Monica Business Park. They just recently left. But they had been there, and they had all their trucks, and they were sleeping there, and it was, we've been very much engaged in trying to help support the community. But these schools, I mean, there's a few other ones that are out looking. We've heard there's a few other buildings in town that are talking to them. So that will absorb some portion of space, at least in the short term."
},
{
"speaker": "Mike LaBelle",
"content": "Congratulations, Jamie, for getting three questions in on one question. But we will. I will touch on the impairments. So impairments for consolidated assets are unusual because of the way the GAAP rules govern assets and the way that you value those if you're going to have a long-term hold on an effectively and undiscounted basis. Where we have unconsolidated joint ventures, there's different accounting rules that we have to abide by. So every quarter, we have to look at the valuations of our unconsolidated joint ventures and determine whether there's a change that has impacted what we think might be other than temporary in a change. And so on these West Coast assets, there's a combination of things where we haven't completed additional leasing in the vacant space at Colorado Center. We talked about the life science market at South San Francisco being slow. And in Seattle, we've talked about, we didn't talk about it on this call, but the market is slower and we haven't achieved positive absorption at Safeco Plaza. So every quarter, we evaluate this and look at the cash flows and value the assets. And it tripped our test this quarter. And so when it trips the other than temporary test, you basically have to bring it down to the fair market value, which is using a more kind of distressed discount and cap rate environment, which is why the numbers are bigger than they were. So it is an accounting issue. It is non-cash. It does not reflect any change in our outlook for these assets or any change in kind of what is going on in these assets right now."
},
{
"speaker": "Doug Linde",
"content": "And just one last point on this, Jamie. So obviously, our joint venture partner had their call yesterday on, and they, as I understand it, didn't mention anything on their Gateway investment. So it's consolidated on their books. It's unconsolidated on ours. So same asset. Our plans and their plans are the same. And we were in a position where we felt we had taken impairment. And obviously, they didn't. So again, these are accounting rules that we have to follow."
},
{
"speaker": "Operator",
"content": "That concludes our Q&A session. At this time, I'd like to turn the call back over to Owen Thomas, Chairman and CEO, for closing remarks."
},
{
"speaker": "Owen Thomas",
"content": "We have no closing remarks. We've gone an hour and a half. And we want to wish all of you a happy New Year. And thank you for your interest in BXP."
},
{
"speaker": "Operator",
"content": "Thank you, sir. This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
bxp | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day and thank you for standing by. Welcome to BXP's Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference call is being recorded. I would now like to hand the conference call over to your first speaker, Helen Han, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Helen Han",
"content": "Good morning and welcome to BXP's third quarter 2024 earnings conference call. The press release and supplemental package were distributed last night, and furnished on Form 8-K. In the supplemental package, BXP has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors.bxp.com. A webcast of this call will be available for 12 months. At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Although BXP believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that expectations will be attained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday's press release and from time-to-time in BXP's filings with the SEC. BXP does not undertake a duty to update any forward-looking statements. I'd like to welcome Owen Thomas, Chairman and Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchie, Senior Executive Vice President, and our regional management teams will be available to address any questions. We ask that those of you participating in the Q&A portion of the call to please limit yourself to only one question. If you have an additional clarity or follow-up, please feel free to rejoin the queue. I would now like to turn the call over to Owen Thomas for his formal remarks."
},
{
"speaker": "Owen Thomas",
"content": "Thank you, Helen and good morning everyone. Our performance in the third quarter demonstrated BXP's continued resilience and provided evidence of property and capital market recovery. Our FFO per share was $0.01 above our forecast and in line with market consensus for the third quarter. We completed over 1.1 million square feet of leasing in the quarter, 5% greater than the third quarter of 2023. And for the first three quarters of 2024, our leasing volume was 25% more than levels we achieved in the first three quarters of last year. Weighted average term for office leases signed this past quarter remained long at 7.2 years and we continue to receive awards for our industry-leading work in sustainability. In just the last quarter, Time Magazine and Statista named BXP one of the World's Most Sustainable Companies and NAREIT awarded BXP the Sustainable Design Impact Award for our 140 Kendrick Building A redevelopment project. Now, moving to the economic and operating environment. We believe the most important market forces for BXP, that being interest rates, corporate earnings, return to the office behavior, outperformance of premier workplaces, and valuation in the public and private markets are all currently working in our favor, serving as a tailwind for BXP's performance. The Federal Reserve cut the Fed funds rate 50 basis points at its most recent September meeting and has signaled for two more 25 basis point cuts in 2024 and additional reductions in 2025. The most recently released inflation and GDP growth economic data has signaled the economy is possibly stronger than previously believed and put into question the magnitude and timing of additional Fed funds rate cuts. No matter how this debate resolves itself, the facts are short-term interest rates are coming down, which is very positive for real estate valuations as well as corporate earnings growth, another important driver for BXP's performance given its correlation to leasing activity. After remaining flat for all of 2023, S&P 500 earnings as a proxy for corporate health, are expected to grow 9.9% in 2024. As mentioned before, companies with earnings growth are much more likely to invest, hire, and procure space as demonstrated in BXP's growing leasing volumes this year. We do not see evidence of a looming recession in the decision-making of our clients. While it is true that long-term interest rates, driven more by market forces than Fed behavior have recently been rising, many corporations, particularly smaller ones, use floating rate and shorter-term financing, which are becoming less expensive. Return to office behaviors are clearly improving across the cities where we operate. It has been highly publicized that Amazon is requiring all workers, including support staff to return to the office five days a week starting December 1. Given Amazon's scale and industry presence, this decision could be a harbinger for the future policies of other technology companies. Dell, Salesforce, Starbucks, and other companies have recently announced more stringent in-office work requirements for their employees. KPMG completed a survey this past summer of 1,300 CEOs regarding in-person work policies. 84% of the CEOs believe there will be a full return to office work at their companies within three years, up from 64% of those surveyed just one year ago. The reasons cited for the increase were concerns about diminished collaboration, innovation, and productivity, inadequate supervision and training for younger employees, and the cost of maintaining vacant offices. BXP competes primarily in the premier workplace segment of the office sector, which continues to demonstrate material outperformance. Premier workplaces are defined in CBR's research as the highest quality 6.5% of buildings, representing 13% of total space in our five CBD markets. Direct vacancy for premier workplaces is 13.2% versus 18.7% for the broader market. Likewise, net absorption for premier workplaces has been a positive 6.5 million square feet over the last three years versus a negative 16.7 million square feet for the broader market. Asking rents for premier workplaces are 50% higher than the broader market, a consistent gap from prior quarters. This outperformance is evident in BXP's portfolio where approximately 90% of our NOI comes from assets located in CBDs that are predominantly premier workplaces. These CBD assets are 90.1% occupied and 92.1% leased as of the end of the third quarter. Lastly, from a timing perspective, valuation changes in the public real estate industry, which are determined by daily trading, lead valuation changes in the private market, which are largely appraisal based. In the first three quarters of 2024, publicly-traded office companies generated a return of 30%. While in the private market, as measured by the NCREIF Index, which is the best proxy for unleveraged private market values, office returns were a negative 7% over the same period. In other words, public markets are trading higher based on expectations of a recovery in the office sector, while the private market appraisal-based marks are still dropping in an attempt to catch up to current market conditions. As a result, BXP has the opportunity to make increasingly accretive private market investments, both in acquisitions and in selective developments that underwrite to yield premiums versus pre-pandemic levels. Regarding the real estate private equity capital markets, office sales volume in the third quarter provided evidence of a pickup in activity. Specifically, volume for significant U.S. office sales was $8.2 billion, 15% greater than the second quarter of 2024 and 32% above the third quarter of last year. Lower short-term interest rates, increased leasing activity for certain assets and locations, and better access to debt financing were the drivers. An important change in the environment has been the increasing availability of debt financing at scale for office assets in the CMBS market with relatively attractive pricing. Very recent examples of CMBS execution include a $3.5 billion 57% loan-to-value five-year refinancing for Rockefeller Center at a fixed rate of 6.2% and a $750 million, 43% loan-to-value five-year refinancing of 277 Park Avenue at a fixed rate of 7%. Office sales this past quarter for assets with comparability to BXP's portfolio include 730/750 Main Street, a fully leased 219,000 square foot multi-use building in the Kendall Center District of Cambridge sold for $362 million or $1,650 a square foot and a 5.7% initial cap rate. A leasehold interest was conveyed from the landowner to a private life science real estate owner and developer. In Santa Monica, 2220 Colorado Avenue, a fully leased 225,000 square foot office building sold for $185 million or $819 a square foot and a 7.1% initial cap rate. A pension adviser was the seller and a fund manager of the buyer. 799 Broadway, a 177,000 square foot new office building located in Midtown South is under contract to sell for $255 million or $1,400 a square foot and a 5.3% initial cap rate. The building is 71% leased and the yield is estimated to be approximately 7% upon stabilization. A private REIT sold the building to a European family office. Moving to BXP's capital allocation activities. We remain active in pursuing acquisitions from both real estate owners and lenders. Our pipeline of potential opportunities is growing, including building and node acquisitions, sites with near-term pre-leasing potential, and new residential developments. No agreements are imminent, but we are encouraged by the activity. We are in active negotiations for the disposition of three non-income-producing sites, which, if successful, should close in 2025 and generate over $70 million of proceeds. For our development pipeline, we delivered into service 180 CityPoint, a 329,000 square foot lab building, which is 43% leased located in our CityPoint Park in Waltham. Though initial leasing completed exceeded our underwriting, the market softened before the asset was fully leased. The opening of Skymark, our 508-unit luxury residential tower development at Reston Town Center, continues to go well, having leased 35% of the units at the base of the building and we believe we are on track to achieve our underwriting in terms of rents and schedule. We have been able to accelerate the completion of 300 Binney Street, a fully leased 236,000 square foot lab redevelopment in Kendall Center in Cambridge, and we will deliver the project to our client and into service in the fourth quarter. We continue to push forward with several residential projects, primarily on land we control that are being entitled and designed and for which we intend to partially fund with joint venture equity capital. Lastly, we broke ground on the Grand Central Madison Concourse Access phase of 343 Madison Avenue, located two blocks south of JPMorgan's new headquarters building and one block north of One Vanderbilt. 343 Madison competes with the Park Avenue submarket of New York City, which, given its access to Grand Central Terminal one-stop commute is under 8% vacant with no block of direct space over 100,000 square feet available and is arguably the strongest office submarket in the United States. 343 Madison, which BXP has been working on for over 10 years, is the only fully entitled ready-to-commence workplace development located in the core of Midtown and we are having constructive conversations with a handful of potential anchor clients. When complete, the building will comprise 942,000 square feet and includes state-of-the-art sustainability features as well as direct escalator access into Grand Central Terminal. We hope to launch this approximately $2 billion project next year, where as a reminder, BXP owns a 55% interest. BXP continues to execute a significant development pipeline with nine office, lab, retail and residential projects underway as of the end of the third quarter, which we expect will contribute to BXP's external FFO per share growth over time. These projects aggregate approximately 2.7 million square feet and $2.1 billion of BXP investment with $1 billion remaining to be funded. So, in conclusion, BXP continues to leverage its key strengths, which are our commitment to premier workplaces and our clients as many competitors disinvest from the office sector; a strong balance sheet with ready access to capital in the public and private debt and equity markets; and one of the highest quality portfolios of premier workplaces in the U.S. assembled over several decades of intentional development, acquisitions, and dispositions. BXP continues to display resilience with a growing leasing pipeline as well as stability in FFO per share and dividend level, and we are well-positioned to continue to gain market share in both assets and clients, while benefiting from a constructive environment of lower interest rates, higher corporate earnings growth, more workers returning to their offices, continued outperformance of the premier workplace sector, and a very competitive cost of capital. Over to Doug."
},
{
"speaker": "Douglas Linde",
"content": "Good morning, everybody. So, Owen noted that our leasing in 2024 through the end of the third quarter is 25% higher than 2023. And during this period, we have completed 3.3 million square feet of signed leases. Post Q3, our active pipeline of leases under documentation sits at 1.53 million square feet as compared to 1.39 million square feet post the second quarter. We've done about 315,000 square feet of that pool since October 1st, executed leases. If we execute most of the remaining leases during the fourth quarter, we will end the year at over 4.5 million square feet of transactions. Our January 2024 guidance assumed 3.5 million square feet. Exclusive of our leases in documentation, we also have an additional transactions under discussion totaling just over 1.5 million square feet in the pipeline that will cede our 2025 activity, about 50% of that involves currently vacant space. As of September 30th, we have 1.04 million square feet of signed leases on vacant space that has not yet commenced. There is now a 210 basis point difference between our occupied space and our leased space. No doubt the analyst community is looking keenly towards 2025 and 2026 occupancy. We will provide our occupancy guidance for 2025 on our next call. However, we can provide the following inputs as you think about your own models. Our Q4 2024 and full year 2025 expirations totaled 3.7 million square feet. We have signed leases that we will recognize revenue on of 476,000 square feet during the fourth quarter of 2024 and 483,000 square feet for 2025, totaling 959,000, which creates an uncovered exposure, if you will, of 2.74 million square feet. Our pipeline of leases in negotiation covers an additional 305,000 square feet of currently vacant space and 395,000 square feet of renewals, all of this set to commence in 2024 and 2025. Obviously, the remainder involve early renewals with expirations after 2025. This leaves pro forma revenue commencing leasing for the next five quarters of about 2 million square feet for us to be flat for the in-service portfolio. Additional leasing with revenue starting in 2025 will be additive. Each of our regional EVPs are in the process of building their business plans for 2025, and this will be the basis for the total leasing volumes embedded in our guidance when we talk to you next time. If you're wondering about the large known 2024, 2025 expirations, which is often a question we get, the largest are 312,000 square feet at Weston Corporate Center, which has been leased by Biogen, but sublet for use, 200,000 square feet at 1000 Winter Street in Waltham; 350,000 square feet at 200 Fifth Avenue, we own 28% of that, two 70,000 square foot law firm leases at Embarcadero Center, and 260,000 square feet at Reston Corporate Center, which is leased to the GSA. This last building is the site for our next multiphase development in Reston Town Center, and the building will be taken out of service on January 1st, 2025. We also have active developments that will be added to our in-service portfolio in 2025 with availability that is noted in our supplemental materials, 360 Park Avenue South, 651 Gateway, and Reston NXT Phase 2. Our BXP regional teams are spending a lot of energy pursuing alternative uses for our suburban land portfolio, which includes vacant office buildings for which the highest and best use may not be waiting for a recovery in office leasing. We are now deep in a public re-permitting process for 17 Hartwell Avenue in Lexington to allow for 312 multifamily units. A similar process is underway for our site containing two office buildings at World Gate in Herndon, Virginia, where we are working on a rezoning for 359 units in 99 townhomes, and the Shady Grove Office Park in Rockville, Maryland, with the first phase including 360 multifamily units and 136 townhomes. Additional land sites in the Bay Area, Waltham, Northern Virginia, and Northern New Jersey are being actively evaluated. This quarter, we took two buildings out of service that we will work to re-entitle, in Waltham and in Northern Virginia. During our last call, I explained that we would see up to a 40 basis point decline in our occupancy for Q3 due to the addition of our partially leased development at 180 CityPoint, Owen noted that. With a slight reduction in the in-service portfolio, we only experienced a 10 basis point deterioration ending the quarter at 87%. We expect to improve by 20 to 30 basis points during the fourth quarter in spite of the delivery of 103 CityPoint, which is 100% available. This quarter, we completed 74 transactions with 32 lease renewals for 681,000 square feet and 42 with new clients encompassing 427,000 square feet. Activity was concentrated in Boston with more than 58% of our total leasing volumes. We completed 647,000 square feet in Boston, 143,000 square feet in New York, 155,000 square feet in D.C., and 163,000 on the West Coast. 10 clients expanded into 142,000 additional square feet, and we had four contractions totaling 100,000 square feet. The majority of the client expansions this quarter came from our Back Bay financial firms. The only significant contraction in the portfolio came from a tech company downsizing in Waltham, they were about 70,000 square feet and went to 150, and we have re-leased all of the space that they vacated. We continue to see downsizing of our legal firm clients on the West Coast and in D.C., and we experienced one in Embarcadero Center, which was a renewal and downsizing this quarter. We executed only one transaction over 55,000 square feet and two others in excess of 45,000 square feet. Our leasing activity this quarter was very granular. As reported in our supplemental, the mark-to-market of the leases that commenced this quarter, so they may have been signed in 2020 or 2021 or 2022 or 2023, 900,000 square feet was down about 4.5% and the transaction cost averaged $11.83 per year compared to about $11 last quarter. The overall mark-to-market of the starting cash rent on leases executed this quarter of the 1.1 million square feet relative to the previous in-place cash rents was actually up 9% with the primary contribution coming from the Boston area. The starting cash rents on leases we signed during this quarter on second-generation space were up 19% in Boston, 10% in New York and then down 11% in D.C. and 3% on the West Coast. Owen's comments about the state of the economy and the zeitgeist around the importance of in-person work with colleagues is translating into improvements in leasing activity. The level of improvement and the source of the incremental demand continue to vary greatly by market. I would also note that decision-making continues to be slow. And while more transactions are being completed, the process takes time, lots of time. Our views this quarter are pretty consistent with the commentary we provided during 2024. The submarkets with the largest concentration of users from financial institutions, alternative asset managers, professional service organizations, and law firms are showing the most consistent pickup in activity. And as we saw this quarter, in some circumstances, these clients are expanding absorption of space. Concessions are flat and taking market rents have risen during the year. So, if we think about New York City, the sub-8% availability in the Park Avenue submarket is a direct reflection of these users growing and competing for limited blocks of space. We have no availability at 399 Park Avenue or 601 Lexington. When clients need to expand in these buildings, we proactively discuss possible terminations with their neighbors. While 599 Lex has always been not quite Park Avenue, in strong markets like this, the building is one of the first to experience the spillover of Park Avenue tenants that are unable to find space. We are now in lease with a Park Avenue tenant that was unable to grow in its current building for a couple of floors. Our most active building in New York during the quarter was the General Motors Building. We completed 58,000 square feet of transactions, including the addition of a new private equity client and the expansion of another. Our other availability in this market is at 510 Madison, where we are in the middle of an amenity refresh. This building tends to lend itself to smaller financial firms given the 12,000 square foot floor plate. This particular market segment of demand has been slower to make decisions. Year-to-date, leases executed by technology tenants in Manhattan has still been pretty light. We have seen a pickup in activity among technology tenants touring the market, and this is encouraging given our current availability at 360 Park Avenue South and the availability we will have at 200 Fifth Avenue. We are in active conversations with tenants at both buildings, but none have progressed to a lease in negotiation. The most active building in Boston as well as in the entire BXP portfolio during the quarter was 200 Clarendon Street. We completed more than 460,000 square feet of leases. Virtually all the leases were with existing clients in the alternative asset management industry and 50% of those clients added additional space. We also completed over 116,000 square feet of leasing in our Boston Urban Edge portfolio. This was made up of eight separate transactions and seven were with new clients for BXP. Our portfolio is uniquely positioned both in terms of quality and availability of capital for investment in new tenant installations. Here, the demand came from a national retailer, a few life science companies with office requirements, a small technology firm, and a fund manager. We didn't execute any leases in our new life science developments this quarter. Life science clients in Greater Boston continue to display very little urgency about any potential new requirements or relocations. We have had tours from some larger users, but the requirements are for late 2026 and 2027 occupancy. Year-to-date, there have been a handful of leases signed on shelf space that total about 300,000 square feet in the markets outside of Cambridge and Boston. Our Reston portfolio was responsible for 55% of our executed leases during the quarter in the D.C. region. Leasing activity and tenant demand growth continues to come primarily from two industry areas, cybersecurity and defense contracting. This quarter, we had a growing cyber firm more than double its square footage. This client signed its initial lease in Reston Town Center for 9,000 square feet in 2020 and has grown six-fold in the last four years. One of the great advantages of BXP's large holdings in Reston is our ability to accommodate the growth of our clients. We saw a pickup of smaller requirements in our CBD D.C. portfolio this quarter, which was good news. We had two clients expand, one at 2200 Penn and another at Capital Gallery and completed leases with two new customers at 1330 Connecticut Avenue. The district's private sector tenant demand continues to be dominated by the legal industry. Many of these potential law firm clients are not satisfied with the existing inventory, either due to the product quality, condition, or the asset's financial condition. While in almost every case, the law firm renewal or relocation is resulting in a smaller requirement, which is leading to negative absorption, these firms prefer to be in the top refurbished amenity-rich, well-capitalized buildings, which is creating a tight micro market. There are limited opportunities in the market and no appetite from traditional lenders to finance any new construction, which has traditionally been the outlet for law firm lease expirations. Our availability at 2200 Penn and 901 New York Avenue will fare well, and we are actually in lease documentation for a late 2026 known expiration at 2200 Penn today. The San Francisco CBD also continues to act as the financial center of the West Coast with its own set of asset managers, including private equity, venture, hedge funds, and specialized fund managers and their financial and legal advisers. This is the source of the bulk of the transactions in the market today from a leasing perspective. Tour activity from these non-tech clients has improved during the year. On a comparative basis, San Francisco is seeing much more demand in 2024 than it did in 2023. There continue to be lots of small clients actively looking for space, and we are seeing these deals at 535 Mission and Embarcadero Center. We have completed or in negotiations on five leases totaling about 40,000 square feet at 535 Mission. This will cover a third of the availability of the building, but we still have another 80,000 square feet to go. At Embarcadero Center, we are in discussions with a number of existing and potentially relocating law firms. In each case, the requirement is a downsizing relative to the current footprint. We will retain the majority of our clients, albeit with space reductions. We are adding other new customers, but the transaction sizes are small, so gaining occupancy takes time. Additional lease reductions from larger tenants upon lease expiration in the market, JPMorgan is the latest, which is stemming from their acquisition of First Republic, continue to mute the positive demand emanating from the AI organizations that continue to look for additional space. During the quarter, the market got the long-awaited announcement of OpenAI's 300,000 square foot expansion in Mission Bay. And it's great that Airbnb renewed their headquarters at 888 Brannon, but expansion requirements from large technology tenants are still sparse in San Francisco. Tenant tour activity is improving at our Mountain View research R&D buildings where we have about 215,000 square feet of vacancy and it's uniquely attractive product. We are in lease for 26,000 square feet with a healthcare diagnostics company for a vacant building. We completed a renewal with an automotive company and recently have issued a multiple full building proposal. This is a significant improvement from last year and from last quarter. These buildings are designed for companies that are making some kind of device, be it a car sensor, a photovoltaic panel or a medical device. They don't compete with the large multi-storey office product that has flooded the market. In summary, 2024 is shaping up to be a better-than-expected year relative to overall leasing at BXP. Leasing in our development properties continues to lag, but these are some of the highest quality workplaces in their prospective markets, and they will lease. We may not be in a clear positive absorption market, but demand continues to grow, and we will continue to gain market share. Mike?"
},
{
"speaker": "Michael LaBelle",
"content": "Excellent. Thank you, Doug and good morning everybody. I'm going to start with a few comments on the debt markets, and then I'll plan to cover the details of our third quarter performance and the changes to our 2024 earnings guidance as well as provide some insight into several of the moving pieces that you should be aware of for 2025. We completed multiple transactions this quarter and continue to have strong access to the debt markets. This quarter, we exercised our right to extend our $334 million mortgage loan secured by 100 Causeway Street in Boston for an additional year at SOFR plus 148 basis points. We also extended $300 million of mortgage financing for Santa Monica Business Park that was scheduled to mature in July 2025 at attractive terms. We bifurcated the loan into a $100 million unsecured term loan and a $200 million mortgage loan. The unsecured loan is for one year with three one-year extensions, and we reduced the pricing at closing to SOFR plus 105 basis points, and the $200 million mortgage loan will be priced at SOFR plus 160 basis points and matures in 2028. The secured debt markets have shown meaningful improvement this quarter for high-quality, well-leased office buildings at leverage points of 50% or less. Credit spreads have compressed, and there is significantly more liquidity in the CMBS markets for both conduit and SASB executions. The SASB market, which is where most large loans in excess of $500 million are financed, was nonexistent in 2023. It reopened in early 2024, but with pricing for the AAA tranches at spreads in the low 200s. More recently, AAA spreads have improved into the mid-100s, which results in a significant improvement in overall pricing and conduit pricing can be even tighter. This trend is a strong signal of improved liquidity in the sector, while the financing market remains challenged for buildings with vacancy, short weighted average lease terms or higher leverage. We have several mortgage financings that are part of our 2025 capital plan, and we plan to take advantage of the improved conditions in the market and extend term. These deals include our $250 million loan for Marriott's new headquarters building in Bethesda and two mortgages totaling $487 million on our Hub on Causeway development in Boston. We own a 50% interest in each of these assets. In the unsecured market, we issued $850 million of 10-year bonds in late August at a 5.75% coupon. We're holding the cash proceeds pending repayment of an $850 million bond that is expiring in January 2025. As we described in our issuance press release in August, we reduced our 2024 FFO guidance by $0.02 per share to account for the incremental net interest expense associated with this bond issuance that was not in our prior earnings guidance. Now, turning to our earnings results for the quarter. We announced third quarter funds from operations of $1.81 per share, that's $0.01 ahead of the midpoint of our guidance as adjusted for our recent bond deal. The primary driver behind our earnings beat is from lower-than-projected G&A expenses. Our portfolio performed in line with our expectations for the quarter. Doug described the improvement in our leasing activity, both in signed leases and in our pipeline. As we get into the third and fourth quarters of the year, most of this activity will not have a revenue impact in 2024 due to the lag between signing a lease and achieving occupancy and revenue recognition. Renewals have an immediate impact, but we generally know who is renewing in advance and the revenue is included in our forecast. My point is that you should not be surprised that our portfolio performance is closely aligned with our 2024 forecast this late in the year. For the full year 2024, we're narrowing our guidance range for FFO to $7.09 to $7.11 per share. Adjusted for the $0.02 of dilution from our bond deal, our new range maintains the midpoint of our updated guidance. While we will provide full guidance for 2025 in January, there are a couple of items where we have seen variations in a number of the 2025 models from the analyst community that you should consider. First is interest income, where we project lower cash balances and interest rates next year. Since our bond offering in August, we have been holding $850 million in cash that we are going to utilize in January 2025 for the payoff of our expiring bond of the same size. We're also using cash balances in combination with operating cash flow to fund our developments. We expect our average cash holdings to be approximately $800 million lower in 2025 than they were in 2024. We expect our interest expense will be flat to modestly lower next year from the burn-off of fair value interest expense and the impact of lower SOFR rates on our floating rate debt portfolio. We also will be vacating Reston Corporate Center, which is the project Doug described in his comments. We will be taking these two older low-rise buildings totaling 260,000 square feet out of service on January 1st, 2025, when the full building lease expires. We have entitlements to build over 2 million square feet of mixed-use commercial and multifamily residential on the site as the next phase of our incredibly successful Reston Town Center. This will lead to a significant increase in density where we expect to create incremental value and earnings over time. From our development pipeline, we will have a full year of contribution from delivering 300 Binney Street this quarter and the Dick's House of Sports store we delivered in the second quarter. We will also have incremental income from the completion and lease-up of our Skymark Residential development in Reston, where our ownership is 20%. Overall, we had a solid quarter with a continuation of strong leasing momentum and our volumes year-to-date up 25% over last year. We modestly beat our FFO guidance for the quarter and maintained our full year earnings expectations. That completes our formal remarks. Operator, can you open the line for questions?"
},
{
"speaker": "Operator",
"content": "Thank you sir. [Operator Instructions] And I show the first question comes from the line of Nick Yulico from Scotiabank. Please go ahead."
},
{
"speaker": "Nick Yulico",
"content": "Thanks. I guess just turning to the leasing markets, can you just give a little bit more feel for what kind of needs to change in San Francisco, West Coast, maybe Boston suburbs as well, where I think that's been more of a sort of vacancy drag on the portfolio? What needs to change for that dynamic to improve in those markets?"
},
{
"speaker": "Douglas Linde",
"content": "So, I'll give a general statement, and then I'll let Rod and Bryan give their perspectives on San Francisco and the Boston suburbs in particular. In general, we need to see more technology and life science demand come back to the markets, which means we need to see both company formations with capital, be it private or public, right? A lot of biotech companies are sort of hoping to go public, but aren't able to go public. And then we need to sort of see the new ideas generated into new jobs and therefore, new kinds of businesses being formed. And that has really not been part of the sort of demand picture in either market in 2020, 2021, 2022, 2023, 2024. It's been sort of more of a retrenching of large tech and I would say, a slight downsizing from both technology and life science. So, Rod, you can sort of talk about the CBD of San Francisco and then Bryan can talk about Waltham."
},
{
"speaker": "Rodney Diehl",
"content": "Yes. Thanks, Nick. Good morning Nick. I would just add to Doug's comment that I think what needs to happen, at least in San Francisco, the demand has picked up certainly. So, as you heard, we've got good activity from multiple sectors and the traditional tenants still dominate, but there's plenty of technology companies that are out in the market. But I think what needs to happen before you're going to see some meaningful change in some of the statistics is going to be a burn off of the sublease availability. That still is an overhang. There's about 8.2 million square feet of sublease space. I would say that, the best space has been spoken for. There's still some buildings that are out there, but that's still causing us to compete with sublease space, which is difficult. So I think before you're going to see some changes in the direct vacancy and particularly in our buildings, some of those better sublease spaces need to be leased up, which is happening. So it's been happening for the last couple of years."
},
{
"speaker": "Owen Thomas",
"content": "In Boston, I'd say, first off, no surprise, Doug did an excellent job of underwriting the total market and where we're at. So I encourage you to re-look at those things because it was spot on. I would say with our Urban Edge, and you've heard us say this before, the Urban Edge is much different than, let's say, the 495 Ring Road and then in particular, the P2 corridor, as we call it, between the Pike and Route 2 on I-95 is much different. The theme for us is drastic differences. So there's a drastic difference between the P2 corridor and anything else in the suburbs in terms of activity and also rental rates. And then the other is product. There's a drastic difference between our product at CityPoint, the premier space that all our leadership has talked about today and let's say, the rest of the market. And it's important to note that these markets product is vintage now over 50 years old. And there's a tremendous amount of that, that's dragging down things. But the difference between CityPoint premier office space at 77 CityPoint, 190, 230, 10 and 20 CityPoint is much different. And that includes what we see in Reston, which is the cluster of amenities. And that is the biggest difference that we're seeing. There's drastic differences between product and then also location."
},
{
"speaker": "Nick Yulico",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Steve Sakwa from Evercore ISI. Please go ahead."
},
{
"speaker": "Steve Sakwa",
"content": "Yeah. Thanks. Good morning. I guess, Owen, you sort of talked about 343 Madison and the work that you're doing there. But also you mentioned the disappointment in not seeing some of the leasing happening at places like 360 Park. So I guess the question is, how are you thinking about the pre-leasing and the risks that you take at 343 Madison to move forward in light of the fact that some of the development has been kind of slower to lease up than you would like?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. I think I'm going to turn it over to Hilary. The big picture answer to your question, Steve, is that north of 42nd Street is primarily a financial services, legal services market and it's very strong and particularly with the access to Grand Central. You go south of 42nd Street, much more tech-driven with the issues that Doug described. But let me turn this over to Hilary."
},
{
"speaker": "Hilary Spann",
"content": "Thank you, Owen. Hi, Steve. I would just echo what Owen has said, and I would add to that, that there have been several sizable leasing transactions completed in the third quarter in Midtown proper, meaning north of 42nd Street as well as a very large lease that printed post the end of the quarter. So Bloomberg signed a renewal for 1 million square feet. Ares signed a lease for 300,000 square feet. Willkie Farr signed a 315,000 square foot lease. All of these leases were in Midtown proper, and they're all at scale. So there is demand from larger tenants in the marketplace. And I think it's just a question of matching the right demand profile client with the premier workplace that we're planning to build. Very different proposition in Midtown South. The market, as Owen alluded to, is dominated by tech and media tenancy. We are starting to see some more traditional clients poke around in Midtown South as they are figuring out that there's very little high-quality space in Midtown available. But I would say the bulk of that leasing demand continues to be from the more traditional tenant base and tech and media simply have not been adding jobs and space the way that finance and the industries that support it have in Midtown proper."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of John Kim from BMO Capital Markets. Please go ahead."
},
{
"speaker": "John Kim",
"content": "Good morning. We're trying to figure out the occupancy trajectory going forward. Doug, you gave very helpful building blocks on what's the puts and takes over the next few quarters. But at the end of the day, you mentioned 2 million square feet of leases need to be signed over the next five quarters with commencements in the next five quarters for occupancy to remain flat. And I'm wondering how realistic that is. This year, you're on pace to sign 4.5 million square feet of leases and how much of that is commencing this year?"
},
{
"speaker": "Douglas Linde",
"content": "I can't answer your latter question because I don't know the actual number in terms of all the things that were signed this year, how much has commenced. We are, I would say, at this point, optimistic that we will sign 2-plus million square feet of leases that will have revenue commencing in 2024 and 2025 so that our occupancy will be at a minimum be flat. I'm hoping that when we go through our planning process with our EPs, we're going to see some opportunities that will be better than that. But again, we're not giving guidance for 2025 at the moment."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Jeffrey Spector from Bank of America Securities. Please go ahead."
},
{
"speaker": "Jeffrey Spector",
"content": "Great. Just back on the West Coast, and I know it's -- you have smaller presence there. But given it's such an important question topic, and I know you discussed it already, but there is a lot of skepticism over the latest return to office mandates, in particular, tech. I know earlier in the year, when we did our tour, we kept hearing tech, they're just not using the stick to bring people back. And so I know, Owen, you talked about that a little bit. Doug, you talked about some of the challenges in San Francisco. Are there lessons learned from New York City? Or do we really need to stop comparing New York to West Coast? West Coast just there are truly just different dynamics, and it's going to take several years for tech firms to really figure out their space needs."
},
{
"speaker": "Douglas Linde",
"content": "So Jeff, my answer is I do think there is a cultural difference between the business community on the West Coast and the business community in cities like New York and Boston. And there is a differentiation. However, that differentiation, I don't believe, will result in any difference in terms of the utilization of space from the company's perspective. It may reduce the number of days any particular company demands their people come to work. And so we are seeing, as Owen said, a lot of organizations saying whatever we have been doing is no longer working for us. and we need to be more aggressive about asking our associates to be more present more of the time. I believe we will see month after month over the next number of months and years, a continual pick up on the West Coast. And clearly, the companies that are involved in the artificial intelligence industry, large scale have said the speed of which we are needing to do all of the work that's required to be \" on top and a winner means we need space and we need our people to be in that space. And as that sector of the economy starts to dominate the culture out there, I would hope that we will see an even larger pickup in other companies responding to the need from a talent perspective relative to productivity. And Rod, you may have a different perspective."
},
{
"speaker": "Rodney Diehl",
"content": "I don't have a different perspective. I completely agree. And I can tell you that it has picked up. And Salesforce, in particular, has -- as of October 1, that's when they kind of instituted their policy of getting people back in the office. And they are tracking that data very closely with our team at the building. And it seems to have -- if you were down there in that building today and you were sitting in that lobby, you would feel a different vibe than you did a year ago. And then one other small anecdote coming in from the East Bay, which is where I live, the BART system, which is our light rail train system, the train station that I go to, there's 3 basic parking lots. And the third lot, which was most distant, had very few cars in it for the last few years. That lot is filling up on days, Tuesday, Wednesday, Thursday, and that hadn't happened before. So they're going somewhere, they're going into the city. And so I think we are seeing a shift."
},
{
"speaker": "Douglas Linde",
"content": "And Jeff, I'll just add one other thing. And again, these are -- this is very anecdotal, but -- but up in Seattle, we've done two leases at Madison Center in 2024. Both of them have been from branches of technology companies that gave space back early during the pandemic and when they changed their policy relative to return to work, needed more space and took an additional floor in both cases at Madison Center. So that does not suggest that any of these companies are going to demand everyone comes back and they're going to start firing people if they don't. We don't know how the stick is going to work. But there are clearly organizations that have said in the technology business on the West Coast that we need to have our people in space, and we want to have the space for those people."
},
{
"speaker": "Jeffrey Spector",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Anthony Paolone from JPMorgan. Please go ahead."
},
{
"speaker": "Anthony Paolone",
"content": "Thank you. Owen, you mentioned in your comments, public markets leading private markets and maybe alluding to opportunities to invest. So can you maybe give us a sense as to where you think or where you see BXP's capital cost being versus maybe what you think you might make on something like 343 Madison or on investment opportunities you might be getting shown? And if we should really start to think about external growth in 2025?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. BXP's look-through cap rate today at current share price is in the mid -- call it, mid-6s. In terms of development yields in New York before the pandemic, development yields were about 6%. And today, I think they're materially higher than that, and that's certainly going to be our target. And then on acquisitions, there have been very few deals done in this premier workplace segment, although there were a couple last quarter, which I provided in my remarks. And again, it's a little bit all over the place, depends on the leasing status and ground lease and all those types of things. But it feels to me like the bid at least is in kind of the high 6%s to 7% cap rate on a stabilized basis. So that's where the market is in terms of the acquisitions, there haven't been a lot of takers of that. In other words, sellers are not accepting that price, and that's why there haven't been that many transactions, but that could clearly change. I also think transaction activity will probably go up in the coming quarters because there is more availability of financing, particularly in the CMBS market, which I described."
},
{
"speaker": "Anthony Paolone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Blaine Heck from Wells Fargo. Please go ahead."
},
{
"speaker": "Blaine Heck",
"content": "Great. Thanks. So along those same lines, in the past, you guys have been pretty transparent about your desire to grow in some of the markets that you've entered most recently like L.A. and Seattle. I guess can you just talk about whether your appetite to grow in those markets has changed at all given the tougher operating environment? And just whether you guys are seeing any interesting investment opportunities in those markets? Or do you think you'll focus your acquisition efforts on markets that are a little bit healthier now?"
},
{
"speaker": "Owen Thomas",
"content": "Yeah. Our strategy top down is to establish a perimeter, which we have with the six markets that we operate in, including some in a couple of cases like Waltham and Reston, places that are outside the CBD. So that's the top-down strategy. In terms of what we actually invest in, it's bottoms up. We're opportunistic. What can we find, what's available, what can our teams generate? We're going to look for and execute on those investments that have the best risk return opportunities. So we're -- we certainly look at where the contributions come from the various regions to our overall result, but we want to be opportunistic in the way we do deals within the perimeter that I described. The last thing I'd say on this is there are opportunities in the West, but they're clearly harder to underwrite. When you're looking at a building in New York or Boston, for example, or, say, in the Reston area, it's easier to have a view on what are the rents, what can the leasing velocity be? What should we expect? Whereas in the West, particularly for some types of assets, that's more challenging because the leasing is slower. So I'm not suggesting we won't do or try to do deals in the West, but they're harder to underwrite."
},
{
"speaker": "Blaine Heck",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Michael Griffin from Citi. Please go ahead."
},
{
"speaker": "Michael Griffin",
"content": "Great. Thanks. I'm curious if you can give any color just on the Bain renewal in Boston and whether or not they were a potential candidate for that development you've got potential in the Back Bay, 171 Dardmouth. Did you just need maybe more of a commitment in terms of rents or weighted average lease term to maybe justify moving them over to the new development? Just any color there would be helpful."
},
{
"speaker": "Douglas Linde",
"content": "So I'm not going to comment about what Bain's decision-making process was. Suffice it to say that a new building construction in Boston today probably cost somewhere in the neighborhood of $1,400 to $1,600 a square foot depending on whether or not you want to include a value for land. And if you need a return and Owen described sort of our development expectations, that will create a rent that is materially higher than the rents that are achievable in existing both under construction and recently delivered new buildings in the financial district and the level of rents that we can currently command in the Back Bay. And so I think the timing at the moment for that new development in Boston doesn't really pencil relative to where existing rents are. Now, if the SOFR curve goes from 5.5% to 3% and lending conditions go from 350 to 400 to non-existent over to 150 basis points over and there is some softening in some of the inputs of the building and the building cost comes down, there's probably a different conversation that could happen at some point in the future with a number of tenants in our Back Bay portfolio about wanting to go to the new building at 170 Dartmment Street. And we hope to start that building at some point, but it's not sort of part of the calculus in 2025."
},
{
"speaker": "Michael Griffin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Alexander Goldfarb from Piper Sandler. Please go ahead."
},
{
"speaker": "Alexander Goldfarb",
"content": "Hey, good morning. Just a question on the D.C. market. You guys made some positive comments on what's going on in D.C. and certainly echoes what we saw when we were down that market earlier in the month. Just looking at twofold. One, as you think about the rents that are rolling in D.C., directionally, do you see those rents, especially in the district rolling up, rolling down? Just trying to get a sense given that this market has had a tough time over the past decade. And then two, is there willingness -- are the tenants themselves willing to pay the rents necessary for new development? Or do you see this market as really just trying to cram into the existing buildings that you have right now?"
},
{
"speaker": "Douglas Linde",
"content": "Yes. So Alex, thanks for the question. I'm going to answer the first part, and then I'll let Jake Stroman answer the second part. So -- in the District of Columbia, every lease that we signed has somewhere between a 2.25% and a 3% annual bump. And generally, those leases are at a minimum of 10 years and generally 15 to 20 years. And so if you compound the rents that where we started with those rents, it is almost impossible to have a rent roll up in D.C. on a like building. However, and I'll let Jake describe sort of where the new market might be for rents in new buildings and how that might impact sort of what the opportunity might be for us. Jake?"
},
{
"speaker": "Jake Stroman",
"content": "Yes, sure. Thanks, Doug. Hello, Alex. Look, Alex, there's no doubt that the preeminent office space and the demand for preeminent office space in the district is driven by the legal industry, as Doug alluded to in his comments. And there are definitely opportunities that exist -- and there are active prospects in the market that are looking for better amenitized and well-located new high-quality product. And so we do believe that there will be opportunities in the D.C. market, whereby, hopefully, BXP is able to capitalize on those opportunities."
},
{
"speaker": "Douglas Linde",
"content": "And just -- and the rent stake that would be necessary for those are what compared to where sort of existing product is?"
},
{
"speaker": "Alexander Goldfarb",
"content": "Yes, they're probably 15% to 20% higher than existing sort of trophy quality product that exists in the market."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Floris Van Dijkum from Compass Point LLC. Please go ahead."
},
{
"speaker": "Floris Van Dijkum",
"content": "Hey, Owen, guys thanks for taking my public you sort of alluded, if I look at the public, and you sort of alluded to this a little bit earlier in your remarks, the public office owners, not all of them, by the way, but some of them like yourselves are getting a green light to grow externally from the market. You're all trading at a premium to consensus and estimated NAV. What -- but you have this issue about the lack of transactions in the market as well. How do you think about the timing or potential, what are the catalysts that are going to need to occur for transaction activity to pick up? And how do you think about your cost of equity to fund those potential transactions going forward?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. Well, I mentioned -- I answered the second question earlier, which is our look-through cap rate today, depending on different models, but it's in the mid-6s. In terms of what is going to spark new activity, I think one of several things or multiple of several things. One, lower interest rates would certainly help. I talked about the -- a new market phenomenon, which is very constructive, which is the opening of the CMBS market for the office sector. I think that will help buyers create liquidity to buy things. So I think that's a catalyst. And then I think lastly, fatigue on the sell side. You're an owner of an asset, you have a business strategy, you want to downsize your office exposure, you want to sell a particular building, you want to reuse the capital to do something else, you have goals. And at some point, you're going to move forward and try to accomplish those goals. So I think that will be part of the calculus going forward as well."
},
{
"speaker": "Floris Van Dijkum",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Caitlin Burrows from Goldman Sachs. Please go ahead."
},
{
"speaker": "Caitlin Burrows",
"content": "Hi. Good morning everyone. I know you aren't giving 2025 guidance, so you're probably less inclined to talk further out. But with that said, I guess, bigger picture, as you consider occupancy improving, development coming online, in-place debt being refinanced, any comments you can give on kind of the trajectory of FFO? Or could you quantify any of those building blocks?"
},
{
"speaker": "Douglas Linde",
"content": "I will just say, Caitlin, that we are an optimistic group here, and we believe that the markets will continue to recover, and we believe that we will pick up a meaningful amount of occupancy over time. And our average rent is somewhere around $80 a square foot, and we should hopefully get to a stabilized level at some point of 400-plus basis points or more of occupancy gain. And you're talking about 80x a 50 million square foot portfolio. So every 100 basis points is 500,000 square feet. So you're talking about 80x 2 million square feet of space. That's a significant amount of growth, both in occupancy and therefore, internally. Owen just described, hopefully, the ability to do some external transactions, which we would believe would be accretive, maybe not a lot in the short, short term, but certainly on a medium- to long-term basis. So we're optimistic about the growth of our earnings over time. And I am sort of the outlier of BXP relative to where long-term interest rates are, but it's clear that short-term interest rates are coming down, which is a good thing. So I think that, that will sort of be a little bit of a sort of neutral for us over the next number of years because we have $1.8 billion of floating rate debt that's going to come down. And as we refinance things, we'll have some amount of increase in our interest expense on the \"fixed rate side. But we just feel -- we feel good about the long-term perspective."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Upal Rana from KeyBanc Capital Markets. Please go ahead."
},
{
"speaker": "Upal Rana",
"content": "Great. Thanks for taking my question. Could you give us some color on the sublease market across your markets? I know you talked about San Francisco already, but what about the others? And then do you have a sense of what percentage of your tenants are currently subleasing their space?"
},
{
"speaker": "Douglas Linde",
"content": "So, sublease is -- the biggest issue is clearly on the West Coast, and it's most dominated in San Francisco and then in Seattle. After that, it falls off pretty dramatically. We really don't have much in the way of a sublease problem in New York City, certainly not in the markets that we are competing with. In our portfolio, there's probably 2 million to 3 million square feet overall of space that has been sublet that's not on the sublease market. Again, we've had these transactions like I just described in Westin where Biogen sublet their space for a long time. And two quarters ago, we had the Riverbend space. So we have some sort of chunkier pieces like that. We have one of those in Reston, Virginia with the College Board. So I'd say it's sort of at that level, but we're not competing with our own tenants relative to transactions in our buildings because most of it was done a long time ago. And in the short term, there's been very little in the way of new sublet space that's been brought on in our portfolio per se."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Peter Abramowitz from Jefferies. Please go ahead."
},
{
"speaker": "Peter Abramowitz",
"content": "Yes. Thank you for taking my question. So you talked about the survey for CEOs. I think that something like 83% or 85% see their people coming back five days a week over the next couple of years. I guess just could you sort of square that with what you're seeing real-time sort of on-the-ground conversations? I know some of the tech tenants have been calling their folks back to the office five days a week. And you gave some helpful anecdotes there on the West Coast. But just kind of curious with how we square survey results like that with the reality of what your conversations are yielding."
},
{
"speaker": "Douglas Linde",
"content": "Sure. So the way you need to think about this is when you say someone is coming back to the office five days a week, they are never in the office five days a week, right? So in 2019, in the best building that we had in our portfolio, if 80% of the seats that were \"in the building were being used on a given day, that would have been nirvana\". And so what we are seeing is that in New York City, we are basically at that level. In Greater Boston and even in Washington, D.C. now, where we have measurements return styles, we are sort of at the sort of 85% to 90% of that level. However, on the West Coast, in San Francisco, we are still sort of at a 65% of that level. And so that's the sort of -- that's what the buildings are telling us. They're also telling us that in all of the markets, the people that are coming in are coming in three-plus days a week. So individual card swipe by a human being that we can identify in general, when you are doing -- coming in, you're coming in very frequently. And so I think it's just a question of building the number of those people who are coming in more frequently that is going to sort of be the thing that creates more \"activity\" in these buildings."
},
{
"speaker": "Owen Thomas",
"content": "Yes. And just to add to Doug's data, and I've mentioned this a few times on prior calls. First of all, CEOs are very -- they're not positive about remote work. They want employees back in the office. They have been reluctant to do so for competitive purposes. Remote work is a benefit that many employees want, but it has a real cost. It's like compensation and other benefits you provide employees. And I think it's notable that groups like Amazon and Salesforce and particularly all the start-up AI companies are saying, you know what, this is a benefit that we're no longer able to provide. We need you to come back. And I think those companies taking those actions will allow their competitors to take similar actions because they're all competing for talent. So I'm not surprised by the survey. It's what we hear from our CEO clients. And I think slowly over time, this issue will continue to dissipate and important."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Dylan Burzinski from Green Street. Please go ahead."
},
{
"speaker": "Dylan Burzinski",
"content": "Good morning guys and thanks for taking the question. Doug or maybe it was Owen, you talked about tech touring activity picking up in New York. Can you kind of compare that acceleration or pickup in tech tenant touring activity to some of your West Coast gateway markets, excluding any of the AI tenants that are in the market? I guess, what I'm trying to get at is, are you seeing that New York even lead on the tech touring activity front as well?"
},
{
"speaker": "Douglas Linde",
"content": "So I will let Hilary talk about the tech in New York, and I'll let Rod talk about the tech demand in San Francisco, and you can make your own conclusion."
},
{
"speaker": "Hilary Spann",
"content": "Hi, Dylan, this is Hilary. The tech demand, I would say, really started to perk up a little bit after Labor Day. And I think it was pretty close to coincident with the timing of the interest rate cut. And it just seems like businesses across the board are having an easier time making planning decisions at this point. That having been said, to Doug's point earlier, it is taking people an exceptionally long time to actually get through the process of making a decision about what space they want to take. So OpenAI recently committed to space in the market at the Puck building. There are other tech tenants that are touring in the marketplace, but I think it's too early to say that there is a solid trend toward them increasing the amount of space they're taking. Certainly, as we've been talking to executives amongst tech companies, they're more constructive on back to office and therefore, the amount of space they need. But I think we're still in the process of sorting out what that means for the actual amount of space that's going to be taken in the market, particularly in Midtown South."
},
{
"speaker": "Rodney Diehl",
"content": "I would just add on the West Coast that I think in addition to the headlines coming out of the AI companies, which has been great, there's definitely a broader base of other technology companies, particularly down in the valley. And I would just make one note of the autonomous vehicle industry. There's a handful of tenants that we're talking to down there that are -- some of them are already our clients, but there's others. And so it's not just AI, definitely."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Ronald Kamdem from Morgan Stanley. please go ahead."
},
{
"speaker": "Ronald Kamdem",
"content": "Hey, guys. Thanks for the time this morning. Just quickly, looking at the health of the New York market overall and the quarter-over-quarter decline in occupancy, can you guys just speak to how much of that was baked into your expectations into the quarter? And looking forward, do you expect a rebound in the fourth quarter? Or are there any headwinds that facing the Manhattan office market that maybe were not as well appreciated by the market? Thanks."
},
{
"speaker": "Douglas Linde",
"content": "I hope that we've been pretty clear that we were going to lose O'Melveny & Myers at Times Square Tower in the third quarter, and that's entirely the only major change in our occupancy in Manhattan. And I would say, in fact, our other leasing activity in Manhattan is above expectation. Now many of those leases haven't commenced yet. So they haven't rolled into occupancy. But our buildings in Manhattan, 360 Park Avenue South aside are seeing a significant amount of interest. And we have active dialogue at buildings like Times Square Tower, at buildings like 200 Fifth Avenue, a lot of activity at 599 Lex. And so it's -- we feel really good about the overall level of sort of transactional demand that is possible for 2024 and 2025 in our Midtown and hopefully, our Park Avenue South/Midtown South market as well."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our last question in the queue comes from the line of Brendan Lynch from Barclays. Please go ahead."
},
{
"speaker": "Brendan Lynch",
"content": "Great. Thank you for taking my question. It sounds like you're potentially interested in acquiring more residential and you have some residential projects beginning the entitlement process. Just wondering if you could give us some color on what the playbook is there?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. So all of what you said is true. We have -- we own today pushing 2,000 units, and we have several projects on land we control that we're pushing forward with. And as Doug described in his remarks, we're looking at some other sites that were -- we thought in a prior market might be well suited for office, and we think that they can potentially be re-entitled to residential. Our playbook in residential is going to be different from what we do with office and life science. Skymark is a good example of this at Reston Town Center. We own the site. We entitled the site. We did all the development work. We're supervising the construction. We have an 80% capital partner, and we also don't lease and manage the properties. So I think what you should expect from our residential business is less long-term hold and more generation of fees, generation of profits on a minority LP interest and generation of carried interest as opposed to long-term hold."
},
{
"speaker": "Douglas Linde",
"content": "Yes. And I would just add the following about our land inventory. And again, I said this in my prepared remarks, we have a significant amount of land inventory where we are carrying that both from an operating perspective as well as a cost of capital perspective. And we are not going to sit around and just wait for the markets to recover. And so we are actively looking at how we can put those resources to use in an accretive way. And it's both multifamily units where we will likely be the developer with third-party money, townhouses where we will probably sell the parcels and Owen referred -- described a couple of parcels that are potentially going to get sold. That's what those are. We are also -- we have some sites that might be good for big box use. We have a site that we've been in contact with somebody who wants to do data centers. And so we are looking to try and as effectively and as quickly as possible, create value from this land inventory because it's not anywhere on our balance sheet, and we get no credit for it relative to our share price. And we think there's actually a significant amount of opportunity there that we are going to try and mine over the next couple of years. And you will start to see some of this occurring in the first quarter of 2025 when hopefully we'll be announcing the commencement of this development at 17 Hartwell Avenue in Lexington, which will be the first of these things."
},
{
"speaker": "Operator",
"content": "Thank you. That concludes our Q&A session. At this time, I'd like to turn the conference back to Owen Thomas, Chairman and CEO, for closing remarks."
},
{
"speaker": "Owen Thomas",
"content": "Yes. We have no more formal remarks. Thanks to all of you for your interest in BXP."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
bxp | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to BXP's Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference call is being recorded. I would now like to hand the conference call over to your first speaker, Helen Han, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Helen Han",
"content": "Good morning, and welcome to BXP's second quarter 2024 earnings conference call. The press release and supplemental package were distributed last night, we furnished on Form 8-K. In the supplemental package, BXP has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors.bxp.com. A webcast of this call will be available for 12 months. At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Although BXP believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that expectations will be attained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday's press release and from time to time in BXP's filings with the SEC. BXP does not undertake a duty to update any forward-looking statements. I'd like to welcome Owen Thomas, Chairman and Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchie, Senior Executive Vice President, and our regional management teams will be available to address any questions. We ask that those of you participating in the Q&A portion of the call to please limit yourself to only one question. If you have an additional clarity or follow-up, please feel free to rejoin the queue. I would now like to turn the call over to Owen Thomas for his formal remarks."
},
{
"speaker": "Owen Thomas",
"content": "Thank you, Helen, and good morning, everyone. BXP's performance in the second quarter once again demonstrated the relative market strength of the premier workplace segment of the commercial office industry as well as BXP's strength and execution. Our FFO per share was $0.06 above our forecast and $0.05 above market consensus for the second quarter. Further, we raised the midpoint of our FFO per share guidance for 2024 by $0.08. We completed over 1.3 million square feet of leasing, which is 41% greater than the second quarter of 2023 and close to our 10-year average leasing volume for the second quarter. As our leasing volume continues to escalate exceeding current lease expirations, we expect our occupancy will increase over time. Weighted average lease term on leases signed this past quarter remained long at nine years. On sustainability this past quarter, we released our 2023 Sustainability & Impact Report, hosted our third annual Sustainability & Impact Investor Update and were recognized by Time Magazine as one of the world's most sustainable companies, ranking number one in the U.S. among property owners. Delivering sustainable real estate solutions is increasingly important to our clients as well as the communities where we operate, and decreases our cost of capital given the growing number of ESG investors interested in our debt and equity securities. Moving to macro market conditions. We continue to experience market tailwinds for the two most important external forces impacting BXP's performance, interest rates and corporate earnings growth. The U.S. inflation report released on July 11th reflected a 3% inflation rate for June, lower than expectations, sparking new forecasts of accelerated interest rate cuts by the Fed as well as lower market yields for the 10-year U.S. Treasury. Lower interest rates are obviously favorable for real estate and BXP's valuation and for broader corporate earnings growth, the second important external factor driving BXP's performance. After remaining flat for all of 2023, S&P 500 earnings growth was 6.6% in the first quarter of this year and is expected to be around 9% for the second quarter. As mentioned repeatedly, companies with earnings growth are much more likely to invest, to hire and to lease additional space as demonstrated in our growing leasing volumes this year. Premier workplaces, defined as the highest quality 6.5% of buildings, representing 13.1% of total space in our five CBD markets continue to materially outperform the broader market. Direct vacancy for premier workplaces is 13% versus 18.5% for the broader market. Likewise, net absorption for premier workplaces has been a positive 6.9 million square feet over the last three years versus a negative 22.8 million square feet for the broader market. Asking rents for premier workplaces are 51% higher than the broader market, a consistent gap from prior quarters. This outperformance is evident in BXP's portfolio where just under 90% of our NOI comes from assets located in CBDs that are predominantly premier workplaces. These CBD assets are 90.4% occupied and 92.2% leased as of the end of the second quarter. We are also experiencing moderate, but steady increases in workers returning to the office based on the turnstile data we capture for roughly half of our 54 million square foot portfolio. Corporations continue to push for increased office attendance, including Salesforce, who recently announced their new policy shift from primarily flexible work to mandatory office attendance for most employees of three to five days per week depending on job function. Regarding the real estate private equity capital markets, office sales volume in the second quarter continued to be muted at $6.9 billion and has ranged from $6.2 billion to $9.1 billion for the last six quarters, well below volumes achieved before the Fed started raising interest rates in 2022. Completed transaction activity for premier workplaces has been very limited, though increasingly, owners are testing the market to understand pricing. Moving to BXP's capital allocation activities. We remain active in pursuing acquisitions from owners and lenders, but as mentioned have seen limited opportunities in the premier workplace segment. We are in active negotiations for the disposition of four land positions, which, if successful, would generate approximately $150 million of proceeds, half of which could be realized this year. For our development pipeline, we delivered into service the 118,000 square foot Dick's House of Sport on Boylston Street at the Prudential Center in Boston, fully leased at a strong yield. On July 12, we opened Skymark, our 508-unit luxury residential tower development at Reston Town Center. We've already leased 21% of the units ahead of schedule and rents are also modestly above projections. We continue to push forward with several residential projects primarily on land we control that are being entitled and designed for which we intend to raise JV equity capital. DXP continues to execute a significant development pipeline with 10 office lab retail and residential projects underway as of the end of the second quarter. These projects aggregate approximately 3.1 million square feet and $2.3 billion of BXP investment with $1.2 billion remaining to be funded and will contribute to BXP's external FFO per share growth over time. The market segment for the broad office asset class remains challenging. BXP continues to leverage its key strengths, which are: our commitment to premier workplaces and our clients as many competitors disinvest in the office sector; a strong balance sheet with ready access to capital and the secured and unsecured debt in private equity markets; and one of the highest quality portfolios of premier workplaces in the U.S. assembled over several decades of intentional development acquisitions and dispositions. So in conclusion, BXP continues to display resilience with a growing leasing pipeline as well as stability in FFO per share and dividend level, and is well positioned to continue to gain market share in both assets and clients during this time of market dislocation for the office sector. Expectations for lower interest rates and stronger corporate earnings growth will also provide tailwinds for our renewed growth over time. So now, Doug, I'd like to wish you a happy birthday. And I'll turn the call over, and you can talk about our strong leasing activity."
},
{
"speaker": "Douglas Linde",
"content": "Thanks, Owen, I really enjoy celebrating my birthday with all of you on the call every two years, one of the highlights. So as we described during our NAREIT June meetings and the webcast that we did, the trend line of BXP's leasing activity in the second quarter of '24 picked up materially relative to what we executed in the first quarter and what we discussed on our last call, all really good stuff. As of June 30, we've completed 2.2 million square feet of leasing for '24. When we spoke to you during our May call, we stated our pipeline of leases under negotiation at that time, May 1, was 875,000 square feet. And as Owen highlighted, we signed leases for 1.32 million square feet between April 1 and June 30, a lot more. And our active pipeline of leases under documentation today has grown to 1.39 million square feet. So if we complete this pool of transactions, we will have leased 3.59 million square feet of space, exclusive of our leases and documentation. We have an additional set of transactions under discussion totaling about 850,000 square feet. So if we execute 50% of those transactions, we will more than achieve our leasing guidance of 4 million square feet for the year. This quarter, we completed 73 transactions, 37 lease renewals for 830,000 square feet, 36 new leases encompassing 500,000 square feet. 12 clients expanded into 228,000 square feet of additional square footage, while we had 4 contractions totaling 63,000 square feet. 45% of our absorption was growth from our existing client pool. As a point of comparison, last quarter, we completed 61 transactions with 29 renewals, encompassing about 400,000 square feet and 32 leases for 494,000 square feet, and we had only 3 expansions for 18,000 square feet, and we had 4 contractions totaling 44,000 square feet. So again, really big improvements. Q2 activity was concentrated in our East Coast markets with 445,000 square feet in New York, 343,000 square feet in Boston and 351,000 square feet in Northern Virginia. These 3 markets made up 1.14 million square feet or 86% of the activity. Our West Coast activity was almost exclusively in San Francisco with 146,000 square feet. The majority of our client expansion came from Manhattan this quarter. The only significant contraction in the portfolio came from a tech company downsizing in Reston. We had 3 transactions over 100,000 square feet, one each in Boston, New York and Reston. Expansions or new clients made up 42% of the activity in New York, 40% in Boston, 37% on the West Coast and 16% in D.C. As reported in our supplemental, the mark-to-market of leases that commenced this quarter, which is about a 375,000 square foot base, was up 6% and transaction costs averaged $11 per square foot per year. The overall mark-to-market of the [ restarting ] cash rent on leases executed this quarter, which was a 1.15 million square feet pool relative to the previous in-place cash rent was about flat. The starting rents on leases we signed during the second quarter were up about 8% in Boston, really flat in New York, down 6% in D.C. and down 7% on the West Coast. Now I want to spend a minute on our occupancy change during the quarter, which seemed to have been a focus of many of the analyst reports that we saw this morning and last night. As we stated in February and May, we have 2 large known expirations, one in April, 200,000 square feet at 680 Folsom, which is in the second quarter figures and one in July, 200,000 square feet at Times Square Tower. That's a JV asset, so our percentage share is 110, but we report the 200. This quarter, we also vacated 148,000 square feet of occupied but non-revenue-producing spaces. What do I mean? Well, we had some tenants in default where we had stopped recognizing revenue yet they were still in possession and we were in legal proceedings to vacate the space. In addition, we took back 60,000 square feet from WeWork at Dock 72, but there, the absolute rent that we were receiving remains the same. It's just on a lower square footage. Finally, we terminated a 33,000 square foot lease in Waltham that was simultaneously released but won't be delivered into next quarter. Those movements account for 92% of the reduction in our occupancy in the second quarter from the first quarter. As of June 30, we have approximately one million square feet of signed leases that have not commenced. Hence, the 200 basis points difference between occupied space and leased space. In the first quarter, our leasing included 383,000 square feet of vacant space leasing. This quarter, that same vacant space leasing was 362,000 square feet. These leases are all part of our leased square footage percentage. Our pipeline of leases in negotiation includes an additional 635,000 square feet of currently vacant space, which if signed will contribute another 130 basis points to our leased square footage. In addition to the known 200,000 square feet expiration at Times Square Tower in Q3, our 2 Waltham life science developments will be added into our in-service portfolio in the third and fourth quarters, 180 CityPoint and 103 Fourth Avenue, respectively. There are combined 32% occupied, which will reduce our in-service occupancy. These additions will result in about a 50 basis point reduction at the year-end. For those of you that are focused on the next quarter, we expect us to be lower by about 40 basis points with a recovery in the fourth quarter where most of the leases that have been signed start to commence where we project occupied space to be between 87% and 87.5%, inclusive of the addition to the in-service portfolio. In previous quarters, we have not been including the additions to in-service portfolio, but we're doing that now because it's a quarter away. Our leased space will continue to be above 89%. BXP continues to lease space. In Manhattan, almost all of our demand continues to originate from financial institutions, alternative asset managers, professional service organizations and law firms. In many circumstances, these clients are expanding. Concessions are flat and taking market rents have risen double digits in 2024. The sub 8% availability in the Park Avenue submarket is a direct reflection of these users growing and competing for limited blocks of space. In one of our assets, we have 3 tenants that would like more space, and we have no immediate availability. We had more than 130,000 square feet of expansions at the General Motors Building and at 601 Lexington Avenue this quarter. Our strongest tour activity in New York City continues to be in the submarket. At the same time, technology demand across the city continues to be light. We completed a single floor lease at 360 Park Avenue South with a digital media firm this quarter, but Midtown South is a tech branded submarket in the city, where transactions over 20,000 square feet have been very limited in 2024. In Princeton, we completed 10 transactions totaling 150,000 square feet during the quarter, including an extension and expansion with a foreign pharma company. In the Back Bay and the Financial District of Boston, we completed 195,000 square feet of leasing this quarter. The majority of this activity was in our Back Bay portfolio and the clients were alternative asset managers and professional services firms. The Back Bay continues to outperform the financial district, which continues to have to digest the new construction pipeline. Our remaining activity was in our Waltham urban edge portfolio, where we completed just over 110,000 square feet and 90% of those transactions were on either existing or near-term vacancy, not renewals. Here, the demand came from a consumer products company, a homebuilder and a few pharma life science companies with office requirements. We've execute one 25,000 square foot life science lab lease. The life science lab demand in Greater Boston continues to be lackluster, with tenants displaying a little urgency around any potential new requirements or relocations. To date, this year, there have been 8 nonrenewal lab deals in Waltham, Lexington, Watertown and West Cambridge that didn't involve a sublet. Only one was greater than 25,000 square feet. Our Reston portfolio was responsible, as I said, for virtually all of our executed leases this quarter in the D.C. region. Leasing activity and tenant demand growth is coming primarily from 2 industries, cybersecurity and defense contracting. We had just over 30,000 square feet of expansion from existing tenants but we also experienced, as I said, a 50,000 square foot contraction from a traditional tech company. The vibrant residential and retail environment continues to be a natural location for small businesses in the financial services and legal industry as well, and we did do 6 leases at 5,000 square feet or less in the Town Center as well as a handful of retail deals. The District of Columbia office market is becoming more and more bifurcated. The private sector tenant demand is dominated by the legal industry in D.C., but in almost every case law firm renewal or relocations are resulting in smaller requirements which is leading to negative absorption as we have all read and seen. It doesn't look like the government leasing or usage is going to help with this problem. However, with the either existing or near-term high vacancy, there are many buildings with overleveraged capital structures unwilling to provide capital for new transactions, and therefore, they have very little client interest. When clients do want space, they prefer to be on the top of refurbished, amenity-rich, well-capitalized buildings. There appears to be limited opportunities in the market that meet these clients' demand so our availability at 2200 Penn and 901 New York Avenue should fare well over the next few quarters. On a comparative basis, the West Coast markets, particularly San Francisco, are seeing more demand in '24 than '23. However, additional sublet availability and technology company lease downsizing upon lease expirations continue to mute the positive demand emanating from the AI organizations that continue to look for space. Tech growth away from AI has yet to emerge. The San Francisco CBD also continues to act as a financial center of the West Coast with its own set of asset managers, including private equity firms and venture firms, some hedge funds a few specialized fund managers and obviously, their financial and legal advisers. This is the source of the bulk of the transactional activity in the market. And while the brokers correctly report a pickup and tenants in the market. If you look more closely, very little of that demand represents net growth from those tenants. Our San Francisco activity continues to center on traditional non-tech demands at Embarcadero Center. This quarter, we completed an 80,000 square foot law firm renewal with no change in square footage and five smaller deals, all 12,000 square feet or less with new tenants on currently vacant space. We continue to see many of the professional services in law firm continuing to downsize, which is in stark contrast to the activities of those same tenants in New York and Boston. We are seeing a steady flow of potential tenants 12,000 square feet or less, which is about a full floor at our 535 Mission property. But this is in contrast to 680 Folsom whose location is less desirable for non-tech demand and where the potential tech clients continue to have inexpensive furnished sublet options. Tenant activity is improving in our Mountain View research R&D buildings, where we have about 215,000 square feet of availability and uniquely attractive products. These buildings are designed for companies that are making some sort of device, be it a car sensor, a photovoltaic panel or a medical device. They don't compete with the large multistory office product that has flooded the market. We saw activity come to a halt when the SVB imploded last year. The entrepreneurial device maker companies still exist, and they are now slowly making capital commitments once again and looking at leasing space. The lab market story in South San Francisco is not dissimilar to Greater Boston. There were only a handful of new leases completed during the first six months of the year that didn't involve a renewal or sublease though there have been about 100,000 square feet of new deals completed in the last 30 days. Overall, we are experiencing an improving operating environment. Leasing available space is primarily driven by gaining market share from competitive landlords and/or lower quality building, but not net new market demand growth. While the markets need consistent incremental absorption to show a macro recovery, we have started to see pockets of strength where low availability is driving constructive client behavior, the Back Bay of Boston and the Park Avenue submarket of New York are the obvious examples. As clients choose premier properties and sound financial condition operated by best property management team, we will continue to be successful in capturing demand, leasing space and increasing our occupancy. And with that, I'll turn it over to Mike."
},
{
"speaker": "Michael LaBelle",
"content": "Great. Thanks, Doug. Happy birthday."
},
{
"speaker": "Douglas Linde",
"content": "Thank you."
},
{
"speaker": "Michael LaBelle",
"content": "So this morning, I'm going to cover the details of our second quarter performance and the increase to our 2024 full-year guidance. So for the second quarter, we reported funds from operations of $1.77 per share that exceeded the midpoint of our guidance from last quarter by $0.06 per share. Our portfolio NOI came in $0.01 ahead of the midpoint of our guidance. The majority of this resulted from lower operating expenses in the quarter. Our rental revenue was closely aligned with our expectations. And as Doug described, our occupancy decline was anticipated in our guidance as we've covered with you in the last two earnings calls. $0.05 of our earnings beat came from a reduction in non-cash interest expense that we don't expect to recur and that you should not incorporate in our run rate going forward. The change is due to our reassessing of future earnout payment related to our Skyline multifamily project in Oakland. The reassessment results in the reversal of $9 million of previously accrued non-cash interest expense. Our structuring of this deal with the protection of an earnout in lieu of an upfront land purchase is saving us nearly $40 million of projected land payments. So moving to the full-year. We're increasing our FFO guidance for 2024 to $7.09 to $7.15 per share. At the midpoint, this equates to $7.12 per share and is an increase of $0.08 per share over the prior guidance midpoint. In addition to the second quarter outperformance, we anticipate $0.02 per share of better projected portfolio NOI in the back half of the year from our in-service portfolio. We've negotiated three lease terminations, all in Boston, with payments that will add incremental income in the second half of 2024. Net of lost rental income or NOI is projected to be higher by approximately $4 million or $0.02 a share. The geography of the expected improvement shows up as an increase in termination income and a modest reduction of same-property NOI. We don't include termination income in our same property guidance, and we guide to it separately. So you will see in our detailed guidance table in our supplemental that our full year '24 termination income guidance is now $14 million to $16 million, up $8 million. Correspondingly, we've reduced our 2024 same-property NOI growth by 25 basis points at the midpoint to a range of negative 1.5% to negative 3% from 2023. If not for the terminations, our same-property performance expectations would have been in line with our prior guidance. To provide a little more detail, most of our termination income comes from terminations we have negotiated to allow us to sign new long-term leases with both expanding and new clients. These transactions are reducing our occupancy by 100,000 square feet temporarily but the impact will be short term as we have new leases coming in after 6 to 12 months of downtime that will cover virtually all of the space. These deals reduce our 2024 occupancy by about 20 basis points and are reflected in our updated occupancy guidance. We've also modified our guidance for net interest expense to incorporate the $0.05 per share of lower interest expense recorded in the second quarter. This results in lower interest expense for the full-year and a new guidance range for net interest expense of $578 million to $588 million. The remaining components of our prior guidance have not changed meaningfully, and overall, our earnings performance for 2024 is exceeding our prior expectations. I would like to spend a minute on interest rates as there's been no consistency quarter-to-quarter on Fed rate cut projections. Back in January, the Street was projecting 4 to 5 rate cuts starting in the second quarter, then the first quarter data came out and the Street changed that to 0 to 1 cut. And now with more progress on inflation, the Street has reverted back to 3 cuts this year. We have not changed our base model that assumes one 25 basis point cut in December. Should the Fed cut by 25 basis points 3x starting in September, our interest expense will be about $2 million or $0.01 per share lower, which is within our guidance range. Another item that could impact interest expense is the refinancing of our $850 million, 3.35% bond expiring in January 2025. We have access to multiple debt markets, and in general, the bond markets have been improving with tighter spreads and lower treasury rates. We are evaluating the timing of replacement financing, and it is possible we could hit the market this year. We would expect to invest any financing proceeds temporarily in bank deposits that currently earn approximately 5% and then redeem the bond at its expiration. We haven't included the impact of a potential debt transaction in our current guidance. So in conclusion, we're increasing our guidance for FFO to $7.09 to $7.15 per share. This is an $0.08 share increase from the midpoint from our prior guidance. The primary reason is the improvement of $0.05 per share of lower noncash interest expense, $0.05 of higher termination income offset by $0.02 of lower same-property NOI from the lost rental income related to lease terminations. That completes our formal remarks. Operator, can you open up the line for questions?"
},
{
"speaker": "Operator",
"content": "Thank you, sir. [Operator Instructions]. And I show our first question comes from the line of Nick Yulico with Scotiabank. Please go ahead."
},
{
"speaker": "Nick Yulico",
"content": "Thanks. Good morning. So I appreciate some of the clarity there on the occupancy guidance and the leasing activity. Sounds like some of this is -- or a lot of this is sort of timing related in terms of the adjustment to the occupancy and same-store guidance. Is there a way to give us a feel for if some of the recent leasing pace continues, how that could translate into occupancy growth next year? I know Owen did talk earlier about getting to the point where occupancy will increase over time. I mean any sort of early thoughts on 2025 impact? Thanks."
},
{
"speaker": "Douglas Linde",
"content": "So Nick, this is Doug. So I think that Owen's comment was 100% accurate, which is our occupancy is going to increase. Mike would also tell you that we have a cycle with regards to particularly our CBD leasing, which by the way, we're in the mid-90s on an occupancy level right now. Where those leases take some time to go from lease to occupied, right? So we have a 200,000 square foot piece of space that's available in a particular building, and we sign a lease for it, but we may not see actual occupancy for 12 to 16 months because the tenant has to actually physically build out the space. And so it's a little hard for us to give you a tight projection on when our occupancy number will actually start to materially increase. The trajectory is -- there's no question it's going up. And if we end the year again with this new adjusted in-service portfolio with the availability that we have in these life science buildings, in the mid 87s, we will -- my guess is, be in the 88 in 2025, and we could get lucky relative to delivering some space where the tenant takes it in and as condition. And suddenly, we get a big pickup in \"occupied\", and therefore, we can start recognizing revenue. Those are the kind of things that would make a material difference, but we're not counting on those."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Steve Sakwa from Evercore ISI. Please go ahead."
},
{
"speaker": "Steve Sakwa",
"content": "Thanks. You guys talked about maybe pursuing some new apartment developments. I'm just curious if you sort of look at pricing today for materials and kind of current rents, what sort of yields do you get on un-trended rents today? And it sounds like you might bring in JV partners, but how would you just sort of think about funding those? And what percentage of those deals would you likely keep?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. Steve, it's Owen. So most of what we're pursuing is on land or other assets that we control that we are re-entitling. There's -- it's no secret that there's a shortage of housing, certainly affordable housing in this country broadly. And I think communities are a lot more interested in entitling housing projects today than they have been in the past. And that's a real help to our activities. The obstacle is what you described, which is costs, which have gone up not only for materials but also capital, given interest rates. But to come to your question, we have a pretty significant portfolio of land that we control that we're pushing through this entitlement and design process, but not all the projects pencil. What we're trying to get on a project basis is mid-6 yields and higher. And as you also suggested, our goal would be to bring in JV partners for that. I mentioned this Skymark project that we are currently opening in Reston, we own 20% of that project and have an 80% JV partner. And our hope is to establish similar types of joint ventures for these projects in our pipeline."
},
{
"speaker": "Douglas Linde",
"content": "Yes. And Steve, this is Doug. I will just make the following additional comment, which is this stuff works with stick frame. So the things that we are looking at in our Suburban I'd say, non-office likely potential properties in the Greater Waltham market as well as in Northern Virginia are the places where you will probably see us being able to start things sooner rather than later. CBD construction and CBD rents are much harder to pencil right now. And all of our teams are looking at it and studying it, but we don't -- we're not sure that 2025 will be a position from -- an economic start on that stuff."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Michael Griffin with Citi. Your line is open."
},
{
"speaker": "Michael Griffin",
"content": "Great, thanks. Owen, I want to go back to your comments around expectation for forward earnings growth and kind of how that translates to leasing. Should we take it as the fact that there is a pivot to earnings growth improves the outlook versus maybe the magnitude of what corporate earnings growth is expected to be maybe relative to history? And then I imagine that a lot of that growth is coming from tech companies, just given the fact that they've been more hesitant to lease space as we've seen over the past couple of years, how does that maybe factor into using that metric as a good forward indicator of leasing demand?"
},
{
"speaker": "Owen Thomas",
"content": "Yes, Michael. Good morning. So we provide in our IR deck, a graph of S&P 500 earnings growth versus BXP's leasing activity. There's a clear correlation. Not all of our clients are in the S&P 500, but S&P 500 earnings growth is just an indicator of, I would say, corporate health. And when companies are growing and they're healthy, they're more likely to invest higher and lease space. So I think it's real. And this year, it's proving itself once again because in '23, we had more muted leasing activity. There was no S&P 500 earnings growth. This year, the growth is stronger and our leasing is stronger. So that correlation holds. You are 100% right. I think, in terms of your comments about tech leasing. When you look at the markets today, I would say outside of tech and life science, our leasing is almost back to normal, whatever that is defined as pre-pandemic. Those are the two places that there is a gap. And I recognize some of the S&P 500 earnings growth is coming from tech companies. But again, when you look at the data, that correlation holds, S&P 500 earnings growth to leasing, and it seems like it's holding this year in 2024."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of John Kim from BMO Capital Markets. Please go ahead."
},
{
"speaker": "John Kim",
"content": "Thank you. You pushed back the stabilization dates of several development projects. How should we think about the likely lease-up period versus those new dates, and Mike, if you can remind us of your capitalization interest policy. I know in the past, you stopped capitalizing as soon as initial occupancy took place. And I just wanted to clarify that position."
},
{
"speaker": "Douglas Linde",
"content": "So John, I think that the stabilization dates assume a 85% occupied square footage of the building. So that's sort of how that works. So presumably, the leasing would be done in the 12 to 18 months prior to that date occurring and we would be building out space and generating revenue when those tenants actually moved in. And I'll let Mike talk about our capitalization method."
},
{
"speaker": "Michael LaBelle",
"content": "So the policy around capitalization is that we stop capitalizing interest and any expenses associated with assets like real estate taxes, 12 months after the base building is completed. So like for 103 CityPoint and 180 CityPoint that Doug described that is going into the in-service portfolio later this year, those base buildings completed in the third and fourth quarter '23. So in the third and fourth quarter '24, the capitalized interest will stop on those assets. And so they're not fully leased. So we'll have some impact there. The 751 gateway asset completed its base building in the second quarter of '24 and 360 Park is later this year. So those will have some impact next year and then later next year for 360 Park. That's kind of the timing associated with how the capitalized interest works."
},
{
"speaker": "Douglas Linde",
"content": "And again, unfortunately, it's just geography, but we throw all of these development assets 12 months after we've completed base building into our in-service portfolio wherever they are leased. And so they have a muting effect on our occupancy, even though they're not really apples-to-apples part of the in-service portfolio that we're describing on a sort of quarter-by-quarter basis."
},
{
"speaker": "Operator",
"content": "Thank you. And I'm showing our next question comes from the line of Blaine Heck from Wells Fargo. Your line is open."
},
{
"speaker": "Blaine Heck",
"content": "Great, thanks. Good morning. Owen, conversations about the potential impacts of the election are ramping up. So I wanted to get your thoughts on whether you see any possible changes in regulations or the overall economic or political environment that would be impactful to your business under either party?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. I don't think it's a huge difference for us. I mean, clearly, there's some tax issues that are coming up over the next couple of years where if there's a -- one party or the other gets elected, it could have some impact. But I will say state and local elections have a larger impact on our day-to-day business. What's going on with real estate taxes in our city, what's our ability to entitle real estate, what's going on with commuter -- transit, what's going on with safety and crime and are -- in the streets of our cities. Those types of issues have a bigger impact on us than issues at the federal level."
},
{
"speaker": "Operator",
"content": "Thank you. And I'm showing our next question, comes from the line of Camille Bonnel from Bank of America. Please go ahead."
},
{
"speaker": "Camille Bonnel",
"content": "Good morning. I wanted to pick up on the portfolio's CapEx spend for the first half of the year, which looks to be tracking in line with 2023 levels and well below your historic average. So could you provide an update on the CapEx assumptions you have planned, given expectations for higher lease commencement?"
},
{
"speaker": "Michael LaBelle",
"content": "So our maintenance CapEx, I would suggest it's going to run somewhere between $80 million and $100 million this year, which is in line with, I would say, historical type of averages, maybe a little bit lower. We do have some repositioning CapEx that is more meaningful this year than it was last year, primarily at 200 Clarendon Street, where we're putting in a pretty significant amenity center that is going to result in tenant retention and higher rents in that asset. So you may have noticed this quarter, there was a little bit more of repositioning capital. On the leasing side, this quarter was lower because we just didn't have that many leases commenced this quarter. It was just a little bit bulky, obviously, quarter-to-quarter on our leases commenced. And I think that a run rate -- annual run rate is $200 million to $240 million of lease transaction costs that would be part of our AFFO calculation."
},
{
"speaker": "Operator",
"content": "Thank you. And I'm showing our next question, comes from the line of Connor Mitchell with Piper Sandler. Please go ahead."
},
{
"speaker": "Connor Mitchell",
"content": "Hey, good morning. Thanks for taking my questions. Kind of following along with Mike's answer there and providing some CapEx on adding some amenities. I was just wondering, with the leasing coming back, you guys had a good quarter of leasing volume and building out the pipeline some more, do you feel it's time to really reengage in building amenity upgrades in existing buildings? Or are you still looking for a little bit more of a push from the demand side?"
},
{
"speaker": "Douglas Linde",
"content": "So this is Doug. What I would say is I'm going to ask some of the regional management teams to discuss what's going on, but we have effectively done almost every building from the sort of a reimagination, reamenitization project perspective, it's either underway or it's just about complete. And I can let Rod talk about what's going on Embarcardero Center and I'll let Peter, Jake talk about the things that we've been doing in the Greater D.C. market, and then Brian can discuss 200 Clarendon Street, but that's kind of the last of the major changes. Hilary has a few little things going on the margin in some of her buildings. But why don't we start with Rod."
},
{
"speaker": "Rodney Diehl",
"content": "Yes. So as Doug mentioned, we are in the process of doing an amenity center at Embarcadero Center. And this is -- we have always had a conference facility. And what we've done now is basically we're decommissioning that conference facility and we're building a brand-new both conference and amenity center over three Embarcadero. So that is under construction, and it's got both indoor and outdoor space. It's going to be available primarily to our tenants, but it will be available to the general public as well. And we're excited about it. And it's an absolute must. I mean we are making those same improvements, similar in concept anyway at our other projects, and it's demanded by the tenants. So very excited about getting this one done."
},
{
"speaker": "Douglas Linde",
"content": "Pete?"
},
{
"speaker": "Peter Otteni",
"content": "Hey, good morning. This is Pete Otteni in D.C. So I would say we've been, as Doug said, through several major projects here in the D.C. market. We just opened Wisconsin Place in the Chevy Chase Maryland market here recently to great fanfare and we're optimistic that, that's going to translate as Rod was just describing, and Doug did into both increased demand and retention at the property. We're under construction at Sumner Square, and that will be done later this year. That's the result of some leasing that we have -- Jake and his team have mostly already done, and that was demanded by some of those tenants through part of their renewal. And then upcoming is at 901 New York Avenue as part of our lease renewal with Finnegan late last year and early this year. we're doing a pretty major renovation of both that lobby, the existing lobbies and the replacement of the amenity center on the lower level. So I would say we are mostly through that in the D.C. market. There's no major ones on the horizon, and I'll see if Jake has anything to add."
},
{
"speaker": "Jake Stroman",
"content": "No, nothing to add other than in terms of the repositioning that we just opened at Wisconsin place. It's been met with quite a bit of fanfare. We've had some broker events, and there's definitely some activity and interest in that space now, which is exactly what we wanted to have happened. And at 901 New York Avenue, we will hopefully commence construction on those renovations in the first quarter of next year. And again, a lot of that information has been shared with the brokerage community and with the plus or minus 100,000 square feet of vacant space we have in that asset, we've got some really good activity on that space."
},
{
"speaker": "Douglas Linde",
"content": "Bryan, do you want to just sort of talk about 200 Clarendon Street?"
},
{
"speaker": "Bryan Koop",
"content": "Yes. We're towards the tail end of our investments in execution. Doug mentioned at 200 Claredon, that's a three-year process of design and inclusion with our clients in that building also tied to commitments to renewal. And that is under construction as we speak and going well. At the Prudential Center, our View Boston should be included in upgrade of amenities for our clients. View Boston has a tremendous amount of design factors that were put in by input from the clients, the major clients at the Prudential Center for event space for meeting space, et cetera. And then we finished at 140 Kendrick in the urban edge portfolio to tremendous success, really great feedback on that high utilization. And if we do any others, it will be on the margin in, let's say, one of the possible urban edge larger assets, but it would be insignificant compared to our other investments."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Caitlin Burrows from Goldman Sachs. Please go ahead."
},
{
"speaker": "Caitlin Burrows",
"content": "Hi, good morning everyone. You guys talked about how the tech and life science areas are two where leasing is not quite back to normal, whatever that might be, but that the other areas are. So just thinking of the tech and life science, I think the details are different for each of them. But like what do you think gets them back? How much downsizing is there still to see? But yes, could you talk about that a little bit more?"
},
{
"speaker": "Douglas Linde",
"content": "Sure. So Camille [ph], this is Doug. So on the tech side, I actually don't think it's about downsizing much anymore, Caitlin, it's really at this point about whether they want to make high value-added investments in their real estate relative to their current platform of human beings and where their spaces are. So as an example, you may see some tech companies, large tech companies making incremental expansions in particular cities because that's where they think talent is. But on the margin, those companies are not growing quickly. We are starting to see dollars, right? And you're seeing this both on the life science side as well as the venture side being raised by companies that will be the next group of organizations that are doing something that to create value for the world at large, the business community, the improvement in the human condition from the perspective of life science and elongating the value of people's lives. That pipeline of money, it takes time to move into the organizations and those organizations to really create for new opportunities for growth from an office perspective. It's been going on. We're hoping that we'll start to pick up, but I'm not smart enough to know when that's going to happen, but we know it will happen. And as we think about our cities and our portfolio, we have a view that there will be more creation of new jobs and new economic activity in life science and in technology broadly thinking, then there will be in traditional financial services to asset management, professional and administrative services. So we're banking on that happening. It's just a question of when, and it's really hard to be able to sort of give you a time frame for that."
},
{
"speaker": "Owen Thomas",
"content": "So and just to add a little bit to what Doug said, and I've mentioned this on prior calls, the -- a lot of the large tech companies took a lot of space in '21 and '22. And I think there's a digestion process that's underway, and we can't really forecast when that completes. But again, I would reiterate Doug's point about where the relative growth will be. And then I think the other thing that's interesting that I mentioned in my opening remarks is what are the in-person work policies of the tech companies, and Salesforce just this last month or last couple of months announced that starting in October, they expect almost all their employees to be in the office three to five days a week, and that's a big change in their policy, and they're one of the biggest employers in San Francisco. So I think that's going to have an impact as well."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Vikram Malhotra from Mizuho. Please go ahead."
},
{
"speaker": "Vikram Malhotra",
"content": "Thanks for taking the question. Just two clarifications to the comments. I guess, one, you've described sort of East Coast and financial leasing picking up, particularly in New York, but maybe more broadly, how much of that is focused primarily on the premium product versus sort of the general market? In other words, is it still the divergence, or is the market actually picking up? Number one. And then number two, just in your comments on leasing and what that may mean for occupancy. Could you maybe give us more color how much of that is actually renewal? Or how much visibility today do you have on renewals into '25? Thanks."
},
{
"speaker": "Douglas Linde",
"content": "Owen, do you want to take the first question?"
},
{
"speaker": "Owen Thomas",
"content": "Yes. I mean, Vikram, the hiccup is clearly in the premium buildings. I gave you all the statistics on it, the asking rent gap. There's a lot of speculation. Well, as the market improves, this gap is going to be decreased. So that hasn't happened. It's definitely stayed flat, if not grown. I do think in certain locations, though, that are very desirable like around Grand Central Station, the market strength does creep into the -- beyond the premier segment. I think that's true for special locations."
},
{
"speaker": "Douglas Linde",
"content": "And Vikram, on your question about sort of renewal versus new. So I -- one of the things I provided in my remarks were the amount of vacant space that we leased in each quarter and what's going forward. And so that number is coming out to somewhere around 40% of our leasing is those types of added occupancy generators, and the rest of it are renewals. And generally, when we're doing renewals, the majority of it is forward, but some of it is relatively broadly speaking sort of in the contractual expiration period of the given year. So we do have a bunch of leasing that we're doing for 2024 expirations, but the majority of that is for 2025 and 2026."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question, comes from the line of Floris van Dijkum from Compass Point LLC. Please go ahead."
},
{
"speaker": "Floris van Dijkum",
"content": "Good morning guys. Thanks for taking my question. Owen, you mentioned something in your comments about potentially transaction activity in the office market maybe starting to pick up and some of the pipeline as we think about it, the foreclosures maybe starting to transact, could you maybe talk a little bit more about that part of the market, what percentage of those assets could be premium or the ones that you would target? And maybe also talk about the disconnect between buyers and sellers? And what does that mean for your -- are people closer to your cost of capital? Or are they -- or expectations on the seller and on the lenders still too high?"
},
{
"speaker": "Owen Thomas",
"content": "Good morning, Floris. Yes. Floris, first of all, on the foreclosure activity and short sales, loan sales and things like that, there's been very limited activity in those areas for premier workplaces. I think generally, the premier assets, usually they are less leveraged. They're in stronger hands, and if they are leveraged, they're usually performing pretty well. And if they have a problem, the owners are doing whatever they can to fix the loans. So we just haven't seen much foreclosure or distressed activity with the premier assets for all those reasons. That all being said, we've gone -- we've had a deal drought here for a couple of years. And investors, other owners, they got to get on with their business plans and at some point, they need to transact. And so I do think we're seeing increased, as I described in my comments, testing of the market of certain assets, I won't get into any specifics, but there are definitely a handful of buildings right now that are being offered in the market, I think they're premier, and it's just going to be interesting to me if that bid-ask spread gets bridged. Because right now, I do think there's a bid out there for premier assets. And so far, no owners have elected to take it. And I think the second half of this year will be interesting to see if any of those deals come to fruition."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question, comes from the line of Reny Pire from Green Street. Please go ahead."
},
{
"speaker": "Reny Pire",
"content": "Hi, guys. Thanks for taking the questions. Just curious, I appreciate your comments on the difference between premier assets versus the broader market averages, but just trying to get a sense for at what point you think you can start to see a pickup in net effective rents for you guys in premier portfolio. Is this something that given the difference in rents between premier and non-premier that you don't think you'll start to see? Or sort of just how should we be thinking about prospects for net effective rent growth?"
},
{
"speaker": "Douglas Linde",
"content": "So I'm not entirely sure of what you want to use as your from when-to-when point. But I can tell you that net effective rents in our Park Avenue submarket of Manhattan and I'll let Hilary comment are higher today than they were six months ago, and they're higher today than they were a year ago. I can say the same thing definitively about the Back Bay submarket of Boston, but it's going to take a long time for that to occur in markets where there is a significantly larger availability rate because of the nature of having to basically steal market share from existing embedded occupancy. And Hilary, you can maybe comment on sort of transaction costs and what's going on with the rents in Manhattan because it's obviously the clearest example of what's going on from an NER perspective."
},
{
"speaker": "Hilary Spann",
"content": "Sure. Thanks, Doug. So in the Park Avenue submarket, which I think is the easiest one to focus on in Manhattan, the vacancy rate, as noted earlier in the call, is less than 8%. And when vacancy drops below, I'd say, about 10%, folks start realizing that if they want to be in that submarket, the pickings are very, very slim and they have to move if they want to get leases done. And that's exactly what we've seen. We first saw face rates rise and concessions remain stable, which is a little bit unusual. In past cycles, you would first see concessions bleed out of the market before face rates began rising. Nevertheless, that's what happened. Face rates have risen. Concessions have remained roughly stable, and so that has caused an increase in net effectives. Now anecdotally and very, very and consistently, we're starting to see concessions move in a little bit. And so we're hopeful that, that means that net effectives will accelerate. But I would just reiterate that there isn't a lot of availability in the strongest submarkets to test that theory against. In addition to the tightness in the Park Avenue submarket and what that's done for net effectives, I would say that it has bled outward in the sense of creating more leasing velocity in adjacent submarkets but those submarkets remain sort of full with concessions. And so I think until those markets demonstrate more tightness in occupancy, we'll see stable concessions and rents flat for the near term."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Peter Abramowitz from Jefferies. Please go ahead."
},
{
"speaker": "Peter Abramowitz",
"content": "Yes, thank you. Just noticed that the operating expense growth was a little bit elevated in the same-store portfolio this quarter. Just wondering if you could comment on that, anything you would call out and anything to look for the rest of the year?"
},
{
"speaker": "Michael LaBelle",
"content": "I actually think our operating expenses were less than we expected them to be. So I think maybe they increased a little bit because there's a little more utilities expenses in the second quarter and repair and maintenance in the second quarter versus the first quarter. We generally get started a little bit slower at the beginning of the year on some of those items. And I think the third quarter is generally higher than the second quarter seasonally as well because of weather conditions again utilities. And I would expect R&M to be a little bit higher too, and that's kind of in line with where our budget is and that it would be probably a little lower in the fourth quarter."
},
{
"speaker": "Operator",
"content": "Thank you. And I'm showing our next question, comes from the line of Omotayo Okusanya from Deutsche Bank. Please go ahead."
},
{
"speaker": "Omotayo Okusanya",
"content": "Hi, yes. Good morning. Thanks for taking my call. A quick question on leverage. Again, our math picked up again a little bit this quarter. You do have kind of debt that matures next year, that'll probably refinance to a higher rate. Just curious how we should kind of think about the trajectory for leverage over the next six to 12 months and also, if the rising leverage is causing any issues, concerns, if I may use those words, with credit rating agencies?"
},
{
"speaker": "Michael LaBelle",
"content": "So our leverage ratio is impacted by the funding of our development pipeline in a negative way. And then in a positive way when that development pipeline delivers and starts generating EBITDA, right? So every quarter, we're funding developments that aren't going to be completing and delivering for a year or two or three. We have two major developments in Cambridge that are going to be delivering, one, 300 Binney Street delivering in the first quarter of next year. And the other one is 290 Binney Street that is 3x the size of that one, that's going to be delivering in 2026. Both of those are 100% leased. So when that stabilize, it will moderate the leverage. The other developments we -- as was mentioned earlier, we pushed out a little bit, but when they stabilize, they will also moderate the leverage. So that will be, I'd say, impactful. And when we think about leverage, we think about kind of pro forma leverage for those types of investments, which would reduce our leverage probably a full turn or so, plus or minus, which would bring it back down below into the 6.5x to 7.5x range, right, which is where we kind of typically target. So I think we're temporarily higher than that, but we were going to stay higher than that for the next several quarters, the time frame that you just described as we complete this pipeline."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Upal Rana from KeyBanc Capital Markets. Please go ahead."
},
{
"speaker": "Upal Rana",
"content": "Great, thanks. Good morning. Could you give us a little more detail on the terminations. It looks like one of them was from [indiscernible] at 1100 Winter. But what were the others? And how do these transpire, any timing associated with these would be really helpful. Thank you."
},
{
"speaker": "Michael LaBelle",
"content": "So the terminations -- not all of them have occurred. The one that you mentioned was in the media. And one of them -- that one was a pure termination. The square footage in the media was inaccurate, however, it only impacts 20,000 square feet of our occupancy in the near term. The other two, one is the tenant that we're downsizing and relocating within our portfolio. They're staying with us. And we've got another tenant that is 4, 5x their size that is going to be coming in and taking their space as well as other vacant space that is in that building. So that deal is not signed yet, but it's something that we're working on, and we're confident in. And then the last one is a tenant at the Prudential Center, where we have a tenant whose business plan has changed. They've been looking to vacate their space and we have somebody else that wants it. So that tenant is going to be coming in. But the exiting tenant will be leaving in either the third or maybe the beginning of the fourth quarter, probably the third quarter, but the new tenants is not going to be coming until the first quarter of '25. And so that's really the situation we're dealing with on these is the exiting tenants are leaving in 2024, and the new tenants aren't coming until 2025. We also had a similar situation in the New York City market at 601 Lex, where we have an expanding tenant that's looking for space, and we found somebody that would exit. And so that tenant has exited, but the expanding tenant will not be going in until mid-'25. So it's just an example, if you add up all that square footage, it's 100,000 square feet of occupancy that's hurting us this year, where we're really -- it's really a good thing because we're bringing in a client that's a growing client who wants to sign a long-term lease with a client who's closer to their expiration date, maybe their plans have changed. In the case of New York, the client had already signed a lease in another building a couple of years ago because they needed space and so they were able to just consolidate into that building. So every situation is a little bit different. It's all case-by-case. But this is kind of what we do. We try to manage these buildings and work these buildings so we can limit downtime, increase rents and cover exposure."
},
{
"speaker": "Operator",
"content": "Thank you. And our final question comes from the line of Ronald Kamdem from Morgan Stanley. Please go ahead."
},
{
"speaker": "Ronald Kamdem",
"content": "Hey, just a quick one for me. Look, if I think about this year on the same-store NOI front, some expirations that you guys have been able to backfill quite nicely, but still sort of end up being a headwind to the same-store NOI. So as we roll into next year, maybe can you talk about whether it's commencements or sort of larger exploration, sort of those two aspects, how should we think about as you're rolling into next year sort of potential headwind tailwinds, either from commencements or expiration? Thanks so much."
},
{
"speaker": "Michael LaBelle",
"content": "So the same-store NOI this year, which is modestly down, right, is due to occupancy being a little bit lower this year than it was last year, right? We've actually offset that a little bit with rent growth. So rents are actually higher than they were last year, but the occupancy has a much bigger impact than the roll up or the roll down of a lease by 5% or 10%. So as Doug described in his occupancy views and we can't -- we don't know the exact timing, but our expectation is that we will start to have more -- some occupancy growth next year. And if we get occupancy growth, that should go into the same-store, so that will help the same-store."
},
{
"speaker": "Operator",
"content": "Thank you. And this concludes our Q&A session. At this time, I would like to turn it back over to Owen Thomas for closing remarks."
},
{
"speaker": "Owen Thomas",
"content": "We have no more closing remarks, and I would like to thank everybody for their interest in BXP. Have a good rest of the day."
},
{
"speaker": "Operator",
"content": "And this concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
bxp | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to BXP First Quarter 2024 Earnings Conference Call."
},
{
"speaker": "",
"content": "[Operator Instructions]"
},
{
"speaker": "",
"content": "Please be advised that today's conference is being recorded."
},
{
"speaker": "",
"content": "I would now like to hand the conference over to your first speaker, Helen Han, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Helen Han",
"content": "Good morning, and welcome to BXP's First Quarter 2024 Earnings Conference Call. The press release and supplemental package were distributed last night and furnished on Form 8-K. In the supplemental package, BXP has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors.bxp.com. A webcast of this call will be available for 12 months."
},
{
"speaker": "",
"content": "At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Although DXP believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be a change."
},
{
"speaker": "",
"content": "Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday's press release and from time to time in BXP's filings with the SEC. BXP does not undertake a duty to update any forward-looking statements."
},
{
"speaker": "",
"content": "I'd like to welcome Owen Thomas, Chairman and Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchey, Senior Executive Vice President, and our regional management teams will be available to address any questions. We ask that those of you participating in the Q&A portion of the call to please limit yourself to one question. If you have any additional query or follow-up, please feel free to rejoin the queue."
},
{
"speaker": "",
"content": "I would now like to turn the call over to Owen Thomas for his formal remarks."
},
{
"speaker": "Owen Thomas",
"content": "Thank you, Helen, and good morning, everyone. BXP's performance in the first quarter continued to defy the negative market sentiment for the commercial office sector. Our FFO per share was in line with our forecast and market consensus for the first quarter."
},
{
"speaker": "",
"content": "We completed just under 900,000 square feet of leasing, which is 35% greater than the first quarter of '23 when we leased 660,000 square feet. And this is a more relevant comparison than to the fourth quarter of '23, given elevated leasing activity associated with the quarter at year-end. Our weighted average lease term on leases signed this past quarter was also notable at 11.6 years in comparison the leases we signed in 2023 at a weighted average lease term of 8.2 years. Our occupancy remains stable. We closed the previously announced joint venture with Norges at 290 Binney Street, our lab development in Cambridge that is fully leased to AstraZeneca."
},
{
"speaker": "",
"content": "This transaction mitigates $534 million of development funding for BXP by raising property level equity for the company on attractive terms. Now moving to macro market conditions. The 2 most important external factors impacting BXP's performance or long-term interest rates and corporate earnings growth. Lower interest rates would improve our cost of capital, spark more transaction activity and investment opportunities in our sector, reduce the cost of new development and be a tailwind for our clients' earnings growth."
},
{
"speaker": "",
"content": "Much has been written and forecasted about the trajectory of interest rates, which we believe will come down over time, but we can only speculate on the exact timing. Companies generally do not hire new employees and increase their office space requirements unless their earnings are growing. Over time, the S&P 500 earnings grow around 10% per year. But in 2023, that growth rate was 0%. And in 2022, it was 5%. Though the U.S. economy is growing and unemployment remains low, only about 7% of the jobs created are in office-using categories versus a long-term average of over 25%. S&P 500 earnings are projected to grow 11% to 13% per annum over the next 2 years, which should be constructive to BXP's leasing activity."
},
{
"speaker": "",
"content": "Many technology clients, a critically important sector driving space demand post the global financial crisis overcommitted to space during the pandemic and are currently in a digestion process, which has curtailed demand. There are exceptions such as net demand for space from the AI sector in San Francisco. Over the long term, we expect many tech companies will experience strong earnings growth and return to requiring more office space. Premier Workplace is defined as the best 6% of buildings representing 13% of total space in our 5 CBD markets continue to materially outperform the broader market. Direct vacancy for Premier Workplaces is 11.2% versus 17.9% for the broader market."
},
{
"speaker": "",
"content": "Likewise, net absorption for Premier Workplaces has been a positive 7 million square feet over the last 13 quarters versus a negative 30 million square feet for the broader market. Asking rents for Premier Workplaces are 50% higher than the broader market, a widening gap from prior quarters. This outperformance is evident in BXP's portfolio, where 89% of our NOI comes from assets located in CBDs that are predominantly premier workplaces. These CBD assets are 91% occupied and 93% leased as of the end of the first quarter."
},
{
"speaker": "",
"content": "Regarding the real estate private equity capital markets, office sales volume in the first quarter was down was $8.7 billion, down 3% from the prior quarter and up 32% from a low base 1 year ago. Office sales as a percentage of total commercial real estate transaction volume are continue to rise to over 20%. Transaction activity for premier workplaces was very limited."
},
{
"speaker": "",
"content": "BXP's overriding goal is to leverage our competitive advantages to preserve and build FFO per share over time. The key advantages for BXP are our commitment to the office asset class and our clients as many competitors disinvest in the sector, a strong balance sheet with access to capital in the secured and unsecured debt and private equity markets, and one of the highest quality portfolios of premier workplaces in the U.S. assembled over several decades of intentional development acquisitions and dispositions. Today, clients and their advisers are more focused than ever on building quality as well as the financial stability and long-term commitment of their building owners, all strong competitive advantages for BXP."
},
{
"speaker": "",
"content": "Last quarter, I spoke about 3 priorities for BXP in 2024, leasing space, new investments and development. Now Doug will provide more details on leasing. We're off to a good start in the first quarter and see a growing pipeline of opportunities for later this year in 2025. On new investment activity, as you know, we pivoted to offense late last year and early this year through buying joint venture interest in 3 significant in-service assets at attractive prices. We remain in active pursuit of opportunities in our core markets and asset types with primarily 2 types of counterparties. Lenders to highly leveraged assets that require recapitalization and institutional owners seeking to diversify from the office asset plan."
},
{
"speaker": "",
"content": "To date, there has been limited market transaction activity for high-quality office assets. With lenders, there are fewer premier workplaces that are struggling with leverage. And in the few cases involving premier workplaces, lenders are generally electing borrowers who agreed to invest modestly in their assets."
},
{
"speaker": "",
"content": "Institutional owners are less interested in selling their highest quality assets, and there remains a material bid-ask spread given assets have, in most cases, not been marked down to market clearing levels. Notwithstanding these current challenges, our expectations are the transactions and our investment activity will increase in coming quarters given the volume of maturing financings, continued markdowns in institutional portfolios and higher for longer interest rates."
},
{
"speaker": "",
"content": "We also have interest from institutional investors in contesting with us for select opportunities. On development, we commenced our 121 Broadway residential tower in Kendall Center as part of the 1 million square feet of commercial entitlements we received from the city of Cambridge to build 290 Binney Street and a future to-be-determined commercial building. Comprising 37 stories and 439 units, 121 Broadway will be the tallest building in Cambridge with a state-of-the-art design and amenity setting a new quality standard for residential offerings in the Kendall Square neighborhood."
},
{
"speaker": "",
"content": "Earlier this month, on Boston Marathon weekend, we celebrated the grand opening for and delivered into service the 118,000 square foot Dick's House of Sports store on Boylston Street at Prudential Center. We continue to push forward with several residential projects under control that are being entitled and designed for which we intend to raise joint venture equity capital in the second half of the year. For office development, we have been approached by multiple clients in all our core markets who are interested in occupying new space and anchoring development projects. Given escalated material labor and capital costs, anchor clients must pay a premium to market rent today to justify the launch of a new development project, which is a challenging dynamic exacerbated by the earnings growth issue previously described."
},
{
"speaker": "",
"content": "Though BXP's new office development activity has slowed, there will also be a very limited new office -- that will also be very limited new office development for the foreseeable future in our core markets, which is favorable for our existing portfolio. As vacancies continue to decline for premier workplaces, rents should rise, which will ultimately bridge the economic gap to justify new development."
},
{
"speaker": "",
"content": "Though we believe buying is a better opportunity than selling in the current market environment, we are interested in raising capital through asset sales if attractive opportunities present themselves. We have a handful of small dispositions defined as under $30 million we are currently exploring."
},
{
"speaker": "",
"content": "BXP continues to execute a significant development pipeline with 11 office lab retail and residential projects underway as of the end of the first quarter. These projects aggregate approximately 3.2 million square feet and $2.4 billion of BXP investment with $1.3 billion remaining to be funded and are projected to generate attractive yields in the aggregate upon delivery. So to summarize, in the face of strong negative market sentiment, BXP continues to display resilience and stability and occupancy FFO and dividend level. BXP is well positioned to continue to gain market share in both assets and clients during this time of market dislocation. The prospect of lower interest rates and stronger corporate earnings also provides a backdrop for renewed growth."
},
{
"speaker": "",
"content": "Let me turn the call over to Doug."
},
{
"speaker": "Douglas Linde",
"content": "Thanks, Owen. Good morning, everybody. I hope what you're going to hear today from me is you're going to be with a pretty constructive perspective on what's going on in our markets and what's going on with our revenue picture and our leasing picture."
},
{
"speaker": "",
"content": "As we sit here at the end of the first quarter, in spite of the absence of a broad pickup in office-using jobs, BXP continues to lease space. We are leasing space. There's momentum in the economy despite persistent high interest rates."
},
{
"speaker": "",
"content": "Overall earnings growth for our clients and potential clients appears to be improving, and we're pretty optimistic it's going to lead to employment and space additions. And while we are not going to see broad reports of shrinking availability across any market, until there is a pickup in white collar job formation, there are pockets of supply constrained in select submarkets where we are seeing competition for space and improving economics."
},
{
"speaker": "",
"content": "As reported in our supplemental, the mark-to-market of the leases that commenced this quarter was up 7% and the transaction costs averaged $8.60 per year, which is lower than it's been in the last few quarters. The overall mark-to-market of the starting cash rents on leases executed this quarter relative to the previous in-place cash rent was up about 2%."
},
{
"speaker": "",
"content": "The starting cash rents on leases we signed this quarter on second-generation space, we're up about 22% in Boston, down 6.5% in Manhattan, down 3% in D.C. and up 8% on the West Coast with San Francisco CBD up 12%. Boston's increased is in large part due to a replacement of a tenant that was in default and had stopped paying. Adjusting for the transaction, the Boston numbers would have been up about 6%. As Owen stated, the seasonal trend line of BXP's leasing activity in the first quarter of '24 picked up relative to what we experienced in the first quarter of '23. This quarter, we completed 61 transactions, 32 new leases for 494,000 square feet and 29 renewals encompassing 399,000 square feet. We had 3 expansions totaling 18,000 square feet and 4 contractions totaling 44,000 square feet."
},
{
"speaker": "",
"content": "As a point of comparison, in the first quarter of '23, there were 57 leases, 29 leases were with new clients for 410,000 and 28 renewals for 250,000. There were 10 expansions and 3 contractions. Last quarter, Fourth quarter of '23, we signed 37 lease renewals and 37 leases with new clients, and there were 8 contractions and 9 expansions among our existing clients."
},
{
"speaker": "",
"content": "This quarter, new leases encompass 55% of the volume. Activity was across the entire portfolio with 178,000 square feet in Boston, 225,000 square feet in the New York region, 154,000 square feet from the West Coast and D.C. lead attack with 336,000 square feet. And to give you some additional color on this activity, there was only 1 transaction greater than 60,000 square feet due to the 215,000 square feet long-term law firm extension that included a 25,000 square foot contraction in D.C. although that same law firm took an additional 7,600 square feet in our Reston portfolio."
},
{
"speaker": "",
"content": "Princeton made up 38% of the New York activity this quarter, almost all new clients. New clients made up 90% of the leasing volume in Boston and in New York, while renewals captured 73% of the West Coast and D.C. market. Equally important is our pipeline. Post March 31, we have over 875,000 square feet of active leases under negotiation, which we define as a transaction that is being documented by our legal teams and some of these transactions have been completed. This is consistent with the level of in-process leases we've made for the last few quarters."
},
{
"speaker": "",
"content": "These transactions include a multifloor expansion of an asset manager in our Midtown portfolio in New York, a full floor expansion by a law firm in Midtown, an asset manager taking a full floor 360 Park Avenue South, consumer brand company relocating to a building in Waltham, a multi-floor renewal of a law firm in San Francisco with no change in the premises and a downsizing along with an extension of a technology company in Reston, Virginia and a similar transaction in Waltham."
},
{
"speaker": "",
"content": "We have seen an uptick in the number of active deals. At the end of the quarter, we had signed leases that had yet to commence on the in-service vacancy, totaling approximately 817,000 square feet, which includes 624,000 square feet that is anticipated to commence in 2024. We also have signed leases with new clients for another 534,000 square feet of currently occupied states. These leases have yet to commence but they are reflected in the reduction of our rollover exposure shown in our supplemental."
},
{
"speaker": "",
"content": "The strongest user demand continues to come from the asset managers, including private equity venture hedge funds, specialized fund managers and their financial and legal advisers. These organizations are the heart and soul of our New York and our Back Bay activity and are an important driver of our San Francisco CBD demand. In some instances, these clients are growing their teams and capital under management. But in all cases, they want to occupy premier workplaces."
},
{
"speaker": "",
"content": "We continue to see significantly more client demand in our East Coast portfolio versus the West Coast due to the disproportionate concentration of technology and media content related demand on the West Coast. However, there have been some subtle and encouraging trends across much of the portfolio. Our Back Bay Boston and Park Avenue Centric New York City portfolio continue to have outsized demand relative to our availability. While concessions are still at elevated levels, we've been able to increase our taking rents and we actually have clients that we cannot accommodate due to a lack of available space in certain buildings."
},
{
"speaker": "",
"content": "In the last 90 days, there is the strong pickup of client activity in our Urban Edge Waltham portfolio. We have an 80,000 square foot tech client expiring in 2024 with a planted downsize to 16,000 square feet. This quarter, we completed a lease for 45,000 square feet and are in negotiations with 2 other clients, new ones for another 37,000 square feet of that expiration, and the existing client will stay with us but relocate within the building."
},
{
"speaker": "",
"content": "Additionally, in a different Urban Edge building, we're negotiating a 45,000 square foot lease with an existing subtenant to extend when their prime lease expires in '25. We're negotiating a 25,000 square foot lease with a lab user proportion of our availability on Second Avenue and we're negotiating a 55,000 square foot lease with a nontech company in a different building. None of these transactions more than 220,000 square feet were in our pipeline on 12/31/2023. All of this occurred in the last 90 to 120 days."
},
{
"speaker": "",
"content": "In the District of Columbia and Northern Virginia, we continue to see more buildings with over leveraged capital structures unwilling to provide capital for new transactions, and therefore, they have very little client interest. At the other end of the spectrum, when the market got wind of our lease extension at 901 New York Avenue and the anticipated enhancements that we are planning, the interest in the available space at New York -- 901 New York accelerated dramatically. Reston continues to house the largest concentration of our Washington regional portfolio. It's the headquarters for VW, [ Batel ], Leidos, SAIC, Peraton, [ Kaki ], Metron, Comscore, Mandiant and the College Board and it's also the home to a number of large technology companies like Microsoft."
},
{
"speaker": "",
"content": "Because of the environment of the Town Center with 7 days a week food, beverage and shopping and is also a natural location for small businesses in the financial services and legal industries. This quarter, we completed a 58,000 square foot lease with a new technology client at Reston Next that's moving from a toll road building, an expansion for law firm, and we are seeing a pickup in small tenant activity relate to [ '23 ] and as well as large users looking to upgrade their premises."
},
{
"speaker": "",
"content": "The AI organizations in the city of San Francisco continue to look for additional space, which will continue the positive absorption story. They continue to focus, however, on build and expensive space. And while there is an abundance of available space in the city, there continues to be outsized demand for view-spaced north of market relative to the available supply."
},
{
"speaker": "",
"content": "We completed a 35,000 square foot lease with a boutique financial adviser at Embarcadero Center this quarter that was only interested in view spaced north of market. We're negotiating 6 transactions with new clients totaling 40,000 square feet as well as an 80,000 square foot renewal with a law firm that's retaining their existing point. Today, the Seattle CBD is almost exclusively a lease expiration-driven market, and there has been a material pickup in the level of activity. The number of tenant tours that we have conducted has picked up in the last 2 quarters. We completed a lease with a new client on a 10,000 square-foot prebuilt suite and are in negotiations with a law firm for a parcel floor and discussions with a technology company for a full floor."
},
{
"speaker": "",
"content": "West L.A, however, continues to be the market where activity remains light. While Century City is seeing great demand and strong rents as financial and professional services firms head west from the downtown market, those clients are not yet prepared to take space in low-rise buildings in Santa Monica. There continues to be pressure from streaming profitability, industry consolidation and job reduction in the gaming and media space that is impacting overall demand growth in the West L.A. area."
},
{
"speaker": "",
"content": "As we forecast during our last call, our occupancies declined also slightly from 88.4% to 88.2% during the quarter, with a known expiration of 230,000 square feet in Princeton, where, as I mentioned, we have signed 80,000 square feet of new client deals this quarter that will commence this year. We have 2 additional large lease expirations across the portfolio in '24 that will occur during the second quarter, 200,000 square feet at 680 Folsom in San Francisco and 230,000 square feet at 7 Times Square, where we own 55%. Occupancy will drop in the second quarter and recover as we move into the fourth quarter."
},
{
"speaker": "",
"content": "Mike is going to spend some time discussing changes to our interest expense outlook in his remarks. The issue of the day is the level of inflation, and I thought I'd make a few brief comments on how inflation is impacting our business. We are not seeing any deflation in our base building costs as we build -- as we bid potential stick-frame residential the projects Owen was describing earlier, but escalation assumptions are now normalized. No more 8% to 9%."
},
{
"speaker": "",
"content": "The changes to the building in energy codes, along with the elevated level of interest expense associated with any construction financing, continue to pressure project costs and make new starts very challenging. However, we are seeing costs come down on tenant improvement jobs, which is a reflection of reduced demand on the group of contractors and subcontractors that focus on interiors work who are looking to maintain a consistent book of business. New high-rise tower construction costs are unlikely to deflate in the longer-term interest rate environment and the long-term interest rates remain at the elevated levels, the longer it's going to be before we see market rents approach the levels necessary to rationalize new office building, leasing economics and corresponding new development."
},
{
"speaker": "",
"content": "We are experiencing an operating environment where leasing available space is primarily driven by gaining market share. That's with the world that we are living in, and we're winning. As clients choose premier properties in sound financial condition, operated by the best property management teams, BXP will continue to be successful in doing just that."
},
{
"speaker": "",
"content": "I'll stop there and turn it over to Mike."
},
{
"speaker": "Michael LaBelle",
"content": "Great. Thank you, Doug. I appreciate it. Good morning, everybody. This morning, I plan to cover the details of our first quarter performance and also the updates to our 2024 full year guidance. We've also been active in the debt markets this quarter. So I'm going to start with a summary of some of the changes in our debt structure."
},
{
"speaker": "",
"content": "In early February, we paid off $700 million of unsecured notes with available cash, that was in line with our plan. We also entered into a $500 million unsecured commercial paper program. This program offers an additional market for us to tap beyond the bank market mortgage and unsecured bond markets that we currently actively utilize."
},
{
"speaker": "",
"content": "We started issuing under the program last week, and we've raised the full $500 million for terms ranging from overnight to 1 month at a weighted average rate of SOFR plus 25 basis points. The all-in rate, including fees is approximately 5.75%."
},
{
"speaker": "",
"content": "We've used the proceeds to pay down our term loan from $1.2 billion to $700 million, which will reduce our borrowing cost on $500 million by 75 basis points or about $0.01 per share in 2024. In addition, we increased our corporate line of credit by $185 million to $2 billion. Our banks continue to be strong supporters of BXP even as they evaluate their global commercial real estate exposure and exit certain relationships."
},
{
"speaker": "",
"content": "Now I'd like to turn to our first quarter earnings results. Despite the difficult real estate operating conditions and the stagnant office using job growth statistics, our portfolio is demonstrating strength and stability. As Owen and Doug described, portfolio occupancy has been relatively steady for the past 6 quarters. Our revenues continue to grow with top line total revenue up again this quarter by $10 million or 1.3%, and our share of portfolio NOI is also higher, up $6 million or 1.2% from last quarter. High interest rates are our biggest earnings challenge. This quarter, our interest expense increased $7 million. It's important to point out that more than half of this increase was due to higher noncash fair value interest expense, related to below-market debt on our recent acquisitions."
},
{
"speaker": "",
"content": "We reported funds from operation of $1.73 per share for the quarter that was in line with our guidance for the first quarter and it was equal to our first quarter FFO from 1 year ago, again, demonstrating the stability of our income statement. Portfolio NOI exceeded our expectations by about $0.02 per share. The majority of this is from lower-than-anticipated net operating expenses that we expect will be deferred to later in 2024. This was offset by higher-than-projected net interest expense of $0.02 per share primarily from higher noncash fair value interest expense related to the acquisitions, and we also booked lower-than-projected interest income due to changes in the timing of closing our 290 Binney Street joint venture."
},
{
"speaker": "",
"content": "So moving to the full year. Since providing our initial 2024 guidance, we finalized the assumptions utilized in valuing the in-place debt and interest rate swaps for our 901 New York Avenue and Santa Monica Business Park acquisitions. For 901 New York Avenue, we increased our assumption for the interest rate on the debt by 70 basis points to 7.7%. And for the interest rate hedge at Santa Monica Business Park, we determined that the change in market value will be amortized through our interest expense for the remaining term of the loan that expires in 2025."
},
{
"speaker": "",
"content": "These adjustments result in an additional $0.05 per share of noncash fair value interest expense in 2024 relative to the estimate we used when we provided our guidance last quarter. This noncash adjustment impacts our full year guidance and is the primary reason we have reduced our FFO guidance for 2024."
},
{
"speaker": "",
"content": "Other interest expense assumptions have also been impacted by the changing expectations for rate cuts in 2024. Last quarter, we forecasted 4 rate cuts commencing in the second quarter which was actually conservative to market expectations at the time. We've now pushed out any rate cuts to late in 2024. The impact on our floating rate debt is partially offset by the lower cost of our commercial paper program, but overall, we expect $0.02 of dilution from higher short-term interest rates compared to our prior guidance."
},
{
"speaker": "",
"content": "The operating assumptions for the portfolio occupancy and same-store NOI remain relatively unchanged from our prior forecast. As Doug described, we do expect occupancy to decline slightly this quarter, we did expect occupancy to decline slightly this quarter and in the second quarter before improving in the back half of the year."
},
{
"speaker": "",
"content": "Our assumption for same-property NOI growth of negative 1% to 3% is unchanged. Other modifications to our guidance include reducing our assumption for 2024 G&A expense by $0.01 per share and a modest reduction in our fee income projection. So in summary, we are reducing and narrowing our 2024 full year guidance for FFO to $6.98 to $7.10 per share. This represents a reduction of $0.06 per share at the midpoint from our prior guidance."
},
{
"speaker": "",
"content": "The primary reasons for the reductions are $0.05 of higher noncash fair value interest expense and $0.02 of higher interest expense from higher short-term interest rates, offset by $0.01 of lower G&A expense. The last item I would like to mention is that we published our 2023 sustainability and impact report, and it can be found on our website. The report contains a wealth of information on our sustainability efforts and the progress towards achieving our critical goals of reducing our energy use intensity, carbon emissions and achieving net 0 carbon operations for Scope 1 and 2 greenhouse gas emissions by 2025."
},
{
"speaker": "",
"content": "We invite you to join us for our sustainability and impact webcast on May 15. If you have not received an invitation, please reach out to Helen and our Investor Relations team. That completes our formal remarks. Operator, can you open up the line for questions?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions]"
},
{
"speaker": "",
"content": "And I show our first question comes from the line of Nick Yulico from Scotiabank."
},
{
"speaker": "Nicholas Yulico",
"content": "Yes, I guess just a bigger picture question maybe for Owen. How you're thinking about all the different opportunities out there? You mentioned that there could be some acquisition opportunities. You did just launch 121 Broadway, which is a substantial capital commitment. You have a stock price, I'm sure maybe you're not happy about."
},
{
"speaker": "",
"content": "And so I'm just trying to understand like how we should think about the investment focus right now for the company? And how you expect to fund that via -- or are you looking to issue equity? Would you buy back stock? Anything along those lines would be helpful."
},
{
"speaker": "Owen Thomas",
"content": "Yes. So Nick, a couple of things I would say. First, let me start with 121 Broadway. It's a fantastic new building -- residential building that we're building in Cambridge but it was also launched as part of the requirements to achieve 1 million square feet of commercial entitlements in Cambridge. It was a requirement of that of receiving those entitlements."
},
{
"speaker": "",
"content": "And those entitlements allowed us to commence the 290 Binney Street development, and we still have FAR available for 1 or 2 additional commercial buildings. But again, you have to think about that development. It's tied into the 290 development that we commenced last year."
},
{
"speaker": "",
"content": "In terms of new investment opportunities, as I described in my remarks, there's a tremendous amount of dislocation going on in the office sector. You've got lots of overleveraged assets and you have also a number of institutional owners that want to decrease their exposure to office. And this is going to create opportunities for us."
},
{
"speaker": "",
"content": "When we look back at prior down cycles in real estate and in office real estate, those were periods of time where BXP significantly enhanced its portfolio with acquisitions like 200 Clarendon Street GM building and others. So we want to participate. We think that's going to happen again in this cycle, and we want to participate in it."
},
{
"speaker": "",
"content": "And as we do that, we are paying very close attention to, obviously, accreting our earnings over time and also watching our leverage. And I think each transaction will have to stay on its own in terms of how we fund it."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Steve Sakwa from Evercore ISI."
},
{
"speaker": "Steve Sakwa",
"content": "Doug, I guess I wanted to just maybe follow up on your positive commentary on leasing and just maybe get a sense for how much of this is for the existing portfolio? How much of this is for the development pipeline? And I realize we're getting sort of close to the middle of the year. So any of the leases being signed are probably really more of a '25 beneficiary than they are going to be at '24."
},
{
"speaker": "",
"content": "But just how do you think about building up the occupancy on the existing portfolio and as importantly, filling up the vacancy within the development pipeline?"
},
{
"speaker": "Douglas Linde",
"content": "Yes. Thanks, Steve. So of the activity that we have in our pipeline, and I'm going to give you 2 different sort of pipeline numbers. So the 875,000 square feet of stuff that we have going on, about 20,000 square feet of that is development and the rest of it, the other 865,000 square feet -- 855,000 square feet are all existing portfolio deals and the majority of it is on available existing space."
},
{
"speaker": "",
"content": "So the world, as I sort of think about it is we have the leases that we signed this quarter, then we have our pipeline of stuff in process. And then I have -- what I have is sort of my tracking list and my tracking list right now has another 1.7 million square feet of deals that we are -- that are active in our teams across the regions. And these are not a tenant is looking at the market and might call us. These are paper is moving back and forth. And there is a legitimate opportunity potentially for a deal to occur."
},
{
"speaker": "",
"content": "Again, on all of that, it's almost exclusively on our in-service portfolio. So if you think about our development pipeline today, it really consists of 360 Park Avenue South and Hilary can comment on activity there and then the life science buildings that we have in Waltham, of which there's no active conversation going on that's part of my pipeline and then the building that we have in our joint venture in South San Francisco. And again, there's nothing really going on there as well."
},
{
"speaker": "",
"content": "And so the vast majority of the activity that we have is about increasing -- first, maintaining and then increasing, albeit slowly the occupancy in the existing in-service BXP core portfolio. And Hilary, if you want to comment on 360 Park Avenue self."
},
{
"speaker": "Hilary Spann",
"content": "Sure. Thanks, Doug. Steve, in terms of the leasing activity in Midtown South, I think we saw a slowdown in the first part of this year. I will say that we are starting to see more activity as 360 Park Avenue South has come online and clients can actually see the very high quality of the finishes and the lobbies and the common areas and the amenities that we've put in place. And so we are starting to see a pickup in our activity there."
},
{
"speaker": "",
"content": "It remains the case that the businesses that are interested in locating at 360 Park Avenue self span across industry sectors. And so while Midtown South in general has historically been home to tech and media tenancies, we're seeing everything from corporate to financial services and as Doug mentioned, an asset management firm come into that building and show interest in occupying that building."
},
{
"speaker": "",
"content": "I think, anecdotally, while the leasing activity is picking up a bit, it remains to be seen where that will settle out in terms of executed leases in the coming quarters, but we feel encouraged by the fact that the volume of interest in the building has stepped up meaningfully since we completed it and opened it."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Anthony Paolone from JPMorgan."
},
{
"speaker": "Anthony Paolone",
"content": "I guess my question is, you mentioned earlier some demand from the AI space. And at the same time, just tech companies having overexpanded and shedding some space. Just wondering if you could put some more dimensions around how that nets out. Exactly how big is the AI demand and maybe perhaps, how much more is there to go before the rest of tech is rightsized?"
},
{
"speaker": "Douglas Linde",
"content": "Yes. So I'm going to give you what I would refer to as a simplistic view of it, and I'll let Rod Diehl give you a more comprehensive view. So the simplistic view of it is on the East Coast, where there really isn't much in the way of incremental AI demand, net-net, most technology companies are when they're renewing a lease, taking less space."
},
{
"speaker": "",
"content": "On the West Coast, predominantly in the greater San Francisco marketplace and then skewing down into the CBD of San Francisco, there is more incremental absorption overall in technology. It's all coming from AI. And I would say it's taking the place of what were traditional technology companies. But Rod, you can go sort of plus that on a little bit more."
},
{
"speaker": "Rodney Diehl",
"content": "Yes. Thanks, Doug. So yes, last year, of course, was a big year for AI in San Francisco. There was 2 very large leases that were completed. I believe that made up about 27% of the overall leasing activity for the year, which was pretty substantial. So coming into '24, there's still been activity on the AI front. There's one of those larger tenants that did the deal last year is also in the market again for more space. So we're watching that closely to see where that goes."
},
{
"speaker": "",
"content": "So I think it's definitely a bright spot. And these different companies often to find themselves as AI, but it's broad across the spectrum of that technology. As you see that down in the Silicon Valley, in fact, there are some AI companies, many of them which are tied into the automotive industry. We have a couple of them in our own portfolio, and some of those are in the market as well. So definitely a consistent point of additional optimism and demand for the Bay Area."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of John Kim from BMO Capital Markets."
},
{
"speaker": "John Kim",
"content": "You've been making a very compelling case between -- the bifurcation between premier workspace and commodity office in the CBD portfolio, which really benefits BXP. But that same bifurcation exists in your portfolio between CBD and suburban, where it's a 15 percentage point occupancy gap. So I'm wondering, just given that performance difference, does that make you reconsider your commitment to the suburbs?"
},
{
"speaker": "Douglas Linde",
"content": "So this is -- let me start. This is Doug, and I'll let [indiscernible] make a comment as well. We are committed to the geographic locations that we currently have occupancy and vacancy. The truth of the matter is that the majority of our availability is in suburban, part of it was self-inflicted. So part of it was during 2020 to 2022 when we were looking at the highest and best use for some of our Waltham suburban assets in our Lexington suburban assets."
},
{
"speaker": "",
"content": "We deem that the value of those assets over the long term is life science facilities would be better than as \"traditional office facilities. And so we effectively cleared out some buildings. So 1050 Winter Street is an example and Reservoir Place and the other big colony buildings which are where the predominant amount of our availability is we're effectively cleared out for those purposes."
},
{
"speaker": "",
"content": "And unfortunately, the market has not been helpful to us. And so we're managing that availability. But quite frankly, we've had the opportunity to lease some of that space to office companies and we've made the decision, at least in one case that we think we're better off holding off that building and doing it in a life science building when the appropriate economic model makes sense, aka we have a tenant that wants to pay the right rent for that building."
},
{
"speaker": "",
"content": "Then our other large availability is in Princeton, and our Princeton portfolio is premier property defined by the other assets in the greater Princeton area. And we are -- we have probably on an activity level more activity in Princeton right now than we do anywhere else in our New York portfolio on a relative basis. I can't explain why the pickup has occurred during the first and the second quarters of 2024, but it has."
},
{
"speaker": "",
"content": "It's predominantly associated with the pharmaceutical and life science industries, but not lab. It's companies that are in that business that are -- that have an SG&A function. And Hilary, you can comment on the Princeton market and I'll let Bryan comment on the Waltham market."
},
{
"speaker": "Hilary Spann",
"content": "Sure. Thanks, Doug. As Doug said, we've seen an incredible pickup in leasing activity in the Princeton market in the first and second quarters while -- and that includes signed leases, but also leasing activity that continues now and we expect to be executed in the second and third quarters."
},
{
"speaker": "",
"content": "A lot of it, as referenced, is new activities. Some of it includes clients that exist in the portfolio of Carnegie Center today and who have expressed needs to expand both from consolidation of business units or expansion of lines of business and from an increased experience of return to office ,and so it's a pretty diverse set of reasons that people are expanding. But to Doug's point, the campus is pretty highly concentrated with pharmaceuticals and in particular, foreign pharmaceuticals, and that is where the bulk of the demand is coming from. And so we're incredibly encouraged by the amount of leasing activity, and we expect to see additional signed leases coming out of it in the coming quarters."
},
{
"speaker": "Bryan Koop",
"content": "This is Bryan Koop for Waltham. I'll continue to echo what Doug talked about, and we intentionally call it an Urban Edge market because it is less than 10 miles from downtown Boston, and that's an attribute that shouldn't be taken lightly in terms of the commute and also the density of the population surrounding that Waltham market."
},
{
"speaker": "",
"content": "Some further color on what Doug brought up. We are seeing a difference between our -- the east side of I-95, which is all the attributes of urban project and maybe for the analysts who are very familiar with this, attributes that we have in Reston, taller buildings, more amenities, et cetera. And we continue to see access and the highway is going to improve there. We put a new ramp in last year, and there is a forecast for more there. Where we are seeing some weaknesses in those assets that Doug mentioned like the Bay Colony, which have attributes that are very similar to the conventional suburban office buildings spread out feels more rural, but actually the location is very close. That's where there is a little bit of weakness. But we continue to believe that Waltham is an urban edge market and quite different than the conventional suburbs that most real estate people would describe."
},
{
"speaker": "Operator",
"content": "And so our next question comes from the line of Blaine Heck from Wells Fargo."
},
{
"speaker": "Blaine Heck",
"content": "Just following up on an earlier question and maybe taking out the element of timing on occupancy, and just focusing on the lease rate this year and potential progression there. You talked about the large exploration still remaining at 680 Folsom and 7 Times Square. But when you think about those in conjunction with your leasing pipeline, which Doug you said was 875,000 square feet plus and Owens' characterization of the pipeline is growing in the back half of the year and into 2025."
},
{
"speaker": "",
"content": "I guess how much do you think you can move the lease rate up by as you look towards the end of the year?"
},
{
"speaker": "Douglas Linde",
"content": "So when you use the word lease rate, you're talking about occupancy rate, right, not economic rent rate, I'm assuming. So again, I think that it's going to be slow and steady. So our projections when we gave our guidance during the call in the first quarter was that we were going to hopefully be flat to where we ended 2023 at the end of 2024 and then we'll continue to make additional progress."
},
{
"speaker": "",
"content": "And then if you look at our exploration schedules, they're pretty manageable, right? I mean we have 5% to 6% expiring every year for the next 4 or 5 or 6 years. And so we don't -- we need to lease space. We need to gain market share, which is, again, my sort of point. And we are gaining market share in our markets, but it's -- when we do have technology companies expiring, we have to fight that water coming at us. And so it's challenge to dramatically increase occupancy in the short term."
},
{
"speaker": "",
"content": "But we are getting to the point where we believe occupancy will continue to moderate upwards."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Michael Goldsmith from UBS."
},
{
"speaker": "Michael Goldsmith",
"content": "What are the economics of the new multifamily development? And how do you think about your cost of capital? And then along the same lines, what is the thought process on the new commercial paper program and what upsize options do you have?"
},
{
"speaker": "Douglas Linde",
"content": "Well, let's let Mike answer the commercial paper question, and then I want to answer the question on our return expectations for multifam."
},
{
"speaker": "Michael LaBelle",
"content": "So we decided to enter in this commercial paper program because we're always looking for additional markets to access especially in this environment. And it's the cheapest form of floating rate paper that we can issue."
},
{
"speaker": "",
"content": "Historically, we've been primarily fixed rate. We're going to continue to be primarily fixed rate, but I think we will have a moderate amount of floating rate debt on a consistent basis over the foreseeable future. Right now, we have about $1.2 billion of unsecured floating rate debt, and we have about $700 million of joint venture unsecured debt."
},
{
"speaker": "",
"content": "I think it will go down from there going forward. But we view using this commercial paper program as a consistent piece of our debt structure over the next several years. And because we can save 75 basis points by using it, it's a very liquid marketplace, we've got high credit ratings. So our access has been good, and now we've experienced it for the first couple of weeks, which has been very, very positive. So we're building an investor base in it."
},
{
"speaker": "",
"content": "So we just felt like additional arrow in our quiver from a capital perspective and lower cost of capital, both drove that decision."
},
{
"speaker": "Owen Thomas",
"content": "Yes. It's Owen, let me address the 121 Broadway development. As I described in my remarks, this is a notable building. It's the tallest building in Cambridge and it's also a very high-quality residential tower given the finishes and our design and planning."
},
{
"speaker": "",
"content": "Due to coordination with the development of the vault for Eversource. The project is not expected to deliver its first units until late 2027 and expected to stabilize and not until the second quarter of 2029. So again, you have to think about this project as part of the overall East Cambridge development that we've been working on and talking to all of you about for the last 2 or 3 years."
},
{
"speaker": "",
"content": "So the forecast returns on the 121 Broadway development alone are below our typical thresholds for development. However, if you look at the yields that we're receiving from the entire entitlement package. So that includes 121 Broadway. It includes 290 Binney Street, and it includes what we think we can get with the remaining commercial entitlements that we still have those projected returns do meet our development hurdles."
},
{
"speaker": "",
"content": "And then to the extent that we are looking at new stick build, our expectation that those returns are going to be meaningfully higher than in urban development. And so we're talking about yields and well in excess of 6%. And that's what we need to consider starting a new residential development in 2024, 2025."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Ronald Kamdem from Morgan Stanley."
},
{
"speaker": "Ronald Kamdem",
"content": "Just a quick 2-parter. So the first is on the occupancy expectations for a pickup in the back half of the year. You talked about sort of the strength in Back Bay and Park Avenue, but those markets are -- have relatively higher occupancy versus the rest of the portfolio. So I guess I'm trying to understand where is the biggest sort of occupancy gains, expectations in the back half? Is it the stronger markets? Or is it other parts of the portfolio like suburban? That's part one."
},
{
"speaker": "",
"content": "Part 2 is just a quick. Any sort of update on life sciences demand? Obviously, we're seeing a better fundraising environment, curious what you guys are seeing on the ground?"
},
{
"speaker": "Douglas Linde",
"content": "So the answer to your first question is it's pretty what I would refer to as granular. It includes occupancy pickups in buildings like the General Motors building, where we are in active conversations with tenants right now to take some space pretty quickly in 2024. It's in Princeton, where as Hilary described, we have a pipeline of activity, and we believe some of those transactions will happen in 2024. It's in the greater Metropolitan Washington, D.C. market, primarily in Western Virginia, where we have a significant pipeline of active smaller deals that are going to occur in 2024."
},
{
"speaker": "",
"content": "It's the activity that I described in Waltham, almost all of that activity is expiring or vacant space, and the majority of that will land in 2024. And so it's kind of everywhere, and there's no really what I would offer you is big ticket that's going to dramatically change things one way or the other. And so we're -- again, that's why we're saying we think we're going to get back to where we were, which is effectively the 88% plus or minus percent occupancy by the end of 2024."
},
{
"speaker": "",
"content": "And look, I hope that we see some positive surprises in addition to that where tenants move into space earlier. The lease -- we believe the leases will get signed. The question, and you've heard me say this before, is we just don't necessarily have a good handle on what the timing is going to be for when we can start recognizing revenue relative to whether the space has been demolished or we're doing a turnkey buildup where we're in control of it, and getting decisions made by our clients in terms of what they want in the space and having all that work to the point where they're actually physically able to occupy the space in 2024, which would mean that it would be able to be in part of our occupancy role numbers."
},
{
"speaker": "",
"content": "On life science, I think life science demand is relatively slow. I'll let Bryan describe the life science demand in the greater Boston market, and I'll let Rod take a poke at talking about what's going on in South San Francisco."
},
{
"speaker": "Bryan Koop",
"content": "So in the Waltham market, which is the only spot we have vacancy, we don't have any in Cambridge. I'd say it's the same as it was in the previous quarter, but maybe a little bit more encouraging. Where we are encouraged is, as you noted, was yes, there is more funding coming back into the life science sector. But also when we talk to clients, we are encouraged by the fact that they are, call it, producing the things that they said they were going to do to their investors, and there is encouragement in terms of the possibility of products down the pipeline."
},
{
"speaker": "",
"content": "So that's where we're getting most of our encouragement is that the clients we have are very excited about what they have going on."
},
{
"speaker": "Rodney Diehl",
"content": "Yes. Just in South San Francisco, our one project is the 651 Gateway building, and that is the -- it's basically a converted office building 16 stories. And that building is completed, and we've done 3 deals in there, 3, 4 floor deals, and those tenants are in various stages of moving in."
},
{
"speaker": "",
"content": "But in terms of new activity, it's been very slow. The few deals that are in the market tend to be smaller, call them, 10,000 to 20,000 feet, not the 200,000 foot deals that were in the market several years back. So that section has been quiet. But our building is actually very well positioned to attract that demand that is in the market. We have a space that is going to be built on a spec basis. We're going to do a full floor, which is going to be ready to accept that tenant when they're out there. So -- but the larger tenants are not there."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Richard Anderson from Wedbush Securities."
},
{
"speaker": "Richard Anderson",
"content": "First to comment, I'd say if you were most any other REIT, you would have normalized out your $0.06 or a lot of it and be up today, not down 3%. So I commend you for a commitment to FFO, as defined by NAREIT, I think it'll be rewarded for that over time. On to my question on -- just taking a peek at the Castle data and still utilization in the office space is sub-60%."
},
{
"speaker": "",
"content": "I don't know how that compares to your premier asset type, but utilization is still not near where it was pre-pandemic. Is there a scenario where the BXP story can still work long term if we're looking at sort of a permanent condition of underutilization of office? Or do you feel like you need to get fully back to have a long-term story to tell. I'm just curious what you think about sort of the very long term when it comes to office utilization."
},
{
"speaker": "Owen Thomas",
"content": "Yes. Let me -- that was a lot to unpack there, but let me take a stab at it. So first of all, Castle data is highly used in the media and I think in the financial community. And I think it's a very imperfect measure of office demand. It's a decent measure of perhaps footfall in an urban area over a period of time."
},
{
"speaker": "",
"content": "So what do I mean by that? Many of the owners of premier workplaces don't use castle systems in their buildings. So we're not really exactly sure which buildings are being measured. It doesn't take into effect that the office market is less occupied today from a leasing standpoint, and it also looks at data over the course of the whole week, which is less relevant for office occupancy, what you really need to focus on its peak days."
},
{
"speaker": "",
"content": "So I know everybody uses it, but it's not really a reflection of our experience, which is the following. We have turnstyle data for roughly half of our 55 million square feet under management. And we have carefully picked out same-store data for buildings that are essentially the same level -- has the same level of leasing as they did in March of 2020 as they do today."
},
{
"speaker": "",
"content": "And when you look at that data in New York, our buildings are basically at the same level of turn style swipes, Tuesday or Thursday, as they were in March of 2009. So New York is basically back. The other thing that's interesting is Friday was already slow before the pandemic and Monday is coming up. So there's -- I actually say New York is basically back to the way it was. Certainly, 3 days a week."
},
{
"speaker": "",
"content": "Boston is at about 75% on that measure. And the only place where it's really lagging is in San Francisco, which is about 45% or 50% for those peak days. And peak days are important because if you're a user of space, you need to have space for your people when they're all coming in. So it's not across the whole week. It's what is it on the peak days."
},
{
"speaker": "",
"content": "So again, we see improvement. As I tried to say over and over in my remarks, we think the issue -- the reason our leasing is slower today is actually not because of work from home. It's because of the earnings growth of the clients that we serve. We're a provider of services to businesses, not consumers. Those businesses are not growing their earnings, and if they're not growing their earnings, they're not hiring people and they're not taking space."
},
{
"speaker": "",
"content": "I think as earnings start to grow again, which frankly, we're seeing right now in the first quarter, our leasing will pick up. And I think Doug did a very good job of articulating some of those green shoots that we're already seeing that we should experience later this year."
},
{
"speaker": "Douglas Linde",
"content": "And Rich, just from a sort of macro thesis perspective, I think what is a 100% clear is that new construction is not part of the vernacular in 2024, 2025, which means unlikely you're going to see buildings delivered that aren't already under construction and there is such stuff under construction, but you're not going to be seeing new buildings delivered in any of these metropolitan areas for the next 5-plus years, right? That's how long it takes to build the building."
},
{
"speaker": "",
"content": "Look at the time frames associated with these press releases about a potential new building in Midtown Manhattan. And so if our thesis is -- continues to be accurate and Owen has described the difference between the premier and sort of the other portions of the office inventory, there is going to become less and less premier space and the premier space will continue to pick up its occupancy, it's the lease percentages and we will see the fruits of that in the properties that we have in all of our marketplaces."
},
{
"speaker": "",
"content": "And again, I harp back to sort of this dislocation that's occurring. What we are seeing in Washington, D.C. relative to the number of buildings that people would deem to be \"a to a minus\" buildings that are incapable at this point of making a leasing transaction because there is no capital available because the buildings are underwater to find out there's too much debt and the equity holders are saying, we're not prepared to put capital in for the benefit of the lender."
},
{
"speaker": "",
"content": "It's changing the characteristics because of how these things occurring. And Jake, maybe you can spend a minute talking about sort of the dynamic of where tenants can look if they want to go into a building in a market, by the way, which has a very significant availability problems [indiscernible]"
},
{
"speaker": "Jake Stroman",
"content": "Yes. I would just maybe second what Doug just noted that we are seeing really great activity across all of the buildings in our D.C. and Northern Virginia portfolio. The weight of the troubled assets and the dislocation in our region is really kind of playing to our favor."
},
{
"speaker": "",
"content": "Most of our buildings are preeminent workplaces and there's definitively a flight to quality, but there's also a real flight to certainty across the brokerage community who wants to do deals with somebody who tend new deals. So we're seeing that playing out in our favor in our region for sure."
},
{
"speaker": "Operator",
"content": "And so our next question comes from the line of Caitlin Burrows from Goldman Sachs."
},
{
"speaker": "Caitlin Burrows",
"content": "Maybe just occupancy at 535 Mission, which is a newer build fleet has fallen below 60%, I think, related to WeWork. So Doug, I know you talked about how South of Market is lagging a bit, but can you talk about the demand at that vacancy? And then bigger picture how does that inform your view of the health of demand at the highest end of the market in SOMA ahead of first generation leases rolling over at that building and sales force in the coming year?"
},
{
"speaker": "Douglas Linde",
"content": "Sure, Cait. I'll make a brief comment and let Rod describe it. So WeWork actually is in negotiation to remain in all the space that we have with them at that building. And we have an expiration with Zillow. It's truly a flash Zillow, their fact consolidation which occurred earlier and that's where the majority of the availability is. And Rod, you can describe sort of leasing prospects there and how things are looking in our portfolio in South market?"
},
{
"speaker": "Rodney Diehl",
"content": "Yes. So that's right. The space that you're referring to is in the low rise of that building and it's the former Zillow/Trulia space. We've had some activity on it. We've had better activity on a couple of floors up top. In fact, we just completed the full floor of spec suites up on the 11th floor, which is getting excellent response from the market. So we expect to get that leased up quickly."
},
{
"speaker": "",
"content": "The balance of the SOMA portfolio, I mean we -- earlier on the call, the 680 Folsom availability was mentioned. That's the 200,000 square feet. We just got that space back technically today is the first day we have it as a vacant space. However, we've been marketing it for some time, and we had activity on that. We've been trading paper with various groups. There's another tenant that we're chasing right now."
},
{
"speaker": "",
"content": "So we're getting good looks for getting our shots at seeing these deals. I would say that we've had more activity on Northern market. So I'd say our Embarcadero Center property, frankly, is getting a little bit more attention in some of the Southern market stuff is. Just I think that's just the nature of where the demand is coming from more the traditional companies tended to be attracted to Embarcadero Center, where tech is still focused more South market."
},
{
"speaker": "",
"content": "There is some space that is on the sublease market at Salesforce Tower that Salesforce has and they've been marketing it and it's getting good looks as well. So I mean, there are groups out there. So I'm very confident that we're going to use the space lease up."
},
{
"speaker": "Operator",
"content": "And so our next question comes from the line of Vikram Malhotra from Mizuho."
},
{
"speaker": "Vikram Malhotra",
"content": "Just 2 quick ones. One, just -- I guess, Mike, I just want to clarify in the -- what you outlined for the guidance adjustment, do you mean just sort of where the curve has shifted overall? Or were you actually baking in some sort of rate cuts in your guidance?"
},
{
"speaker": "",
"content": "And then secondly, I guess, just in terms of achieving that occupancy uptick in the second half, is sort of the 1Q leasing run rate you also anticipate that to move up just given where expirations are?"
},
{
"speaker": "Michael LaBelle",
"content": "So on the interest rate expectations, we have included an additional a rate cut in our expectations late in the year. And I think if that rate cut does not occur, it won't have a meaningful impact on what our guidance range is because of when it is within the year."
},
{
"speaker": "",
"content": "So we'll just have to see what happens with the inflation numbers in the Fed as we kind of think about where rates might be going both later this year and next year. But I don't think if there's no cuts this year, it's going to have a significant impact to our guidance. The other question was on leasing? I didn't -- can you restate the question?"
},
{
"speaker": "",
"content": "So the occupancy for Q1 was down a little bit in for Q2 it's going to be down a little bit again because of the 2 expirations that Doug talked about, which is the expiration of 680 Folsom in Times Square Tower. And then we don't have significant expirations of individual size in the back half of the year. And that's when many of the signed leases that we already have done, which Doug talked about, which is, I guess, 815,000 square feet for the company, of which over 650,000 square feet is in 2024, plus the LOIs that we have will start to take hold."
},
{
"speaker": "",
"content": "And so that gives us confidence that the occupancy will stabilize after the second quarter and hopefully start to move northward after that. That's our expectation."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Omotayo Okusanya from Deutsche Bank."
},
{
"speaker": "Omotayo Okusanya",
"content": "Yes. I just wanted to go back to the guidance for the year. So if we take first quarter, we take the midpoint of the second quarter, you're about at 344 midpoint of guidance, the 704. We're talking about rates higher for longer, occupancy probably picking up in fourth quarter or so of the year. So could you just help us walk us through the acceleration of earnings in the back half? What the drivers of that will be?"
},
{
"speaker": "Michael LaBelle",
"content": "So Omotayo, there's really 3, I think, impacts that are going to help us in the third and fourth quarter. The first is we expect NOI from the portfolio to be up, and we expect that to occur because the occupancy improvement that we have talked about. So I would expect that both third and fourth quarter will show higher portfolio NOI than what we have in the first and second quarter."
},
{
"speaker": "",
"content": "The other is G&A. So G&A is seasonally high in the first and second quarter because of just the timing of the vesting schedules as well as taxes that are paid on payroll. So that's a pretty meaningful move between quarters, it could be between $0.05 and $0.07 lower in the third quarter and the fourth quarter from where it is today."
},
{
"speaker": "",
"content": "And then the last piece is we do expect to have interest income be lower than it is today as we fund our development pipeline. And that is offset a little bit by capitalized interest. But I see our interest expense as being slightly lower next quarter and then stable and our interest income will drop a little bit sequentially by quarter as we spend on our development pipeline."
},
{
"speaker": "",
"content": "So those are really the 3 things that are driving the improvement in our FFO in the third and fourth quarter to achieve the midpoint of the guidance range."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Michael Griffin from Citi."
},
{
"speaker": "Michael Griffin",
"content": "Just maybe on the debt side, Owen, I'd be curious to get your thoughts. I mean, are banks willing to lend on new office development projects yet. And if so, what kind of interest rate you think today would lend at? And what kind of yield would you need to have to justify undertaking the development?"
},
{
"speaker": "Michael LaBelle",
"content": "So this is Mike. I'll respond to this and the rest of the team can add on. Lenders in general are not getting payoffs. So typically, they have volume requirements that are pretty significant because they're constantly getting paid off and they need to replace and hopefully grow that."
},
{
"speaker": "",
"content": "In this environment, their borrowers are not necessarily paying them off. So they're not excited about increasing their exposure to commercial real estate and office properties right now. So I think as a whole, banks are not excited to provide lending, I think they would be more likely to lend on a stabilized piece of property at an appropriate debt yield than do a construction loan."
},
{
"speaker": "",
"content": "I think there's very little in the way of construction financing available out there, particular anything speculative. But if you came to a banking, you had a fully leased property maybe you could get that done. But again, the pricing is going to be, I don't know, 300 to 400 over SOFR. So SOFR is at 5.3%. So you're talking about 8% to 9% money. So it's really, really hard to make sense of that when that is the case."
},
{
"speaker": "",
"content": "So again, Doug talked about very little in the way of new construction going on. And I think the bank financing market is another limiting factor to that picture."
},
{
"speaker": "Owen Thomas",
"content": "Yes. Just to add to that, on your question on development yields. So let's divide this between office, life science versus residential. So on office, life science, our targets when rates were very low, we're in the 6% to 7% range. And I'd say those have gone up at least 200 basis points."
},
{
"speaker": "",
"content": "And as Mike described, it's very difficult to get financing. And also, as I described in my remarks, the cost of development has gone up and part of those costs are the inflation that Doug described, but also a part of it is the yield requirements given higher rates. So that's contributing."
},
{
"speaker": "",
"content": "And then on the residential, the way we've always thought about it was 100 basis points over exit cap with no -- with untrended rents. And so today, little hard to gauge, but there is some evidence of high-quality residential trading, say, in the mid-5s. So I think in terms of development yields, you're probably at least in the mid-6s on residential. And I -- and for us, to engage in that. We need a joint venture partner as we have at Skymark, which is our development that's going on right now in Reston."
},
{
"speaker": "Michael LaBelle",
"content": "The other -- just one other trend in bank financing, it's important to note is there's an upturning going on and there's an analysis of profitability going on by these banks of their relationships. So if you have a broad relationship where you're providing other kind of fee services and other things with these banks, and they can see a profitable relationship today and growing going forward, they're going to be willing to provide capital where they're not seeing that, they are exiting relationships."
},
{
"speaker": "",
"content": "So that -- again, that benefits us because we have a very broad set of relationships that we have, and we do these bond deals where these things get fee income and things like this. And so we -- the relationship profitability we have is acceptable. So we are -- we continue to have banks wanting to add to our stable on our financing. And you've seen that. I mean, last year, we added 3 or 4 new banks to our facility. We continue to have banks that are interested in looking at what we're doing and are calling on us."
},
{
"speaker": "Bryan Koop",
"content": "Mike, the additional information market that we've wondered also is that as that just goes down their criteria for making a loan, of course, goes up. And the underwriting of the actual development firms that have a particular property has been incredibly closer and also the criteria for pre-leasing plus credit and the capital stack of equity. And it's just not there right now. And they're passing on everything that is in any way weak on the development front."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Dylan Burzinski from Green Street."
},
{
"speaker": "Dylan Burzinski",
"content": "Just wanted to go back to tech leasing and some of the comments that you made in your prepared remarks on about a lot of these companies overcommitting to space during the pandemic and then being currently in a digestion process. I guess if we sort of weigh that with how much earnings have grown for a lot of these companies over the last several years versus the head count that has grown despite some of the layoffs that have gone on."
},
{
"speaker": "",
"content": "I mean, how long do you expect this digestion process to last? Is this sort of a '25 event, in 2026 event? I'm just curious how you guys are sort of thinking about that and maybe in your discussions with a lot of these tenants, what they're telling you guys?"
},
{
"speaker": "Owen Thomas",
"content": "Short answer. I mean, you're touching on a very key issue as it relates to the health of the [indiscernible] the answer is we don't really know. But I agree with what you said, our instinct is, yes, there was some over commitment. There's some digestion. There's some shedding going on, several tech companies have taken charges sub lease space out in the market. That seems to have slowed down recently."
},
{
"speaker": "",
"content": "But our instincts and what we've seen in past cycles is at some point, those companies are healthy. They're in the center of all the innovation that's going on in the nation. They're going to -- they have a bright future. They're going to grow their earnings, and I think they will be back in the space market, but trying to figure out the exact timing of that is very challenging."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Alexander Goldfarb from Piper Sandler."
},
{
"speaker": "Alexander Goldfarb",
"content": "Owen or Doug or whoever wants to take it. So I'm going to ask a 2-parter, but it's all related to the same. As you guys think about investment -- future investment to grow the company, a multipart, whether your landholdings in Northern Virginia still have any potential for data centers. If there's any office to resi conversion because of the new laws that may present opportunities to you whether it's existing assets or to invest in an asset that would be convertible?"
},
{
"speaker": "",
"content": "And three, what do you think it takes for Lexington AV next to Grand Central to finally benefit from what's going on West of Grand Central to come east of Grand Central?"
},
{
"speaker": "Owen Thomas",
"content": "Well, there's a lot there. You violated Helen's rule of one question. That's okay, Alex. We'll still answer them all. So anyway, I'll just start. Lexington Avenue is doing well. I mean where we are at 53rd Street, it's right where the subway station is and 601 and is fully leased or very close to it and 599 is well on its way. So and 399 -- I mean on Park Avenue, but it's back end is on the lag, right, at the same location and those buildings are performing extremely well."
},
{
"speaker": "",
"content": "I think that location on Lexington Avenue is also unique because of the access to the subway. So on residential, so I don't think there's any -- I don't want to say any assets, but I don't think there's going to be a significant opportunity in our portfolio of existing assets to convert them to residential. I mean frankly, the only ones that are empty or ones that we've emptied out for life science conversion and some -- they all have some level of leasing. I'm not sure they have the physical characteristics for it."
},
{
"speaker": "",
"content": "That all being said, we do have land parcels that you see in our supplemental and in several cases, we are working with local communities to rezone that land from commercial to residential. And given some of the regulatory overlay that's going on in many of our communities and states that process is a little less challenging than it used to be."
},
{
"speaker": "",
"content": "So I think that's where we will benefit. And then I do think there may be opportunities, and we're certainly looking at them for our residential team to get involved in office building conversions of buildings that we don't currently own. We've always felt that this is going to be an important in commercial real estate, it's certainly one that's going to unfold slowly, but you're seeing it unfold right now, and there's an increasing number of projects in many of our markets."
},
{
"speaker": "Douglas Linde",
"content": "Yes. And just to put a little bit of meat on the sort of carcass of that on the residential conversion side for us. So it's 17 Hartwell Avenue. In Lexington, we have a 30,000 square foot office building that we will demolish and that we are getting entitlements to build 350 plus or minus residential units."
},
{
"speaker": "",
"content": "In Shady Grove, which is a piece of land that we bought hopefully, to have thought about doing some life science. We said we're going to pivot, and we're going to do, hopefully, some life science at some point, but we're going to be residential. And so we're selling a piece of parcel to a townhome developer, and we're also working on the residential portion of that development."
},
{
"speaker": "",
"content": "And then third, we bought some older relatively inexpensive office buildings with an existing parking structure in Herndon, Virginia, and we just received approval to convert that site to multifamily, both townhome and multifamily apartments, and we are likely to sell the townhomes and potentially either sell or develop the residential. So we are actively doing that."
},
{
"speaker": "",
"content": "And then jumping to the other side of the country, our assets at North First, which we've owned for quite some time, which we had hoped to build up some kind of office on. We are now working with the city of San Jose on converting a portion of that site to a residential entitlement, and we would build some residential and potentially provide a parcel for affordable housing to somebody else who would build that."
},
{
"speaker": "",
"content": "And then obviously, down in Santa Monica, there's a real question about what Santa Monica Business Park will become over the next, call it, decade or 2. But I -- it would not be unlikely to see not just office development there, but to also see other uses, including some kind of residential on that site. So this is sort of something that we are working actively on as we speak."
},
{
"speaker": "",
"content": "It's not about converting an office building in Times Square to residential or an office building in the CBD of Washington, D.C. to residential, or an office building in Back Bay or in the Financial District in Boston to residential. Our buildings do not line up with the kinds of assets that likely would be potentially convertible if the economics actually worked, which they don't right now over the next, call it, 4 or 5 years."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Upal Rana from KeyBanc Capital Markets."
},
{
"speaker": "Upal Rana",
"content": "Just real quick, Doug, thanks for your color on the existing pipeline. And the update on the Carnegie Center. I wanted to see if you can give us an update on the ongoing backfill at 680 Folsom and 7 Times Square?"
},
{
"speaker": "Douglas Linde",
"content": "Why don't I let -- I mean, I think, Rod, you mentioned 680 Folsom before, but you can reiterate that. And then Hilary, you can talk about 7 Times Square."
},
{
"speaker": "Rodney Diehl",
"content": "Yes. Just real quick on 680. Yes, we have 200,000 feet on the low-rise portion of that building and it's excellent space. It's some of the best space in the market. It's a nice floor plate size, it's 34,000 feet and it's got high ceilings and it's excellent space."
},
{
"speaker": "",
"content": "So we've been marketing it, and we've had proposals that we've been pursuing. And -- so we're going to continue to do that on that space, but it's very high-quality space in our portfolio."
},
{
"speaker": "Hilary Spann",
"content": "On 7 Times Square, I think the team here in New York has done a fantastic job of converting some of the space that was sublet by the major law firm tenant in that building to direct tenancies, and in the first quarter, we signed a direct lease at 7 Times Square for 27,000 square feet. So we're continuing to chip away at the pending vacancy."
},
{
"speaker": "",
"content": "I will say that the Times Square submarket unique more or less among markets in Midtown is exhibiting reasonable sort of weakness. In terms of demand, and that just has to do a little bit with the streetscape and some of the other things that are going on there, which we are working very hard with the city and other folks in the neighborhood to address. But I think we are encouraged by our ability to convert sublease tenants to direct tenants."
},
{
"speaker": "",
"content": "We are pursuing every tenant that's in that submarket that makes sense for the building. And we're just going to continue to chip away at it. But at the moment, I wouldn't describe it as a submarket that's got lots of large tenant demand sort of breaking down the door. It's just chipping away at it lease by lease."
},
{
"speaker": "Operator",
"content": "And I show our last question in the queue comes from Camille Bonnel from Bank of America."
},
{
"speaker": "Jing Xian Tan",
"content": "[indiscernible] are looking for ways to manage the revenue streams and recently, the Mayor of Boston has been talking about raising commercial property taxes. I understand you can pass a lot of these costs through to tenants. So not much of an impact to your operating margins. But do you get a sense that these potential tax increases could change a tenant's view on whether they take a lease in the market versus going somewhere else? And does this make investing in Boston less attractive, adding upward pressure to cap rates?"
},
{
"speaker": "Douglas Linde",
"content": "So let me take a stab at that, and I'll let Bryan provide his perspective as well. We don't think passing expenses on to tenants is a good way to treat our clients. And we do everything we possibly can to reduce our operating expense escalations every single year, and we spend hours and hours finding ways to change the things that we're doing, so that we do not have to have dramatic increases."
},
{
"speaker": "",
"content": "The commercial property sector currently bears a disproportionate portion of the benefit or the burden of taxes in the city of Boston. As assessments change and residential assessments go up and commercial assessments go down, obviously, we all know understand what's going on with regards to overall environmental issues associated with interest rates, valuations, occupancy, capital cost, it's very hard for us to think it would be a good thing for the commercial office property sector to bear a higher proportion of those expenses than they currently are bearing."
},
{
"speaker": "",
"content": "And so we're -- we don't think that these types of policies are good for our business or good for the companies that occupy our buildings. We're hopeful that these types of ideas will not do the day and that there will be pushback from the constituents in the various communities that we'll sort of see that it probably isn't the right time to be asking the commercial sector to have a larger proportion of the burden on any kind of regulation given the challenges associated with our business. Bryan?"
},
{
"speaker": "Bryan Koop",
"content": "Really no further clarification, Doug, other than we have made it quite clear to political leadership our position."
},
{
"speaker": "Operator",
"content": "This concludes our Q&A session. At this time, I'll turn the call back over to Owen Thomas for closing remarks."
},
{
"speaker": "Owen Thomas",
"content": "Yes, no further comments. Thank you all for your attention and interest in BXP."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
c | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to Citi's Fourth Quarter 2024 Earnings Call. Today's call will be hosted by Jenn Landis, Head of Citi Investor Relations. We ask that you please hold all questions until the completion of the formal remarks, at which time you'll be given instructions for the question-and-answer session. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. Ms. Landis, you may begin."
},
{
"speaker": "Jenn Landis",
"content": "Thank you, operator. Good morning, and thank you all for joining our fourth quarter 2024 earnings call. I am joined today by our Chief Executive Officer, Jane Fraser; and our Chief Financial Officer, Mark Mason. I'd like to remind you that, today's presentation, which is available for download on our website, citigroup.com, may contain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these statements due to a variety of factors, including those described in our earnings materials as well as in our SEC filings. And with that, I'll turn it over to Jane."
},
{
"speaker": "Jane Fraser",
"content": "Thank you, Jenn, and a very good morning to everyone. I'm going to start with the macro backdrop and then walk you through our results for the full year. I'll share some thoughts on the progress we're making executing our strategy, and then conclude with why we have decided to adjust our 2026 return target. We entered 2025 with strategic clarity and good momentum across all our businesses. From the global macro perspective, economies have done a good job tolerating hikes from central banks and inflation has clearly been receding. While policies will certainly impact economic activity, whether in the form of tariffs or taxes, 2025 doesn't look that different from 24. The U.S. remains at the heart of the macro picture. Growth is not only being driven by the higher-end consumer, but also by a strong innovative corporate sector. China's growth has been slower-than-expected, but there is still the prospect of further stimulus. Europe continues to underachieve and many emerging markets have re-emerged as bright spots, a trend which certainly benefits us given our global network and deep presence in countries, such as India and throughout the Middle East and ASEAN. I told you, 2024 was a critical year and I'm proud of what we accomplished and how our businesses performed. We finished with a very strong fourth quarter which Mark will detail shortly. For the full year, our net income was up nearly 40% to $12.7 billion. We exceeded our full year revenue target with revenues up 5% ex-divestitures. Fee revenue was up 17% and we saw a smaller impact from Argentina's currency devaluation. We delivered expenses within our guidance and improved our efficiency ratio by 340 bps whilst increasing investment in our transformation. Our RoTCE grew over 200 bps albeit from a low level. Our five core businesses each generated positive operating leverage for the full year which we also achieved at the firm level. Services was up 9% and had another record year despite the low rate environment as a result of new mandates and our emphasis on fee growth. We grew share in both TTS and security services backed by our best fourth quarter in a decade, market was up 6%. The performance of this franchise in the low volatility year shows the benefit of our diversified product mix. Equities was strong throughout and was up 26% in what was a record year for us. Banking was up 32% as we gained share across all three investment banking products and we announced an innovative $25 billion private credit partnership with our long-term client Apollo. Under business leadership, we expect to continue to gain on our competition in 2025 and beyond. 2024 was a turning point for wealth as we sharpened our focus on investments, right-sized the expense base and improved the client experience. Revenue was up 7% for the year including fee growth of 18%. Citigold and Asia were particularly strong and net new investment asset flows grew a very pleasing 40%. We attracted top talent throughout the year in wealth most recently bringing in Kate Moore as our CIO and Anne McCosker as our Head of Lending. This business has tremendous potential with both new and existing clients and we're really leaning into it. USPB revenues were up 6% driven by borrowing across both card portfolios and by fee growth. We announced a 10-year extension of our cobranded partnership with American Airlines ensuring that this valuable relationship enters into its fifth decade. With the acquisition of the Barclays portfolio, we will become American Airlines exclusive partner in 2026 and we expect to deliver more value for our cardholders and high returns for our shareholders as a result. We grew our tangible book value per share by 4% and ended 2024 with a CET1 ratio of 13.6% approximately 150 bps above our regulatory capital requirement. After repurchasing $1 billion in common shares during the fourth quarter, we returned almost $7 billion in capital to our common shareholders in 2024. Even how committed we are to returning capital, I am particularly pleased to announce that our board authorized a $20 billion share repurchase program. You can see the very tangible progress we're making in executing the strategy that we laid out at our Investor Day three years ago. We have materially simplified our firm since then. We exited consumer businesses in nine countries and near completion of wind downs in three and are on-track to exit the final two. This includes Banamex, which we legally separated from our institutional business in December. We're now fully-focused on getting ready to IPO, with the timing heavily dependent on regulatory approvals and market conditions of course. To align our structure with our strategy, we went through a significant simplification of our organization, removing management layers and the regional construct. This has accelerated decision-making and made us a better partner to our clients. We have strengthened our culture by better aligning compensation with our shareholders' interests, enhancing our scorecards to ensure we're delivering for clients. We attracted top industry talent throughout our organization and that includes new leaders around my table for banking, wealth, and technology. We have raised the bar on what we demand from each other and what we expect to deliver to our clients. We have continued to innovate to improve the client experience and our efficiency. We are now live with Citi Payments Express in 18 countries and have converted 4 million retail bank customers to our simplified banking platform in the U.S. We accelerated our use of AI arming 30,000 developers with tools to write code, launched two AI platforms to make our 143,000 colleagues more efficient. The investments we're making to modernize our infrastructure, streamline processes and automate controls are changing how we run the bank. We consolidated our balance sheet reporting to one unified ledger. We implemented a cloud-based solution for risk analytics to better value trading assets. We have closed out three longstanding consent orders. Our capital, liquidity and reserves are robust. Our focused strategy, infrastructure, and targeted client selection have all reduced our risk profile significantly. We have made considerable progress on our transformation. While there are areas that are more advanced, there are others where we still have a lot more work to do, particularly around data and regulatory reporting as last summer's regulatory actions reinforced. We have reviewed the entire data program and made changes to its governance and structure as well as increased the level of investment. As CEO, I want this company set up for long-term success and to ensure that we have enough capacity to invest for that. In terms of expense guidance, therefore, most of the sales from the org simplification and stranded costs will be used to fund the additional investments we need to make this year in both transformation and technology. As a result, we expect our total expenses in 2025 to be slightly below the 2024 level and to deliver another year of positive operating leverage. We expect our elevated expense level to be temporary and for it to keep coming down beyond 2025. However, when we take the required investments into account, we now expect our 2026 RoTCE to be between 10% and 11%. The 2026 RoTCE is a waypoint. It is not a destination. Our intention is to continue to improve returns well above that level and we are accountable for doing so. We are relentless in our determination to run the bank more efficiently, fulfill Citi's potential and meet the expectations of our shareholders. Before I turn it over to Mark, I'd like to acknowledge the catastrophic wildfires in Los Angeles. Many of our clients and several of our colleagues have lost their homes and we will do whatever we can to help them recover from this devastating event. They and their loved ones are in all of our thoughts at Citi. Now, over to Mark."
},
{
"speaker": "Mark Mason",
"content": "Thanks Jane and good morning everyone. I am going to start with the fourth quarter and full year financial results focusing on year-over-year comparisons unless I indicate otherwise. I will also focus on our current expectations for 2025 and 2026. On Slide 7, we show financial results for the full firm which reflect improved performance both in the quarter and the year. As a reminder, in the fourth quarter of last year, revenues were significantly impacted by Argentina currency devaluation. Adjusted revenues and non-interest revenues for the full firm and services are shown in the appendix of the earnings presentation on Slide 36. This quarter we reported net income of $2.9 billion, EPS of $1.34 and RoTCE of 6.1% or $19.6 billion of revenues generating positive operating leverage for the firm and in each of our businesses. Total revenues were up 12% driven by growth in each of our businesses and a smaller impact of Argentina currency devaluation. Net interest income excluding markets was roughly flat with growth in USPB and wealth offset by declines in corporate other and banking. Non-interest revenues excluding markets was up 40% driven by continued strong fee momentum across services, banking and wealth along with lower partner payments in USPB as well as a smaller impact of Argentina currency devaluation. And total markets revenues were up 36%. Expenses were $13.2 billion, down 18%, largely driven by the absence of the FDIC special assessment and restructuring charge in the prior year. Excluding the impact of the FDIC special assessment and divestiture related impacts, expenses were down 7% driven by the absence of the restructuring charge in the prior year and savings associated with our organizational simplification partially offset by higher volume related expenses. Cost of credit was $2.6 billion, largely consisting of cards, net credit losses and ACL build. At the end of the quarter we had over $22 billion in total reserves with a reserve to funded loan ratio of 2.7%. And on a full year basis, we delivered $12.7 billion of net income with an RoTCE of 7%. On Slide 8, we show full year revenue trends by business from 2021 to 2024. This year we delivered $81.1 billion of revenue, up 5% on an ex-divestiture basis, driven by growth in each of our businesses and a smaller impact of Argentina currency devaluation. Services revenues increased 9% to $19.6 billion benefiting from a smaller impact of Argentina currency devaluation, fee growth and higher deposit volumes. Markets revenues increased 6% to $19.8 billion primarily driven by growth in equity, which had its highest annual revenue in a decade and spread products. Banking revenues increased 32% to $6.2 billion, largely driven by growth in Investment Banking with fees up 42%, as we gained approximately 50 basis points of share on an increased wallet. Wealth revenues increased 7% to $7.5 billion, primarily driven by a 15% increase in non-interest revenue, as we continue to grow client investment assets. USPB revenues increased 6% to $20.4 billion, driven by growth in cards, as we continue to see strong customer engagement and an increase in interest earning balances as well as lower partner payments. Overall, this year demonstrates another year of performance consistent with our medium-term target of 4% to 5% annual growth and the value of our diversified business model. On Slide 9, we show the full year expense trend from 2021 to 2024. Excluding the impact of the FDIC special assessment, our full year expenses were $53.8 billion in-line with our target. Expense reduction was driven by savings related to our organizational simplification and stranded cost reduction, as well as lower restructuring and repositioning charges. Organizational simplification, stranded cost reduction, as well as efforts to drive efficiencies across the businesses contributed to a net decline of roughly 10,000 direct staff. These savings were mostly offset by higher volume related expenses, as well as investments in the transformation and other risk and controls and the civil money penalties. As you can see at the bottom of the page, we spent $2.9 billion on transformation this year, which includes investments in our infrastructure, platforms, applications and data. Transformation investments were up 1%, driven by an increase in certain programs including data largely offset by a reduction in the transformation bonus award. And we spent $11.8 billion on technology, focused on digital innovation, new product development, client experience and other areas such as cybersecurity. Turning to Slide 10, we provide details on our $2.4 trillion balance sheet which decreased 3% sequentially largely driven by the impact of foreign exchange translation. In the fourth quarter, we deployed some of our excess liquidity into loans while maintaining 116% LCR and $933 billion of available liquidity resources. Our $1.3 trillion deposit base remains well diversified across regions, industries, customers and account types. We maintained strong capital ending the year with a preliminary 13.6% CET1 capital ratio, approximately 150 basis points above our regulatory capital requirement of 12.1%. For the year, we returned nearly $7 billion in the form of common dividends and repurchases to our shareholders. Turning to the businesses on Slide 11. We show the results for services for the fourth quarter and full year. Services revenues were up 15%, driven by a smaller impact of Argentina currency devaluation and reflecting continued momentum across security services and TTS, both of which gained share this year. NIR increased 61%, driven by a smaller impact of Argentina currency devaluation as well as continued strength in underlying fee drivers such as U.S. dollar clearing, commercial card spend, cross border transactions, and assets under custody and administration. NII was roughly flat as the benefit of higher deposit volumes was offset by the impact of lower interest rates in Argentina. Expenses increased 1% driven by continued investment in technology and platform modernization partially offset by productivity savings. Cost of credit was $112 million with a net ACL build of $84 million and net credit losses of $28 million. Average loans increased 5% primarily driven by continued demand for export and agency finance as well as working capital loans. Average deposits increased 4% as we continue to see growth in operating deposits. Services generated positive operating leverage and delivered net income of $1.9 billion and $6.5 billion for the year and continues to deliver a high RoTCE coming in at 29.9% and 26% for the year. On Slide 12, we show the results for markets for the fourth quarter and full year. Markets saw its highest fourth quarter revenue in a decade and increased 36% with broad-based gains across all products. Fixed income revenues increased 37% driven by rates in currencies which were up 39% and spread products and other fixed income up 30% both reflecting increased client activity. Rates and currencies also benefited from a conducive trading environment compared to a challenging prior year quarter. Spread products and other fixed income was driven by credit and mortgage trading as well as higher securitization volume. Equities revenues increased 34% driven in part by strong execution of strategic client transactions in cash equities and momentum also continued in prime with balances up approximately 23%. Expenses decreased 8% primarily driven by lower legal expenses and productivity savings. Foster credit was $134 million driven by a net ACL build primarily related to spread products. Average loans increased 6% primarily driven by asset-backed lending in spread products as well as margin loans in equities. Average trading account assets increased 15% largely driven by client demand for U.S. treasuries and foreign government securities. Markets generated another quarter of positive operating leverage and delivered net income of $1 billion and $4.9 billion for the year and delivered an RoTCE of 7.4% and 9.1% for the year. On Slide 13, we show the results for banking for the fourth quarter and full year. Banking revenues were up 27% largely driven by investment banking with fees up 35% as we saw growth across all products. ECM was driven by continued investment grade issuance momentum and increased leverage finance activity. ECM saw strong issuance activity particularly in follow on and convertible instruments. In M&A, growth was driven by continued strong client engagement as well as the completion of previously announced acquisitions given the more conducive macro environment. For the year, we gained share across regions, products and several sectors including healthcare and technology. Corporate lending revenues excluding mark-to-market on loan hedges, decreased 24%, driven by lower revenue share and volumes partially offset by a smaller impact of Argentina currency devaluation. Expenses decreased 9%, primarily driven by benefits of headcount reduction, as we right sized the workforce and expense base, partially offset by higher volume-related expenses. Cost of credit was a benefit of $240 million, driven by a net ACL release of $247 million, primarily driven by improved macroeconomic conditions. Banking generated positive operating leverage for the fourth quarter in a row and delivered net income of $356 million and $1.5 billion for the year and delivered an RoTCE of 6.5% and 7% for the year. On Slide 14, we show the results for wealth for the fourth quarter and full year. As you can see from our performance this quarter, we are making good progress against our strategy and expect that momentum to continue. Revenues were up 20%, driven by a 22% increase in NIR, as we grew investment fees with client investment assets of 18% including net new investment assets of $16 billion. NII increased 20%, driven by higher average deposit spreads and volumes. Expenses decreased 3% driven by the continued benefit of headcount reductions, as we right-sized the workforce and expense base. End of period client balances increased 8%, driven by higher client investment asset flows and market valuation. Average deposits increased 3%, reflecting the transfer of relationships and the associated deposits from USPB, partially offset by a shift in deposits to higher yielding investments on Citi's platform. Average loans decreased 1%, as we continued to optimize capital usage. Wealth generated a pretax margin of 21% and another quarter of positive operating leverage, delivering net income of $334 million and $1 billion for the year and delivered an RoTCE of 10.1% and 7.6% for the year. On Slide 15, we show the results for U.S. Personal Banking for the fourth quarter and full year. U.S. Personal Banking revenues were up 6%, driven by NII growth of 5% and lower partner payments. Branded cards revenues increased 7% with interest earning balance growth of 7%, as payment rates continue to normalize and we continue to see spend growth, which was up 5%. Retail services revenues increased 7%, driven by lower partner payments and interest earning balance growth of 3%. And retail banking revenues were roughly flat, as the impact of higher deposit spreads was offset by the impact of the transfer of relationships and the associated deposits to our wealth business. Expenses decreased 2%, driven by continued productivity savings, partially offset by higher volume related expenses. Cost of credit was $2.2 billion, largely driven by net credit losses, as well as a build primarily for volume growth. Average deposits decreased 18%, largely driven by the transfer of relationships and the associated deposits to our wealth business. USPB generated another quarter of positive operating leverage and delivered net income of $392 million and $1.4 billion for the year and delivered an RoTCE of 6.2% and 5.5% for the year. On Slide 16, we show results for all other items which includes corporate other and legacy franchises and excludes divestiture related items. Revenues decreased 34%, primarily driven by net investment securities losses as we reposition the portfolio, higher funding costs and close, exits and wind outs. Expenses decreased 51%, primarily driven by the absence of the FDIC special assessment and restructuring charge in the prior year as well as the reduction from the closed exits in wind down. And cost of credit was $397 million with net credit losses of $257 million and a net ACL build of $140 million primarily driven by Mexico. Turning to Slide 18, where I will walk you through our current expectations for 2025. As a reminder, what underpins our current expectations is a reflection of a number of scenarios that include different macro and capital market environment. And based on what we know today, we expect revenues to be around $83.5 billion to $84.5 billion, a roughly 3% to 4% increase year-over-year. We expect a continuation of the NIR ex-markets momentum we saw this year driven by investment banking as we continue to gain share in the areas of strategic focus such as healthcare, technology, as well as leverage finance and sponsors assuming a constructive industry wallet. Wealth, supported by a continued focus on growth in client investment assets and banker productivity, which will drive investment revenue services as we execute the strategy we laid out at our Investor Day in June, expanding our leadership position with large institutions and growing our market share with commercial clients in TTS. And in security services, continuing to gain share through investments in our digital and data capabilities while deepening with asset managers and asset owners. Turning to Slide 19, we expect NII ex-market to be up modestly this year. However, there are several tailwinds and headwinds that I will walk you through. Looking at the left hand side of the page, we expect most of the increase to come from volume growth and mix, primarily driven by higher loan volumes in USPB, mainly in cards and deposit volumes in services. We expect the continued benefit from lower yielding investment securities rolling off and being repriced into higher yielding assets such as cash, loans and securities. Partially offsetting these tailwinds are several headwinds including various scenarios around lower rates both in U.S. and non-U.S. Which we expect to be mostly offset by repricing actions across the franchise as well as the potential impact of card late fee reduction and FX. Turning to Slide 20, we expect expenses to be slightly lower than $53.8 billion for 2025. Our expectations reflect continued benefits from our organizational simplification, reduction in stranded costs, and productivity savings from our prior investments. However, offsetting most of these benefits are increased investments in the transformation, technology and the businesses as well as higher volume related expenses. Embedded in our outlook for the year is roughly $600 million for repositioning, which remains elevated, as we continue to reduce stranded costs, drive efficiencies across the businesses, and as benefits from investments in transformation and technology allow us to eliminate manual processes. As Jane said, we recognize that, our expense base remains elevated and we remain very focused on bringing down our expenses each year, while ensuring that, we have enough capacity to invest in the company. Now turning to Slide 21, I will talk you through our expectations going forward. As we enter 2025 and think forward to 2026, we continue to have a clear path to improve returns. Having gone through another robust planning process and having provided revenue and expense targets for 2025, we want to update you on our 2026 RoTCE target range. In 2026, we expect continued revenue growth from both NII and NIR, with drivers largely consistent with recent performance. We expect expenses to decline from 2025 and are targeting an expense level below $53 billion. The reduction in our expense base will come from a decrease in legacy and stranded costs, a more normalized level of severance, and an increase in productivity savings from our prior investments. We will maintain strict discipline on the entire expense base looking for more opportunities to drive further efficiencies, as we go into 2026. We also remain laser-focused on continuing to optimize RWA, but as you know, the future of capital rules and therefore requirements remain uncertain. In light of all of this, we are now targeting an RoTCE in the range of 10% to 11% in 2026. We're committed to driving positive operating leverage and improving our returns every year, for both the firm and the businesses and we will do so in a sustainable way, which will set this company up for long-term success. With that in mind, as part of the $20 billion share repurchase program, we plan on buying back $1.5 billion of common stock in the first quarter. As we take a step back, 2024 represents another year of solid progress and a set of proof points towards improving firm-wide and business performance, as well as continued execution against our transformation. And as we enter 2025, these priorities remain critical, as we continue to make progress on improving our returns. With that, Jane and I will be happy to take your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question will come from Jim Mitchell with Seaport Global."
},
{
"speaker": "Jim Mitchell",
"content": "Good morning, everyone. Just I think as Jane noted, it seems like a material driver of the reduction in the OCC target in '26 is expenses. I think you kind of backed off the lower end of that given higher investments in the transformation, but also talked about it being somewhat temporary. So when we think about and we appreciate the below 53 for '26, but how much more is there to go beyond that in terms of eliminating parallel running parallel systems, reduce consultant spend and all that stuff? Is there still that path to a 60% or lower efficiency ratio?"
},
{
"speaker": "Jane Fraser",
"content": "Well, Happy New Year, Jim. I know you want to talk about the guidance, so let me put it into context here. Last year you've heard me be very clear about our two priorities. First one is driving the business performance and the second is executing the transformation. You've seen this quarter, you've seen last quarter, you've seen the full year, our businesses are delivering the progress we wanted them to. The strategy is working. We change the business mix, we're generating more fee based revenues. You see that in services with NIR up 37% this year, wealth NIR up 15%, IBCs up 35%, an important part of the mix around the quality of our earnings. We said services is a crown jewel. It's delivered growth, high returns, it's taken share. It's a crown jewel. We made a strategic plan well and you've seen us very steadily prove out why we can be a force globally with a clear path to delivering the financial performance that we said we would do. We've consistently delivered on our revenue and expense targets. And I see a lot more opportunity and more upside to strengthen our business performance. We're very tangibly getting after it. We're pretty excited by it. The second priority, transformation. I got to tell you, I'm broadly pleased with the progress we've made in risk and compliance and accountability. I'm excited by the work we've got going on in controls for the business as well at the moment. We've been very transparent. Data was an area we have more work to do in. Last year, as you know and then as part of the annual planning process, we took a big step back to reassess our plan. And I decided along with Mark and the management team, we needed to expand the scope and accelerate some of the work to satisfy our regulators' expectations. I'm confident that the decision to do that, it was the right one. It's the right one for our transformation efforts. It's certainly the right one for the firm overall. I could have taken a short term decision to cut other investments that are important for our long term investment and competitiveness. I'm just not going to do that. You shouldn't want me to do that. And as I said in the opening comments, this ‘26 target is a waypoint not the final destination."
},
{
"speaker": "Mark Mason",
"content": "And if I could add."
},
{
"speaker": "Jim Mitchell",
"content": "Yes, please Mark."
},
{
"speaker": "Mark Mason",
"content": "Yeah, thanks. I just want to address the second part of your question, Jim, in terms of the path to less than 60%. I think Jane framed it out quite nicely in that, we're building a franchise that will have continued and sustainable top line revenue momentum. We are focused on driving out the inefficiencies and stranded cost and legacy franchise expenses from the organization and the benefits from these investments we've made in the transformation will yield a lower cost structure over time as well. And so the combination of those things will get us to that targeted operating efficiency as we come out of 2026 at less than 60%. So yes, there is still a path and we are focused on that path."
},
{
"speaker": "Jim Mitchell",
"content": "Okay, great. That's very helpful. And then just maybe pivoting to the buyback rate to see the $20 billion authorization. Obviously, can't help but ask about beyond 1Q. If we do sort of get this more certainty, maybe no increase in capital requirements, does it -- does that start to help you may be at least temporarily lower the buffer to take advantage of your trading below tangible book and getting the accretion and accelerating the buyback? Or, how do you think about the rest of the year on the buybacks?"
},
{
"speaker": "Mark Mason",
"content": "Look, I'll make a couple of comments. One, we're very pleased to have announced the buyback program at $20 billion. I think in many ways that is a demonstration if you will, of continued confidence in the earnings generation and momentum that we have around that, as well as the recognition that we are trading below book and not where we want to be. And you've heard both Jane and I, speak to the importance of increasing and doing more in the way of buybacks. We've increased that to $1.5 billion. I think that supports that same degree of confidence that we have in the momentum. We are constantly looking at every year on an annual basis, as we go through our planning process at the management buffer that we have of 100 basis points. And despite the last couple of quarters at running above the 13.1%, our target is the 13.1%. And so, as we get -- as we go through the balance of the year, as we get clarity on reg rules and what have you, you will see us continue to that 13.1%. Obviously, the two important characteristics that we keep or drivers that we keep in mind is, the opportunity to invest more in the business at accretive returns and where we're trading and the need to do more buybacks in order to reflect the underlying value. So target is 13.1%, we continue to look at that management buffer as the regulatory environment evolves and we will continue to do more in the way of capital actions as that makes sense."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of John McDonald with Truist Securities."
},
{
"speaker": "John McDonald",
"content": "Thank you. Mark, just wanted to follow-up on your answer to Jim right there. So when you look at the 10% to 11% RoTCE target for 2026, is that kind of assuming you'll be around the target or like using the 13.1% as the target and then longer-term you hope to bring that target down as rules get clarified and the franchise gets simplified?"
},
{
"speaker": "Mark Mason",
"content": "John, good to hear from you. In fact, yes, the 10% to 11% RoTCE target we've set for '26 does assume that we are running and using a 13.1% CET1 ratio. Obviously, there will be an SCB that comes out sometime later this year. The rules are continuing to evolve and what have you and we'll factor those in, as we know more about them. But yes, it does assume the 13.1% which is our management target, if you will, for CET1."
},
{
"speaker": "John McDonald",
"content": "Okay, great. And then my next question is, could you clarify what you're expecting this year for card net charge-offs? I understand, the quarterly cadence has seasonality, but for the full year expecting the charge offs to be in the range of last year's guidance. Can you just kind of clarify that, and then maybe just talk about provision build, which you had a lot of in 2024 and whether that could slow down, as the maturation of balances slows down?"
},
{
"speaker": "Mark Mason",
"content": "Sure. In terms of the net credit losses and the forecast that we have, we are expecting that, the net credit losses will be at the high end of the range that we've given. In the case of branded cards that 3.5% to 4% is the full year range that we've given. In the case of retail services, it's 5.75% to 6.25%, excuse me. And so right now, retail services is at that high end at 6.28% for 2024. We'd expect it to stay at that high end, although I'm sorry. And then on branded cards, we're at 3.64% we'd expect it to creep up to about the 4% level over the course of the year. But full year NCL rate and we know that there's seasonality through the quarters. And so you'll see movement through the quarters based on that dynamic. And then just in terms of the provision build, there are a couple of drivers there. One is obviously volume and we do expect to see volume growth in USPB. So that will be an important factor in how the CECL calculations are done. And then the second driver is obviously as we run models and the models have they have a base scenario, they have a downside and upside scenario depending on the broader macro factors, unemployment, GDP, etcetera, etcetera and are waiting towards the likelihood of high or upside or downside scenario. Those factors become important considerations in the provisioning. And so that's how we think about that going into 2025. I hope that helps."
},
{
"speaker": "Operator",
"content": "Our next question will come from Mike Mayo with Wells Fargo."
},
{
"speaker": "Mike Mayo",
"content": "Hi. Just a clarification. So you are guiding for three consecutive years of lower expenses, including that $600 million reposition this year. So they were down in ‘24, you're guiding them lower in ‘25, and you guide them lower in ‘26 again. And you're also guiding for three consecutive years of higher revenues based on what you said. I didn't say that in the written materials, but I think I heard you say that Mark. So three years of lower expenses, three years of higher revenues through at least 26%. Is that correct?"
},
{
"speaker": "Mark Mason",
"content": "No, I mean, I think you described it correctly like we're seeing continued momentum on the top line and we're focused on continuing to bring our expenses down just as we did in '24, a tad bit in '25 and then more in '26."
},
{
"speaker": "Mike Mayo",
"content": "All right. Then I guess this is for Jane. Well that beat haggis on toast if you achieve that, but I'm wondering why that efficiency might not improve even more. If you have $5 billion of stranded costs and transformation costs in 2024 and some of that goes down, I heard you're investing in tech and transformation and volume and the businesses and there's always a trade-off between the bottom line results you show today and the growth you show in the future. And it seems like you're going to get this done, the lower expenses, why you're leaning into a little bit extra growth. So talk about that trade off and where you're leaning in for growth a little bit more."
},
{
"speaker": "Jane Fraser",
"content": "First of all, I'm a little disturbed by your comment about haggis on toast, it's haggis with mashed potatoes and whiskey, just to be clear for everyone. It's Robert Burns night coming up soon. On expenses, Mike and everyone expenses are a focus not just for Mark and I but for the entire management team. We're making sure that focus and discipline is really getting installed and instilled into the DNA of Citi. And you've seen that as you've referenced. We've been meeting our expense guidance over the last couple of years. We've been driving positive operating efficiency. We're all very focused on improving our operating expense base. Consolidating technology, the simplification work, automation, getting different utilities put in place rather than fragmented around the firm using AI tools now, our location strategy, right? So that core operating expense base is something that we're really looking at how do we drive to be more efficient, more modern and getting it to the level it should be, for the revenues that we generate. We all want transformation to get done quickly and we want it to get done right. That is why our expenses are temporarily elevated to make the investments that are needed there. This is not all run rate. As you say, as CEO, I will not sacrifice the right long-term investments in our growth and competitiveness for short-term expediency. This is a waypoint, it's not a destination and we know what we need to do. We've got our arms around all of this with execution."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Betsy Graseck with Morgan Stanley."
},
{
"speaker": "Betsy Graseck",
"content": "Hi, good morning. Jane, just to follow-up on what you mentioned. As you do execute, we all expect or at least, I do that the market will be giving you credit for that execution, and meaning multiple should increase. I'm a little bit -- I have a few questions here on the buyback, because right now, today, as we all know, you're trading blow book. It has got to be, buying back stock has got to be the most accretive use of capital today. And why wait on the buyback when you can lean into it today and keep your 2026 guide? I mean the old guide was 11% to 12%, RoTCE, new guide 10% to 11%. I'm kind of confused why you don't pull that lever more aggressively because buying back the stock, the accretion to tangible book, it's got to be the easiest thing to do to help that RoTCE go up when you compare and contrast against all the hard work you've been doing, which will obviously be very important to getting the RoTCE up. But why not lean more into that buyback? And can you give us a sense of the timing of that $20 billion?"
},
{
"speaker": "Jane Fraser",
"content": "Yes. Betsy, I love the passion. I've got to say, I can hear the determination in your voice. I think it's the same determination we feel. Look, we're very committed to returning capital to shareholders period or full stop. We've got a $20 billion buyback program. As Mark said that is reflective of the growing earnings power that we have and our confidence in the path ahead. We've been increasing the amount of capital turn over the last few quarters, and we -- I'm also happy to see a more aggressive Basel III scenario firmly off the table. We have nonetheless a 13.1% CET ratio that we put in the plan that can change over time as well. But there's not complete certainty around where the capital requirements are going to go. We hope there will be a holistic one that is reflective of the risk profile of the bank that's been improving significantly over the last few years. So we have some great growth opportunities. I look at the different areas. I'm excited by what we see in wealth. We've got a great runway with our clients who want to do business with us in banking. We've got some very important investments and investment agenda that we're putting in to help us continue growing the bank, gaining competitiveness in a responsible way. I'll just conclude with exactly your point. The bar is high on those investments, right? We don't make them unless we see extremely attractive marginal RoTCE and there's a lot of things we say no to in order to put the $20 billion program in place. In terms of timing, like our peers, we're not committing to this particular timeframe from this, but you can see our commitment. You can hear our commitment."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Ebrahim Poonawala with Bank of America."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Hey, good morning. I guess maybe Jane, I want to follow-up on a couple of segments. I think you said 2024 turning point for wealth and you've seen very steady progress on the RoTCE in wealth. Just talk to us in terms of [Indiscernible] has been in the seat for a year now, you've seen progress, what needs to happen? Just talk to us a little bit about the franchise positioning competitively both in the U.S. and abroad as you think about going head to head with some of your global peers and where are the most likely growth opportunities over the next year or two?"
},
{
"speaker": "Jane Fraser",
"content": "Yes, so my vision is that we become a global leader in wealth management. There are not many firms that have the globality of Citi. We have all the assets especially the client relationships all around the world, which we just not tapped for investments in the past. It's a big opportunity. We have $5.3 trillion off from existing clients. I think the fact that I find interesting is 55% of it, it's almost $3 trillion with affluent clients in our branch network in America, in the U.S. We're also very well-positioned to capture new wealth. Just think about what Citi does in terms of our footprint, our capabilities really supports wealth creation from the commercial bank, our investment banking side, markets obviously servicing it too. These are all great feeders for us to strengthen wealth relationships with our clients. To report in Andy. Andy greatly sharpened the focus on the investment business. This is where we see this big upside. He's been building a differentiated value proposition around wealth creation. He's been leveraging a lot of the leading capital market capabilities, the different relationships we have with PE firms, asset managers around the world, get a great platform in place. And importantly, improving our client experience, again particularly around investments and asset allocation, performance etcetera. What else I've got to love is the surgical approach that he's taking to the expense base and driving productivity, something that we're doing across the firm. I'm also excited by the talent he's bringing in. The market leaders like Kate Moore and Keith Glenfield in the investment space. And we've made a lot of investments in training and building this investment culture that we didn’t have before. So to your point, the proof points are working. Q4 revenue up 20%, operating margin at 21% on its way to 25% to 30%, 10% RoTCE on its way to 15% to 20%. These last few quarters, you've just seen us on that March and the number I'm most excited by net new investment asset inflow of $42 billion up 40% year-over-year. The strategy is working. We're going to be a leader in wealth, the growth opportunities Asia, U.S, Middle East, all the places where we are with our existing clients and the new wealth generators of the future."
},
{
"speaker": "Ebrahim Poonawala",
"content": "If I can draw a parallel segment with the RoTCE is about 5% to 6% last few quarters, there you brought in a [Vivek] Agarwal from JPMorgan. Just give us a sense of could we see a similar trajectory in that business over the next 12 months and where the opportunities are to improve their ROE?"
},
{
"speaker": "Jane Fraser",
"content": "Yes. Absolutely, we have a strong performance, the strategy we have in place is delivering nicely. If you look at the revenues, the investment banking fees, positive operating leverage all through the year and gaining share, all three products, gaining share in all three in all of the geographies we're in. I'm really excited and happy to see the healthcare and the technology at two areas that we've been investing heavily behind. And you're also seeing us playing a leading role in some of the key transactions, the biggest transactions last year, Mars, Kellanova, single advisor, big role in Boeing, and then just this week, the J&J acquisition of Intra-Cellular. The deals that matter playing a leading role in. So when this joined, the mandate a bit similar to Andy, become a top three investment bank, deliver the full potential of One Citi to our clients. So we've got a lot of upside there, instilling some more discipline in capital allocation, client coverage, some of the cross firm linkages. We're getting a lot more from our people. We've been bringing in some great new talent. We've also been cutting some of the unproductive spend. I think what you can see is, we're just on a path of systematically growing our wallet. We'll be improving our operating margin, generating higher returns that should be your expectation over the next couple of years of what you'll see from us. As we head into great environment in 2025, it should be pretty conducive for a lot of client activity. I'm very confident we've got the -- we're well positioned. We've got the groundwork done to take advantage of it."
},
{
"speaker": "Mark Mason",
"content": "I thought I heard you say RoTCE of 5%. It's actually 7% for the full year for banking and on its way to the target that we have set of mid-teens for our banking business."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Erika Najarian with UBS."
},
{
"speaker": "Erika Najarian",
"content": "Thank you. Hate to ask [indiscernible] question on the buyback, but clearly the way the stock is reacting today, the buyback is very important to your shareholders. I guess my first question, if I could have the two questions is, it's very clear that you want to return capital to shareholders. It's very clear that you have excess capital. It's very clear that your PPNR trajectory is positive. And so what are the specific mile markers that Citi needs to see in order to increase that piecing from that $1.5 billion a quarter to something that is more suggestive of a pace that would be in line with that $20 billion authorization? I know that this has been asked of you already, but is it the consent order? Is it the stress test? We have some news over the holidays that were positive for the sector. What are those specific mile markers? I mean, you're doing it on the PPNR side, right? What do you need to see to have gain even more confidence again like in leaning to Betsy's words to go all in on the buyback?"
},
{
"speaker": "Mark Mason",
"content": "Yes. So thank you for the question. Let me make clear a couple of things. So one, and I have said this already, so I apologize for repeating myself. But one, our target for CET1 is 13.1%, right? And so what you're going to see over the course of the year is us managing down to that target. That's one point. The second point I want to be clear that it's not the consent order. That's not something that is impacting the capital actions and decisions that we take. We obviously forecast out the performance. As I've said, Jane has said already, we see very strong continued earnings momentum. I'm managing towards a 13.1% CET1 ratio and you'll see the buyback trajectory reflect getting down to that CET1. The one thing I will mention and you mentioned already is that we obviously have another CCAR process stress test that we will go through. And none of us can predict what's on the other side of that from an SCB point of view, but that will be an important factor as we get through the first half of the year and into the second half of the year in terms of the level of buybacks that we will be taking on a quarter by quarter basis. So I hope that helps. There are no artificial constraints so to speak that are in place. This is us planning and forecasting the performance of the franchise, ensuring that we can fuel high returning growth opportunities so that we're building a sustainable franchise looking at the capital requirements that we have and the management buffer that we put in place and therefore taking that excess capacity and putting it towards buybacks but with an eye towards the regulatory environment that we're in. And what by that are the capital requirements that come out of the annual stress testing process that's run. So that's the basics of it as we sit here today."
},
{
"speaker": "Erika Najarian",
"content": "Got it. And just my second question as we think about 2026, and again I don't want to put words in your mouth because clearly it's very critical in terms of your targets and hitting them. So you targeted less than $53 billion. Is it fair to assume like Jim was asking that $51 billion to $53 billion is not the target but it's less than $53 billion. But to that end, just taking a step back, I think Jane, you said something very important in that you want to get to the returns in a sustainable way. And clearly, your shareholders are scarred by previous management when the returns went up to double digits and went back tumbling down and wasn't sustainable. And should we just really think of this as look, like it takes a while to turn around a money center bank and 2026 may have been the target in 2022, but we're going to get there in '27, '28 anyway and we're just doing this in a sustainable way and we're not robbing the bank of investments. I guess, I'm just trying to think about everybody is super focused on what you had said, what you had said previously and now you have different targets, but is it just really like look it just takes longer, we'll get there but it just takes longer and maybe just an addendum to that, how should we expect Banamex to impact that 10% to 11% RoTCE in terms of the immediate impact after IPO and then after you deploy the excess capital that you get back?"
},
{
"speaker": "Jane Fraser",
"content": "Erica, we chose the words very carefully to say that ‘26 is a waypoint, it's not the destination. And when I'm looking out to ‘27, ‘28 what is the bank that we want to be in terms of our strategy, our performance, our culture, all those different dimensions and we just relentlessly keep going down that path, but we're going to take the right and responsible decisions as we go down it. So our potential is for more than our medium-term target RoTCE. The potential of the Bank and the journey that we're on is to improve our returns beyond there for sure. And then, you asked a question about Banamex. On that front, look, we had a singular focus on the separation of two banks. That was an enormous body of work, because we had to put up Mexico's eighth largest bank, de novo, in a very short period of time. It got done December 1st. That was over 100 regulatory approvals to get that done. Now we have turned our full attention to the IPO. We're getting ready to be able to IPO as soon as we can. But given market conditions and given regulatory approvals, it's possible this could go into '26, but we're doing everything in our control to be ready as soon as possible. We are not the right owner of the Bank. We are committed to the simplification of Citi. We will follow a responsible process here."
},
{
"speaker": "Mark Mason",
"content": "Just in terms of the impact and the timing that Jane referenced, just keep in mind that, the financial impact of exiting Banamex comes in two forms. One is the gain or loss on sale and two is the risk weighted asset release. The gain or loss on sale will run through the P&L at deconsolidation. So that's the point where we've gotten or we've IPO-ed more than the 50%. And the ultimate benefit will be driven by the RWA release when we fully divest our stake. And so, hopefully that helps, but it's not until we've deconsolidated that we see that P&L impact and the CTA and other things like that kind of flow through the P&L for Banamex."
},
{
"speaker": "Operator",
"content": "Our next question will come from Gerard Cassidy with RBC Capital Markets."
},
{
"speaker": "Gerard Cassidy",
"content": "Jane, I'll pass on the -- but I'll take you up on the whiskey."
},
{
"speaker": "Jane Fraser",
"content": "I didn't say I was buying, just to be clear."
},
{
"speaker": "Gerard Cassidy",
"content": "Okay, I got it. Our expense report on this end. Anyway, just following up Mark on your comments about the IPO with Banamex, can you guys remind us or refresh our memories on when the IPO process starts, what will you be -- once it goes public, what percentage ownership do you guys expect to have? And second, have you given us any color on whether you expect to report a gain on this transaction or a loss, as you just referenced will go through the P&L?"
},
{
"speaker": "Mark Mason",
"content": "Yes. We haven't given you any sense for the exact timing of that. As you know, this is a process. And so, Jane just spoke to the timing of that process, the first step having been completed on December 1st with the separation. We are now obviously gearing up and readying ourselves for the IPO. There will obviously be important filings associated with that, given our intent to dual list. There will be regulatory approvals, that are required kind of, as we make headway with potential investors as part of the IPO process. And so, there are series of IPO steps that we will need to take over the course of the year in order to continue to ready ourselves. There are things that we don't control, like, as Jane mentioned, the regulatory approval process and timing for that as well as the market conditions. And so all of those factors are important, and then how the IPO occurs in terms of percentage that is taken on at that first tranche versus follow on tranches are important factors on when we get to deconsolidation. And so I haven't given you an exact timing on that, but you can envision 15% kind of tranches that happened over a 12, 18-month, 24-month period. And then obviously reaching a point of deconsolidation at which point that currency translation adjustment starts to flow through the P&L. There's no material impact on capital, but it does flow through the P&L and then ultimately we over the course of time. So I'm sorry I'm not giving you precise dates and percentages and part of that is because we are obviously on the front end of not only readying ourselves, but considering alternative IPO structures and potential investors/shareholders as part of that process."
},
{
"speaker": "Gerard Cassidy",
"content": "Well, I appreciate the insights. And then, as a follow-up question and I really don't mean this what have you done for me lately type question because you guys have made so much progress in what you're doing in your strategic changes here. But can you talk about the U.S. Personal Banking, many of your questions today is about the RoTCE consolidated and how you can improve that. And this business has a very low RoTCE as you guys know below your cost of capital and structurally when you look at it, if you look at the loans at the end of period just over $220 billion your deposits about $90 billion which is quite a bit different than your peers who have much higher ROEs. So how do you approach this business? And again I know you've been very busy divesting a lot of the businesses that are not important but it seems to me that this is a giant hurdle that you guys have to approach at some point in the near future?"
},
{
"speaker": "Jane Fraser",
"content": "Let me just chat a bit through this. So how did what's the path to the high returns in U.S. Personal Banking? It's coming from top line revenue growth, improved expense base and also a more normalized credit environment. And that gets us to the mid to high-teen returns in the medium term. I think we feel very confident and comfortable in that. You're seeing the proof points, I talked about banking wealth earlier. We've had another good quarter of revenue growth. We've had the ninth consecutive quarter of operating leverage. So I think you should be getting some comfort around that. What's going to drive that growth? Co-brands, we just extended with American to be their sole issuer. It's going to give exciting benefits to the American Airlines and the Citi cardholders, and it will be beneficial for both our growth and our returns. In the proprietary front, we're investing. There's a lot of investment in innovation to drive growth. So refresh the start of Premier card, we've been enhancing the reward offerings and you're seeing us often now number one in recognitions and awards around that area. Retail Services being forensically focused on improving the partnership economics and driving top line growth. And then retail banking, there we're driving primary checking growth. We put in simplified banking, so we get a much more streamlined customer proposition that's driving more of a relationship based banking approach as opposed to a transactional one. Importantly as well, the retail banks been feeding our Wealth business. You heard me earlier talking about that, almost $3 trillion of off us investment opportunity that we have from the retail banking customer base. We transferred $17 billion of deposits from USPB to wealth. So you got to take that those dynamics into account. So, I hope you're taking from me. I feel confident in our ability to get to the medium-term targets we set for the business of mid-to-high teens. I feel comfortable about the growth trajectory that we've got based off the innovations we're putting through and the changes and good expense discipline and a better credit environment. So when you look at the mix of our business, you'll see us performing nicely here."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Matt O'Connor with Deutsche Bank."
},
{
"speaker": "Matt O'Connor",
"content": "Hi. I just want to follow-up on Page 9 where you break out the technology and transformation investment spend. Sorry if I missed this, but did you talk about the pace of those two levels in your '25 and '26 expense guidance? I know directionally you said it's going up, but did you get a magnitude?"
},
{
"speaker": "Mark Mason",
"content": "I did not. Obviously, for both technology and transformation those are areas that we are going to continue to invest in for all the reasons that we've mentioned. They obviously contribute to the number in '25 being slightly down from the 53.8%. But they also represent as I mentioned, what we believe is required to kind of get the work done that we need to get done. And so, those numbers will increase. There are lots of puts-and-takes, as you know through an annual expense forecast, including as you would expect we've got volume -- we've got revenue growth here that's going to come with volume growth. Volume incentive comp, there's merit increases that go with that, and then we also have a series of productivity actions that are playing through to offset those headwinds, whether it be the additional carryover from the org simplification and full year impact of that, or some of the legacy stranded coming down. And so, there are puts-and-takes, but transformation and technology specifically, we are continuing to invest in order to achieve what we need to get done here and also ensure the businesses have what they need to drive sustainable growth going forward."
},
{
"speaker": "Matt O'Connor",
"content": "I guess, how do you know that the recent increase that you are modeling internally in these areas? How do you know you are spending enough and in the right ways to address your goals in the transformation and also satisfy the regulatory requirements?"
},
{
"speaker": "Jane Fraser",
"content": "Well, if I jump in, I feel very confident indeed that we know what we need to do, we know what we need to be spending on through the annual planning process that concluded last month. It was clear that, we did need to invest some more. We increased the scope of some of the work on the data front. We brought some other work forward. We looked at what we needed to do on the technology front and some of the critical investments. This is pretty forensic. And when, we're looking at transformation, we're looking at technology. We know what our target states need to be and we know what we need to do to get there and the outcomes they need to be delivering. So we've got our arms around this, and I think you're hearing that confidence from us around know what we need to do, we know the investments we need to make, we know what the outcomes and the benefits for shareholders and the regulatory side need to be."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Saul Martinez with HSBC."
},
{
"speaker": "Saul Martinez",
"content": "Hi. Thanks for taking my questions. Mark, the NII ex-markets outlook, if I just take the fourth quarter and annualize that, it gets to something in the neighborhood of, I think, around 47.4%, 47.5%, which is above the full year ‘24 level. I am not sure exactly what up modestly means, if that's 1%, 3%, 4%. But correct me, if I'm wrong, but it seems like maybe there's a little bit of conservatism built in. But can you just -- if you can just comment on how you think how we should think about the quarterly trajectory of NII ex-market? Obviously, there's day count issued in 1Q, but maybe how do you think through like how we should expect that NII to evolve over the course of the year?"
},
{
"speaker": "Mark Mason",
"content": "Yeah. why don't I just cut to the chase on it a little bit, Saul, in the sense that up modestly, call it a couple percentage points, 2 to 3 percentage points or so, right, in terms of how I think about it. And I think I've taken I've gone through the tailwinds and headwinds. I won't take you through that again, but I think the important takeaway should be that we are going to see continued momentum across the franchise driven by loan growth in the branded card side of the business and continued deposit momentum particularly operating deposits and services. And we're going to do everything that we always do around the management of pricing and we'll get a benefit from how we've been managing our investment portfolio as those things mature. And the combination of those efforts will offset some of the more than offset some of the headwinds that you would expect in a declining rate environment and modestly, let's call it, 2% to 3%."
},
{
"speaker": "Saul Martinez",
"content": "Okay. Fair enough. And then on the expense outlook getting to below 53% in 2026, I know that's consistent with what you said in the past. But it does imply a pretty sharp reduction in '26, especially in light of continued revenue growth, It's pretty material operating leverage. Just, how much benefit do you get from a more normalized severance? In other words, how much the severance how much are we thinking about severance coming down? What sort of the impact or how to think about the legacy stranded costs coming down? Just maybe a little bit more meat on the bone in terms of how much these items will benefit '26 versus '25?"
},
{
"speaker": "Mark Mason",
"content": "Yeah. Look, a couple of things. So if you look if I as I look at our severance costs, which as I mentioned has been running high with 700. We're forecasting 600 in 2025. I think kind of normal through the cycle is probably, call it, 300 or so. And so that gives you some sense for that. I think the other thing is if you look at the other page and again there were a number of drivers or levers that we intend to pull to bring that down, but in the all other page where you look to the right, we show wind downs and what's remaining in terms of legacy franchise. And there's if you add those numbers together $1.9 billion or so of expenses and think about a subset of that being stranded. And we're going to continue to focus on how do we bring down stranded cost over the next couple of years. So those are two important factors or contributors to the decline from the slightly lower than 53.8% to the 53%. There are additional productivity saves from prior investments that we've made, but those are important factors. And then, as we look at the transformation spend that will continue to or start to pay dividends or help to bring down cost as well. So you've got really those four variables that contribute to us bringing that number down. And as Jane has mentioned, we're going to, even post '26 continue to bring or drive out more inefficiencies around the organization to fund required investments for the business growth and all with a continued focus on getting to less than 60%, as we exit 2026, less than 60% operating efficiency."
},
{
"speaker": "Operator",
"content": "Our final question will come from the line of Mike Mayo with Wells Fargo."
},
{
"speaker": "Mike Mayo",
"content": "Hi. Just first full year of having the five line of business structure. Mark, do you still have the same line of business targets that you had last year? And Jane, with all the -- it must have been a degree of hell to organize this way, get rid of your two intercompany holding companies, eliminate five layers of management, expand the span of control. You guys went through a lot last year. I'm just wondering, is the worst over in terms of that kind of reorganization internally and the culture and the sentiment and how you see that continuing? But first a concrete question about the targets please."
},
{
"speaker": "Mark Mason",
"content": "I guess I'll start first. In terms of the targets, look, we set the targets across each of the lines of business for the medium-term. We've obviously brought down the 2026 to 10% to 11%. And so, you'd imagine, there's some movement at least for the 2026 in terms of those targets. Banking will likely be a little bit lower than the mid-15% if I think about 2026, as being that medium-term target date. But over time, I expect that, the targets that I've set are the targets that we will achieve and even more, because as Jane mentioned 10% to 11%, while that's our 2026 target. It is not our longer-term target, as we think about RoTCE and the strength of these businesses in the aggregate franchise. Hopefully, it answers your question."
},
{
"speaker": "Jane Fraser",
"content": "On terms of org simplification, culture, the best is still ahead that is for sure. The org went through a lot. I'm really proud of how people responded, and I think we're really proud of how each of the lines of business are driving the business performance forward. The bank is simpler. There is tremendous transparency for me. There's much greater proximity to the businesses now, and you can see that the benefits that we're starting to realize from the strategy as we get closer and closer to the RoTCE targets and beyond for each of the businesses. So I am pleased to have '24 behind us. I'm proud of what we achieved in 2024. All the focus is on the future onwards."
},
{
"speaker": "Operator",
"content": "There are no further questions. I'll now turn the call over to Jenn Landis for closing remarks."
},
{
"speaker": "Jenn Landis",
"content": "Thank you, everyone. Please call us or e-mail us if you have any follow-up questions. Have a great afternoon. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes the Citi's fourth quarter 2024 earnings call. You may now disconnect."
}
] |
c | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to Citi's Third Quarter 2024 Earnings Call. Today's call will be hosted by Jenn Landis, Head, Citi Investor Relations. We ask that you please hold all questions until the completion of the formal remarks, at which time you'll be given instructions for the question-and-answer session. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. Ms. Landis, you may begin."
},
{
"speaker": "Jennifer Landis",
"content": "Thank you, operator. Good morning, and thank you all for joining our third quarter 2024 earnings call. I am joined today by our Chief Executive Officer, Jane Fraser; and our Chief Financial Officer, Mark Mason. I'd like to remind you that today's presentation, which is available for download on our website, citigroup.com, may contain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these statements due to a variety of factors, including those described in our earnings materials, as well as in our SEC filings. And with that, I'll turn it over to Jane."
},
{
"speaker": "Jane Fraser",
"content": "Thank you, Jenn, and a very good morning to everyone. Well, we certainly live in interesting times, and while I usually start our calls with our views on the global macro-environment, we're particularly proud of our progress this quarter and so I shall start there. Indeed, in a pivotal year, this quarter contains multiple proof points that we are moving in the right direction and that our strategy is delivering concrete results. We saw revenue growth and positive operating leverage for the firm and across all five businesses. Our businesses performed well as the rate-cutting cycle began with a double-digit increase in fee-based revenues, reflecting the growing diversity of our earnings mix. We continue to have share gains in services and banking. In wealth, we saw a sizable increase in client investments and flows. We brought expenses down, whilst continuing to invest in our transformation and businesses, and we continued to attract the top leaders in the industry and successfully combine them with our own teams in banking and wealth. So, while we are not yet where we want to be, the impact of the changes we're making is clearly evident in our momentum and our improving performance. Turning to the macro. Now while growth is a notch slower than last year, global economic performance continues to be surprisingly resilient. Whatever you want to call the US landing, the sentiment around it is more optimistic, supported by the recent positive payrolls report. And we see a healthy yet more discerning US consumer and a US corporate sector on its front foot. Manufacturing weakness is restraining a modest rebound in Europe, which continues to struggle with more structural challenges around its competitiveness as highlighted by Draghi's report. And in China, consumer sentiment and the property market remain a concern as markets await details on the expected fiscal stimulus. India, ASEAN, Japan, the Middle East, Mexico, and Brazil are all notable bright spots globally. Today, we reported net income of $3.2 billion and earnings per share of $1.51 with an RoTCE of 7%. Overall revenues grew by 3% ex-divestitures, with each of our core businesses delivering growth and positive operating leverage. While we continue to make substantial investments in our transformation, the efficiencies gained from our simplification and other efforts drove a 2% reduction in overall expenses. Turning to the five businesses. Services delivered a record quarter with revenues up by 8%. Fee growth, the best indicator of underlying momentum was significant. And this combined with loan and deposit volume growth drove this quarter's excellent performance. Treasury and Trade Solutions was up 4% year-over-year, reflecting good underlying momentum in the core drivers. And Security Services was up 24%, reflecting the benefit of new mandates and an increase in assets under custody. Both TTS and Security Services achieved over 10% wallet share in our target markets through the first half of the year. Last week, we announced that we are the first global bank to complete the integration of our cross-border services with Mastercard Move. Now this will ultimately enable near-instant secure payments to the vast Mastercard debit network, starting with 14 markets with more to come early next year. And this is another great example of our continued investment in market-leading innovations. In Markets, revenues were up slightly on the back of a better-than-expected September. Equities was up 32% with robust performance across all products. Our continued strong performance in Equities validates both our strategy and execution to grow Prime and Cash. Fixed Income, however, was down 6%. Our Rates and Currencies business didn't match last year's standout performance. It was a particularly pleasing quarter in banking. Despite the muted IPO market, investment banking fees are up 44%, that's driven by investment-grade debt issuance as our clients pulled forward activity ahead of the US election. Corporate sentiment remains positive as Boards pursue strategic transactions such as the $36 billion Mars acquisition of Kellanova, where we are the sole advisor and the lead financier. Our strategy in banking continues to gain momentum. We are steadily growing our share in key target sectors, such as healthcare and tech with a healthy pipeline ahead and a significant upside of our franchise continues to attract the top talent to Citi. During the quarter, we announced an innovative $25 billion private credit partnership with our long-time client Apollo, giving us the ability to source new transactions without using our balance sheet. This partnership positions us with another solution for debt financing for our clients and it allows us to engage in private credit with the same depths and expertise as we currently do with syndicated debt markets. We are also starting to see the positive impact of the significant changes we've implemented in our Wealth franchise with revenues up 9%. It's a notable example of the traction that I referenced earlier. As Andy and the team intensify the focus on our Investments business, we grew client investment assets by 24% and we were particularly pleased with the performance in Asia and in Citigold. I continue to be excited by the opportunities and the sheer potential of our franchise. During the quarter, we signed an agreement to exit trust administration and fiduciary services as we continue to sharpen the focus of our Wealth business. We have more to do to reach our medium-term margin and return targets, but this quarter is a good indicator that we are on the way there. US Personal Banking revenues were up 3%. We grew Branded Cards' revenues by 8% with account acquisitions, spend and payment rates, all driving higher interest-earning balances. Lower discretionary spending is impacting our retail services portfolio. However, we continue to see lower payment rates contributing to interest earning balances. In retail banking, we are growing our mortgage portfolio as the rate environment shifts, as well as growing overall loans. The US consumer dynamics remain remarkably consistent with prior quarters. Our customers are healthy, but more discerning in their spend with signs of stress isolated to the lower FICOs. We have maintained strong credit discipline and our card portfolios continue to perform very much in line with our expectations. In terms of capital, while uncertainty about the Basel III Endgame prevails, our capital position remains very robust and we ended the quarter with a CET1 ratio of 13.7%. During the quarter, we returned $2.1 billion in capital, including the repurchase of $1 billion of common shares. We will continue to repurchase stock as we evaluate the right level on a quarterly basis. As you know, our transformation is our number one priority. This quarter, we closed another longstanding consent order, which related to the effectiveness of our anti-money laundering systems. We have increased our investments in areas where we have not made sufficient progress such as data quality management. I and the management team remain steadfast and determined to get this transformation right and to get this done. We will close out this pivotal year with momentum and with determination to continue to improve performance in each business and the firm overall. We are committed to meeting our revenue and expense targets for the year, as well as our return target for the medium term. I am very proud of our senior leadership and the entire organization as we demonstrate the potential of our unique global franchise. It is a privilege to lead this firm. With that, I would like to turn it over to Mark, and then we will be delighted, as always, to take your questions."
},
{
"speaker": "Mark Mason",
"content": "Thanks, Jane, and good morning, everyone. I'm going to start with the firm-wide financial results, focusing on year-over-year comparisons for the third quarter unless I indicate otherwise. And then spend a little more time on the businesses. On Slide 5, we show financial results for the full firm. For the quarter, we reported net income of approximately $3.2 billion, EPS of $1.51, and an RoTCE of 7% on $20.3 billion of revenues. Total revenues were up 1% on a reported basis. Excluding divestiture-related impacts, revenues were up 3%, driven by growth across each of our businesses. As you can see on the bottom-left side of the page, net interest income, excluding markets was down 1% year-over-year, largely due to lower interest rates in Argentina. And non-interest revenue, excluding markets was up 9% as we continued to see strong fee momentum across services, banking, and wealth. Year-to-date revenues were up 1% on a reported basis and are up 3% excluding divestiture-related impacts. Expenses were $13.3 billion, down 2%, largely driven by savings associated with our organizational simplification and stranded cost reductions, partially offset by volume related expenses and continued investments in the transformation and other risk and control initiatives. Year-to-date, expenses are up 1%, primarily driven by the FDIC special assessment and civil money penalties. Cost of credit was $2.7 billion, largely driven by net credit losses in card, as well as ACL builds across the businesses, primarily for portfolio growth and mix. At the end of the quarter, we had over $22 billion in total reserves with a reserve-to-funded loan ratio of approximately 2.7%, and year-to-date, excluding the divestiture-related impacts, we generated positive operating leverage for the firm and reported an RoTCE of 7.2%. On Slide 6, we show the expense trend over the past five quarters. This quarter, we reported expenses of $13.3 billion, down 2% and 1% sequentially. As we've said before, we will continue to increase our investments to address data governance and data quality related to regulatory reporting and are committed to spending whatever is necessary to address these areas and the transformation more broadly. Although a lot more work remains, we have started to see benefits from our prior investments play through. We've continued to simplify our technology infrastructure, retiring over 450 applications year-to-date and now over 1,250 since our 2022 Investor Day. We've upgraded 100% of our over 2,300 ATMs in North America and Asia Pacific to next-gen software for better customer security and monitoring. And we've streamlined our cloud onboarding process, reducing time to onboard applications to the public cloud from over seven weeks to two weeks. Each of these initiatives will result in both improvement of our operating efficiency and our safety and soundness. And in terms of our full-year expenses, we continue to expect that we will be at the higher end of the guidance range of $53.5 billion to $53.8 billion, excluding the FDIC special assessment and Civil Money Penalties. And as we've said before, we, of course, will continue to look for opportunities to absorb the Civil Money Penalties. On Slide 7, we show net interest income, loans, and deposits where I'll speak to sequential variances. In the third quarter, net interest income declined 1%. Excluding markets, net interest income was up 4%, largely driven by volume growth in USPB, as well as higher deposit spreads in services and wealth. NIM declined by 8 basis points, driven by a decline in markets due to seasonally higher dividends in the second quarter. Average loans were up 1%, driven by growth in services and USPB, partially offset by modest declines in Banking and Legacy Franchise. Average deposits were roughly flat as growth in Services was largely offset by a decline in Legacy Franchise. And as you think about guidance for NII ex-markets in the fourth quarter, as short-end rates continue to come down, we expect a headwind on floating-rate assets, which will be somewhat offset by disciplined deposit pricing. Further offsetting that will be a continued benefit from securities being reinvested at higher yield. And as a reminder, we expect an ongoing NII headwind as Legacy Franchises loans and deposits continue to come down. So taking all of this into account, we expect NII ex-markets to be roughly flat sequentially in the fourth quarter and for the full year to be slightly down, better than we had previously guided. On Slide 8, we show key consumer and corporate credit metrics, which reflect our disciplined risk appetite framework. Across our cards portfolio, approximately 85% of our loans are to consumers with FICO scores of 660 or higher. Based on what we see, the US consumer continues to remain healthy and resilient. Spend and payment rates continue to normalize and underlying credit performance remains broadly in line with our expectations. NCLs increased year-over-year as card loan vintages that were originated over the last few years continue to mature at the same time. Sequentially, NCLs declined while delinquencies increased, both in line with historical third quarter seasonality. Absent this seasonality, we continue to see stabilization in early-stage delinquencies. We remain well reserved with a reserve-to-funded loan ratio of approximately 8.2% for our US card portfolio. Our corporate portfolio is largely investment-grade and corporate non-accrual loans remained low at 31 basis points. As such, we feel very comfortable with the over $22 billion of total reserves that we have in the current environment. Turning to Slide 9, we provide details on our balance sheet, capital, and liquidity, which are a reflection of our risk appetite, strategy, and business model. Our $1.3 trillion deposit base is well-diversified across regions, industries, customers, and account types. $840 billion are corporate, spanning 90 countries, and are crucial to how our clients fund their daily operations around the world. The majority of our remaining deposits, about $400 billion are well-diversified across the Private Bank, Citigold, Retail, and Wealth and Work offerings. And of our total deposits, roughly 70% are US dollar-denominated with the remainder spanning over 60 currencies. Our asset mix also reflects our strong risk appetite framework. Our $689 billion loan portfolio is well-diversified across consumer and corporate loans. In the quarter, deposit growth outpaced loan growth, resulting in higher cash balances, which contributed to available liquidity resources of approximately $960 billion. We continue to feel very good about the strength of our balance sheet and the quality of our assets and liabilities, which position us well to serve our clients and execute on our growth strategy. On Slide 10, we show the sequential CET1 walk to provide more detail on the drivers this quarter. First, we generated $3 billion of net income to common shareholders, which added 27 basis points. Second, we returned $2.1 billion in the form of common dividends and share repurchases, which drove a reduction of 18 basis points. Third, we generated 12 basis points from unrealized AFS gain. And finally, the remaining 9 basis point reduction was driven by an increase in RWA as we continue to invest in accretive growth opportunities. We ended the third quarter with a preliminary CET1 capital ratio of 13.7%, relative to our target of 13.3%. As a reminder, effective October 1st, our new CET1 capital ratio requirement is 12.1%, and we still plan on holding a 100 basis point management buffer on top of that for now. As we think about the coming quarters, there are a few things that we will continue to consider as we manage our capital levels, including client demand, as well as how the macro and Basel III Endgame evolves. We will take all of this into account as it relates to capital levels and the level of share repurchases on a quarter-by-quarter basis. Turning to the businesses on Slide 11. In Services, revenues were up 8%, reflecting continued momentum across Security Services and TTS, both of which continued to gain share through the first half of this year. Net interest income was roughly flat as the benefit of higher deposit volume was largely offset by a decline in interest rates in Argentina. On a sequential basis, net interest income was up 7%, driven by volume growth as we continue to onboard high-quality operating deposits and the benefit from higher deposit spread. Non-interest revenue increased 33% driven by a smaller impact from currency devaluation in Argentina as well as continued strength in underlying fee drivers in TTS and security services. Excluding the impact of the Argentine peso devaluation, NIR increased 11%, driven by growth in cross-border transactions, US dollar clearing volumes, and commercial card volume. Expenses increased 3%, primarily driven by investments in technology, other risk and controls, and product innovation, including the expansion of the CitiDirect commercial banking platform into additional markets. Cost of credit was $127 million, primarily driven by a build related to unremittable corporate dividends being held on behalf of clients. Average loans increased 5%, primarily driven by continued demand for export and agency finance, as well as working capital loans. Average deposits increased 4% as we continue to see growth in operating deposits. Services generated positive operating leverage and delivered net income of approximately $1.7 billion and continues to deliver a high RoTCE coming in at 26.4% for the quarter and 24.7% year-to-date. On Slide 12, we show the results for markets for the third quarter. Markets' revenues were up 1%, driven by growth in equities, partially offset by a decline in fixed income. Equities revenues increased 32%, driven by momentum in Prime with balances up approximately 22%, growth in derivatives, and higher cash volume. Fixed income revenues decreased 6%, driven by rates and currencies, which was down 10%, partially offset by spread products and other fixed income, which was up 5%. While rates and currencies declined from last year, which was the strongest third quarter in the previous 10 years, we did see good momentum in FX from increased corporate client activity. Spread products and other fixed income was higher, driven by financing securitization volumes and underwriting fees, partially offset by lower commodities on lower gas volatility. Expenses increased 1%, primarily due to higher volume-related expenses. Cost of credit was $141 million, driven by an ACL build primarily related to portfolio mix and spread product. Average loans increased 10%, largely driven by asset-backed lending and spread products as well as margin loans in equity. Average trading account assets increased 18%, largely driven by client demand for US treasuries, foreign government securities, and mortgage-backed securities. Markets generated another quarter of positive operating leverage and delivered net income of approximately $1.1 billion with an RoTCE of 7.9% for the quarter and 9.7% year-to-date. On Slide 13, we show the results for banking for the third quarter. Banking revenues were up 16%, largely driven by growth in investment banking. Investment banking revenues were up 31% and fees were up 44% with increases across debt capital markets, advisory, and equity capital markets. DCM benefited from continued strong investment-grade issuance. Advisory benefited from strong announced deal volume earlier this year. And in ECM, we saw a stronger follow-on activity, which was offset by fewer IPOs amid market volatility in August. Both year-to-date and in the quarter, we've driven wallet share gain, including in the healthcare and technology sectors where we've been investing. Corporate lending revenues, excluding mark-to-market on loan hedges increased 5%, primarily driven by a smaller impact from currency devaluation in Argentina. Expenses decreased 9%, primarily driven by benefits of headcount reductions as we continue to right-size the workforce and expense base. Cost of credit was $177 million, driven by an ACL build primarily for portfolio mix changes. Average loans decreased 1% as we maintained strict discipline around returns. Banking generated positive operating leverage for the third quarter in a row and delivered net income of $238 million with an RoTCE of 4.3% for the quarter and 7.2% year-to-date. On Slide 14, we show the results for Wealth for the third quarter. As you can see from our performance this quarter, we are making good progress against our strategy and expect that momentum to continue. Revenue was up 9% driven by a 15% increase in NIR as we grew investment fee revenues on momentum in client investment assets, which grew 24%. NII increased 6%, driven by higher deposit volumes and spreads. Expenses decreased 4%, driven by the continued benefit of headcount reductions as we right-size the workforce and expense base. Cost of credit was $33 million, largely driven by net credit losses of $27 million. End of period client balances increased 14%, driven by higher client investment assets and deposits, both in North America and internationally. Average deposits increased 4%, reflecting the transfer of relationships and the associated deposits from USPB, partially offset by a shift in deposits to higher-yielding investments on Citi's platform. Average loans decreased 1% as we continued to optimize capital usage. Wealth generated another quarter of positive operating leverage and delivered net income of $283 million with an RoTCE of 8.5% for the quarter and 6.8% year-to-date. On Slide 15, we show the results for US Personal Banking for the third quarter. US Personal Banking revenues were up 3%, driven by NII growth of 2% and lower partner payments. Branded cards revenues increased 8% with interest-earning balances growth of 8% as payment rates continued to normalize and we continue to see growth in spend volume, which were up 3%. Retail services revenues were down 1% due to a slowing growth rate in interest-earning balance. Retail banking revenues decreased 8%, driven by the transfer of relationships and the associated deposits to our wealth business. Expenses decreased 1%, driven by continuous productivity focus, partially offset by higher volume-related expenses. Cost of credit was $1.9 billion, largely driven by net credit losses and a modest build for volume growth. We continue to expect branded cards to be in the 3.5% to 4% NCL range for the full year. In Retail Services, we continue to expect to be around the high end of the 5.75% to 6.25% range for the full year, driven by both the impact of persistent inflation and high interest rates as well as lower sales activity at our partners. Average deposits decreased 23%, largely driven by the transfer of relationships and the associated deposit to our wealth business. USPB generated another quarter of positive operating leverage and delivered net income of $522 million with an RoTCE of 8.2% for the quarter and 5.2% year-to-date. As we've said before, the USPB segment creates a lot of value for the firm. We knew 2024 would be a tough year as we lap the credit costs, but we have a path to higher returns. We will continue to drive revenue growth through product innovation while improving the operating efficiency of the business and at the same time, we expect the credit environment to normalize, all of which will ultimately drive USPB to a high-teens return over the medium term. On Slide 16, we show results for All Other on a managed basis, which includes Corporate Other and Legacy Franchises and excludes divestiture-related items. Revenues decreased 18%, primarily driven by closed, exits and winddowns as well as margin compression on mortgage securities that have extended. Expenses were down 5% as the reduction from closed, exits and winddowns was partially offset by a legal reserve. And cost of credit was $289 million, largely driven by net credit losses and an ACL build in Mexico. Slide 17 shows our full-year 2024 outlook and medium-term guidance. We generated $61.6 billion of revenue year-to-date, driven by NIR ex-markets growth of 12%, and are on track to meet our $80 billion to $81 billion full year guidance. As I mentioned, we now expect NII ex-markets to be slightly down for the full year. And with year-to-date expenses of $40.4 billion, excluding the FDIC special assessment and Civil Money Penalties, we continue to expect to be on the higher end of our full year guidance range. As we take a step back, the third quarter represents another quarter of solid progress, and a set of proof points towards improving firm-wide and business performance. We remain focused on continuing to improve our performance and executing on our transformation. These priorities remain critical to strengthening our operations and becoming a more efficient, agile, and client-centric company as we continue to make progress on achieving our medium-term targets. With that, Jane and I will be happy to take your questions."
},
{
"speaker": "Operator",
"content": "At this time, we will open the floor for questions. [Operator Instructions] Our first question will come from Glenn Schorr with Evercore. Your line is now open. Please go ahead."
},
{
"speaker": "Glenn Schorr",
"content": "Hi, thanks very much. Good guidance. I appreciate it. I'm curious on the card losses in Retail Financial Services. If you could talk to like the 2024 exit rate seems like it will be higher than the full year guide at 6.25%. Maybe you could talk to the trajectory there and then the huge reserves that you have built in there and anything you could tell us about the portfolio so we can keep the expectations in the right spot. Thanks."
},
{
"speaker": "Mark Mason",
"content": "Yes, sure. Why don't I take that? Good morning, Glenn. So a couple of things. So one, I think that on Retail Services, you're seeing a couple of things kind of play out. So one, you're seeing kind of spend volumes trend down a bit. You are seeing payment rates come down as well. That obviously is fueling the average interest-earning balanced growth that we're seeing. And then you're also seeing with the spend volume come down, there's a denominator effect that plays through, which pushes up obviously the loss rates that we -- that we're seeing. That still in the quarter is in line with our guidance. But in light of what we saw earlier in the year and normal seasonality, we'd expect that number to be on the higher end of that range and likely higher in the fourth quarter. But the higher in the fourth quarter again depends on what traffic is like and what the holiday spending season looks like through the end of the year. I would say the reserve levels we have are very healthy as it relates to this portfolio. I think in the back of the deck, we show kind of the reserve-to-loan ratio at about 11.7% or so. So well reserved for the Retail Services portfolio in light of the environment that we're in. Similarly, we are seeing the stabilization from a delinquency point-of-view across both portfolios kind of play through. And so, net-net, we are, obviously, actively managing this. The retail partner activity is a critical component of it and that will drive fourth quarter activity or levels, but we do feel as if we'll end up on the higher end of the range here."
},
{
"speaker": "Glenn Schorr",
"content": "Okay. Thanks for all that, Mark. Just one quickie on your partnership with Apollo, very interesting and in line with a lot of other things we've seen. So, I'm curious on why -- how you thought about going with one specific partner versus a group? And then more importantly, are there other parts of the franchise that could benefit -- with stronger ties to private markets, I'm thinking specifically in the asset-backed world? I appreciate it. Thank you."
},
{
"speaker": "Jane Fraser",
"content": "Yes. So we're delighted to partner with Apollo because, what this does is, it's uniting our comprehensive banking reach and expertise together and it's enabling us to offer our clients more innovative and tailored financing solutions. There will be some other partners involved in this as well. Mubadala is another participant in this. And when we look at this, it's very, very beneficial for our clients. We're always looking at how we can best serve our clients, give them the most options. And this platform enhances corporate and sponsor clients' access to the private lending capital pool at real scale. I think $25 billion is a very sizable partnership here and it provides funding certainty and strategic transactions. It's exclusive for [LPOs] (ph), non-investment grade in the US. The US is obviously the bulk of the private credit market, so the BMS globally. It would be great to see that market developing in Europe. And I -- it wouldn't surprise me to see us doing more partnerships in other pieces going forward."
},
{
"speaker": "Operator",
"content": "Our next question will come from Ebrahim Poonawala with Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Good morning. I guess maybe, Mark, for you like looking at Slide 7 on NII, and maybe we can break it down into markets and ex-markets. In the ex-markets NII, $11.96 billion this quarter. Based on what you've said, the back book repricing deposit flex, is it safe to conclude that the ex-markets NII bottomed in 2Q 2024? And I noticed the securities yield actually went lower 7 bps quarter-over-quarter. So was there something one-off that impacted the yields this quarter relative to the expectations you outlined earlier?"
},
{
"speaker": "Mark Mason",
"content": "Yes. So when you look at Slide 7, you got a couple of things playing through. So your point around that the low number, the low $11.46 in the second quarter, that really is a combination relative to first quarter FX translation, some seasonally lower card balances, and lower interest payments in Argentina playing through that sequential 1Q to 2Q. The third quarter, as I mentioned earlier, is really a byproduct of volumes on the lending side and spreads, deposit spreads in services, and wealth. I think that I've already given kind of the guide for the fourth quarter where that is likely to be flat. But I think it's important to just remind everyone of the headwinds and tailwinds that play through this NII line. And from a tailwind point-of-view, I would expect to see continued volume from loans, and USPB in particular, but also services and we're talking ex-markets of services. I'd also expect to see continued benefit from the reinvestment of securities at higher yields. And then we're actively managing beta as it relates to with our clients. And if you think about kind of what we saw in the uptick of rates, we're actively managing that on the downtick as it relates to our institutional clients. I think the other point here is, let's not forget that our interest-rate sensitivity skews more towards non-US. And so a lot of what we think about and talk about tends to be how US rates move and the betas around that. We're still going to have a bit of beta catch-up outside of the US and so that's one of the headwinds there as well as the legacy franchise exits. So you've got this long-winded way of saying, I do expect flat into the fourth quarter. I'm not going to give guidance for 2025. But what I will say is to keep the growth momentum to get to our medium-term targets, that's 4% to 5% of a CAGR and that's going to be a combination of NII and NIR, but skewing NIR, and I want to point that out because the third quarter and the year-to-date numbers that you see in our performance shows very strong fee NIR growth across each of these five businesses. And I don't want to lose sight of that as you all really try to get a handle on how we get to that medium-term. We're evidencing that shift towards more fee revenue as we speak. So I'll stop there, but I think that's important and hopefully, I've answered your question around the NII forecast here."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Yes. That's helpful. And agreed on the fee momentum. Just one quick on the Wealth segment. We've seen a considerable progress year-to-date in terms of going from a zero ROE to about 8.5% RoTCE, significant operating leverage. I think I heard Jane say that momentum should continue. Is it fair to assume that RoTCE remains -- like wealth remains a positive story as we think about how Citi's ROE continues to improve from here as we get towards the targets? Any color on the wealth side would be helpful. Thank you."
},
{
"speaker": "Jane Fraser",
"content": "Yes, I agree with you. I think we're all very pleased to see the progress. On the strategy we laid out at Investor Day, the wealth target we have in the medium term is 15% to 20%. And with that, a 25% to 30% operating margin. And we're making steady progress there. I think the first piece was putting the pieces of the global wealth organization together. And now we're focused on positioning for growth and reshaping the business to deliver the returns that we all expect. A very important part of that is shifting our mix by growing investments. We had 24% growth in client investment assets this quarter. I would call that a good start to realizing the potential that we have here. And at the same time, Andy continues to right-size our expense base and drive productivity. Our adviser productivity increased over 50% in Citigold North America. So a number of different areas that are -- that he's focused on so that we can continue to grow the investment space, including some important new talent that we've been bringing in that I'm sure you've noticed."
},
{
"speaker": "Operator",
"content": "Our next question will come from Mike Mayo with Wells Fargo. Your line is now open. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. What assurance can you give that Citi can both meet its 2026 expense guide, the $51 billion to $53 billion? And I know the year-to-date run-rate implies $54 billion. So getting from that $54 billion run-rate down to the $51 billion to $53 billion by 2026 and meet its regulatory targets. In other words, assurance that Citi can both walk and chew gum at the same time. And I guess I'd highlight, as you know, on October 2nd, Senator Warren asked the OCC to impose growth restrictions because Citi is “too big to manage”. Now I would assume you don't agree with that, but still the question that a lot of people have is, what assurances can you give that an asset cap won't happen at Citigroup? Thanks."
},
{
"speaker": "Mark Mason",
"content": "Thanks, Mike. So why don't I start with your expense question and then I'm sure Jane will chime in on some of the other parts of your question? So look, we put out medium-term targets of $51 billion to $53 billion in 2026, revenue dependent, of course, and that's with the -- consistent with the target we gave of less than 60% efficiency ratio. And we've got a target this year, as you know, on the high-end of $53.8 billion. And so we've got to get from $53.8 billion down to $51 billion to $53 billion by 2026. I'm not giving guidance for 2025, but you can expect that would probably likely glide down to that number. What's driving the reduction? So we've talked before about $1.5 billion in savings, largely related to the restructuring and driving down headcount reduction associated with that. We talked about another $500 million to $1 billion related to expense reductions from eliminating stranded cost. As we continue to exit, we're out of nine of these consumer countries already. And we talk about starting to see efficiencies and benefits from the investments in the transformation and technology towards the end of 2026. And those are the three drivers that are important for us to continue to realize between now and 2026. Will there be headwinds? Yes, there will be. The transformation is a multi-year process. We're also investing in risk and controls and regulatory spend to support improving our operations. Of course, there'll be headwinds, but there will also be things that we shift away from. There'll be tailwinds associated with it. Jane mentioned some of the productivity efforts that both Andy as well as Vis are pushing on. You look across these businesses and you see positive operating leverage across the board. So that means that Andy Morton, as well as Gonzalo are too looking at their cost structures at expenses that they can take out or productivity that they might improve. And so there will be additional costs that we have to incur. We incurred additional costs this year, but there also be additional productivity savings that we've continue to tease out to ensure that we get to these targets."
},
{
"speaker": "Jane Fraser",
"content": "And Mike, let me pick up on part of the second part of the question in terms of the progress on the transformation. As you know, as Mark is talking about, the transformation reverses historic under-investment in Citi's infrastructure. It enhances our risk and control environment. And it's a strategic overhaul as we've talked about that goes well beyond the consent order to simplify and to strengthen Citi to the benefit of all of the stakeholders we have. We are already a very different Citi today. We've made enormous change over the past three years, dramatically simpler business model, significant org change. So we align our structure to that model. We now have a flatter organization with greater accountability. And as Mark talked about through the investments in our transformation, we're focused on simplifying our operational model, modernizing our infrastructure risk and controls, and all of that reduces risk as we go. We are well on the way in executing the transformation plans. We've made meaningful progress as was acknowledged publicly by one of our regulators. And it's a wide range book of work. We've made significant strides in areas such as risk management, compliance, and accountability. And that's well beyond the big bodies of work about consolidating our platforms. So, we had 1,250 retired since 2022, as Mark mentioned. Other areas of progress enhance our stress-testing capabilities. They're faster, more frequent, more precise assessments. We put in place new target operating models for wholesale credit risk, enterprise risk, price risk firmwide. A huge body of work reducing risk and high-risk processes such as payments and markets through systemic preventative controls. We've been implementing the Cin[ph] platform this is the strategic cloud solution for market risk analytics that values trades on-demand and at scale. And we've embedded risk and controls into our performance management framework and tied that to compensation for the full firm. So these are just giving you a flavor of this big body of work that we are executing and getting done with risk. I was very pleased that we closed the FRB, AML, BSA consent order, particularly given heightened risk and scrutiny in this area. That is the third consent order we've closed since 2021. And we've been very transparent on where there are areas in which our execution is delayed against our original timelines, and as is the case with our data work, we take a step back, determine what we need to change in those areas, and get back on track, and make relevant tech and people investments. So I feel very confident about the strategy we've laid out for the firm, the deliberate path we're on, the huge progress we've already made, and that we will continue making with determination and with clarity going forward."
},
{
"speaker": "Mike Mayo",
"content": "So just one follow-up when -- and you do have the amended consent order that's not new anymore. But is this a problem with your dealing with clients or is this an issue with giving the regulators the information that they need? And just again, you don't -- just to confirm, you don't have an asset cap now, is it fair to assume that you don't expect an asset cap anytime soon, or could you have an asset cap and we don't even know about that? Thanks."
},
{
"speaker": "Jane Fraser",
"content": "We don't have any problems dealing with our clients, quite the opposite. We're a source of strength for our clients in terms of the provision of their payments businesses, their trading businesses, their consumer credit businesses all across the board. So I would say quite the opposite. We are a source of tremendous strength for them and you see that in the results of this quarter on -- which were very pleasing across the board in every single one of our businesses. And we are working closely with our regulators. We incorporate their feedback as well as our own lessons learned if we fall behind in an element of the consent orders, but do understand the breadth of the consent order work as I laid out and the meaningful progress we're making across multiple areas. And when we fall behind in an area, we increase the investments needed and look at any lessons learned in the approach and address it. So I'm -- I feel very comfortable."
},
{
"speaker": "Mark Mason",
"content": "Yes. So again, we don't have -- we're not talking about issues as it relates to client information, client data or client reporting. We're not talking about information as it relates to financials. We're talking about regulatory reporting, all right, in regular reported reporting, as I've mentioned in prior calls, we're a global firm. We've got over 11,000 regulatory reports. And we're talking about ensuring that the data that we capture at trade entry is the data that's required to ultimately show up on these various regulatory reports in the way that we need it, ensuring that we've got the proper controls on that front-end. So we don't do -- we don't have to do a lot of the reconciliation and management and manual adjustments to that data in order to get it how we need it in the report and ensuring that we have standardized rules and controls around that process so that we can do it as efficiently as possible. But this is largely around ensuring that we improve those regulatory reports that we have to produce by starting with the underlying data that's required to do that."
},
{
"speaker": "Operator",
"content": "Our next question will come from Jim Mitchell with Seaport Global. Your line is now open. Please go ahead."
},
{
"speaker": "Jim Mitchell",
"content": "Hey, good morning. Mark, consensus expectations and it is just another expense question in a different way, but consensus has you not hitting your revenue growth targets and you certainly free to disagree and I think that's fine. But they also have your expenses at the high end of your $51 billion to $53 billion range in 2026. I guess, does that make sense or do you feel confident that if revenues do sort of disappoint your targets that you could come in at the -- you should or can come in at the lower end of that range to help get to your RoTCE target?"
},
{
"speaker": "Mark Mason",
"content": "Yes. So let's take it in pieces. So I think the first thing is that, I think Jane and I have been very consistent with trying to give guidance on full year performance for the past couple of years. And we've largely actually delivered on that guidance. If you look at the top-line growth since Investor Day, it's largely consistent with what we talked about in the medium term. If you looked at the expense guidance that we've given, largely consistent with that, including this year, even if I -- even as I look at the $80 billion to $81 billion revenue guidance we gave for the year and you look at the $60.6 billion that we've done year-to-date and you think about what we have to deliver in order to hit that target, that is achievable, particularly when you remember that we had a large Argentina devaluation last year. That fee momentum required in the fourth quarter is very achievable. And we believe that we will obviously hit the high end of the range for 2024. As I think about that outer year period and the guidance that we gave there, look, you all want proof points before you actually believe that we can deliver on that medium-term target. I'm pointing you to proof points. I'm hopeful that as you see those proof points through 2024, full year and each of the quarters that you will start to believe in that revenue momentum that's required in the medium term. The fee revenue is a very good indicator. What we delivered this year and this quarter is a very good indicator of the momentum we should see across these businesses in the next couple of years. I also hope that you would then see that as we deliver on the expense target that we have a path to continuing to deliver on the medium-term expense target, the drivers of which I mentioned earlier. Yes, if revenues come in short of the target that we've set for ourselves, you would naturally expect for the volume and transaction-related expenses and compensation expenses to come down in a commensurate way with that revenue decline. And you would also expect that we would look to see if there are other productivity opportunities that we can tease out in order to still deliver on that operating efficiency target that we've set for ourselves."
},
{
"speaker": "Jim Mitchell",
"content": "No, that's great color. I appreciate it. And maybe just as a follow-up on the capital question. I guess one thing that's been a bit of a headwind over the last year has been sort of growth in the DTA deductions. Do we start to see that become a tailwind again? How do we think about that accreting back into capital over the next couple of years?"
},
{
"speaker": "Mark Mason",
"content": "Yes. Look, the main driver of our DTA utilization will be driving higher income in the US. That's going to be the major driver. And as we think about -- so as you think about each of the strategies that Jane has described for our business, you will often hear the importance of winning in the US. You'll hear it as it relates to banking and the activity that we saw, the strong performance we saw this quarter in [indiscernible] world, you hear it as it relates to the wealth business and the importance of us growing investments, particularly in North America. You see it in USPB, which is largely a US-focused business. That DTA utilization is about us increasing net income or higher net income in the US and as we work to execute on our client-driven strategy, we are looking for opportunities to do that. We're incenting the business to drive that momentum. And that's what's going to give us a higher utilization on a quarter-by-quarter in the coming years."
},
{
"speaker": "Operator",
"content": "Our next question will come from Erika Najarian with UBS. Your line is now open. Please go ahead."
},
{
"speaker": "Erika Najarian",
"content": "Hi. I think we --"
},
{
"speaker": "Mark Mason",
"content": "Good morning."
},
{
"speaker": "Erika Najarian",
"content": "[Multiple Speakers] Good afternoon, guys. The first one is for you, Jane. As I speak with longer-term investors, they often offer the commentary that clearly, the path from the 7% RoTCE this quarter to the 11% to 12% is -- hopefully will be bridged and to be able to initiate a position before that progress is made they really sort of want to see more capital optimization. And this question is not really the same question I ask you about buybacks every quarter, but really maybe a progress update on Banamex. So there was chatter in the market about Banamex needed to have four quarters of separate financials before being IPOed. And I'm wondering if you could give us specific progress on how that's going. And Mark, maybe remind us on what Banamex's contribution is as we think about the unlocking that excess capital versus taking it out of the P&L?"
},
{
"speaker": "Jane Fraser",
"content": "Yes. I'd be delighted to, Erika. And I would also just before I jump into Banamex from point to a laser-focus on capital optimization. It's been a mantra for a long time in our markets business in banking and a discipline that we've driven throughout the organization. And I would say there isn't anyone at Citi that is not keenly aware of the focus around optimizing our capital. Returning to shareholders, particularly given where we're trading and making sure that we drive to returns. So if I turn to Banamex, our singular focus right now is the separation of the two banks, which we expect to complete in the fourth quarter of this year. This has been an enormous body of work because we are creating effectively [De novo] (ph]), Mexico's eighth-largest bank. We've just now got the core regulatory authorizations that we need to proceed with separation. Although there are a few other approvals pending. We are in the very final stages and are working with our clients to prepare them for this switchover and later on in Q4. Once the separation is complete, we will turn our full attention to the IPO itself and the successful execution of the IPO is the highest priority for our Head of International, Ernesto Torres Cantu to run Banamex and our incoming Banamex Executive Chairman who starts this quarter, Nacho Deschamps. We plan to be ready to IPO at the end of 2025 based on the factors that we can control. But I think as Mark and I have always said, the timing is going to be driven by market conditions to ensure we maximize the shareholder value. And we're making the necessary investments to continue growing share and I was very pleased that Banamex outpaced the average market revenue growth year-to-date, good expense discipline being maintained despite the complex separation process and the environment. So I'm pleased with where we are and I hope that gives you a bit of a flavor of what the path ahead looks like."
},
{
"speaker": "Mark Mason",
"content": "Yes. In terms of the second part of your question, a couple of things. So one, we've been seeing good growth in our Mexico consumer business. We've also been investing in it appropriately so to make sure that we protect the strength of that franchise as we prepare it for separation and ultimately for the IPO. Erika, if I understood your question right, if you turn to Page 16 of the deck in the bottom right-hand side, we show the P&L for Mexico consumer for 2022 and 2023. And so you can see the contribution from a revenue and expense point-of-view, it's about $1.5 billion in 2023. And I believe we probably -- I think it's about $4 billion or so of TCE that we have associated with this business. So that gives you some sense for the contribution, but it continues to perform quite well as we manage it through the -- through this process."
},
{
"speaker": "Erika Najarian",
"content": "Perfect. Thank you. And as a follow-up question, I'm sure it is frustrating for you to see the stock reaction in a quarter where you had PPNR strength and better expectations for net interest income in the fourth quarter. So maybe I'll frame the question this way for you, Mark. As we think about the gyrations in interest-rate expectations globally, maybe remind us sort of -- is it fair to assume that Citi is asset-sensitive internationally and neutrally positioned domestically. How should we think about late fees? I know you told us that late fees going to $8 for a part of your initial -- your initial guide for the year. And additionally, I think perhaps because capital markets was so strong across the board across all of your peers, maybe that's not why you're getting good credit for your strength this quarter. So as we look into 2025 and having NIR be that bigger contribution to your revenue CAGR, maybe walk us through what are the other sort of core fee strengths that we should look forward to other than like -- other than FIC and banking remaining strong and coming back that could bring into that path to 2026."
},
{
"speaker": "Mark Mason",
"content": "Okay. There's a lot there, but thank you. Thank you for the question. I would like to see the stock reacting much more favorably because this really has been a strong quarter for us. And in fact, as you mentioned, NII, when you look through it, we've in fact taken our NII guidance up just a tad bit as we referenced that the full year would be slightly down versus modestly down with the fourth quarter that's flat to the third quarter. And so that is an important takeaway. I mentioned the headwinds and tailwinds earlier and we shouldn't lose sight of those. We will get a lift from reinvesting the securities as those mature, we will continue to see volume growth and those are important drivers of tailwind activity for us. You rightfully mentioned our interest rate exposure analysis that we do on a quarterly basis that reflects the asset sensitivity of our business. And last quarter, it was about $1.6 billion, or so of a negative, assuming a 100 basis point decline across the curve, assuming a static balance sheet, and cross currencies. And as you look at that asset sensitivity, again, you rightfully pointed out that we skew non-US in terms of the magnitude of that decline in NII, should we see that parallel shift. And in fact, it's as much as $1.3 billion, or so of that $1.6 billion is non-US dollar related across 60 currencies. And so you'd have to see all of that move in tandem for that drag. And the US dollar drag is about $300 million, assuming a 100 basis point shift, and that's been coming down. If you look back over the quarters, we've been thoughtfully managing that down and that's down to about a $300 million number. I would expect when we print the third quarter too, it will be down a bit more. And so again, we are asset-sensitive, but it does skew outside of the US, and thank you for asking the question because I think it's important to remind our investors and analysts of that dynamic, which in many ways may be different from that of other institutions. In terms of the late fees, we did say that we were including late fees in our assumptions and our outlook that we've given. I'll state the obvious, Erika, which is that we want people to obviously paid on time and we do everything that we can to assist and ensure that they do that. With that said, we don't have a definitive timeline on late fees, nor are we overly reliant on late fees to drive revenue for our firm. And so it looks like that decisioning will likely kind of fall closer to sometime in 2025. And so there is a small adjustment in the last quarter of our revenue forecast, but it's inside of the guidance that we gave and doesn't materially change that in any way. And then the last part of your question, I think, was around NIR and the fee revenue. And as I mentioned earlier, I'm not going to give guidance for 2025, but I think your question was around where are we likely to see continued momentum as it relates to fee revenue growth. And I'd start with services, which with fees were up some 33% year-over-year. And yes, we should adjust for the Argentine peso devaluation. But even if you adjust for that, it's double-digit, 11% year-over-year non-interest revenue growth. And when you look at those drivers, they've been consistently strong, cross-border transaction value up 8%, US dollar clearing volume up 7%, commercial card spend up 8%. In the supplement, you'll see that it's mid-to-high single-digit year-to-date growth across those KPIs as well. We expect that will continue with our corporate clients and as we bring on new commercial clients as well. I'll turn you to -- if you look at Banking, we talked about already, so I won't kind of lean into that too much, but except to highlight a really strong quarter in Banking, in investment banking fees, in particular, the rebound that we've been talking about, but importantly, us capturing share in that rebound and these important partnerships that position us well as sponsors start to lean back into the market, the investments that we've been making in talent and sectors we need to strengthen, all of those things are going to play to continued fee momentum as we go into 2025. Wealth, again, really strong performance this quarter with revenues up 9%. But look at the client investment assets up 24%. The client balance is up 14%. That's driving fee momentum and it's a keen area of focus for Andy and that team that he's pulled together and it's a real opportunity for us given the $5 trillion or so of assets that our clients hold away from us and we're better positioning ourselves to capture that. And then finally, you can see kind of continued momentum on USPB. But it's across-the-board is what I'm saying, Erika, in terms of that fee momentum, and it is important. It's an important aspect as we think about getting to those medium-term targets in that 4% to 5% revenue."
},
{
"speaker": "Operator",
"content": "Our next question will come from Gerard Cassidy with RBC. Your line is now open. Please go ahead."
},
{
"speaker": "Gerard Cassidy",
"content": "Hi, Mark. Hi, Jane."
},
{
"speaker": "Mark Mason",
"content": "Good morning."
},
{
"speaker": "Gerard Cassidy",
"content": "Mark, you touched on in your prepared comments about growing the US Personal Banking RoTCE to higher levels. And you mentioned two items. One, innovative products and the normalization of credit costs. Can you elaborate on those two items that will be contributing to the driver aside from the efficiency improvement that you also touched on?"
},
{
"speaker": "Mark Mason",
"content": "Yes, sure. So I mean, so obviously, USPB is a combination of the cards businesses that we have in the retail banking business and that cards portfolio has both branded as well as retail services as part of it. And even within branded, we have proprietary cards where we frankly have been looking to how we can come up with new innovative products. So an example of product innovation is the recent refresh that we did of our Strata Premier Card, which was designed to drive acquisition and engagement with a new rewards offering. And with that acquisitions are up some 7% both quarter-over-quarter and year-over-year for branded cards. So that's an example of product innovation. Another one is we also launched Flex Pay at Costco a few quarters ago, and you can see good installment loan growth as a consequence of that, up some 15% or so. And so that type of product creation is important to acquisitions. It's important to ensuring the card stays top of wallet and important to kind of driving some of that top-line performance. And then the other thing that I mentioned, you're right, was around cost of credit and that really is the continued normalization of cost of credit. I mentioned a couple of times now the idea that multiple vintages are maturing at the same time and that's kind of -- that has to play through and us to -- for us to kind of see a more normal level of credit. And that will be important to the returns. And again, we are starting to see stabilization in both the cost of credit line, but also in delinquencies and that's a good indicator for us."
},
{
"speaker": "Gerard Cassidy",
"content": "Very good. And just following up on credit. In the Banking division, you guys mentioned cost of credit was, I think, $107 million due to a ACL build of $141 million and it was due to a mix -- a change in the mix in the portfolio. Can you share with us what that mix change was that drove this provision?"
},
{
"speaker": "Mark Mason",
"content": "Yes. There's nothing -- it's a mix of kind of different asset classes and clients that we've lent against. There's nothing material or significant in that number when you look at the non-accrual loans, that ratio is still 31 basis points. So it's a mix change of our exposures, but nothing material there."
},
{
"speaker": "Jane Fraser",
"content": "And we continue to see a very healthy corporate sector really across the world."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Vivek Juneja with J.P. Morgan. Your line is now open. Please go ahead."
},
{
"speaker": "Vivek Juneja",
"content": "Hi. Two questions to Jane and Mark. One is on expenses and the other is on your response to the asset cap question before. So first one, expenses for an easier one. You had -- earlier in the year, you had said you expect about $700 million to $1 billion of severance charges in the $53.5 billion to $53.8 billion. Did you have any in the third quarter? Expect any in the fourth? And do you expect to be done with those this year or any to continue into next year too?"
},
{
"speaker": "Mark Mason",
"content": "Yes. So that number was a combination of restructuring charges and severance charges or repositioning charges. And we break out obviously restructuring so that you can see those. And this restructuring component was largely driven by the org simplification. That will be done this year. The normal severance or repositioning charges that we take as a normal course of BAU, you'd expect that to occur in any year and it certainly will be part of 2025 and 2026 going forward. We did have some this quarter. I would expect that we will have some next quarter, but I don't see us being outsider by any stretch, the range that I gave and again the range was for the combination of both."
},
{
"speaker": "Vivek Juneja",
"content": "Okay. Thanks on that. And shifting to the asset cap question, Jane and Mark. I -- we didn't hear a clear answer on, A, do you have an asset cap? And B, if -- even if you don't, what is the effective implication or impact of what the regulators have said?"
},
{
"speaker": "Jane Fraser",
"content": "So let me be crystal clear. We do not have an asset cap and there are no additional measures other than what was announced in July in place and not expecting any. So then the implications of what we're doing as I've laid out, we've increased investments in the areas where we were behind, particularly in the data related to our regulatory processes and regulatory reporting. We're increasing investment behind it, and we continue to make progress -- material progress on the orders in place, including closing the BSA/AML order this quarter. The third order closed since 2021."
},
{
"speaker": "Vivek Juneja",
"content": "And you don't expect anything meaningful, Jane, that would impact business like there was this new story about the China sub-license that you didn't get approved by the regulator. Anything more meaningful like that might be occurring that maybe --"
},
{
"speaker": "Jane Fraser",
"content": "Absolutely, let me be crystal clear. Absolutely nothing."
},
{
"speaker": "Vivek Juneja",
"content": "Okay. Great. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Matt O'Connor with Deutsche Bank. Your line is now open. Please go ahead."
},
{
"speaker": "Matt O’Connor",
"content": "Hi. Just a couple of clarification questions. I guess first on Banamex, are you on track to sell IPO at the fourth quarter of next year or does it just get pushed out by a quarter with the legal separation taking a little bit longer?"
},
{
"speaker": "Jane Fraser",
"content": "Look, I think as I mentioned in response to Erika's question, we plan to be ready to IPO at the end of 2025 based on the factors we can control. The timing is going to get driven by how we maximize shareholder value and that will be market conditions. So that's where we stand."
},
{
"speaker": "Matt O’Connor",
"content": "Okay. Sorry. So I think that means it's by the end of 2025, you talk about 1Q 2026, but that was kind of my clarification question on that."
},
{
"speaker": "Jane Fraser",
"content": "[Multiple Speakers]"
},
{
"speaker": "Matt O’Connor",
"content": "I thought you need four quarters -- I thought you needed four quarters after you legally separated it to officially IPO it?"
},
{
"speaker": "Jane Fraser",
"content": "We believe as we stand at the moment, we will -- we would be ready to IPO at the end of 2025. It's much more a focus on what the market conditions at that point will be. And Mark and I are in very, very much focused on the shareholder value and maximizing that over -- rushing over one quarter versus another quarter."
},
{
"speaker": "Mark Mason",
"content": "And there's no hard rule on -- Sorry, go ahead."
},
{
"speaker": "Jane Fraser",
"content": "Yes. There isn't a hard rule on -- you have to have got four full quarters after you have separated."
},
{
"speaker": "Matt O’Connor",
"content": "I see. Okay. That's super helpful. We just haven't had that many of these, so that's helpful. And then just separately, I think in the prepared remarks, you guys mentioned a modest provision within services for some of the unremitted corporate dividends. And I just wanted to clarify that, and what country is that? And I guess I thought there wasn't really much liability to you guys from that. So any clarification on that? I know it was a small amount, but I think that might be helpful. Thank you."
},
{
"speaker": "Mark Mason",
"content": "Sure. It's a small amount. And if you look in the back of the deck, we have a page on Russia exposure, it's related to that."
},
{
"speaker": "Matt O’Connor",
"content": "Okay, but still feel like there's not risk to you guys from all those kind of trapped dividends. And I guess why take a small reserve if there's legally any risk to you guys?"
},
{
"speaker": "Mark Mason",
"content": "Well, it's the way we treat the exposure there. We're following kind of the guidelines on how we need to treat exposures in the country that we aren't able to distribute to clients, but we actually have to hold on their behalf. And so we have to book a reserve associated with that. And so we do that. We obviously show on the page what the exposure is in the event of a loss of control and you can kind of see how that ultimately nets out, but we're following the appropriate guidelines for what's required to for reserves of that nature."
},
{
"speaker": "Matt O’Connor",
"content": "Got it. Okay. Thank you."
},
{
"speaker": "Mark Mason",
"content": "Yes."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Ryan Kenny with Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Ryan Kenny",
"content": "Hey, thanks for taking my question. I have one for Mark. So you mentioned that services NII is a tailwind as rates declined. Can you just unpack how that happens? Is there any benefit from swap roll-off or pay floating swaps that we should be thinking about that's embedded in that statement?"
},
{
"speaker": "Mark Mason",
"content": "There are a couple of things kind of to keep in mind on the Services business. So one is, obviously this is a client business, it's not just a deposit-taking business. And so how we think about pricing to those clients becomes really important. You've got the US and non-US dynamic that's playing through, where for institutional clients, we've largely been holding to the higher betas that we saw as rates have ticked up again with the relationship in mind and we have some offsetting pressure outside of the US as those betas kind of catch-up. But I think importantly, you also heard me mentioned the reinvestment into securities at higher yields and that reinvestment or those higher yields ultimately play out through the businesses. And so that will show up as part of kind of NII as we think about services, but the other businesses as well. And so those are important components of the NII story for services. I think when you look at the end quarter performance and NII is down 5%, a big part of that is driven by the Argentina high -- lower or rates movement in the quarter versus last year. So lower rates we're earning in Argentina playing through that line, particularly in this quarter. If you adjusted for that on the NII line, it would be flat to slightly a little bit better. So that's really what it is. It's kind of management of client relationships as well as the higher earnings on reinvested securities contributing to that as well as volume from operating account growth that we expect."
},
{
"speaker": "Ryan Kenny",
"content": "Thank you."
},
{
"speaker": "Mark Mason",
"content": "Yes."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Saul Martinez with HSBC. Your line is now open. Please go ahead."
},
{
"speaker": "Saul Martinez",
"content": "Hey guys. I guess a couple of quick questions. First, just a follow-up on Banamex. Jane, as you know, there are concerns about judicial reform in Mexico and the implications for rule of law and Mexican asset prices have suffered as a result, I think the largest Mexican bank trades up something in the neighbourhood of seven times earnings. If market conditions don't improve and Mexican asset prices remain depressed and these concerns persist, then what -- I mean, do you just wait till market conditions improve, or how do you think about this process in the context of what seems to be a deteriorating macro backdrop for Mexico?"
},
{
"speaker": "Jane Fraser",
"content": "Yes. We've got to wait and see what the market conditions will be, but the North Star for me and for Mark is crystal clear, right? It is optimizing and maximizing our shareholder value. And so, if the conditions are not appropriate at that time, then we will wait until they are. In the meantime, the business is performing well. It's accretive to our returns. It's not a drag here in any shape or form. And so there is no need to rush for a suboptimal result here. But we will IPO and we will exit Banamex, but we won't do that in a reckless manner. We will be disciplined about it as you would expect us to be and as I think we're demonstrating that we are on multiple different dimensions."
},
{
"speaker": "Saul Martinez",
"content": "Great. Fair enough. And then I guess a follow-up on the US Personal Banking RoTCE improvement and the normalization of cost of credit, it seems to be a big component of that. But Mark, can you just remind us where you are in terms of the cost of credit versus what you would think a more normalized level is for Branded Cards and Retail Services? I guess how much more -- how much of a tailwind does a more normalized credit environment entail in terms of the credit costs?"
},
{
"speaker": "Mark Mason",
"content": "Again, I don't want to get into 2025 at this stage. I mean, I assure you we will give more color and commentary on that as we get into the fourth quarter earnings in January. What I will say, again, as you think about these businesses we do see continued top-line -- we do expect continued top-line momentum. We've had eight consecutive quarters of positive operating leverage in USPB of 49% this quarter. So we're managing the expense base well. We think there's more upside to the top line. We're really focused on growth across the portfolios. And I do think that cost of credit, again, if for no other reason, but the compounding effect of those vintages maturing as well as kind of inflation starting to come off, rates trickling down, that should be better for the consumer and should start to play out in both the macroeconomic scenarios that we run for CECL purposes, but also ultimately in delinquencies and NCLs. And we're starting to see that improvement in delinquencies and its stabilization already somewhat. So I don't want to get into guidance, but that's kind of how I think about the drivers or contributors to improve returns over the medium term."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Mike Mayo with Wells Fargo. Your line is now open. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi, thanks for the clarification on the asset cap question that I asked earlier. And I know you are limited on how much you can say about regulators, but just to be clear, because a lot of email traffic going back, you did say there is no asset cap and you don't expect one and you don't expect other additional actions at this time."
},
{
"speaker": "Jane Fraser",
"content": "Correct."
},
{
"speaker": "Mike Mayo",
"content": "Okay. Thank you for clarifying that. And I guess, look, I have great respect. I'm an ex-regulator, Paul Volcker was my hero. I respect regulators and nobody wants to see you cut corners to get to your $51 billion to $53 billion of expenses. But I'm just wondering -- and you have consolidated systems, apps, layers, bureaucracy and you're divesting lots of activity. So it's just even the amended consent order was surprising because you have taken so many efforts and if you should have had an amended consent order or other actions, they probably should have been in place one, five, 10, or literally 20 years ago. And so that's just confusing on the outside. So with that said, is this a matter of spending more money or about doing these tasks more intelligently? In other words, if you put more gas in the tank, the car is not going faster. So is it the amount of resources or just being more intelligent in terms of resolving some of these regulatory issues?"
},
{
"speaker": "Jane Fraser",
"content": "So, let me break it down to a couple of pieces. So I start off just to remind everyone, the consent orders are very, very broad and this -- the action that was taken was because we're behind in a narrower area, which is the data, particularly regarding our regulatory reporting where we're behind is the main area of focus. We moved swiftly to address it. We're very transparent about it from early on in the year that we were falling behind on this. And overall, I'm pleased with our progress. And as you say, Mike, I listed a number of areas of progress and trying to make it as tangible as we can, given what we can and can't say as this is supervisory. I'm pleased that our businesses continue to improve their performance while the transformation is going on. They are the two priorities we have this year. So I think effectively, yes, we can walk and chew gum at the same time. And the huge benefit of all of the simplification on the business, on the organization, the other efforts is making it easier for us to execute and be very focused. And well, maybe, Mark, I pass it over to you."
},
{
"speaker": "Mark Mason",
"content": "I think your question is helpful in the sense that you said, is it kind of a rethink on our approach or is it the need to spend more money? And one of the things that we've done, Mike, is take a step back and look at how we've been approaching data, for example. So this is -- and we are going to make -- we have made some changes to our approach. And those changes relate to how we get after resolving data issues that are identified, ensuring that there is engagement from the front-end business from the functions that are most relevant and that there's consideration for what's required on reg reporting, in order for us to get that process, streamlined and correct. And so there is -- there are aspects of this that require a change in our approach and we've been taking that change and making that change rather, and we'll make more changes accordingly as we've taken that step back. And then the other -- and there are aspects of it that require at a minimum review of what is causing either the delay or us not moving at the pace that we'd like to or that we'd like to move or that our regulators would like. And that is in fact what the resource review plan was that was in the amended consent order. It was basically a statement saying that you need to ensure that you have sufficient resources and that they're allocated towards achieving the timely and sustainable compliance. And so part of our process is in fact that taking a regular review of what is on track in the way of our milestones and deliverables, where we see things that are being delayed or going red, what is the underlying root cause for why? Is it a resource issue where we need to put more dollars and people or technology to it? Is it a process issue where we need to reconsider our approach? And on the other side of that root cause, taking action to fix it. And so your question is spot-on. The answer is that in many instances, it will be a little bit of both. But importantly, our processes include that type of analysis and assessment so that we can get after the execution on this in an effective way. I hope that helps."
},
{
"speaker": "Jane Fraser",
"content": "And all of this drives productivity and other benefits for our shareholders as well as making sure that we're strengthening Citi from the regulatory perspective."
},
{
"speaker": "Mike Mayo",
"content": "And then my last follow-up, you know, to the extent that you see a disconnect between your performance and the stock price, that would seem to create more of an opportunity to buy the stock at $64 when tangible book value is $90. And so I hope that I've used this analogy before, but hopefully, you're selling the chairs and the desks and the silverware and the executive dining room to go ahead and buyback stock, whatever you can."
},
{
"speaker": "Jane Fraser",
"content": "Yes. It's clearly given where we are trading, it is -- we're very focused around the opportunities to buyback stock and mindful of the importance of it. And equally, yes, we are proud of the performance of the franchise this quarter. It was a very strong quarter and an important set of proof points for our investors that we are on a deliberate path. We're making the progress that we need to and actually pretty excited about the path ahead of us and the potential that we see."
},
{
"speaker": "Operator",
"content": "There are no further questions. I'll now turn the call over to Jenn Landis for closing remarks."
},
{
"speaker": "Jennifer Landis",
"content": "Thank you, everyone, for joining the call. Please follow up with IR if you have any additional questions. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes Citi's third quarter 2024 earnings call. You may now disconnect."
}
] |
c | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to Citi's Second Quarter 2024 Earnings Call. Today's call will be hosted by Jenn Landis, Head of Citi Investor Relations. We ask that you please hold all questions until the completion of the formal remarks, at which time you'll be given instructions for the question-and-answer session. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. Ms. Landis, you may begin."
},
{
"speaker": "Jenn Landis",
"content": "Thank you, operator. Good morning, and thank you all for joining our second quarter 2024 earnings call. I am joined today by our Chief Executive Officer, Jane Fraser; and our Chief Financial Officer, Mark Mason. I'd like to remind you that today's presentation, which is available for download on our website, citigroup.com, may contain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these statements due to a variety of factors, including those described in our earnings materials as well as in our SEC filings. And with that, I'll turn it over to Jane."
},
{
"speaker": "Jane Fraser",
"content": "Thank you, Jenn, and good morning to everyone. Before I discuss the results of the quarter, let me first address the regulatory actions by the Federal Reserve and the Office of the Controller of the Currency, which were announced on Wednesday. These actions pertain to the consent orders we entered into with both agencies in 2020. And those orders covered four primary areas: risk management, data governance, controls, and compliance. Addressing these areas is the primary goal of our transformation, our number one priority. It is a multi-year effort to modernize our infrastructure, unify disparate tech platforms, and automate processes and controls. This week's actions focused primarily on data quality management. We've been public this year about the fact that we were behind in this particular area and that we had increased our investment as a result. The regulatory actions consisted of two civil money penalties and under the amended consent order with the OCC, a new process designed to ensure we're allocating sufficient resources to meet our remediation milestones and that is called the Resource Review Plan. We are currently developing a plan for submission to the OCC. Now by way of background, while the Federal Reserve is the primary regulator for Citigroup, our bank holding company, the OCC is a primary regulator for Citibank, N.A., we call it CBNA, which is our largest banking vehicle with approximately 70% of our assets. The amended consent order with the OCC allows CBNA to continue paying to Citigroup at a minimum the dividends necessary for debt service, preferred dividends and other non-discretionary obligations. While we're developing and seeking OCC consent for our Resource Review Plan, dividend amounts above that would require the OCC's non-objection. Now these dividends are intercompany payments that are made from CBNA ultimately to the parent Citigroup. They should not be confused with the common dividends Citigroup pays to its shareholders. Indeed, there is no restriction on Citigroup's ability to pay common dividends to shareholders, nor is there a restriction to buying back shares. And let me be very clear, even with the investments needed for our transformation, Citigroup has more than sufficient resources to also invest in our businesses and make the planned return of capital to our shareholders. We will increase our dividend from $0.53 to $0.56 a share as we announced in late June and we will resume modest buybacks this quarter. While these actions were not entirely unexpected to us, it is no doubt disappointing for our investors and for our people. We completely understand that. At the same time, we're confident in our ability to get these specific areas where they need to be, as we have been able to do in other areas of the transformation. And we are pleased that it was acknowledged on Wednesday that we have made meaningful progress in executing our transformation and simplifying our firm. A multi-year undertaking such as this was never going to be linear, but I can assure you, the investments we have been making are starting to come together to reduce risk, improve controls and deliver very tangible outcomes. The tech investments we have made are making a difference. We have reduced the time it takes to book loans, automated controls for our traders to reduce errors, move risk analytics to a cloud-based infrastructure, and increase the resiliency of our platforms to reduce downtime. The changes to our organization and our culture are making a difference. We have eliminated managerial constructs and layers, whilst empowering our leaders. We introduced new tools to better manage human capital needs. Our focus on culture has increased accountability and attracted great new talent such as Vis Raghavan, Tim Ryan, and Andy Sieg. You have my and the entire management team's commitment that we will address any area of the consent order where we are behind by putting the necessary resources and focus behind it. We will get this work where it needs to be as we have with the execution of our strategy and the simplification of our organization. Now, turning to what was another good quarter, our results show the relentless focus we have in executing our strategy as we continue to drive towards our medium-term return target. We reported net income of $3.2 billion with an earnings per share of $1.52 and an RoTCE of 7.2%. Revenues were up 4% overall as well as up in each of our five core businesses, where all but one had positive operating leverage. Expenses were down 2% year-over-year. The steps we're taking to simplify our organization, right-size businesses such as Markets and Wealth, and reduce stranded costs are beginning to take hold even as we increase investment in our transformation. Over the medium-term, we expect these simplification and stranded cost actions to drive $2 billion to $2.5 billion in annual run rate saves. Services grew 3%, driven by solid fee growth, which we have prioritized. TTS saw increased activity in cross-border payments and in commercial cards. Security services was up 10% with new client onboarding, deepening with existing clients and market valuations, helping increase our assets under custody by a preliminary 9%. At our recent Services Investor Day, we very much enjoyed the opportunity to talk to you in-depth about how we're going to continue to grow this high-returning business. And we're very pleased that people are starting to recognize why we describe it as our crown jewel. Overall, Markets had a strong finish to the quarter, leading to better performance than we'd anticipated. Fixed income was slightly down year-on-year due to lower FX and rates, but we had good issuance and loan growth in financing and securitization, an area which generates attractive returns. Equities was up 37%, driven by strong performance in derivatives, which includes a gain on the Visa B exchange offer. Banking was up 38%, as the wallet rebound gained some momentum and we again grew share. Our clients continued to access debt capital markets with investment-grade issuance near-record levels. Equity issuance increased, particularly in convertibles, as companies wait for a fuller opening of the IPO window. Investment banking fees were up 63% versus the prior year, and we've seen some healthy volumes associated with announced deals year-to-date, particularly in natural resources and technology. Combined with the strong pipeline, advisory activity looks promising as we think about the rest of the year [Technical Difficulty]. Wealth is starting to improve. Growth in client investment assets drove stronger investment revenue, especially in Citigold, and was up a preliminary 15%. Our focus on rationalizing the expense base is also starting to pay off with expenses down 4%. Andy and his team continue to attract top talent from the industry, as they focus on our investments business and on enhancing the client experience. US Personal Banking saw revenue growth of 6% with all three businesses again contributing to the top-line. There was good revolving balance and loan growth in both branded cards and retail services, and we continue to see differentiation in the credit segment with the lower-income customers seeing pressure. Retail banking benefited from higher mortgage loans and improved deposit spreads, while delivering strong referrals to Wealth. Overall, while we saw operating margin expansion, our poor returns were pressured by the combination of credit seasonality and the normalization of certain vintages. We certainly expect USPB's returns to improve from here. The recent stress tests again showcased the strength of our balance sheet. Our CET1 ratio now stands at 13.6% and we expect our regulatory capital requirement to decrease to 12.1% as of October 1, given the reduction of our stress capital buffer. Our tangible book value per share grew to $87.53. During the quarter, we returned $1 billion in capital to our common shareholders and we are increasing our dividend by 6%. We expect to buy back $1 billion in common shares this quarter, and we will continue to assess the level of buybacks on a quarterly basis, particularly given the uncertainty around the Basel III endgame. Looking at the macro environment as we enter the second half of the year, US is still the world's most structurally sound economy. After a break in progress, inflation now appears back on a downward trajectory. Services spending has remained on an upward trend, although there are clear signs of a softening labor market and the tightening of the consumer budget. And, of course, you might have heard there is an election in November. In Europe, while rate cuts have begun, the region's lack of competitiveness continues to be a drag on growth. In Asia, China is growing moderately, albeit with government stimulus, and their pivot to high-tech manufacturing is being challenged by tariffs on EVs and semiconductors. Despite this uncertainty, as you saw at our Services Investor Day when we went through our performance over the last two years, our business model can produce good results in a wide variety of macro environments and there is plenty of upside for us across our five businesses. We have made an incredible amount of progress in simplification, both strategically and organizationally. We've completed most of the exits of our international consumer markets. We streamlined our organization to catalyze agility and faster decision-making. We are modernizing our infrastructure to improve our client service, and we are automating processes to strengthen controls. We are on a deliberate path. We will continue to execute our transformation and our strategy so we can meet our medium-term targets and then continue to further improve our returns over time. With that, let me turn it over to Mark, and then we will be delighted, as always, to take your questions."
},
{
"speaker": "Mark Mason",
"content": "Thanks, Jane, and good morning, everyone. I'm going to start with the firm-wide financial results, focusing on year-over-year comparisons for the second quarter, unless I indicate otherwise, and then spend a little more time on the business. On Slide 6, we show financial results for the full firm. For the quarter, we reported net income of approximately $3.2 billion, EPS of $1.52 and RoTCE of 7.2% on $20.1 billion of revenue. Total revenues were up 4%, driven by growth across all businesses as well as an approximate $400 million gain related to the Visa B exchange offer. A significant portion of this gain is reflected in equity markets with the remainder reflected in all other. Expenses were $13.4 billion, down 2% and 6% on a sequential basis. The combination of revenue growth and expense decline drove positive operating leverage for the firm and the majority of our businesses. Cost of credit was $2.5 billion, primarily driven by higher card net credit losses, which were partially offset by ACL releases and all businesses except USPB, where we built for loan growth. At the end of the quarter, we had nearly $22 billion of total reserves with a reserve-to-funded loan ratio of approximately 2.7%. On Slide 7, we show the expense trend over the past five quarters. This quarter, we reported expenses of $13.4 billion, down 2% and 6% sequentially, which includes the $136 million civil money penalties imposed by the Fed and OCC earlier this week. The decrease in expenses was primarily driven by savings associated with our organizational simplification, stranded cost reductions, and lower repositioning costs, partially offset by continued investment in transformation and the Fed and the OCC penalty. As we said over the past few months, we will continue to invest in the transformation and technology to modernize our operations and risk and control infrastructure. We expect these investments to offset some of our sales and headcount reduction going forward. However, based on what we know today, we will likely be at the higher end of the expense guidance range, excluding the FDIC special assessment and the civil money penalties. With that said, we will, of course, continue to look for opportunities to absorb the civil money penalties. Before going into the balance sheet and the business results for the quarter, I'd like to also give more color on the transformation and address what the Fed and OCC announced Wednesday. We've made good progress on our transformation in certain areas over the last few years, and I want to highlight some of those areas before discussing the announcement. First, wholesale credit and loan operations, where we implemented a consistent end-to-end operating model and consolidated multiple systems with enhanced technology, this has not only reduced risk, but enhanced operating efficiency and the client experience. We've also made improvements in risk and compliance as we enhanced our risk assessment and technology capabilities to increase automation for monitoring. And in data, while there's a lot more to do, we stood up a data governance process and streamlined our data architecture to ultimately facilitate straight-through processing. Overall, we've improved risk management and consolidated and upgraded systems and platforms to improve our resiliency. These efforts represent meaningful examples of how we're making progress against our transformation milestones. That said, we have fallen short in data quality management, particularly related to regulatory reporting, which we've acknowledged publicly since the beginning of the year. As such, we've begun to put additional investments and resources in place to not only address data quality management related to regulatory reporting and data governance, but also stress-testing capabilities, including DFAST and Resolution and Recovery. We also reprioritized our efforts to ensure we're focused on data that impact these reports first. We take this feedback from our regulators very seriously and we're committed to allocating all the resources necessary to meet their expectations. Now, turning back to the quarterly results. On Slide 9, we show net interest income, deposits, and loans, where I'll speak to sequential variances. In the second quarter, net interest income was roughly flat. Excluding Markets, net interest income was down 3%, largely driven by the impact of foreign exchange translation, seasonally lower revolving card balances, and lower interest rates in Argentina, partially offset by higher deposit spreads in Wealth. Average loans were roughly flat as growth in cards and Mexico consumer was largely offset by slight declines across businesses. And average deposits decreased by 1%, largely driven by seasonal outflows and transfers to investments in Wealth as well as non-operational outflows in TTS. On Slide 10, we show key consumer and corporate credit metrics, which reflect our disciplined risk appetite framework. Across our card portfolios, approximately 86% of our card loans are to consumers with FICO scores of 660 or higher. And while we continue to see an overall resilient US consumer, we also continue to see a divergence in performance and behavior across FICO and income bands. When we look across our consumer clients, only the highest income quartile has more savings than they did at the beginning of 2019, and it is the over 740 FICO score customers that are driving the spend growth and maintaining high payment rates. Lower FICO bands customers are seeing sharper drops in payment rates and borrowing more as they are more acutely impacted by high inflation and interest rates. That said, as we will discuss later, we're seeing signs of stabilization in delinquency performance across our cards portfolio. And we've taken this all into account in our reserving and we remain well reserved with a reserve to funded loan ratio of 8.1% for our total card portfolio. Our corporate portfolio is largely investment-grade at approximately 82% as of the second quarter, and we saw a nearly $500 million sequential decrease in corporate non-accrual loans, largely driven by upgrades and repayments. Additionally, this quarter, we saw an improvement in our macro assumptions driven by HPI, oil prices, and equity market valuations. And our credit loss reserves continues to incorporate a scenario weighted-average unemployment rate of nearly 5% and a downside unemployment rate of nearly 7%. As such, we feel very comfortable with the nearly $22 billion of reserves that we have in the current environment. Turning to Slide 11, I'd like to take a moment to highlight the strength of our balance sheet, capital, and liquidity. It is this strength that allows us to support clients through periods of uncertainty and volatility. Our balance sheet is a reflection of our risk appetite, strategy, and diversified business model. Our $1.3 trillion deposit base is well-diversified across regions, industries, customers, and account types. The majority of our deposits are corporate at $807 billion and span 90 countries. And as you heard at the Services Investor Day, most of these deposits are held in operating accounts that are crucial to how our clients fund their daily operations around the world, making them operational in nature and therefore very stable. The majority of our remaining deposits, about $404 billion are well-diversified across the Private Bank, Citigold, Retail, and Wealth at Work offering, as well as across regions and products. Of our total deposits, 68% are US dollar-denominated with the remainder spanning over 60 currency. Our asset mix also reflects our strong risk appetite framework. Our $688 billion loan portfolio is well-diversified across consumer and corporate loans, and about one-third of our balance sheet is held in cash and high-quality short-duration investment securities that contribute to our approximately $900 billion of available liquidity resources. We continue to feel very good about the strength of our balance sheet and the quality of our assets and liabilities, which position us to be a source of strength for the industry and importantly for our clients. On Slide 12, we show a sequential walk to provide more detail on the drivers of our CET1 ratio this quarter. We ended the quarter with a preliminary 13.6% CET1 capital ratio, approximately 130 basis points or approximately $15 billion above our current regulatory capital requirement of 12.3%. We expect our regulatory capital requirement to decrease to 12.1% as of October 1, which incorporates the reduction in our stress capital buffer from 4.3% to the indicative SCB of 4.1% we announced a couple of weeks ago. We were pleased to see the improvement in our DFAST results and the corresponding reduction in our SCB. That said, even with the reduction, our capital requirement does not yet fully reflect our simplification efforts, the benefits of our transformation or the full execution of our strategy, all of which we expect to reduce our capital requirements over time. And as a reminder, we announced an increase to our common dividend from $0.53 per share to $0.56 per share following the SCB result. And as Jane mentioned earlier, we plan on doing $1 billion of buybacks this quarter. So now turning to Slide 13. Before I get into the businesses, as a reminder, in the fourth quarter of last year, we implemented a revenue-sharing arrangement within Banking and between Banking, Services and Markets to reflect the benefit the businesses get from our relationship-based lending. The impact of revenue sharing is included in the all other line for each business in our financial supplement. In Services, revenues were up 3% this quarter, reflecting continued underlying momentum across both TTS and security services. Net interest income was down 1%, largely driven by lower earnings on our net investment in Argentina, partially offset by the benefit of higher US and non-US interest rates relative to the prior-year period. Non-interest revenue increased to 11%, driven by continued strength across underlying fee drivers as well as a smaller impact from currency devaluation in Argentina. The underlying growth in both businesses is a result of our continued investment in product innovation, client experience, and platform modernization that we highlighted during our Services Investor Day last month. Expenses increased 9%, largely driven by an Argentina-related transaction tax expense, a legal settlement expense, and continued investments in product innovation and technology. Cost of credit was a benefit of $27 million, driven by an ACL release in the quarter. Average loans were up 3%, primarily driven by continued demand for export and agency finance, particularly in Asia, as well as working capital loans to corporate in commercial clients in Latin America and Asia. Average deposits were down 1%, driven by non-operating deposit outflows. At the same time, we continue to see good operating deposit inflows. Net income was approximately $1.5 billion, and Services continues to deliver a high RoTCE coming in at 23.8% for the quarter. On Slide 14, we show the results for Markets for the second quarter. Market revenues were up 6%. Fixed income revenues decreased 3%, driven by rates and currencies, which were down 11% on the back of lower volatility and tighter spreads. This was partially offset by strength in spread products and other fixed income, which was up 20%, primarily driven by continued loan growth and higher securitization in underwriting fees. In addition to a benefit from the Visa B exchange offer, we continue to see good underlying momentum in equity, primarily driven by equity derivatives, and we continue to make progress in prime with balances up approximately 18%. Expenses decreased 1%, driven by productivity savings, partially offset by higher volume-related expenses. Cost of credit was a benefit of $11 million as an ACL release more than offset net credit loss. Average loans increased to 11%, largely driven by asset-backed lending and spread products. Average trading assets increased 12%, largely driven by client demand for treasuries and mortgage-backed securities. Markets generated positive operating leverage, and delivered net income of approximately $1.4 billion, with an RoTCE of 10.7% for the quarter. On Slide 15, we show the results for Banking for the second quarter. Banking revenues increased 38%, driven by growth in investment banking and corporate lending. Investment banking revenues increased 60%, driven by strength across capital markets and advisory, given favorable market conditions. DCM continued to benefit from strong issuance activities, mainly in investment grade as issuers continued to derisk funding plans in advance of what could be a more volatile second half in the context of a number of important global elections as well as the macro environment. In ECM, excluding China A shares, we're seeing a pickup in IPO activity, led by the US as well as continued convertible issuance as issuers take advantage of strong equity market performance and expectations for rates to be higher for longer. And in advisory, we're seeing revenues from the relatively low announced activity in 2023 coming to fruition as those transactions close. Both year-to-date and in the quarter, we gained share across DCM, ECM, and advisory, particularly in technology, where we've been investing. Corporate lending revenues excluding mark-to-market on loan hedges, increased 7%, largely driven by higher revenue share. We generated positive operating leverage again this quarter as expenses decreased 10%, primarily driven by actions taken to right-size the expense base. Cost of credit was a benefit of $32 million, driven by an ACL release, reflecting an improvement in the macroeconomic outlook, partially offset by net credit loss. Average loans decreased 4% as we maintain strict discipline around returns combined with lower overall demand for credit. Net income was $406 million, and RoTCE was 7.5% for the quarter. On Slide 16, we show the results for Wealth for the second quarter. Wealth revenues increased 2%, driven by a 13% increase in NIR from higher investment fee revenues, partially offset by a 4% decrease in NII from higher mortgage funding costs. We continue to see good momentum in non-interest revenue as we benefited from double-digit client investment asset growth, both in North America and internationally, driven by net new client investment assets as well as market valuation. Expenses were down 4%, driven by the initial benefit of expense reductions as we right-sized the workforce and expense base. Cost of credit was a benefit of $9 million as an ACL release more than offset net credit loss. Preliminary end-of-period client balances increased 9%, driven by higher client investment assets as well as higher deposits. Average loans were flat as we continue to optimize capital usage. Average deposits increased 2%, largely reflecting the transfer of relationships and associated deposits from USPB, partially offset by a shift in deposits to higher-yielding investments on Citi's platform. Client investment assets were up 15%, driven by net new investment asset flows and the benefit of higher market valuation. Wealth generated positive operating leverage this quarter, and delivered net income of $210 million, with an RoTCE of 6.4% for the quarter. On Slide 17, we show the results for US Personal Banking for the second quarter. US Personal Banking revenues increased 6%, driven by NII growth of 5% and lower partner payments. Branded cards revenues increased 8%, driven by interest-earning balance growth of 9% as payment rates continue to moderate and we continue to see growth in spend volumes up 3%, primarily driven by customers with FICO scores of 740 or higher. Retail services revenues increased 6%, primarily driven by lower payments from Citi to our partners due to higher net credit losses and interest-earning balances grew 8%. Retail banking revenues increased 3%, driven by higher deposit spreads as well as mortgage and installment loan growth. USPB also generated positive operating leverage this quarter, with expenses down 2%, driven by lower technology and compensation costs, partially offset by higher volume-related expenses. Cost of credit increased to $2.3 billion, largely driven by higher NCLs of $1.9 billion and an ACL build of approximately $400 million, reflecting volume growth in the quarter. But let me remind you of the three things driving our NCLs this quarter. First, card loan vintages that were originated over the last few years are all maturing at the same time. These vintages were delayed in their maturation due to the unprecedented levels of government stimulus during the pandemic. Second, we continue to see seasonally higher NCLs in the second quarter. Third, certain pockets of customers continue to be impacted by persistent inflation and higher interest rates resulting in higher losses. However, across both portfolios, we are seeing signs of stabilization in delinquency performance, but we will continue to watch the impact of persistent inflation and high interest rates as the year progresses. Despite these factors, we still expect branded cards to be in the 3.5% to 4% NCL range for the full year, and retail services to be at the high end of the range of 5.75% to 6.25%. Average deposits decreased 18% as the transfer of relationships and the associated deposits to our Wealth business more than offset the underlying growth. Net income was $121 million, and RoTCE for the quarter was 1.9%. As we said before, we will continue to take actions to manage through the regulatory headwind, lap the credit cycle, and grow revenue while improving the overall operating efficiency of the business to ultimately get to a high-teens return over the medium-term. On Slide 18, we show results for all other on a managed basis, which includes corporate/other and legacy franchises, and excludes divestiture-related items. Revenues decreased 22%, primarily driven by the closed exit and winddowns and higher funding costs, partially offset by growth in Mexico as well as the impact from the Visa B exchange offer. And expenses decreased 7%, primarily driven by closed exit and winddowns. Slide 19 shows our full year 2024 outlook and medium-term guidance, both of which remain unchanged. We continue to remain laser-focused on executing on our transformation and enhancing the business' performance. And while we recognize there's a lot more to do on transformation, we are pleased with the progress that we're making towards our 2024 and medium-term targets and remain committed to these targets. With that, Jane and I will be happy to take your questions."
},
{
"speaker": "Operator",
"content": "At this time, we will open the floor for questions. [Operator Instructions] Our first question will come from Mike Mayo with Wells Fargo. Your line is now open. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. Could you elaborate more on the amended consent order? Jane, you said it was disappointing to have gotten that this week. It's almost four years into the consent order. And a little bit why it hasn't been resolved? And what's on the -- that's the loss column, and maybe a little bit more on the win column too. I mean you have, what, 12,000 people thrown at the problem, billions of dollars. Is it not enough people? Not enough money? Is it -- do you need to look at it in a different way? Are you not talking the same language? I mean, you have John Dugan as your Lead Independent Director, exit of the OCC, and it seems like you got your report card, I guess you passed overall, they went out of the way to say some nice things, but it looks like you got failing grades and data and regulatory management. So, your confidence is going to be resolved, but it's already been four years and it hasn't been resolved. So, what is it going to take from here? And how can you resolve the regulatory concerns while continuing or serving shareholders better? And then, in the win column, since it's so nebulous this back-office, what are you achieving? You mentioned some items, but you could put more meat on those bones? Thanks."
},
{
"speaker": "Jane Fraser",
"content": "Yes. Thank you, Mike. That's a few different parts of that. So, let's start by just taking a step back. Our transformation is addressing decades of underinvestment in large parts of Citi's infrastructure and in our risk and control environment. And when you unpack that, those areas where we had an absence of enforced enterprise-wide standards and governance, we've had a siloed organization that's prevented scale, a culture where a lot of groups are allowed to solve problems -- the same problem in different ways, fragmented tech platforms, manual processes and controls and a weak first-line of defense, too few subject matter experts. So, this is a massive body of work that goes well beyond the consent order. And this is not old Citi putting in band-aid. This is Citi tackling the root issues head-on. It's a multi-year undertaking as we've talked about and you saw the statement by one of our regulators this week, we have made meaningful progress on our transformation -- excuse me, and on our simplification. Mark, do you want to..."
},
{
"speaker": "Mark Mason",
"content": "Yeah. And so, what -- as Jane says, the progress that we -- that we've made, it spans multiple parts of the consent order and transformation work. Remember, that consent order and transformation work includes risk, it includes controls, it includes compliance, it includes data and data-related to the regulatory reporting. And we've got evidence and proof points of progress against all of those things."
},
{
"speaker": "Jane Fraser",
"content": "Thank you, Mark."
},
{
"speaker": "Mark Mason",
"content": "Yes."
},
{
"speaker": "Jane Fraser",
"content": "So, transforming -- to answer your question about how do we fix it and serve our investors at the same time, transforming Citi will drive benefits for our shareholders, our clients, and our regulators. This is not mutually exclusive. At the beginning of the year, we honed in on two priorities, the transformation and improving our business performance. And we're able to do so because we've largely cleared the decks. We have a clear focused strategy. We've executed the divestitures. We've got a much simpler organization, so we can focus on these two priorities and we are able to do both. You can see that in our results again this quarter, multiple solid proof points on the execution of the strategy and we know what we need to do on both fronts. We have plans in place on the transformation and on the strategy and we're executing against them. We have been and we will be transparent when we have issues and how we're addressing them."
},
{
"speaker": "Mark Mason",
"content": "Yeah. And just to add a couple of data points to that, Mike, you've heard us mention some of these before, but we've retired platforms. We've reduced the number of data centers. Platforms are down some 300. We've moved from 39 corporate loan platforms down to south of 20. We've got 20 cash equities execution platforms down to one. We've reduced the six reporting ledgers down to one, 11 sanctioned platforms down to one. So, we've been making considerable progress over the past couple of years. With that said, there's a lot more work to be done around the data regulatory reporting work. If you think about Citi, we've got 11,000 global total reg reports, right? So, we've got to make sure that the data that's going into those reports is the quality of the data that we want it to be, but more importantly, that we're doing it efficiently that it doesn't take thousands of people to reconcile that information. And so, this is an end-to-end process in the way we're approaching it. One example is the 2052a liquidity report that we have. It has 750,000 lines of data, and that data is -- it's important again that we're efficiently collecting it from multiple systems with standards and governance that ensures that it's of the quality that we want it to be without again having to have manual activity supporting it."
},
{
"speaker": "Operator",
"content": "The next question comes from Glenn Schorr with Evercore. Your line is now open. Please go ahead."
},
{
"speaker": "Glenn Schorr",
"content": "Hi, thank you. So, Mark, I heard your comments on credit this year -- I'm talking US Personal Banking. I heard your comments for credit for the rest of this year and I think in a position that you're very conservative reserves. But right now, you put up a 3% margin, credit costs are almost half of what revenues are in the space. I guess, my question is, as we roll forward, in a slowing economy with likely a little bit lower some rate cuts, how does the P&L evolve? How does it improve from here? Because can we be expecting credit cost to come in a slowing economy? I'm just trying to figure out the path forward because it could be impactful that USPB obviously marches to where you need it to be."
},
{
"speaker": "Mark Mason",
"content": "Yeah. Look, like I said, we do think that there is certainly upside to USPB. We're looking for that upside in the medium-term targets that we've set for ourselves. You got to remember that when you look at the quarter and you look at the half, frankly that we're still in a period where we're seeing the normalization of the cost of credit. And as I mentioned in the prepared remarks, you have kind of a compounding [Technical Difficulty] now maturing at the same time that's playing through the P&L, that's not just true for us, that's true for others as well. And so, we'd expect and we are -- we do believe we're seeing some signs of a cresting when you look at delinquencies now. And so, we would expect that those losses start to normalize and loss rates start to come down as we go towards the medium-term. At the same time, we're investing in the business and we're looking to see continued growth in volume and on the top-line. And the combination of those things as we drive towards the medium-term will help us to deliver both the top-line growth and certainly improve returns from where we sit today and in-line with what we've guided to. So, it's a combination of top-line performance from volume, and obviously, the environment plays into that, but we feel like we've got a reasonable assumption around top-line growth there, cost of credit normalizing, continued discipline on the expense line, allowing for us to get improved returns across that USPB business."
},
{
"speaker": "Glenn Schorr",
"content": "Okay. I appreciate all of that. And one quickie on DCM. You had amazingly good performance. There's been plenty of conversation about pull-forward this year on just refi driving like three quarters of the activity. Could you just help us think through the second half, when thinking about DCM and just to make sure that we don't like start modeling this into perpetuity?"
},
{
"speaker": "Jane Fraser",
"content": "Look, I think when we think about the back half of '24, we're going to see a different mix of activity in Banking. We do still expect demand to be quite strong across our capital market products because you've got a wall of maturing debt securities coming up in the second half that carry on for a couple of years. But we did see some clients accelerating issuances into the first half, getting ahead of potential market volatility. So, if you put it all together, I think we expect the rate environment and the financing markets to continue to be accommodative and as well as to a continued deal-making with M&A being a bit larger in the overall mix, although some of the regulatory elements have put a damper on part of that."
},
{
"speaker": "Mark Mason",
"content": "Yeah. The only thing I'd add to that is, look, the wallet for the year is obviously going to depend on a couple of things. So, one, the return of a more normalized IPO market; two, the direction of volatility of interest rates; the ongoing global conflicts that we're all kind of seeing and witnessing; and then finally, as Jane mentioned in her remarks, the elections and what those outcomes look like, not just in the US but abroad. And so, there are a number of factors there that will play to the wallet, but as we said, we believe we're well-positioned to be there to serve our clients and to do so in a way that makes good economic sense."
},
{
"speaker": "Operator",
"content": "The next question is from Jim Mitchell with Seaport Global. Your line is now open. Please go ahead."
},
{
"speaker": "Jim Mitchell",
"content": "Hey, good morning. Just Mark, maybe on NII down almost 4% year-over-year, it seems a little bit more than the guidance, but down modestly for the year. So, can you discuss sort of the puts and takes this quarter and how we should think about the quarterly trajectory for the rest of the year?"
},
{
"speaker": "Mark Mason",
"content": "Yeah. So, I'd say a couple of things. So, one, as I mentioned, in the quarter, and if you see it on Slide 9, ex-Markets were down about 3%. That's largely driven by some FX translation that played through, but also some seasonally lower revolving card balances and then lower interest rates in Argentina. And what that is in Argentina, we have capital there, the policy rate was adjusted downward, and as that happened, we obviously earn less on that capital that flows through the NII line. As I think about the back half of the year and the guidance we have of modestly down, there are a couple of puts and takes to keep in mind. So, one is going to be rates, right? So, as I think about the higher yield that we can earn on reinvestment, that will be a tailwind that plays through from an NII point of view. The second would be volume growth, particularly in our card loans portfolio. And we do expect to see continued volume growth across the -- certainly the branded portfolio and so that will be another tailwind for us on the NII line. In terms of the headwinds, you've got the lower NII earned in Argentina from rates that will continue to play through. We've got assumed higher average betas in 2024, specifically on the non-US side. We still have in our forecast the impact of CFPB late fee. So, assuming that that goes into effect for this year, that will have an impact and it's in the forecast. And then, the impact of lost NII from the exits that we have. And so, the combination of those things will probably mean that NII in the back half of the year is a little bit higher than the first half, but again, consistent with the guidance that we gave of modestly down."
},
{
"speaker": "Jim Mitchell",
"content": "That's helpful. And maybe just quickly kind of a similar question on expenses, better-than-expected this quarter, but there was no restructuring or repositioning charges. I think to get to the high end of your range, you'd have to be up a little bit in the back half from 2Q run rate, is that because you expect more repositioning/restructuring in the second half, or maybe just talk through expense trajectory from here?"
},
{
"speaker": "Mark Mason",
"content": "Yeah. So that's right. When I talked about at the first quarter, I talked about kind of a downward trend for each of the quarters after Q1. The second quarter came in a bit lower than we were expecting. I'm sticking with the guidance and that does mean that the back half of the year will likely come in -- will come in higher than the second quarter. That's a combination of a couple of things, including the pace of hiring and investment that we will do in the transformation work that has to be done. It also includes repositioning charges that we might take or need to take as we continue to work through our businesses across the firm and the franchise. And then, the second quarter did -- yes, the second quarter did have a one-time or so in some delayed spending that will pick up in the third and fourth quarter around advertising and marketing and some of the other line items. So, yes, the second quarter will -- the third and fourth quarter, the back half will be higher than the second quarter, but consistent with the guidance that I've given."
},
{
"speaker": "Operator",
"content": "The next question is from Erika Najarian with UBS. Your line is now open. Please go ahead."
},
{
"speaker": "Erika Najarian",
"content": "Hi. I had two questions, and I'll ask the first one on expenses first since it's a good follow-up to the previous. Mark, just to clarify, let's just say take the highest end-of-year range at $53.8 billion, just trying to think about how consensus will move. So, we take that $53.8 billion and then add the $285 million of FDIC expenses year-to-date so far and add the civil money penalties of $136 million, so that gets us to $54.2 billion for the year and any other repositioning charges in the second half of the year would already be included in the $53.8 billion?"
},
{
"speaker": "Mark Mason",
"content": "So, yes, the answer to last part of your question is yes. So, in the range that I've given, $53.5 billion to $53.8 billion, that includes our estimate for the full year of repositioning and any restructuring charges. That range excludes the FDIC special assessment that we saw earlier in the year and it excludes the CMP of $136 million."
},
{
"speaker": "Erika Najarian",
"content": "Got it. And my second question is for Jane. I mean, I'm sure you're getting tired of the question on capital return. So you're buying back $1 billion -- you plan to buy back $1 billion this quarter. It looks like you didn't buy back any in the second quarter. And I'm asking this question in this context because consensus has a buyback of nearly $1 billion in the fourth quarter and staying at this rate for the first half of next year and ramping higher. And I guess, is the $1 billion number a catch-up pace because you didn't buy back any in the second quarter? And I fully appreciate that you also have the Banamex IPO coming, which is different from peers that are also waiting for Basel clarification, but I'm just wondering, do we need to wait for that Banamex IPO for the company to feel comfortable moving away from that quarter-to-quarter guidance? And also, of course, I just want to readdress the beginning of the question when I asked specifically about the pace."
},
{
"speaker": "Jane Fraser",
"content": "Okay. So, we are not going to be giving guidance going forward around our buybacks. We are going to continue to give quarterly -- and make it a quarterly determination as to the level. And a lot of that is to do with the uncertainty about the forthcoming regulatory changes. I think we were delighted to see a slight reduction in our stress capital buffer, reflecting the financial strength and resiliency of our business model and also good to see the benefits of our strategy playing out, but with the regulatory changes uncertain and we are -- that's one of the major factors for us to continue with the quarterly guidance."
},
{
"speaker": "Mark Mason",
"content": "Yeah. That's right. On the first part of your question, Erika, I'd say, look, we were in discussions with our regulators and we made a prudent call as it relates to buybacks in the quarter for Q2 [Technical Difficulty] Q3, as we talked about would be at $1 billion and that should not be necessarily viewed as a run rate level. As Jane mentioned, we'll take it quarter-by-quarter from here."
},
{
"speaker": "Operator",
"content": "The next question is from Gerard Cassidy with RBC. Your line is now open. Please go ahead."
},
{
"speaker": "Gerard Cassidy",
"content": "Thank you. Hi, Jane. Hi, Mark."
},
{
"speaker": "Mark Mason",
"content": "Good morning."
},
{
"speaker": "Gerard Cassidy",
"content": "Mark, regarding the comments you made about the higher credit losses, the three factors that you gave us, can you also talk about if this was a factor at all for you folks? Was there any FICO score inflation back during the pandemic that might be playing into these kind of credit losses? And as part of the credit card question, you mentioned the CFPB, the fees that you have factored them, the lower fees, you factor that into your forward look, where do we stand on that? Do you guys have any color on that as well?"
},
{
"speaker": "Mark Mason",
"content": "Yeah. So, on the first part of the question, look, we all kind of have talked about in the past the prospect of FICO inflation back during the COVID period of time. We've been very, very focused on ensuring that acquisitions that we've made have been appropriately kind of analyzed in the underwriting of that to get comfortable with the quality of new customers that we've been bringing on. In light of the environment, we have looked at moving towards higher FICO scores for new account acquisitions. But as I think about what we're seeing now, there is that dichotomy that I mentioned where we have the higher FICO score customers that are driving the spend growth and that frankly have still continued strong balances in savings and it's really the lower FICO band customers where we're seeing the sharper drop in payment rates and more borrowing. And so, the FICO inflation has effectively kind of fizzled out when we look at the mix and dynamic of the customer portfolio that we have at this point. And in terms of the CFPB, late fees, well, I don't have an update on that. Like I said, we've built in an assumption in the -- in our forecast, but in terms of the timing, I don't have a formal update on the certainty of it."
},
{
"speaker": "Operator",
"content": "The next question is from Ken Usdin with Jefferies. Your line is now open. Please go ahead."
},
{
"speaker": "Ken Usdin",
"content": "Hey, thanks, good morning. Hey, Mark, talking about the NII outlook and the fact that now we've got a little bit of a discrepancy starting between US rates, maybe higher for longer, and then the beginnings of some of the non-US curves starting to at least put forth their first cut, I know we've got that good chart that you have in the Qs about the relative contributions, can you just help us understand a little bit of like just generally how you're thinking through that discrepancy and how that informs the difference between US-related NII and non-US-related NII as you go forward?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, thank you. So look, I think that as we look at it out through the -- certainly through the medium-term, we expect to see continued NII growth at obviously a modest level, certainly lower than what we've seen historically. And that's in large part because -- or in-part, I should say, because of how we've been managing the balance sheet and that has allowed for us to reinvest as securities have rolled off and earn a higher yield on them relative to what we were earning. In some instances, they were five-year terms on some of these investments. And so, we still think there's some upside from a reinvestment point of view. The point you make around kind of non-US dollar or US rates kind of coming off, that will play through a little bit as we think about the beta increases that we're expecting outside of the US. And so, we've assumed that we have higher betas pickup outside of the US. If rates kind of come off in a more substantive way, then we could see kind of a little less NII pressure than we're forecasting there. But net-net, as I think about the combination of volume growth that we're expecting between loans and deposits over that medium-term, the higher yield we can earn on our assets, combined with the pricing capabilities that we have across the portfolio, offsetting some of that beta, we believe will have continued NII growth. As I think about what I often point to in terms of the IRE analysis and you have to remember that, that is a shock to the current balance sheet and it assumes that the full curve is moving simultaneously across currencies. And in that case, the 100 basis point parallel shift downward would be a negative $1.6 billion, with about $1.3 billion of that coming from non-US dollar. But again, that does assume that all of those currencies come down at the same time and doesn't account for the rebalancing of the balance sheet and things that I mentioned like the reinvestment higher yields that we'd be able to earn."
},
{
"speaker": "Ken Usdin",
"content": "Got it. Okay. And just one follow-up on the OCC amendment, and that's specifically related to the resource review plan. Do you have a line-of-sight on how long that will take you guys to finish because it seems like -- and is that what we should be thinking about in terms of just understanding like what side of what you need to get done in terms of the other language that's written in the order?"
},
{
"speaker": "Jane Fraser",
"content": "So, Ken, look, the Resource Review Plan is just that it's a plan to ensure that we have sufficient resources allocated towards achieving a timely and sustainable compliance with the order. Essentially, if an area is delayed or looking as if it could be, we'll determine what additional resourcing, if any, is required to get back on track, and then we'll share that with the OCC in a more formalized way than we do today. We obviously review this pretty constantly ourselves. We're already working on the plan after it's finalized with the OCC. So, it will be confidential supervisory information that we can't disclose. So, we won't be able to tell you that the plan is -- whether the plan -- what the nature of the plan is going to be, but it won't be much more complicated than what we talked about. And we're expecting to get it, we're not expecting this to take long."
},
{
"speaker": "Operator",
"content": "The next question is from Betsy Graseck with Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Betsy Graseck",
"content": "Hi, good afternoon."
},
{
"speaker": "Mark Mason",
"content": "Hello."
},
{
"speaker": "Jane Fraser",
"content": "Hi, Betsy."
},
{
"speaker": "Betsy Graseck",
"content": "Okay. So, I know we talked a lot about expenses. I just have one kind of overarching question here, which is on how we should think about the path of expenses between now and the medium term as we have kind of come quite a long way in the simplification process, maybe if you could give us a sense as to how far along simplification impact on expenses we are? And overlapping with the regulatory requirements, do these net out or are we skewed a little bit more towards regulatory requirements being a bit heavier than what's left on simplification from here? Thanks."
},
{
"speaker": "Mark Mason",
"content": "So, thank you, Betsy. I guess, I'd say a couple of things. So, I think we said it in the past, so the target for the medium-term, I think 2026 is somewhere around $51 billion to $53 billion of expenses. As we've said, we'll have about $1.5 billion in savings related to the restructuring that we've done and another $500 million to $1 billion related to net expense reductions from eliminating the stranded costs as well as additional productivity over that medium-term period. And so, we've made, I think, very good headway, as Jane has mentioned in the org simplification and the restructuring charges associated with that, those saves will -- have started to generate some of those saves in the early part of that, meaning this year will likely be offset by continued investment that we're making in areas of the business like transformation, but also in business-led or driven growth. And you should expect in terms of the trend that we would have a downward trend towards 2026 and achieving that range."
},
{
"speaker": "Jane Fraser",
"content": "And I just want to reiterate, we remain confident that we will meet our 11% to 12% RoTCE target over the medium-term. And we've got the -- we have the ability to manage the different elements we've been talking about today, making sure that we're investing sufficient resources into the transformation, so we can be on-track with that, as well as in our businesses, as well as the return of capital to our shareholders. And so, we feel confident around that and good about that we can manage this."
},
{
"speaker": "Mark Mason",
"content": "Yeah, I think that's a great point, Jane. Look, the reality is, as was pointed out earlier, we spent about $3 billion last year, a little bit under that on the transformation-related work. And the plan has called for us to spend a little bit more than that this year. And frankly, in the first half of the year, as we work through the transformation work and some of the things that Jane and I have mentioned earlier in the year that we've been focused on like data and data related to regulatory reporting, we've had to spend more than we had planned for in the first half, right? And we've done that and we funded that. We've been able to find productivity opportunities that allow for us to still stay within the guidance that we've given for the full year. So, we are managing this entire expense base, right? So, not -- the whole $53-plus billion of it, we are actively managing that with an eye towards what's required from a transformation point of view to keep it on-track, to accelerate in areas where we're behind, and to shore up areas where we are tracking in accordance to what the order requires and where are there other inefficiencies that can allow for us to free up the expense base. And so, things like the work that Andy Sieg has done with the finance team around that expense base and finding efficiencies there are opportunities that we've been able to tease out of the business. Things that we have done in parts of USPB and that we have continued to get up there in parts of Banking, which you see in the down 10% this quarter are areas where we've been keenly focused on, where are there duplicative roles, where are there inefficient processes that we can actually drive greater efficiency out of. So, long-winded way of saying, we understand the expense guidance that we've given. We also understand and stress the importance of funding the transformation with what's required and we are doing both."
},
{
"speaker": "Betsy Graseck",
"content": "Okay, great. Thank you very much. Appreciate that."
},
{
"speaker": "Operator",
"content": "The next question is from Vivek Juneja with JPMorgan. Your line is now open. Please go ahead."
},
{
"speaker": "Vivek Juneja",
"content": "Hi. Okay, let me just clarify this, Mark and Jane, just to make sure that we all have it right. The $53.5 billion to $53.8 billion does not include anything thus far on what you think you may need to spend on the Resource Review Plan, meaning what additional resources you would have to put to fix the consent order, am I right there?"
},
{
"speaker": "Jane Fraser",
"content": "No, you're not right. So, I think -- as you've heard us talk about, Vivek, for a while now that we knew the areas that we were behind in elements of our transformation program and that we began addressing those and making the investments, some of that is in people, some of that is in our technology spend, it's using different tools and capabilities to get areas addressed earlier and we began that earlier in the year. And you saw that acknowledged as well by our regulators, who pointed to the fact that we've already begun addressing the areas that we're behind. Mark?"
},
{
"speaker": "Mark Mason",
"content": "That's right, Jane. What you have heard is that, despite having to spend more, some $250 million or so more, we're not changing the guidance, right? And so, we have -- as Jane mentioned, we have worked on areas already that we've needed to and we have looked for ways to absorb that and are doing so within our guidance."
},
{
"speaker": "Vivek Juneja",
"content": "Okay. So, going forward, even though this plan is still to be sort of put together and approved by the regulators, we should not expect any change to this expense?"
},
{
"speaker": "Mark Mason",
"content": "Look, the plan -- the Resource Review Plan, as Jane mentioned, is what we're working through now with the regulators. That will be a process for demonstrating to them that we are spending and allocating the appropriate resources to accomplishing the commitments that we have. Appropriate resources can range from people to technology to enhancing our processes and ensuring better execution. If you think about what that will entail, it will entail areas where we are delayed or behind as we identify those areas, being able to tease out the root cause of any delay and ensure that we've got proper funding allocated to get it back on track. And that's me framing out how I think about what something like this might look like. And so, what we're saying is that, if we identify issues in the quarters to come that we haven't identified already, that's the process we're going to apply to those issues. And as you've heard us say repeatedly, we're going to spend whatever is necessary to then get those things back on track, and as we've done thus far this year, we're going to look for opportunities to absorb those headwinds. I hope that's clear."
},
{
"speaker": "Operator",
"content": "The next question is from Matt O'Connor with Deutsche Bank. Your line is now open. Please go ahead."
},
{
"speaker": "Matt O'Connor",
"content": "Hi. Apologies if I missed it in the opening remarks, but what drove the decline in credit card revenues from 1Q to 2Q? It looks like they were down about 6% in aggregate even though average loans went up, spending went up. What was the driver of that?"
},
{
"speaker": "Mark Mason",
"content": "Credit card revenues seasonality..."
},
{
"speaker": "Jane Fraser",
"content": "Yeah. Seasonality..."
},
{
"speaker": "Mark Mason",
"content": "Seasonality playing through there."
},
{
"speaker": "Jane Fraser",
"content": "Sequentially."
},
{
"speaker": "Mark Mason",
"content": "Yeah, sequentially. Yeah."
},
{
"speaker": "Jane Fraser",
"content": "I think if you look year-over-year, you'll be able to see a pretty common trend there. The consumer is slowing in some of the -- in the spend, as Mark had referred to Matt, but -- and a lot of the spending and the growth areas we are seeing and the underlying numbers is being driven by the affluent customer."
},
{
"speaker": "Mark Mason",
"content": "Yeah, I think there's also the dynamic on the CRS of the reward -- across the portfolio of rewards playing through from one quarter to the other. So, the combination of those things are playing through the revenue line there."
},
{
"speaker": "Jane Fraser",
"content": "But nothing that's particularly worrying us, Matt."
},
{
"speaker": "Matt O'Connor",
"content": "Okay. And then, just separately on -- the very early kind of part of the prepared remarks, you talked about the dividends being capped in terms of what can be upstreamed from the bank to the holding company because of the OCC thing that came out this week. Like, for all intents and purposes, like does that impact how you run the company or subsidiary or impact liquidity or capital? I understood the comment, no change to dividends or buybacks at the holding company, but is there any impact from that, that we would notice on the outside? Thank you."
},
{
"speaker": "Jane Fraser",
"content": "Look, the -- let's be clear. This action does not impact our ability to return capital to our shareholders. The dividends that are referenced are just intercompany payments from CBNA to the parents. So, first of all, don't confuse what a dividend is here. We will -- it's not going to impact how we run the company, the subsidiary, the capital or the liquidity at all, and the dividends are not capped."
},
{
"speaker": "Mark Mason",
"content": "Yeah. I think the -- Jane, that's right. And I think let's not lose sight of the purpose of the orders that are there. And the purpose of the orders that are there are to ensure that we're funding and allocating the effort appropriately, right? So, the regulators want essentially the same thing we want, right, is for us to get this done, right? And so, that is the primary objective. The reference to the dividending from out of CBNA up to the parent is certainly referenced there between now and establishing that Resource Review Plan, but as Jane mentioned that does not constrain the parent from doing the things that it will need to do. And as opposed to -- it's not a cap. What it is, is that anything above the debt service of the parent or the preferred dividends and other non-discretionary obligations would require a non-objection from the OCC."
},
{
"speaker": "Jane Fraser",
"content": "Until the resource plan is agreed..."
},
{
"speaker": "Mark Mason",
"content": "Until the resource plan..."
},
{
"speaker": "Jane Fraser",
"content": "And as you'll have seen the resource plan needs to be submitted within 30 days. And as I indicated, we're working on that one and not anticipating that to be a problem."
},
{
"speaker": "Operator",
"content": "The next question is from Saul Martinez with HSBC. Your line is now open. Please go ahead."
},
{
"speaker": "Saul Martinez",
"content": "Hi, good afternoon. Thanks for taking my question. Just -- I guess I just want to follow-up on the latter question. I just want to be very clear. So, the -- what you're saying is that the requirement that CBNA receive a non-objection to before dividending upstream to the parent, that does not impact how you think about your capital flexibility, how you think about -- it doesn't restrict you in any way and shouldn't impact, for example, your ability to benefit from -- for example, a Basel endgame rule that is softened or some of the benefits, Mark, that you talked about in terms of simplification. So, you don't see this impacting your ongoing level of capital flexibility and your ability to repurchase stock going forward if some of these things actually do play out?"
},
{
"speaker": "Mark Mason",
"content": "No. No, I don't."
},
{
"speaker": "Saul Martinez",
"content": "Okay. That's fair enough. That's clear as it can be. Good."
},
{
"speaker": "Mark Mason",
"content": "Thank you."
},
{
"speaker": "Saul Martinez",
"content": "Second question on, I just want to follow-up on USPB. I mean, I still -- I get the point that you're seeing normalization in losses in cards, but even if I adjust for reserve builds, your RoTCE is still single-digit. I would think even at these NCL levels, your cards business is pretty profitable. You're a scale player. I mean, you're above sort of pre-pandemic levels, but not -- I don't know if I -- it doesn't seem like it's that much higher by a dramatic amount. It would seem to imply that the retail bank is a huge drag on profitability even maybe even losing money, I don't know. But can you just talk about what you can do to sort of improve the retail bank profitability and just give any more color that you can in terms of the path to get to that high-teen RoTCE that you talked about?"
},
{
"speaker": "Jane Fraser",
"content": "Yeah, let me let me kick-off there. And let's say, look, clearly, we're very focused on improving the returns in USPB to get us to the high-teens level over the medium term. And you've seen us generating healthy positive operating leverage this quarter. We've had a number of quarters of good revenue growth. And as Mark said, however, we're at the low point of the credit cycle. We knew this year we would see the pressure on returns from the elevated NCLs and some of the industry headwinds we've talked about. But as the NCL rates approach steady-state levels and the mitigating actions that all of us have been putting in place against the industry headwinds as those take hold, we expect the returns will improve and support the medium -- the firm-wide medium-term targets. In the retail bank, we're continuing to focus on growing share in our six core markets and we're doing that leveraging our physical and digital assets and it plays an important role in enabling the wealth continuum and the growth that we are looking at in our Wealth franchise. We are continuing to improve our operating efficiency, being very disciplined in expense management and managing carefully the branch and digital productivity of the retail bank network. But we're at the high point of the credit cycle, it's driving the low point for USPB, and as I said in my remarks, we're expecting to see those returns improve from here."
},
{
"speaker": "Operator",
"content": "The next question is from Steven Chubak with Wolfe Research. Your line is now open. Please go ahead."
},
{
"speaker": "Steven Chubak",
"content": "Hi, good afternoon. So, Mark, I have a fairly technical question on DTA utilization and specifically the NOLs. The deduction is still fairly significant at $12 billion. It roughly equates to about 10% of your market cap. And the good news here, I suppose is that it should come back into capital over time, but we've seen very little utilization over the past two years despite the firm being profitable. And so, wanted to better understand is, what's constraining your ability to utilize those DTAs? And are there catalysts on the horizon that can actually help accelerate that utilization beyond organic earnings generation?"
},
{
"speaker": "Mark Mason",
"content": "Mason Yeah, thank you. So, I'm going to give you a very simple answer to a very complicated question. It really comes down to driving US income, right? And so, we are focused on not just all of the things that we've mentioned, but driving higher income in the US that allows for us to utilize the disallowed DTA. We saw some of that in the quarter, and we expect to see more of it as we move through the medium-term, but that is the major driver of that utilization. And..."
},
{
"speaker": "Jane Fraser",
"content": "And we've got our -- and we have many of our business heads very much focused around that opportunity as well. So, winning in the US is a very important leg, for example, of the strategy that this is refreshing. Similarly, we see opportunities in -- from the commercial bank, we see it in Wealth, we see it in obviously in US Personal Banking and in Services. So, we're very -- we're focused from a business strategy point of view on this not just from the financial side."
},
{
"speaker": "Steven Chubak",
"content": "Yeah, thank you both for that color. And maybe just a quick follow-up. Just on the retail services business, we are seeing some evidence that your competitors in this space have been more aggressive leading with price in an effort to win some new mandates. I was hoping you could just speak to what you're seeing across the competitor set and your appetite or willingness to potentially offer better economics in response to increased competition from some of your peers?"
},
{
"speaker": "Jane Fraser",
"content": "Well, I think you'll be delighted to hear that we're very focused on returns rather than just on revenues. So, when we enter into discussions with a partner who may be a new RFP for their portfolio or looking at new ones such as the one we just agreed with Dillard's, it's all about the returns and the profile of the business rather than the revenue side of things. And it's a shift probably from some of the ways in the past, but I'm very pleased with how disciplined the team is being around this and we're seeing the benefits of it."
},
{
"speaker": "Mark Mason",
"content": "And that may be different from what you hear and see from other players in the space, but as Jane mentioned, we're keenly focused on ensuring that, yes, we have a good partnership, but that we're generating an appropriate return. That's part of achieving our medium-term targets. And as you know, since you brought up retail cards, I mean, when we think about how CECL works in the reserves you have to establish for these partnerships, we're establishing full lifetime reserves that's on the balance sheet where ultimately we end up splitting those through the partner sharing economics. So, it's another important consideration as we think about expanding and taking on these relationships and renegotiating partnerships to making sure that returns make good sense for us."
},
{
"speaker": "Jane Fraser",
"content": "And Mark and I have no problem saying no to revenue that doesn't come at the right returns and being very disciplined around that."
},
{
"speaker": "Operator",
"content": "The next question is from Vivek Juneja with JPMorgan. Your line is now open. Please go ahead."
},
{
"speaker": "Vivek Juneja",
"content": "Hi. Sorry, just a follow-up on this whole consent order stuff, Jane. What do you think this does in terms of timing? How much longer for you to sort of get this past you? Are you talking couple of years? Is it now longer by a year? Any sense of that? Any sense of helping us think through that?"
},
{
"speaker": "Jane Fraser",
"content": "Look, in terms of the consent order and the areas we've had delays, there are four areas to the consent order; it's risk management, it's data governance, it's around compliance, and it's around control. As we've said, we were falling behind in certain areas related to data and we've been investing to address the areas that we were behind. We also saw an increase in the scope related to regulatory reporting. So, we added some more bodies of work there and we are well underway. So, we are not expecting this to extend on the original expectations that we have on when we will complete the body of work for the consent order. We have a target state for the different areas of it. We have the plan to achieve those target states. We'll make the investments necessary to ensure that we do so. We'll try and get this done as quickly, but as robustly as possible. And we're doing this by making strategic fixes and investments rather than what I would call the old city way, which is a series of band-aids that remediate, but don't actually fix the underlying issue. And that way, we are delivering for our shareholders as well as our regulators and our clients because we're putting in strategic solutions that will benefit all, but I'm not expecting this to change the timeframes."
},
{
"speaker": "Vivek Juneja",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The final question comes from the line of Mike Mayo with Wells Fargo. Your line is now open. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. Just two clarifications. So, this is a very high-profile amendment to the consent order. And I think what I hear you saying, but if you can confirm, your risk compliance and controls are getting passing grades. It's really the data. And as it relates to the data, you're talking about, 11,000 regulatory reports, some of which have 750,000 lines of data. Is that really the scope of what you need to fix? Because people see this externally and say, hey, you're failing in terms of overall controls and resiliency, but I think I hear you saying it's really more about just the data and the regulatory reporting, which is important, but more of a slice of a broader picture. Is that correct?"
},
{
"speaker": "Jane Fraser",
"content": "Yeah. Mike, maybe I just -- you're asking a great and it's an important question. So maybe I try and explain what we -- the data elements because it's an area that Mark and I have pointed to. So, first of all, we use data all over the firm. We use it to deliver 72 million customer statements every month. Our corporate clients, that you heard about at our Service Investor Day access account data real-time across multiple countries on CitiDirect, and we're moving $5 trillion roughly per day for those clients around the world. We trade billions of dollars in a millisecond on our trading platforms. We can see our liquidity positions real-time around the world. This can only be done if you've got pretty pristine data and highly automated ecosystems. So -- but what is the transformation doing? What it is doing is simplifying how data moves through the firm and it's about upgrading the management and governance over those flows. And we -- as I've said, we're doing a strategic overhaul of large parts of our infrastructure. So, what are we doing? We're making sure we're capturing data accurately using smart tools and automation. We will often talk about this smart system, make sure there's no errors when we book a trade. We've seen our error rate down 85% as a result of it. We're housing our upstream data in two standardized repositories. They're the golden sources, Olympus and Data Hub, which you've heard me talk about a few times. And they're a golden source now for all of the downstream data use, populating the thousands of regulatory reports Mark talked about and other areas. And what a single repository means is that the data models, the data quality rules, the controls you put in place to govern and manage that data, they all sit in one place rather than being distributed all over the firm as they have been historically. Mark has been investing in building a standardized reporting infrastructure. You've heard us talk about a single full-suite reporting ledger versus the six or so reporting ledgers that we've had in the past. And we're delivering all of this through consolidated systems, through the automation and streamlining of data flows. So, instead of being in multiple pipes, the flows go through single pipes. So, it's a -- sorry to get a bit plumber on you for a moment, but I think it's important to understand what it is, because it's a lot of work. It's a strategic overhaul. It's not a series of tactical fixes. Where we're behind, as we do the work on data, we identify specific issues we need to fix as we execute the plan that we have in place. There's some more areas to address and we knew back when we did the plan. So, we've -- and we've also accelerated the work on improving the accuracy of our regulatory reports and we increased the scope of this work as well. It's more comprehensive than originally planned. So, what we're doing? We're adding resources and data experts. We're learning from best practices. And we're using some great AI and other data tools that are helping to identify anomalies in data and data flows much quickly. We're also to the -- to some of the culture side, we're learning from pilots how do we accelerate broader deployment at scale across the firm in a consistent enterprise-wide manner. So, all of these things in the data side are going to enable us to leapfrog competitors, more revenue opportunities, better client service, fewer buffers, drive more efficiencies, and hope at the end of -- the end goal here is, it becomes a competitive advantage for the firm. That is the data plan. Clearly, there's a very important element of it related to the consent orders. We're behind in a few areas. We're investing. We've already begun that investment, as Mark and I have talked about, to get it done, we'll get it done."
},
{
"speaker": "Mark Mason",
"content": "The only thing I'll add..."
},
{
"speaker": "Mike Mayo",
"content": "Real short follow-up..."
},
{
"speaker": "Mark Mason",
"content": "Sorry. What was that, Mike?"
},
{
"speaker": "Mike Mayo",
"content": "Yeah, just to say -- real short follow-up to that. So you're doing all this great stuff, but you still fell short. Just in, like, one sentence, despite doing all this great stuff that you described, the regulators still said you didn't get it done. Why after doing all that, didn't you get that it done in the eyes of the regulators and why won't be fixed now? Just like a one-sentence explanation for that if you have it?"
},
{
"speaker": "Jane Fraser",
"content": "I always said that a transformation of this magnitude over multiple years would not be linear. We have many steps forward. We have setbacks, we adjust, we learn from them, we move forward, and we get back on track."
},
{
"speaker": "Mark Mason",
"content": "And Mike, if I could just put one number into context, because you played back the 11,000, which was a number of global regulatory reports across the landscape here. There are probably 15 to 30 that are core US reports that are pivotal to our US regulators. And a lot of what we're discussing here is about ensuring that we're prioritizing the data that impacts those 15 to 30 reports as we work through this."
},
{
"speaker": "Operator",
"content": "There are no further questions. I'll now turn the call over to Jenn Landis for closing remarks."
},
{
"speaker": "Jenn Landis",
"content": "Thank you all for joining us. Please let us know if you have any follow-up questions. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes Citi's second quarter 2024 earnings call. You may now disconnect."
}
] |
c | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Hello and welcome to Citi's First Quarter 2024 Earnings Call. Today's call will be hosted by Jenn Landis, Head of Citi Investor Relations. 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. If you have any objections, please disconnect at this time. Ms. Landis, you may begin."
},
{
"speaker": "Jennifer Landis",
"content": "Thank you, operator. Good morning and thank you all for joining our First Quarter 2024 Earnings Call. I am joined today by our Chief Executive Officer, Jane Fraser and our Chief Financial Officer, Mark Mason. I'd like to remind you that today's presentation, which is available for download on our website, citigroup.com, may contain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these statements due to a variety of factors, including those described in our earnings materials, as well as in our SEC filings. And with that, I'll turn it over to Jane."
},
{
"speaker": "Jane Fraser",
"content": "Thank you, Jenn, and good morning to everyone. Today, I'm going to touch on the macroeconomic environment before I update you on the progress we're making, and then I'll discuss the quarter. While global economic performance was surprisingly [desynchronized] (ph) last year, the overall story has been consistent of late, one of economic resiliency supported by tight labor markets and the consumer. Growth this year looks poised to slow in many markets, and conditions are generally disinflationary. We're already seeing some Central Banks in the emerging markets starting to cut rates. In the U.S., a soft landing is viewed as increasingly, likely. But we continue to see a tale of two Europe's, with Germany hurt by the weak demand for goods, while southern European countries such as Spain and Greece benefit from stronger demand in services. In Asia, Japan is joining in the [areas of] (ph) bright spot, and China's economy has gained some more traction, although its property market remains a concern. Amidst all these dynamics, we continue to focus on executing against our strategy and delivering the best of Citi to all our stakeholders. I said 2024 will be a pivotal year for us, as we put our business and organizational simplification largely behind us and we focus on two main priorities. The transformation and the performance of our businesses and the firm. Last month marked the end to the organizational simplification that we announced in September. The result is a cleaner, simpler management structure that fully aligns to and facilitates our strategy. We are now more client-centric. We're already seeing faster decision making and a nimbler organization at work. We have clear lines of accountability, starting with my management team. Fewer layers, increased spans of control and frankly much less bureaucracy and needless complexity. It will all help us run the company more efficiently, will enhance our clients' experience and improve our agility and ability to execute. And while reducing expenses wasn't the primary driver of the program, more roles were ultimately impacted than the 5,000 that we discussed in January. We also took a number of other steps to sharpen our business focus and improve returns by right-placing businesses to better capture synergies, exiting certain businesses in markets that just didn't fit with our strategy, and right-sizing the workforce in wealth. As a result of all these combined steps, which include the simplification, we are eliminating approximately 7,000 positions, which will generate $1.5 billion of annualized run rate expense saves. The combination of these actions and the measures we're taking to eliminate our remaining stranded costs will drive $2 billion to $2.5 billion in cumulative annualized run rate saves in the medium-term. We are keeping a close eye on the execution of these efforts and overall resourcing to ensure we safeguard our commitment to the transformation. As you know, given its magnitude and scale, the transformation is a multi-year effort to address issues that have spanned over two decades. We've made steady progress as we retire multiple legacy platforms, streamline end-to-end processes, and strengthen our risk and control environment, all of which are necessary not only to meet the expectations of our regulators, but also to serve our clients more effectively. A transformation of this magnitude, well it's never linear. So while we've made good progress in many areas, there are a few where we are intensifying our efforts, such as automating certain regulatory processes and the data related to regulatory reporting. We're committed to getting these right and we'll look to self-fund the necessary investments to do so. Turning to the quarter, we had a good start to a pivotal year. We reported net income of approximately $3.4 billion, earnings per share of $1.58 and an RoTCE of 7.6% on over $21 billion of revenues. Our revenues were up over 3% year-over-year, excluding divestitures, which was primarily the $1 billion gain from the India consumer sale last year. Our expenses were slightly down quarter-over-quarter, excluding the FDIC special assessments. Services continues to perform well and generate very attractive returns. Revenue was up 8% for the quarter as both businesses won new mandates and deepened relationships with existing clients. Fees were up a pleasing 10% for services year-over-year driven by the investments we've made across our product offering platforms and client experience. In Securities Services, we took share again this quarter, and in TTS, cross-border activity continued to outpace global GDP growth and commercial card spend remained robust. We look forward to diving deeper into these two businesses at our investor presentation on services in June. Markets bounced back from a tough final quarter in ‘23. While revenues were down 7% as lower volatility impacted rates and currencies, that was off a very strong first quarter last year. We saw good client activity in equities and in spread products, where both new issuance and securitization activity were particularly robust. We fully integrated our financing and securitization capabilities within our markets business and we started to see the benefits of having a unified spread product offering for our clients. The rebound in banking gained speed during the quarter, led by near record levels of investment grade debt issuance, as improved market conditions enabled issuers to pull forward activity. And after a bit of a slow start, ECM picked up in the second half of the quarter, notably in convertibles. Our strong performance in both DCM and ECM drove investment banking revenue growth of 35% and overall banking revenue growth of 49%. While M&A revenues are still low across The Street, I was pleased that we participated in some of the significant deals announced in the quarter, such as Diamondback's merger with Endeavor Energy and Catalent’s merger with Nova Holdings. We are cautiously optimistic that we could see a measured reopening of the IPO market in the second quarter in light of improved market valuation."
},
{
"speaker": ".",
"content": "As you've seen, Andy continues to form his team and is focused on three areas. First, rationalizing the expense base. Second, turning on the growth engine by focusing on investment revenues. And third, enhancing our platforms and capabilities to elevate the client experience. Now these won't happen overnight, but getting these things right will help us get more than our fair share of the $5 trillion of assets that our clients have away from us. And that will help us get our returns to where they need to be in this business in the medium-term. USPB had double-digit revenue growth for the sixth straight quarter. We feel good about our position and our resiliency as a prime lend-centric issuer and are seeing positive momentum across proprietary card and partner card businesses. Healthy spend growth persists in branded cards, primarily driven by our more affluent customers. Across both portfolios, increased demand for credit continues to drive strong growth in interest earning balances. And while they're only a small part of our portfolio, we are keeping an eye on the customers in the lower FICO bands. We also continue to see strong engagement in digital payment offerings, such as Citi Pay, as a point-of-sale lending product, which is easily integrated into merchants’ checkout processes. And we are driving more value from our retail branches, as well as getting the expense base right to increase returns there. Our balance sheet is strong across the board, an intentional result of our high quality assets, robust capital and liquidity positions, and rigorous risk management. During the first quarter, we returned $1.5 billion in capital to our common shareholders and that includes $500 million through share buybacks. Our CET1 ratio ticked up to a preliminary 13.5% and we grew our tangible book value per share to $86.67. We have a great franchise around the world with great clients who are served by great colleagues. I'm pleased with where we are and I'm excited about where we're going. With the organizational simplification behind us and a good quarter under our belt, we have started this critical year on the right foot. Now while there will be bumps in the road, no doubt, we will continue to execute with discipline and we are committed to reaching our medium-term targets. With that, I'd like to turn it over to Mark, and then we will both be delighted, as always to take your questions. Thank you."
},
{
"speaker": "Mark Mason",
"content": "Thanks, Jane, and good morning, everyone. I'm going to start with the firm-wide financial results focusing on our year-over-year comparisons for the first quarter, unless I indicate otherwise, and then spend a little more time on the business. On slide six, we show financial results for the full firm. In the first quarter, we reported net income of approximately $3.4 billion, EPS of $1.58, and an RoTCE of 7.6% on $21.1 billion of revenue. Total revenues were down 2% on a reported basis. Excluding divestiture-related impacts, largely consisting of the $1 billion gain from the sale of the India consumer business, in the prior year, revenues were up more than 3% driven by growth across banking, USPB, and services, partially offset by declines in markets and wealth. Expenses were $14.2 billion, up 7% on a reported basis. Excluding divestiture-related impacts and the incremental FDIC special assessment, expenses were up 5%. Cost of credit was approximately $2.4 billion, primarily driven by higher card net credit losses, which were partially offset by ACL releases in wealth, banking, and legacy franchise. At the end of the quarter, we had nearly $22 billion in total reserves with a reserve to funded loan ratio of approximately 2.8%. On Slide 7, we show the expense trend over the past five quarters. We reported expenses of $14.2 billion, which included the incremental FDIC special assessment of roughly $250 million. Also included in this number are $225 million of restructuring charges, largely related to the organizational simplification. In total, we've incurred approximately $1 billion of restructuring costs over the last two quarters. As part of these actions we expect approximately $1.5 billion of annualized run rate saves over the medium-term related to our headcount reduction of approximately 7,000. In addition to the restructuring, we took approximately $260 million of repositioning costs largely related to our efficiency efforts across the firm, including a reduction of stranded costs associated with the consumer divestitures. The expected savings from these actions will allow us to continue to fund additional investments in the transformation this year. And relative to the prior year, the remainder of the expense growth was largely driven by inflation and volume-related expenses, partially offset by productivity savings. In the remainder of the year, we expect a more normalized level of repositioning, which is already embedded in our guidance. Therefore, you can expect our quarterly expense trend to go down from here in-line with our $53.5 billion to $53.8 billion ex. FDIC expense guidance. On Slide 8, we show net interest income, deposits, and loans where I'll speak to sequential variances. In the first quarter, net interest income decreased by $317 million, largely driven by markets, which resulted in a 4 basis point decrease in net interest margin. Excluding markets, net interest income was relatively flat. Average loans were up $4 billion, primarily driven by loans in spread product in markets, as well as card and mortgage loans in U.S. Personal banking, partially offset by declines in service. And average deposits were up nearly $7 billion, primarily driven by services, as we continue to grow high quality operating deposits. On Slide 9, we show key consumer and corporate credit metrics. This quarter we adjusted our FICO distribution to be more aligned with the industry reporting practices and now show our FICO mix using a 660 threshold. Across branded cards and retail services, approximately 85% of our card loans are to consumers with FICO scores of 660 or higher. And we remain well-reserved with a reserve-to-funded loan ratio of 8.2% for our total card portfolio. In our corporate portfolio, the majority of our exposure is investment grade, which is reflected in our low level of non-accrual loans at 0.5% of total corporate loans. As a reminder, our loan loss reserves incorporate a scenario-weighted average unemployment rate of approximately 5%, which includes a downside scenario unemployment rate of close to 7%. As such, we feel very comfortable with the nearly $22 billion of reserves we have in the current environment. Turning to Slide 10, I'd like to take a moment to highlight the strength of our balance sheet, capital and liquidity. We maintain a very strong $2.4 trillion high-quality balance sheet, which increased 1% sequentially. Despite this increase, we were able to decrease our risk-weighted assets, reflecting our continued optimization efforts and focus on capital efficiency. Our balance sheet is a reflection of our risk appetite, strategy, and diversified business model. The foundation of our funding is a $1.3 trillion deposit base, which is well diversified across regions, industries, customers, and account types. The majority of our deposits, $812 billion, are corporate and span 90 countries. Most of our corporate deposits reside in operating accounts that are crucial to how our clients fund their daily operations around the world. In most cases, we are fully integrated in our client systems and help them efficiently manage their operations through our three integrated services, payments and collections, liquidity management, and working capital solutions, all of which greatly increased the stickiness of these deposits. The majority of our remaining deposits, about $423 billion, are well diversified across the private bank, Citigold, retail, and wealth at work, as well as across regions and products. Now turning to the asset side. Over the last several years, we've maintained a strong risk appetite framework and have been very deliberate about how we deploy our deposits and other liabilities into high quality assets. This starts with our $675 billion loan portfolio, which is well diversified across consumer and corporate loans. And the duration of the total portfolio is approximately 1.2 years. About one-third of our balance sheet is held in cash and high quality, short duration investment securities that contribute to our nearly $1 trillion of available liquidity resources. And for the quarter, we had an LCR of 117%. So to wrap it up, we are active and deliberate in the management of our balance sheet, which is reflected in our high-quality assets and strong capital and liquidity position. On Slide 11, we show the sequential CET1 walk to provide more detail on the drivers this quarter. First, we generated $3.1 billion of net income to common shareholders, which added 27 basis points. Second, we returned $1.5 billion in the form of common dividends and share repurchases, which drove a reduction of about 13 basis points. Third, we saw an increase in our disallowed DTA, which resulted in a 10 basis point decrease. And finally, the remaining 6 basis point benefit was largely driven by a reduction in RWA. We ended the quarter with a preliminary 13.5% CET1 capital ratio, approximately 120 basis points, or over $13 billion above our regulatory capital requirement of 12.3%. That said, our current capital requirement does not yet reflect our simplification efforts, the benefits of our transformation, or the full execution of our strategy, all of which we expect to bring down capital requirements over time. So now turning to slide 12. Before I get into the businesses, let me remind you that in the fourth quarter we implemented a revenue sharing arrangement within banking and between banking services and markets to reflect the benefits that businesses get from our relationship-based lending. The impact of revenue sharing is included in the all-other line for each business in our financial supplement. In services, revenues were up 8% this quarter, driven by continued momentum across both TTS and Securities Services. Net interest income increased 6%, driven by higher deposit and trade loan spreads. Non-interest revenue increased 14%, largely driven by continued strength across underlying fee drivers. In TTS, cross-border volumes increased 9%. U.S. Dollar clearing volumes increased 3%, and commercial card spend volumes increased 5%, all of which was driven by strong corporate client activity. In Securities Services, our preliminary assets under custody and administration increased 11% benefiting from higher market valuations, as well as new client onboarding. The growth in both businesses is a direct result of our continued investment in product innovation, the client experience, and platform modernization to gain share across all client segments. TTS continues to maintain its Number One position with large corporate and FI clients, and see good momentum in the commercial client segment, and we continue to gain share in Securities Services. Expenses increased 11%, largely driven by continued investments in technology and product innovation. Cost of credit was $64 million as net credit losses remain low. Net income was approximately $1.5 billion. Average loans were up 4% primarily driven by strong demand for working capital loans in TTS. Average deposits were down 3% as the impact of quantitative tightening more than offset new client acquisitions and deepening with existing clients. However, it is worth noting that we continue to see good operating deposit inflow. And services continues to deliver a high RoTCE of 24.1% for the quarter. On slide 13, we show the results for markets for the first quarter. Markets revenues were down 7% as lower fixed income revenues more than offset growth in equities. Fixed income revenues decreased 10% driven by rates and currencies, which were down 21% on the back of lower volatility and a strong quarter in the prior year. This was partially offset by strength in spread products and other fixed income, which was up 26% driven by an increase in client activity, particularly in asset-backed lending. And we continue to see good underlying momentum in equities, with revenues up 5% driven by growth across cash trading and equity derivatives. And we continue to make progress in prime with balances up more than 10%. Expenses increased 7%, largely driven by the absence of a legal reserve release last year. Cost of credit was $200 million, primarily driven by macroeconomic assumptions related to loans and spread products that impacted reserves. Net income was approximately $1.4 billion. Average loans increased 8%, primarily driven by asset-backed lending and spread products due to an improvement in market activity. Average trading assets increased 4% sequentially, largely driven by seasonally stronger activity in the first quarter. Markets delivered an RoTCE of 10.4% for the quarter. On slide 14, we show the results for banking for the first quarter. Banking revenues increased 49% driven by growth in investment banking and corporate lending and lower losses on loan hedges. As I previously mentioned, corporate lending results include the impact of revenue sharing from investment banking, services and markets. Investment banking revenues increased 35% driven by DCM and ECM, as improved market sentiment led to an increase in issuance activity, particularly investment grade, which is running at near record levels. Advisory revenues declined given the low level of announced merger activity last year. However, in the quarter, we participated in the pickup and announced M&A across sectors, including those where we've been investing, such as technology and healthcare. Corporate lending revenues, excluding mark-to-market on loan hedges, increased 34%, largely driven by higher revenue share. We generated positive operating leverage this quarter as expenses decreased 4%, driven by actions taken to right size the expense base. Cost of credit was a benefit of $129 million, primarily driven by changes in portfolio composition. The [NPL] (ph) rate was 0.3% of average loans, and we ended the quarter with a reserve-to-funded loan ratio of 1.5%. Net income was approximately $536 million. Average loans decreased 6%, as we maintained strict discipline around capital efficiency as we optimized corporate loan balances. RoTCE was 9.9% for the quarter, reflecting a rebound in activity, reserve releases, and continued expense discipline. On slide 15, we show the results for wealth for the first quarter. Wealth revenues decreased 4%, driven by a 13% decrease in NII from lower deposit spreads and higher mortgage funding costs, partially offset by higher investment fee revenue. We're seeing good momentum in non-interest revenue, which was up 11% as we benefited from higher investment assets across regions, driven by increased client activity, as well as market valuation. Expenses were up 3% driven by technology investments focused on risk and controls, as well as platform enhancements, partially offset by the initial benefits of expense reduction as we continue to right-size the workforce. Cost of credit was a benefit of $170 million, driven by a reserve release of approximately $200 million, primarily related to a change in estimate, as we enhanced our data related to margin lending collateral. Net income was $150 million. End of period, client balances increased 6% driven by higher client investment assets. Average loans were flat as we continue to optimize capital usage. Average deposits decreased 1%, largely reflecting lower deposits in the private bank and Wealth at Work, and the continued shift of deposits to higher yielding investments on Citi's platform, which more than offset the transfer of relationships and the associated deposits from USPB. Client investment assets were up 12%, driven by net new investment asset flows and the benefit of higher market valuation. RoTCE was 4.6% for the quarter. Looking ahead, we're going to improve the returns of our wealth business by executing on our three foundational priorities. As Jane mentioned, this will take time, but over the medium to longer term, we view this as a greater than 20% return business. On Slide 16, we show the results for U.S. Personal Banking for the first quarter. U.S. Personal Banking revenues increased 10% driven by NII growth of 8%, and lower partner payments. Branded Cards revenues increased 7%, driven by interest earning balance growth of 10%, as payment rates continue to moderate. And we continue to see healthy growth in spend volumes up 4%, primarily driven by our more affluent customers. Retail services revenues increased 18%, primarily driven by lower partner payments due to higher net credit losses, as well as interest earning balance growth of 9%. Retail banking revenues increased 1% driven by higher deposit spreads, loan growth, and improved mortgage margins. Expenses were roughly flat due to lower compensation costs, including repositioning, offset by higher volume related expenses. Cost of credit of approximately $2.2 billion increased 34%, largely driven by higher NCLs of $1.9 billion as card loan vintages that were originated over the last few years were delayed in their maturation due to the unprecedented levels of government stimulus during the pandemic and are now maturing. In branded cards, the NCL rate came in at 3.65%, in-line with our expectations. In retail services, the NCL rate of 6.32% was slightly above the high end of our guidance range for the full year and will likely remain above the range in the second quarter, reflecting historical seasonality patterns. However, given the persistent inflation, higher interest rates, and continued sales pressure at our partners, we now expect to be closer to the high end of the full year NCL guidance range for retail service. This expectation, along with the continued mix shift from transactors to revolvers across both portfolios, led to an ACL build of approximately $340 million. Net income decreased to $347 million. Average deposits decreased 10% and as the transfer of relationships and the associated deposits to our wealth business more than offset the underlying growth. RoTCE for the quarter was 5.5%. We recognize that this business is facing a number of headwinds from a regulatory perspective and from higher credit costs given where we are in the credit cycle, both of which are putting pressure on returns for the quarter and for the full year 2024. However, this doesn't impact our longer-term view of the business. We feel good about our position as a prime and lend-centric issuer. We will continue to take mitigating actions to manage through the headwinds, [lap] (ph) the credit cycle, and drive more value from retail banking and retail services, while improving the overall operating efficiency of the business, all of which will ultimately result in a higher returning business over the medium-term. On Slide 17, we show results for All Other, on a Managed Basis, which includes corporate other and legacy franchises, and excludes divestiture-related items. Revenues decreased 9%, primarily driven by closed exits and wind-downs, as well as higher funding costs, partially offset by higher revenue in Mexico. And expenses increased 18%, primarily driven by the incremental FDIC special assessment and restructuring charges, partially offset by lower expenses from the wind-down and exit markets. Slide 18 shows our full year 2024 outlook and medium-term guidance, both of which remain unchanged. We have accomplished a lot over the past few years and have made substantial progress on simplifying our business and organizational structure. The year is off to a good start as we are laser focused on executing the transformation and enhancing the business performance. These two priorities will not only enable us to be a more efficient, agile company, but a client-centric one that brings together the best of Citi to drive revenue growth and improve return. And we are on the path to reach our 11% to 12% return target over the medium-term. With that, Jane and I will be happy to take your questions."
},
{
"speaker": "Operator",
"content": "At this time, we will open the floor for questions. [Operator Instructions] Our first question will come from Mike Mayo with Wells Fargo. Your line is open. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. Well, you just finished your seven months of your org simplification and you said 7,000 positions go away with $1.5 billion of expense savings. So that's very concrete, but more generally after 20 years, 30 years, 40 years of matrix structure down to five lines of business, you're reporting these differently, you're talking about them differently. But the question that I think a lot of people have is, are you simply reporting these lines of business differently or are you actually running them differently? Thanks."
},
{
"speaker": "Jane Fraser",
"content": "Thank you, Mike, for the question. The simplification that we've just gone through, it is what we said it is. It is the most consequential set of changes, not only to the organization model that we have, but how we run the bank. It's aligned the structure with the strategy. It's simplified the bank, it's eliminated needless complexity. It's created greater transparency into the five businesses and their performance, as you can see. It's increased accountability. And very simply, it's just easier for our people to focus on our clients, but also getting things done and the execution that we have ahead of us. So maybe if I try and bring this a bit more alive. The first thing we did was we elevated the five businesses and that eliminated the ICG and PBWM layer. And we brought all the elements that the businesses needed to run end-to-end under the direct management of those five business heads, an example being operations. And -- it's enabled transparency, greater accountability, and this end-to-end and total P&L focus, so focus on the bottom-line and the returns, driving growth, expense discipline, et cetera. We also right place businesses to align with the strategy. So banking, all being under one umbrella, the investment bank, the corporate bank, commercial bank, really helping us drive synergies there. Putting finance, F&S and securitization into markets so that we have a unified spread product there, also beginning to see the benefits of that this quarter. So that's an example on the businesses, but I do want to highlight a couple of other areas around this change. So by eliminating the regional layer and putting in a far slimmer, lighter management structure in place in the geographies. That's enabled us to make sure that our countries are focused on client delivery and legal entity management. And we've eliminated the whole shadow geographic P&L. We've eliminated a large number of committees in the geographies. And this is where a lot of the functional and management roles were streamlined and eliminated through the last seven months. And we also broke the regions into smaller, lighter clusters. And that allows us to much better capture the big changes in trade flows and financial flows, et cetera, we're seeing around the world. It's just much nimbler. The third piece, we created the client organizations. So that organization makes sure that our core capabilities and disciplines are being applied firm-wide to drive revenue synergies. And then the governance has got a lot easier. It took up a lot of time. And we've given much clearer mandates in that we've more than halved the number of committees. That's 200 committees plus that we've eliminated in the firm, either by consolidating them or eliminating them. The spans and layers, if you exclude me, 98% of the firm now operates within eight layers. That is a much, much faster decision-making. It's much quicker to get execution done. It also means that you can very quickly get closer to where the engine [room] (ph) of the firm is. We've got clearer accountabilities, we've eliminated most co-heads, we've reduced matrix reporting, we've got the producer to non-producer ratio improved. So all of this really means, as I've said, a clearer deck, so we can be laser-focused on business performance in those five businesses and the transformation. It already feels different. Around my table, I'm much closer to the businesses and the clients. It makes it much easier for Mark and I and the rest of the team to run the bank like an operator versus the head of a holding company. You don't have to go through these aggregator layers to get things done. And we're done, as we said we would be at this point, we're wrapping up the final consultation period, not an easy few months with the organization. We've had to say goodbye to some very good people. We put a lot of change through the organization. And now as we close the chapter on this, we look forward to being back in BAU mode, again continuing to drive improvements in simplification and processes and alike. But now the focus is going to be really getting the full benefit from all the changes we've made in business and organization and moving forward."
},
{
"speaker": "Operator",
"content": "Our next question is from Glenn Schorr at Evercore. Your line is open. Please go ahead."
},
{
"speaker": "Glenn Schorr",
"content": "Thanks very much. Yes, so I think it shows how much you've helped us, see the simpler organization. I think people have totally bought into the expense story, so a lot of credit for you guys. I think where I personally and others still have questions on is, on the revenue side and getting to those 4% to 5% medium-term targets. So could you take us just conceptually where we're going to -- where you think you'll drive that growth from this baseline where we're at now? And if you want, you can totally use my second question in there and tell us what good things you're doing inside the Investment Banking line to help tease out one of the [industry] (ph)?"
},
{
"speaker": "Jane Fraser",
"content": "It's not that one in, Glenn. So I'll kick off with some of this, pass it to Mark and then I'll come back to banking. So look, we are laser focused on the growth and improving the returns of these businesses to where they should and will be in the medium-term. And it's not just the growth story, but let me anchor it in those medium-term return targets. In services, we want to continue around the mid-20s in RoTCE. Banking should be getting to around 15%. Markets 10% to 13%. So we'd like to see at the higher end of that range. USPB getting that back to the mid-teens and then moving on to the high teens in the medium-term. And then lastly, as Andy and Mark have talked about getting wealth to a 15% to 20% return in the medium-term, but the goals to the mid-20s in the longer-term here. And we're confident that our strategy is going to drive the revenue growth of 4% to 5% CAGR in the medium-term. And that's a combination of maintaining our leadership in certain businesses, gaining shares in others. We have good client growth. Look at our win rate for example in TTS at over 80%. We've got our commercial bank also bringing in new clients in the mid-market and helping them accelerate their growth and success around the world. But Mark, let me pass it over to you."
},
{
"speaker": "Mark Mason",
"content": "Sure. And good morning, Glenn. And we appreciate the acknowledgement around the expenses. As you know, we've been quite focused on that and working hard to ensure that we deliver on what we say, we're going to do there. I'd point on the revenue line, I'd first point to, if you look back since Investor Day, we've in fact been able to deliver on the guidance that we've given for the medium-term, so that 4% to 5% top-line growth. And yes, it was a different rate environment, but that growth that we delivered over the past couple of years has been a mix of both revenue and underlying business strength. As you think about the guidance we talked about for this year, we talked about the NII ex-markets being down modestly. And so what that means is that the momentum and the growth that we expect is going to come from the non-interest revenue. And I think this quarter, is a good example of where and how that’s likely to play through. So the revenue topline being up 3 plus percent. But when you look through each of the businesses and if you look on each of the pages where we disclosed the revenue, you can see the underlying NIR growth in the bottom left hand corner of each of those pages that's coming through as well. So security services up 14% with growth in both TTS between cross-border clearing commercial cards, but also -- and security services, right, with the growth that we're seeing from continued momentum in assets under custody. We expect that trend to continue with existing clients and more -- and new clients, as well as how we do more with our commercial market -- commercial middle market business excuse me. So NIR growth there, the investment banking pieces, the other driver of fees, we’re seeing that while it start to rebound, we’re part of that rebound, the announced transactions were part of those in sectors that we've been investing in. We're bringing in new talent to help us realize and experience that. And even in wealth, where we're not pleased with the top-line performance this quarter, down 4%. When you look through that, we do have good underlying NII growth in the quarter in wealth, and that's up 11% year-over-year. And it's in the area that Andy and the team is leaning in on, which is investments, and not just in one region, but across all the regions. And then finally, the USPB piece, which is showing good NII growth as well. So the long and short of it is that the 4% growth that's implied in $80 billion to $81 billion, is going to be continued momentum, largely in fees, helping us to deliver for our clients and make continued progress towards that medium-term target."
},
{
"speaker": "Jane Fraser",
"content": "So let me pick up the [side] (ph). I'm sure Jenn Landis will give us the evil eye for sneaking in a second question there, Glenn, but let me pick up on banking and what's going on there. So we have a very clear strategy that we've been executing over the last couple of years, really to lay the foundation for growth in banking. North America is our key priority. It's the biggest contributor to the global IB wallet. Tech, health care, and industrials are likely to constitute over 50% of the fee wallet going forward. So we have better aligned our resources to position the franchise for this, defending areas of traditional strength in industrials and the like energy, whilst investing in high-growth sectors such as healthcare and technology with some strong talent. Financial sponsors are sitting on $3 trillion of estimated firepower, which they are incentivized to deploy. So they're likely to be between 20% to 30% of global investment banking fees. We have great relationships with this community. We have built that over years and decades. You are going to see us more active in the LevFin space, in the right situations for our key clients, and we will continue to ensure we are well-positioned to active around this important opportunity. You'll likely see us seeking to remain competitive in the private capital asset class, that can be an important source of liquidity for many clients. And the middle market will be fertile hunting ground for corporates and private equity. And our investment bank and commercial bank are going to be closely coordinated to harvest the deal flow around the world. And indeed, the new org structure that I was just talking about really enables us to drive a more joined-up, client-centric strategic coverage across corporate, commercial, and investment banking. So over and above the wallet recovery, Mark and I can be very laser focused on ensuring that we're driving revenue growth from a more holistic focus on the wallet share across flow and episodic activity. Vis Raghavan is the right person to take over at this important moment for our banking franchise. The momentum that we've been generating with the foundations we've been laying, the intention here from him is to accelerate that. He will focus on increasing our performance intensity, driving productivity and discipline growth and he will keep us firmly on the path towards delivering on our commitments, fundamentally improving the operating margin, generating higher returns and that all-important fee revenue."
},
{
"speaker": "Operator",
"content": "Our next question is from Betsy Graseck at Morgan Stanley. Your line is open. Please go ahead."
},
{
"speaker": "Betsy Graseck",
"content": "Hi, good morning. Or, yes -- we're almost pinging into the afternoon here."
},
{
"speaker": "Jane Fraser",
"content": "Hi Betsy."
},
{
"speaker": "Mark Mason",
"content": "Great to hear you, Betsy."
},
{
"speaker": "Betsy Graseck",
"content": "I guess a couple of questions. Well, I know we talked through the institutional securities business already on moving that expense ratio a little bit. Could we dig in a little bit on the wealth side, because the expense ratio there is running a little higher, and so it would be useful just to understand the pace or speed or timeframe when we should expect to see that start to inflect?"
},
{
"speaker": "Jane Fraser",
"content": "Yes, absolutely. And some of it, just as a reminder, the actions that we've been taking on org simplification and that Andy's also been taking in the wealth business. We will work through notice periods in the coming weeks, and so you'll see the impact coming through in our headcount numbers, and in wealth and the expense base next quarter. Look, As Mark said in his opening and Andy's been talking about, this should be a sort of up to a 30% pre-tax margin business. Andy's focused on rationalizing the expense base. He's also, as Mark said, turning on the growth engine, he's enhancing our platforms and capabilities to elevate the client experience. The heart of the opportunity for us lies with our existing clients. They are an extraordinary client base, but they're under-penetrated. So [now] (ph) the operating efficiency is frankly going to be -- is going to come on the revenue side here. That said, Andy's taken a number of pretty decisive moves this quarter on the expense side. Mark, let me pass it over to you."
},
{
"speaker": "Mark Mason",
"content": "Yes, I mean, look, I think that the quarter expenses that you see of growth of 3% is not yet reflective of the work that Andy has been steadfast at. There is still some investment in there in technology and in the platform that's important, but I think coming out of the first quarter you'll start to see some of the reduction in expenses that's a byproduct of that work. And the work has been across the entire expense base in the wealth business. So that includes non-client-facing roles and support staff. It includes looking at the productivity of existing bankers and advisors. And those kind of reductions will start to play out in the subsequent quarters. I do want to point out, as Jane mentioned, this is a growth business for us. And so you can see on some of the metrics on page 15, the bottom left, some of those good signs of investment momentum. And I highlight that because as the expenses come down from some of those efficiencies, there will be a need for us to continue to invest and replenish low-performing or low-producing bankers and advisors with resources that actually can generate the revenues we expect and take advantage of the client opportunity that's in front of us. So long-winded way of saying, there's some operating efficiency upside for us for sure is a combination of the top-line and the expense we’re playing through the balance of the quarters in the year here."
},
{
"speaker": "Operator",
"content": "Our next question is from Jim Mitchell at Seaport Global. Your line is open. Please go ahead."
},
{
"speaker": "Jim Mitchell",
"content": "Okay, good morning. Jane and Mark, I very much appreciate the comments on your growth opportunities and driving growth, but revenues are often dictated by the macro that – it’s a little bit out of your control. Can you talk a little bit about the flexibility on the expenses, you have a range in 2026 of [51 to 53] (ph), So if revenues are coming in below the targets, is it, I guess, a, fair to assume you'd be at the very low end of that range, or is it -- and I think there is some revenue growth built in there. So is there some flexibility to the downside to try to get your targets in a tougher revenue environment? Thanks."
},
{
"speaker": "Mark Mason",
"content": "Yeah, look I mean with the top-line growth as you've heard us say, is a CAGR of 4% to 5%. We put that target out there [51 to 53] (ph) as a range of what we're working towards. We're given you a good sense of how we expect to get there with the $2 billion to $2.5 billion reduction by then. We've already signaled the $1.5 billion that's in front of us. The reality is that if there's softness in revenues, that's why we have a range. Obviously, the volume-related expenses would come down with any softness in revenue. And depending on the drivers of why that revenue is softening, we'd look at the investments that we're making across the business and make sure that those are appropriately calibrated for where we are in the cycle and what we're seeing on the top-line. With that said, we've got to continue to invest in the transformation. We're not going to compromise that. That's going to be something that we have to spend on to ensure we continue to get right. But that's kind of how the dynamic works. There's a top, we've got a mix of businesses that I think we've demonstrated resiliency around if you think about the past couple of years. And we expect for those to continue to drive some top-line momentum but we've got levers in case they don't."
},
{
"speaker": "Operator",
"content": "Our next question is from Ebrahim Poonawala at Bank of America. Your line is open. Please go ahead."
},
{
"speaker": "Ebrahim Poonawala",
"content": "Thank you. I guess just one question, Mark. Around capital. So you talked about [$13 billion] over the Reg. minimum. You could easily be doing 2 times the buyback you did in one quarter, if not more. I know you don't like to talk about out quarters, but give us a sense of, at least this quarter, should we expect the pace of buybacks to increase and if you could provide additional color as we think about the rest of the year would be greatly appreciated. Thank you."
},
{
"speaker": "Mark Mason",
"content": "Sure, look – and I've said it repeatedly, Jane has said it repeatedly given where we trade, we think buying back is smart and we'd like to do as much as we possibly can and -- as much as makes sense, in light of the uncertainty that's out there. We have run at about [$13.5 billion] (ph) this quarter. That does give us capacity above the [$13.3 billion] (ph). (Technical Difficulty) we want to make sure we can support the clients that want to do business with us, whether that be in markets or other parts of the franchise. And then there's still uncertainty out there about how the capital regulation evolves. The good news is, we are hearing kind of favorable things about how the Basel III endgame proposal could evolve, but that hasn't happened yet. It's not finalized. It's not in place yet. And so we want to see how that continues to play out. We're obviously in the midst of a CCAR process. We want to see how that evolves. And we'll continue to take the buyback decision on a quarter-by-quarter basis, but we recognize that there's an opportunity there and we'll get after it just as soon as it makes good sense for us."
},
{
"speaker": "Operator",
"content": "Our next question is from Erika Najarian at UBS. Please unmute your line and ask your question."
},
{
"speaker": "Erika Najarian",
"content": "Hi. Good afternoon. Hey. So, you know, clearly the theme of this -- that's emerging on the Q&A is, you know, a healthy skepticism about the revenue targets in-line with the, in light of the expense declines, which you know, it's not really as analysts, where we're sort of a little bit [parroting] (ph) what we're hearing from long-only investors that haven't yet you know jumped into the stock. So to that end I guess I'm going to ask Ebrahim's question differently then ask a question about card late fees. How are you balancing, clearly your valuation would demand that the buybacks be ramped up from $500 million, but growing revenues at a 4% to 5% CAGR, you know, would mean potentially some capital clawback into the business. I guess, how are you balancing that, especially given that the demand for buyback is louder at Citi than any other money center peer. And could you give us a sense of what card late fees are and, you know, how that would impact the $80 billion to $81 billion for the year, if we do get an earlier implementation in October?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, thank you, Erika. On the first part of the question, I just remind you and everyone else that we're playing for the long-term here, right? So we have set some medium-term targets. Obviously, Jane has re-casted the vision and the strategy. I think we're making very good progress against that. But we're playing for the long-term. And what that means is that we have to continue to invest in the franchise. It's why I've given you a range around the expenses at least in part. It's why I've continued to stress the importance of protecting the transformation and risk and control spend. And it's why, I started the answer to Ebrahim's question by saying that we want to be sure that we can match the client demand out there where the returns to do so makes sense. And so we are having to balance kind of the use of capital and other resources against that longer-term strategic objective and utilize it where it makes sense and generates good returns against the idea of returning that to shareholders. And so this will continue to do that. It's an everyday assessment. It's an everyday discussion with the teams. Frankly, it's why things like the revenue sharing has been put in place to intensify the discussion around the clients that we're using balance sheet with and ensuring that we're driving broader revenues across the platform. And so that's kind of how we're operating in terms of making that trade-off on a regular basis, in addition to obviously the broader regulatory environment that we're in. In terms of the second part of your question around late fees, we haven't disclosed kind of the dollar amount of the late fees. What I would say is that we did and have factored that into the $80 billion to $81 billion. And the only thing I'd add to that is, it did kind of -- it's being implemented a bit earlier than what we had assumed, but again, it's inside of the range of the guidance that I've given you for top-line revenue for the year."
},
{
"speaker": "Jane Fraser",
"content": "And also just as a reminder, 85% of our [two-CCAR] (ph) portfolios are prime. And in CRS, where you tend to see some of the lower income households, we do have that -- the economics of the fee change will be shared with our partners in CRS. So we want our customers to pay on time with a number of mechanisms to do so. But in terms of the economics, I think we, along with the rest of the industry, will be putting in mitigating actions over time, some of which we've already begun to implement."
},
{
"speaker": "Operator",
"content": "Our next question is from John McDonald at Autonomous Research. Your line is open. Please go ahead."
},
{
"speaker": "John McDonald",
"content": "Thanks. Mark, I was hoping you'd give a little more color on how you're feeling about the credit card charge-offs. You maintained the outlook for the year. You mentioned the higher end on retail services. You still feel like -- you'll see a peak this year and what kind of metrics are you looking at in terms of delinquency formation and seasoning to inform that view that you might see the peak in card charge-offs this year?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, thanks, John. We have obviously continued to manage this portfolio very actively. We've seen continued top-line growth, we've seen continued average interest earnings, balance growth. We've talked about how we expect for the cost of credit to normalize, and we've seen that continue to happen. The range that we've given on branded cards, we're inside of that range. When you look at the spend across the portfolios, the spend is really happening with the affluent customers more so than anything else. And so we're watching the lower income customer profile or customers that we have. But again, as Jane mentioned, we tend to skew to the higher end to begin with. Where we're really seeing the pressure is where I mentioned in terms of retail services. And so there, the current NCLs are higher than the high end of the full year range that I've given. But if you look back, that is not inconsistent with seasonality that we've seen in the past in that portfolio where the first two quarters are higher than the back half of the year, in part because of coming out of the holiday season and how losses tend to mature or materialize through that process. And so I’d expect to not only see them be higher than the average range in Q1, but also in Q2 before coming down. And then I still expect that in 2025, you tend to see them further normalize and come down a bit off of these ranges. But look, the reality is that we continue to watch it in the factors that are out there, that are important include how unemployment evolves, what happens with inflation, what happens with interest rates and those will be important factors as to how the loss rates continue to evolve over time. I think the final point I'd make, and I mentioned it in the prepared remarks, is that we have to remember that the loss rates in both portfolios reflect multiple vintages maturing at the same time. And you'll recall, and this is an industry dynamic, you know, through the COVID and pandemic period, losses were at an all-time low, payment rates at all-time highs, supported by government stimulus. And now coming out of that, we're seeing the COVID vintages mature albeit at a lagged pace from what would be normal. And we're seeing the incremental acquisitions that we've done, start to mature at their normal pace. And so these loss rates are exacerbated by that impact, and that's an important factor we can't lose sight of. But the bottom-line is that we're watching it. The macro factors matter. We feel good about the quality mix that we have and we'll kind of see how things evolve from here."
},
{
"speaker": "John McDonald",
"content": "Okay, and on the branded side, you still expect kind of the peak this year. You're still inside of the range for the full year and expect 2025, you could move lower on the branded charge-offs?"
},
{
"speaker": "Mark Mason",
"content": "Yes, I still kind of expect that trend line of peaking and then kind of moving a bit lower in branded."
},
{
"speaker": "Operator",
"content": "Our next question is from Ken Usdin at Jefferies. Your line is open. Please go ahead."
},
{
"speaker": "Ken Usdin",
"content": "Great, thanks. Can I follow up on the card line of thinking and just ask you, Mark, to talk a little bit about just cost of credit? We did still see some card-related build this quarter, even with the comments you just made and seasonal softer loan growth. So just from a bigger picture perspective, how do you think -- continue to think about reserve builds from here and how that informs your outlook for cost of credit?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, sure. Look, I think that, you know, when I think about the reserve builds, I think it's the same factors that come into play. So obviously the view on the macro is important. And right now, if you think about some of the key macro factors that impact the cards portfolio, the unemployment assumption weighted is about 5%, the downside is about you know 7% kind of weighted over the period. And so feel -- how that evolves will be an important factor. How [HPI] (ph) evolves will be, you know, important consideration here for this portfolio. But also what happens with volumes becomes a factor on reserve builds and how important or how much they increase or decrease. And then the final piece is mix, and it's kind of related to that revolver point. As we see the mix evolve from transactors to revolvers, that's going to play into how much of a reserve, from a lifetime point of view, we have to continue to build. And so it's -- why I mentioned on John's question, you know, the importance of looking at, you know, the interest rates looking at what's happening with inflation, watching the lower income customer base, because all of those things combined with how we think about the scenarios and the weighting will be a factor on the reserves. But I will say, Ken, as I sit here and think about what we have in the quarter, I feel very good about the reserve levels. The 8.2% for combined kind of, you know, ACL to loan ratio feels right for the mix of this portfolio, and we'll continue to watch it."
},
{
"speaker": "Ken Usdin",
"content": "Okay. And a separate question on TTS. That NII related to TTS has been remarkable with rising rates. This quarter, granted there was a lesser day and there could be currency stuff in there, the first quarter that it stepped back, I'm just wondering like where is that in its asset liability sensitivity, the TTS-NII, and what are your thoughts about that piece of the NII puzzle going forward? Thanks."
},
{
"speaker": "Mark Mason",
"content": "Sure. Yeah, I think I'd say a couple things. We do have some Argentina playing through the NII line. I will say that the best way to think about it is kind of the underlying beta activity. And we have seen, this is a corporate client, it is an institutional client, we have seen betas, particularly in the US, at kind of normalized or terminal levels and playing a bit through that. We are seeing betas outside of the U.S., continue to increase as it relates to the TTS client base. But all of that, again, is inside of the range that we've talked about. I don't expect to see kind of year-over-year growth on the NII line anywhere close to kind of what we've seen in prior years, prior quarters, just in light of kind of how the rate environments evolved and in light of kind of quantitative tightening – and tightening and the impact on deposit levels. The last point I'd make on this is, we will continue to drive and see growth as it relates to the operating deposits. And that'll be an important tailwind that kind of plays through."
},
{
"speaker": "Operator",
"content": "Our next question is from Vivek Juneja at JP Morgan. Your line is open. Please go ahead."
},
{
"speaker": "Vivek Juneja",
"content": "Hi, thank you. Jane, Mark, just a question maybe on Argentina. You had -- you've shown $100 million in NII, total net income benefit of $500 million after tax, so probably implying about $500 million, $600 million of non-interest income benefit. Which line item -- sorry, which segment did that come through and is that sustainable?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, look, there's a mix obviously of things that are driving that net income, including a tax impact on the heels of last year Argentina devaluation activity that's in that line. But the short answer is that you know if you think about the nature of the business that we do in Argentina, it is a big part of our institutional client relationships. And the primary activities include some of the TTS type of activities that we've talked about, so liquidity management payments, custody within the services business. And so you'd see a good portion of the activity in Argentina playing through the services business, some of it in markets as well, but again, the majority of the activity in services."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Thanks so much. Our next question is from Scott Siefers at Piper Sandler. Your line is open. Please go ahead."
},
{
"speaker": "Scott Siefers",
"content": "Hi, everyone. Thanks for taking the question. Mark, I think you touched on at least a component of this a couple questions ago, but maybe just broadly an update on your rate positioning. I guess I only ask because it looks like we might be starting to diverge in terms of global rate trajectories, if we potentially go, lower in Europe but higher here for a while. In the aggregate, do these kind of complicate your management or make you feel better or worse about the overall NII momentum for the company?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, let me try and take it in two pieces, I guess. So one is, if I think about how the rate implies have evolved from the three to six to now something a little bit north of one, in the context of what I expect for our performance. It doesn't have a material impact on the guidance that I've given of $80 billion to $81 billion. And in part, that's because, as I think about the timing for the planned cuts, which was generally backloaded, as well as some of the other factors that play through. So, you know, Argentina just announced a policy rate reduction yesterday or a couple of days ago. If rates are a bit higher for longer, we'll watch how the betas continue to evolve. I mentioned earlier the late fees for the cards business happened a bit sooner. Late fees are actually booked in our NII line and so those factors you know put me in a place where I feel like, there'll certainly be puts and takes around how that rate curves evolve, and therefore I'm very comfortable kind of leaving the guidance where it is. To answer your broader question in terms of kind of how we're positioned, you know, I'd point you to the 10-K that we have that's out -- and in that 10-K, we offer as we have before a number of IRE scenarios for plus or minus 100 basis points and what it means for our business. And if you look at it, you'll see that for the aggregate firm, for Citi, U.S. dollar and non-U.S. dollar, that we're asset sensitive. So as rates increase, we should see an increase in our NII performance. But if you look at the breakdown, and that's about, I think it was about a [$1.4 billion] (ph) or something in terms of the impact of that move. But if you look at the breakdown, what the breakdown will show is that for U.S. dollar, at this point, we're neutral. So if rates were to go up, rates were to go down, no material impact as it relates to our revenue. For the non-U.S. dollar, we're still quite asset sensitive, right. And so that should give you some sense for at that -- and we recognize the limitations with IRE, it assumes, you know, a 100 basis point parallel shift across the curve, the static balance sheet, et cetera. But that should give you some sense for the implications of the rate curve moves as it relates to our book of business."
},
{
"speaker": "Operator",
"content": "Our next question is from Gerard Cassidy at RBC Capital Markets. Your line is open, please go ahead."
},
{
"speaker": "Gerard Cassidy",
"content": "Hi Mark, hi Jane."
},
{
"speaker": "Jane Fraser",
"content": "Hi, Gerard."
},
{
"speaker": "Mark Mason",
"content": "Hi Gerard."
},
{
"speaker": "Gerard Cassidy",
"content": "Mark, can you share with us, there's been obviously a lot of conversation around the credit card charge-offs and the credit quality there. If we could shift over to the corporate side, which obviously is very strong. We've seen spreads narrow in the markets on high-yield corporate debt, leveraged debt, et cetera. It's very robust out there, but around the global geopolitical risk, do you think the spreads would be widening. Can you guys share with us what you're seeing in the corporate side in terms of competition, are underwriting standards getting a little weaker now, as people are trying to grow their books, what are you seeing on that front?"
},
{
"speaker": "Mark Mason",
"content": "Look, we're still seeing good demand for corporate credit. And what I'd say is that we've been very disciplined about where we want to play on the risk profile here. We've been very disciplined in terms of the investment grade, you know, large multinationals that we serve. And that hasn't shifted from an underwriting point of view. We have seen spaces like private credit pick up quite a bit. And that, I think, will continue to evolve. I think, importantly, as we think about our corporate lending activity, you'll note that, actually, we've been very disciplined about how we want to deploy balance sheet and part of that again is a byproduct of the revenue sharing that we've implemented where there's been healthy debate and discussion around the names that we want to continue to serve and whether they're positioned to take advantage of the broader platform that we have. And so I think the space will continue to evolve. I think there's been good, healthy demand, despite continued strong balance sheets. And part of that demand has been because of where rates are likely to go and continue to evolve. And I think we're well positioned to be thoughtful about that. But Jane, you may want to add a couple points to it."
},
{
"speaker": "Jane Fraser",
"content": "Yeah, look, around the world, the corporate client base and our commercial banking mid-market client base have very healthy balance sheets. And we're also seeing market access gradually opening up as well, which is also helpful for the quality issuers across all asset classes. We've seen both the issuers taking advantage as well as the investors. The deals are well oversubscribed. So that's also been beneficial as corporates think about their financing needs. The other piece I just pop out there as well is the recent large M&A announcements in multiple industries is a sign of rising confidence from CEOs and Boards. And active discussions are increasing as supportive capital markets create confidence as people think about larger strategic transactions. This is going to feed acquisition finance, bridge financing, and some of the higher margin capital markets and lending activity as well. So as we look forward, I think it's recognizing the shift in some of the drivers from companies just investing, refinancing, looking at where they can, diversifying their capital, raising in different quarters. But I just close by saying, I couldn't agree with you more about geopolitical risks and fragility. I think the market's too -- but it's too benign in its risk pricing on some of these factors."
},
{
"speaker": "Mark Mason",
"content": "Important for us to take …"
},
{
"speaker": "Operator",
"content": "Our next question is from Matt O'Connor at Deutsche Bank. Your line is open. Please go ahead."
},
{
"speaker": "Matt O'Connor",
"content": "Hi. In your prepared remarks, you talked about intensifying certain efforts regarding regulatory processes and data on Slide 4 here. And I was just wondering if you could elaborate on, you know, I guess what you're doing or trying to do differently on that front and if there's any meaningful financial impact. Thank you."
},
{
"speaker": "Jane Fraser",
"content": "Yeah, look, I think Matt, as we've talked about many times, the transformation is our top priority. It will be for the next few years. It is foundational for our future success, both in terms of delivering the strategy and the medium-term financial path. And we've been making significant investments behind it, as well as not only in the consent order but also making sure we've got this modern efficient infrastructure. We're currently deep into a very large body of work, upgrading our data architecture, automating manual controls and processes, consolidating fragmented tech platforms. And all of these help enhance our business performance more broadly, not just the risk and control in the medium-term. As I've said, though -- there are a few areas where we are intensifying our efforts, such as the automation of certain regulatory processes and data remediation, particularly related to regulatory reporting. We're committed to getting these right. The org changes will help us with execution and making sure that we have the impetus and everything that we need behind it, the investments that we need. We keep a close eye on execution, making sure we've got the right level of resourcing and expertise. And we'll invest what we need to do, to make sure that we address these different concerns. I can't go into much more detail in terms of our CSI, obviously, but – at [some day] (ph) this magnitude, you'd expect us to have some areas where we have good progress and others where we need to intensify efforts."
},
{
"speaker": "Mark Mason",
"content": "Yeah -- I mean, I think that's exactly right. But you'd also expect that in this type of environment and on the heels of the regional bank stress last year that we're looking at stress scenarios, we're enhancing our CCAR processes, we're enhancing our resolution and recovery processes, all of those things just to kind of -- to make sure that we're shoring up capabilities and you'd expect that across the industry quite frankly."
},
{
"speaker": "Operator",
"content": "Our next question is from Saul Martinez at HSBC. Your line is open. Please go ahead."
},
{
"speaker": "Saul Martinez",
"content": "Hi, good afternoon. I'll change tack a little bit here, but I'm curious if there's any update on the Mexican IPO, and more specifically I'm kind of curious how [set it stone] (ph) the IPO processes -- you will have a new administration and even if the candidate from same-party, she may have a less confrontational view the private sector, perhaps be more allowing a low bank -- local bank to extract value from buying a bank. And, you know, I guess if the facts on the ground were to change, would you be open to a sale potentially being back on the table? Because it does seem like this is a situation where a private market valuation could be higher and even materially higher than a public market valuation."
},
{
"speaker": "Jane Fraser",
"content": "The guiding principle that we have and we've had all along is making sure that we make a decision here that is in the best interest of our shareholders and makes the most sense for them. We are -- we never say never, but we are very focused on the IPO path here. We believe it is the right one for our shareholders. We are well on track in the path in Mexico. We are very pleased to bring Ignacio Deschamps in as the Banamex Chairman to help guide the IPO process. We announced the management teams for the two banks earlier this quarter. We're far down the path of the technological separation of both banks and then the full legal separation in the second half of the year. Obviously, the election is coming up fairly shortly, but we're not anticipating that we would be deviating from the IPO path. That is the path that we are on at the moment. I'll never say never, but we do believe that this is the right one. But we'll keep an eye on what's happening in Mexico as we always do."
},
{
"speaker": "Operator",
"content": "Our next question is from Chris Kotowski at Oppenheimer. Please go ahead."
},
{
"speaker": "Chris Kotowski",
"content": "Hello and thanks. Just a quick one for Mark. Previously you had talked about quote bending the cost curve, between the third and the fourth quarter of this year. And on this call I thought I heard you say, it's basically bent that second quarter should be down and we should be sequentially lower from here. So did it just happened six months earlier or is there still some other bending that comes late this year."
},
{
"speaker": "Mark Mason",
"content": "I'll take it. I'll take that."
},
{
"speaker": "Jane Fraser",
"content": "Damn. I wanted that one."
},
{
"speaker": "Mark Mason",
"content": "I'll take that. I mean I'll take the win, a downward trajectory from here through the end of the year in-line with the guidance of $53.5 billion to $53.8 billion. And so yes."
},
{
"speaker": "Operator",
"content": "Our next question is from Steven Chubak at Wolfe Research. Your line is open. Please go ahead."
},
{
"speaker": "Steven Chubak",
"content": "Hi, good afternoon. So Mark."
},
{
"speaker": "Jane Fraser",
"content": "Hello, Steven."
},
{
"speaker": "Steven Chubak",
"content": "Hi, Jane. Hi, Mark. I did want to ask on DFAST and SCB, just recognizing this will be the last opportunity before the results come out. The macro scenario Fed assumptions look quite similar to last year, but just given the significant transformation that's underway, repositioning actions which [admittedly] (ph) depressed earnings last year. I want to get a sense as to whether there are any [IDEO] (ph) factors that could result in greater SCB volatility in the coming exam and just broader thoughts on the longer-term trajectory for the SCB, just given the Org simplification efforts are underway."
},
{
"speaker": "Mark Mason",
"content": "Yes, Steven. The first part of your question is just impossible to answer, to be candid with you, right? We obviously have an internal base scenario we've run. We have a severely adverse scenario that we've run. We've provided a balance sheet as part of the submission, but ultimately, the regulators have to run through their models, the information that we've provided and that informs what happens with the stress capital buffer. And we don't have as much transparency to that as we'd like. And so really hard to call at this stage. The second part of your question, I think is spot on, and I kind of alluded to in my prepared remarks, in that we have the medium-term targets that we've set. And we're still in the midst of kind of the execution of our strategy, the evolution of the business mix and the business model. The mix towards more consistent, predictable, and repeatable revenue streams that would impact PPNR, the simplification which obviously plays through an expense base that will be lower, when we get to that medium term period. So all of those things, the divestitures and kind of what that means and how that might impact the G-SIB score and the like, and the freeing up of capital, which we've already freed up, you know, $6 billion or so. And so all of those things have kind of yet to have been factored in. And we believe will be beneficial to the SCB over the medium term."
},
{
"speaker": "Operator",
"content": "Our next question is from Mike Mayo at Wells Fargo. Your line is open. Please go ahead."
},
{
"speaker": "Mike Mayo",
"content": "Hi. A follow-up, Mark. You said, TTS, we said -- we will have growth and operational deposits. And I was just wondering what gives you such confidence that you will or is that accelerating or the same pace or what?"
},
{
"speaker": "Mark Mason",
"content": "We have seen growth in the quarter, in operating deposits. The confidence comes from the focus that we've had with our existing clients, as well as the growth we've seen with new clients, doing more with existing and more countries, more deeply penetrating the commercial middle market space. And so we've been very thoughtfully focused on deposits that obviously give us the most value and also provide the most stickiness, as it relates to that relationship. And so yes, the confidence is rooted in what we're seeing in the way of underlying operating deposit growth, including inside this quarter."
},
{
"speaker": "Jane Fraser",
"content": "It's also a lot of the investments that we've been making, fuel a lot of the growth we've got. We have a market leading product innovations and those continue to drive good returns, good growth. If it's Citi Token Services, Citi Payment Express, 24/7 -- all of these different elements really mean that this business is utterly invaluable and indispensable to our clients. And the stickiness of the deposits, and the operating deposits comes with that. So we feel good about that growth. And you'll hear more about this as well, Mike, in the Investor Day in mid-June, which will be, I think we hope will be very helpful to everyone, so you really get your arms around how this business operates, makes money and see why we call it a crown jewel."
},
{
"speaker": "Operator",
"content": "Our next question is from Vivek Juneja at JPMorgan. Your line is open. Please go ahead."
},
{
"speaker": "Vivek Juneja",
"content": "Hi, Mark. A completely different topic because I think I understood your answer to be just for my previous question to be the tax benefits, so we'll leave it at that. I don’t know, if it is different, then I need to go down that path. But the question I signed on to ask was, you talked about the percentage of revolvers increasing from transactors in the private label and the retail partner cards. What is that percentage and how does it compare with what it was pre-pandemic?"
},
{
"speaker": "Mark Mason",
"content": "Yeah, I don't -- we haven't broken down the transactor versus revolver mix, and so I'm not going to get into that. I will say that the revolver levels are at least back to where they were pre-pandemic and leave it at that. But we are seeing kind of continued revolver activity which you'd expect kind of given the way the cycle has evolved and given payment rates have started to moderate and the stimulus has kind of unwound and so all of that is kind of consistent with expectations but obviously is a factor in reserve levels as I mentioned earlier."
},
{
"speaker": "Operator",
"content": "Our final question is from Betsy Graseck at Morgan Stanley. Your line is open. Please go ahead."
},
{
"speaker": "Betsy Graseck",
"content": "Hi. Thanks so much. I just wanted to make sure of one thing on the expenses. I know in the past you've talked about the fact that 1Q will be a little elevated with the restructuring, and you showed that was the $225 million in the quarter. And then when we look to 2Q, should we still be expecting a step down in 2Q? And is that step down just the elimination of the $225 million? Or is there some restructuring that we're likely to see in 2Q as well? In other words, should I just fade sequentially 2Q, 3Q, 4Q to hit your annual number? Or is there a bigger step down in 2Q that I should still be expecting here, thanks."
},
{
"speaker": "Mark Mason",
"content": "Sure, I think you should just fade it to answer your question very directly. But I'd also point out that, you know, in Q1, if you really look through to it, it has the $250 million of FDIC charge in it. And so when you back that out, we effectively are coming in lower than what we had guided. All right? Despite that, I'm telling you the same -- I'm making the same point, which is you can expect a downward trend from here through to the end of the year. And while there won't be additional restructuring charge, there will be the normal BAU activity around repositioning that plays through. So hopefully, that answers your question, Betsy. The guidance still holds and the downward trend is what we are managing towards as we kind of play out the balance of the year."
},
{
"speaker": "Operator",
"content": "There are no further questions. I will turn the call over to Jenn Landis for closing remarks."
},
{
"speaker": "Jennifer Landis",
"content": "Thank you all for joining us. If you have any follow-up questions, please call us and we look forward to talking to you. Thank you very much."
},
{
"speaker": "Operator",
"content": "This concludes the Citi First Quarter 2024 Earnings Call. You may now disconnect."
}
] |
cag | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning. This is Melissa Napier from Conagra Brands. Thank you for listening to our prepared remarks on Conagra Brand’s Fourth Quarter and Fiscal Year 2024 Earnings. At 9:30 AM eastern this morning, we will hold a separate live question-and-answer session on today's results, which you can access via webcast on our Investor Relations website. Our press release, presentation materials and a transcript of these prepared remarks are also available there. I'm joined this morning by Sean Connolly, our CEO, and Dave Marberger, our CFO. We will be making some forward-looking statements today. And while we are making these statements in good faith based on current information, we do not have any guarantee about the results we will achieve. Descriptions of our risk factors are included in our filings with the SEC. We will also be discussing some non-GAAP financial measures. Please see our earnings release and slides for the GAAP to non-GAAP reconciliations and information on our comparability items, which can be found in the Investor Relations section of our website. And I'll now turn the call over to Sean."
},
{
"speaker": "Sean Connolly",
"content": "Thanks Melissa. Good morning, everyone. Thank you for joining our fourth quarter fiscal ‘24 earnings call. I'll begin today's call by sharing some perspective on our fourth quarter and fiscal ‘24 performance, particularly in the context of our broader environment. Then, before I turn it over to Dave, I'll discuss how we're thinking about fiscal ‘25. Let's get started with the key points we want to convey on Slide 5. Overall, we demonstrated solid progress throughout fiscal ‘24 amidst a challenging consumer environment. In Q4, we continued to see positive impact from our investments to maximize consumer engagement with our brands. This again resulted in sequential volume improvement in our domestic retail business. We also saw strengthened share, particularly in frozen and snacks where our volume progress has been most meaningful. Even with these significant investments, we reported full year adjusted gross and operating margin expansion supported by productivity improvements across our supply chain. Further, our strong free cash flow enabled us to continue to reduce our net leverage ratio and strengthen our balance sheet consistent with our goals. Our progress in ‘24 reinforces the strength and resiliency of our business. We expect fiscal ‘25 to be a continued transition toward a normalized operating environment. That means a gradual waning of the challenging industry trends seen throughout fiscal ‘24, as consumers adapt and establish new reference prices. In light of this, we've prudently tempered our fiscal ‘25 outlook. We’ll provide more detail on that shortly. Let's turn to Slide 6, which provides a snapshot of our fourth quarter and full year 2024 results. Heading into fiscal ‘24, we knew that the consumer environment was challenged and it continued that way throughout the year. Against that backdrop, we remained agile, modified our plans, and made steady progress as the year unfolded. And while our ramped up investments pressured dollar sales, they delivered the desired impact on volumes, as I will unpack for you in a moment. We also reported adjusted gross margin expansion of 58 basis points and adjusted operating margin expansion of 34 basis points over the prior year period, a two year increase of 284 basis points and 159 basis points, respectively. Although we saw one year declines in organic net sales and adjusted EPS, our two year organic net sales and adjusted EPS CAGRs remained solid at 2.2% and 6.4%, respectively. Before I dive deeper into the fiscal ‘24 results, I want to share some perspective about our progress over the last five years, shown here on Slide 7. Our business today is substantially larger and more profitable than it was pre-COVID, and we've reported strong performance across each of our KPIs despite volatile market conditions. This reflects our efforts to deploy our playbook, which is focused on investing in our brands to sustain our share of mind and share of wallet with the consumer and drive profitable growth. As a result, we delivered an overall improvement in net sales, operating margins, and adjusted EPS. And our focus on maximizing free cash flow enabled us to reduce our net leverage from more than 5.5 times to less than 3.4 times, all while continuing to invest to make our brands stronger and far more resilient than they've ever been. That resiliency has been demonstrated more recently in the steady volume recovery we've delivered in our domestic retail business, illustrated here on Slide 8. We still have some work to do, but you can see how volumes recovered significantly in the second half of the year. We anticipate the consumer environment will remain challenging in fiscal ‘25, but our proven ability to navigate today's difficult operating environment reinforces our confidence in continued volume progress from here. Critically, we have seen strong improvement in volume consumption trends in our key domains of snacks and frozen. As you can see, snacks returned to growth in Q4 with frozen knocking on the door. The resiliency of our portfolio is particularly evident when compared to the broader market. Slide 10 shows our strong share gains throughout fiscal ‘24. As you can see, in Q4, approximately 65% of our portfolio held or gained volume share amid a slow environment, marking the fourth consecutive quarter of share gains. It's worth noting that our share performance is even stronger within our highly strategic frozen and snacks domains, where an impressive 80% of our brands have held or gained volume share. And as you can see here on Slide 11, our performance is highly competitive versus our near-in peers. Turning to Slide 12 and looking at the results from our single largest category, frozen single-serve meals. Our investments enabled us to drive steady improvement throughout fiscal ‘24, and in the fourth quarter, we returned to volume growth, significantly outpacing the category. In fact, that growth behind our enhanced investments across frozen single-serve meals has enabled us to deliver record share levels in the category shown here on Slide 13. Encouragingly, volume trends on Birds Eye frozen vegetables are also improving. Slide 14 shows Birds Eye’s volume sales have improved faster than the total frozen vegetable category on a quarterly basis. This is particularly evident in the fourth quarter, as our volume sales performance significantly outpaced that of the total category. To wrap up on frozen, I want to reiterate the steady, solid growth of this category over the past 40 years. I know I've shared this slide in the past, but it bears repeating as it's one of the many reasons we remain bullish on frozen. Frozen’s 4% CAGR is in the top tier of foods growing in in- home consumption over this extended time frame. Now turning to our snacks business on Slide 16. We saw strong momentum in the fourth quarter while trends in snacking were down across several of our competitors. This is largely due to our on trend snacking brands that span advantaged snacking subspaces like meat snacks, popcorn, and seeds. We've seen strong volume sales performance across each of these subcategories given the rise of protein and fiber-centric snacking, as brands like Duke's, David, and Angie's BOOMCHICKAPOP have enabled us to answer consumer demands for healthier on-trend snack options. Moving on to our staples domain on Slide 17. While we saw an overall improvement in volume sales in the second half, we were wrapping supply chain disruptions in chili and canned meat, resulting in a 17.5% volume increase in Q4. We also saw brand building investments drive volume growth in certain previously challenged refrigerated products. As a result, as we enter fiscal ‘25, we'll make further prudent investments to stimulate broader volume recovery in staples. Despite the challenging macro environment the past year, our innovation continued to resonate with consumers in a big way. Slide 18 highlights some of our innovation that we launched during fiscal ‘24, as well as some items that will hit store shelves in fiscal ‘25. The expansion of our Birds Eye brands to include delicious, culinary inspired products that appeal to a younger, more affluent household has seen significant success in the market. Consumers have also embraced our Banquet Mega chicken filets and Healthy Choice modern dinners, which cater to a greater variety of eating occasions. And finally, Wendy's Chili, delivering the flavors that consumers know and love from the QSR industry, became available at grocery stores nationwide, and it continues to perform very well for us. As I mentioned earlier, we delivered full year adjusted gross and operating margin expansion, thanks in large part to our successful cost savings initiatives and strong supply chain productivity. These strong productivity results helped fuel the significant brand building investments I've discussed here this morning. At the end of fiscal ‘24, savings as a percentage of cost of goods sold reached our long-term target of approximately 4%, and service levels improved close to pre-COVID levels at 97%. We also delivered substantial improvements in free cash flow and a five day improvement in our cash conversion cycle relative to the prior year period. As we look ahead to fiscal ‘25, we remain on track to deliver $1 billion of cost savings by the end of the year. Now looking at the year ahead, we anticipate the consumer will remain challenged in fiscal ‘25, but that we will gradually transition toward a more normalized operating environment as consumers adapt. Here are our key assumptions for fiscal ‘25. We expect our brands will continue to benefit from our ongoing strategic investments to maximize consumer engagement and drive further volume improvements. We'll continue to drive our cost savings and productivity initiatives and expect to achieve 4% cost savings as a percentage of cost of goods sold. This will help offset projected inflation and further enhance our competitive position. For fiscal ‘25, we anticipate adjusted gross margins will remain stable despite continuing our brand building investments. Further, while Ardent Mills is expected to deliver another strong year, it will not be at the level of a particularly strong fiscal ‘24. Turning now to our financial guidance for fiscal ‘25 on Slide 23. Again, our outlook anticipates both continued investment in our brands and a gradual waning of the challenging macro trends experienced by the industry in fiscal ‘24 as consumers continue to establish new reference prices. We view this stance as prudent. Accordingly, we are guiding to an organic net sales range of minus 1.5% to flat compared to fiscal ‘24; adjusted operating margin of approximately 15.6% to 15.8%; and adjusted EPS of approximately $2.60 to $2.65. Our steady progress in 2024, despite a difficult consumer environment, demonstrates the underlying resiliency of our business, and this reinforces our confidence to drive further volume improvement and margin expansion in fiscal ‘25. With that, I'll pass the call over to Dave to discuss our financials in more detail."
},
{
"speaker": "David Marberger",
"content": "Thanks, Sean, and good morning, everyone. As Sean discussed, we made solid progress throughout the fiscal year in a challenging consumer environment. I'll first highlight the full year results shown on Slide 25, before discussing the fourth quarter. Fiscal ‘24 organic net sales of $12 billion were down 2.1%, largely driven by the industry wide elongated volume recovery in our domestic retail business. Adjusted gross profit and adjusted operating profit both improved 0.3% over prior year, despite lower sales, as strong supply chain productivity helped offset cost of goods sold inflation, absorption impacts from our lower volumes, and the brand investments we made during the year. Advertising and promotion expense as a percentage of net sales was consistent with last year at 2.4%. Adjusted SG&A, which excludes A&P, was approximately flat to the prior year as general cost increases were mostly offset by lower incentive compensation expense. We delivered an adjusted operating margin of 16% and adjusted EPS of $2.67 for the fiscal year. And as Sean mentioned, we finished the year at a net leverage ratio of 3.37 times and improved our free cash flow by approximately $1 billion over fiscal ‘23. I'll now discuss our fourth quarter results, starting with our net sales bridge on Slide 26. Organic net sales declined 2.4%, driven by a volume decline of 1.8% and a 0.6% price/mix reduction, reflecting the increased brand building investments. We also saw a small benefit from favorable foreign exchange. Slide 27 outlines Q4 top line performance for each segment. Volume declines in our Grocery and Snacks and Foodservice segments were partially offset by volume increases in our Refrigerated and Frozen and International segments for the quarter. As Sean discussed, we made good progress in our snacks business as consumption trends were positive in the quarter, helping us gain share. In grocery, we've seen positive results in select areas where we've increased investment and innovation, and we continue to evaluate prudent investment opportunities in our grocery business to improve volumes moving forward. We are pleased with the volume inflection we delivered in Refrigerated and Frozen in Q4, demonstrating the consumer impact of our trade investments. Declines in Foodservice volume were driven by a slowdown in QSR traffic, along with actions we've been taking to eliminate low profit business, which is reflected in the strong operating margin performance in Foodservice that you will see shortly. Our International business delivered another strong sales quarter, with volume and price/mix both up year over year, driven by strong results from our Mexico and Global Export businesses. Overall, we are seeing some green shoots from our frozen, snacking and International volumes in Q4 and remain confident that our continued innovation, brand and trade merchandising investments will help this continue in fiscal ‘25. The components of our Q4 adjusted operating margin bridge are shown on Slide 28. Adjusted gross margin improved 62 basis points over prior year to 27.6%. Productivity improvements, which approximated 4% of cost of goods sold in the quarter, more than offset net inflation, which approximated 2.7% of cost of goods sold, which helped fund trade merchandising investments in our brands. Adjusted operating margin improved 22 basis points over prior year to 14.8%, driven by the adjusted gross margin improvement I just discussed, partially offset by increased A&P and adjusted SG&A. Slide 29 details our adjusted operating profit and adjusted operating margin performance by segment for Q4. Grocery and Snacks adjusted operating margin improved 220 basis points, aided by pricing taken earlier in the fiscal year and by a $7 million net benefit related to insurance proceeds for prior year lost sales from our canned meats recall. Refrigerated and Frozen adjusted operating margin declined 172 basis points from increased trade merchandising investments. International adjusted operating margins declined 283 basis points, mainly from transitory supply chain issues impacting our Canadian business, while Foodservice adjusted operating margins improved 427 basis points, a result of discontinuing less profitable business. As a reminder, results from our annual goodwill intangible impairment testing also negatively impacted reported profits, primarily in our Refrigerated and Frozen and Grocery and Snacks segments. The primary drivers of the impairment charges were a combination of higher interest rates, revised net sales projections, and some market multiple contraction seen throughout the industry. The adjusted EPS bridges for the fourth quarter and full year are shown on Slide 30. Fourth quarter adjusted EPS was $0.61, $0.01 less than prior year. Taxes were favorable in the quarter by $0.02, while a reduction in equity earnings from Ardent Mills was a $0.03 headwind. At the bottom half of the slide, you can see that our year over year EPS declined by $0.10, largely driven by $0.07 of headwinds from additional interest expense and a reduction in pension income versus the prior year, as well as a $0.05 headwind from Ardent Mills as that business moves towards a more normalized level of operations. Let me take a minute to talk about our 44% joint venture ownership in Ardent Mills. Ardent Mills is a premier flour milling and ingredient company. The primary business of Ardent is in the milling and selling of flour products at a margin. Most of the remaining business is commodity revenue that is generated by managing volatility in grain markets through trading operations. The decrease in Ardent's fiscal ‘24 results reflects slightly lower volume trends in the milling industry and a move towards a more normalized commodity revenue environment, which hit record levels in fiscal ‘23. Slide 31 reiterates the progress we've made to strengthen our balance sheet and improve cash flow. In Q4, we repaid a $1 billion senior note that matured in May 2024 through a combination of cash on hand, commercial paper borrowings and the issuance of a $300 million one year unsecured term loan. For the fiscal year, our ending net debt was $8.4 billion, a reduction of $777 million, or 8.5% from fiscal ‘23. We delivered strong year-over-year improvement in net cash flow from operating activities, primarily through reduced inventory balances and improved cash returns from Ardent Mills, generating $2 billion in net cash flow from operations and free cash flow of $1.6 billion, an improvement of approximately $1 billion over prior year. Capital expenditures increased 7% over prior year to $388 million. And we paid $659 million in dividends in fiscal ‘24. I'm very proud of these results, which reflect a focused commitment by the entire Conagra organization on cash flow. Reducing debt and lowering our net leverage ratio have been priorities for us. Slide 32 shows the consistent progress we've made, finishing fiscal ‘24 at a net leverage ratio of 3.37 times, well on our way to achieving our targeted 3.0 times leverage ratio by the end of fiscal ‘26. Sean already previewed the guidance metrics shown here on Slide 33. For fiscal ‘25, we are expecting organic net sales growth to be flat to down 1.5% versus fiscal ’24, adjusted operating margin between 15.6% and 15.8%, and adjusted EPS between $2.60 and $2.65. The considerations underlying our fiscal ‘25 guidance are shown on Slide 34. As Sean discussed earlier, we're encouraged by the steady volume improvement and market share gains we've seen from the investments put in place during fiscal ‘24, and we expect to continue these investments in fiscal ‘25. We are projecting approximately 3% net inflation in fiscal ‘25, capital expenditures of $500 million, and full year gross productivity savings of approximately $350 million, or 4% of cost of goods sold. We expect operating margin of 15.6% to 15.8%, which is down from 16% in fiscal ‘24. This decline is driven by higher expected SG&A in fiscal ‘25, mostly from higher incentive compensation expense, which was down in fiscal ‘24. We expect to generate a free cash flow conversion of approximately 90% and further reduce our net leverage ratio to approximately 3.2 times by the end of fiscal ‘25. We expect to resume a minimal amount of share repurchases in fiscal ‘25 to offset dilution from our share-based equity incentive plans. In terms of how we expect the year to progress, we expect Q1 to deliver the lowest volume, top line, and adjusted gross margin of any quarter. While we still receive the benefit from pricing put in place in fiscal ‘24, Q1 will be impacted by continued brand building investments and wrapping on our highest top line quarter in the prior year. We are planning for sequential volume improvement each quarter after Q1 to achieve our full year sales guidance. Also, SG&A in the first quarter will face a headwind from wrapping the Q1 fiscal ‘24 adjustment to reduce incentive compensation expense. This morning, we announced that our Board of Directors authorized the continuation of the company's annualized dividend rate of $1.40 per share, a 53% dividend payout ratio based on the midpoint of our fiscal ‘25 EPS guidance and in line with our targeted payout ratio. That concludes our prepared remarks for today's call. Thank you for your interest in Conagra Brands."
},
{
"speaker": "Q -",
"content": ""
}
] |
cag | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the Conagra Brands Third Quarter Fiscal Year 2024 Earnings Conference Call. [Operator Instructions] Note, this event is being recorded. I would now like to turn the conference over to Melissa Napier, SVP, Investor Relations. Please go ahead."
},
{
"speaker": "Melissa Napier",
"content": "Good morning. Thank you for joining us today for our live question-and-answer session on today's results. Once again, I'm joined this morning by Sean Connolly, our CEO; and Dave Marberger, our CFO. We may be making some forward-looking statements and discussing non-GAAP financial measures during this session. Please see our earnings release, prepared remarks, presentation materials and filings with the SEC which can all be found in the Investor Relations section of our website for more information, including descriptions of our risk factors, GAAP to non-GAAP reconciliations and information on our comparability items. Operator, please introduce the first question."
},
{
"speaker": "Operator",
"content": "The first question today comes from Andrew Lazar with Barclays."
},
{
"speaker": "Andrew Lazar",
"content": "I guess, Sean, based on scanner data, most expected, I think, some upside in grocery and snacks and maybe a bit more weakness in refrigerated and frozen -- this dynamic was certainly more extreme, I think, in the quarter than I think many had modeled. So I guess in Grocery & Snacks, Conagra had about a 4% benefit from price mix and that was well ahead of what we thought. So curious kind of what drove that. And then in Refrigerated & Frozen, you talk about success in single-serve meals but trying to corroborate how we sort of marry that with the 8% organic sales decline in that segment and maybe that's more of a function of refrigerated versus frozen in some way. So those 2 aspects would be really helpful."
},
{
"speaker": "Sean Connolly",
"content": "Yes. Let me unpack all of that for you, Andrew. As I said in the prepared remarks, things unfolded very much in line with what we expected. And as you heard us say, our investments in frozen have driven a nearly 7-point swing in our scanner volume from Q1 to the most recent 4 weeks where volume came in down a fairly modest 1.2%. So very strong progress in frozen overall which is important because that's been the focus of our investment. What you're seeing and the reason for the optics being a bit confusing is the reason the R&F segment in total numbers don't show the same magnitude of inflection is noise in the refrigerated part of the business which was, by the way, also consistent with what we anticipated. Recall, our refrigerated businesses are predominantly pass-through categories and one of the rare areas in our portfolio where we've actually experienced deflation and rolled back prices accordingly as pass-through categories do. And while that creates some short-term volatility in dollars until it's in the base as deflation passes through. Importantly, margins are preserved due to the lower COGS. The other dynamic that I'll point out there in RNF is, in addition to that piece, our table spreads business benefited in Q3 a year ago due to a large competitor having a particularly weak quarter due to supply chain challenges. So that's kind of some color on R&F and why the divergence between frozen and refrigerated. With respect to Grocery & Snacks segment, we also expected a solid quarter in the GMS segment and we got it. And there were several factors there from pricing in tomatoes to bounce back in canned meat like Chile, Vienna sausage, where you remember we had a recall in the year ago period but also strong innovation like our new Wendy's Chili, where we've grown significant market share. So overall, our grocery brands are great consumer options for people who are seeking to make convenient meals at a great value. It's also a good mix for us. But I think the big picture is one of the benefits of a scale, diversified portfolio is that, as they say, there are horses for courses. So you're inherently hedged when the macro environment is less stable than normal. Big picture for us. I like the volume momentum we saw in Q3. I like what I've seen so far in Q4 and I expect further progress from here."
},
{
"speaker": "Andrew Lazar",
"content": "Got it. Got it. And then I guess just lastly, obviously, volumes in the quarter were still down but a sequential improvement and that's obviously what the expected step-up in investment spend. So I guess you kind of talked to this a little bit but how would you characterize like the current volume momentum? And would you expect volume trends to inflect positively by the time we get to the start of FY '25? Or are dynamics still such in the broader industry that's a little bit hard to peg right now?"
},
{
"speaker": "Sean Connolly",
"content": "Well, it's one of the reasons why we're looking at this so closely. It's one of the reasons why I referenced the most recent 4-week scanner data in frozen being down a mirror of 1.2. We obviously are seeing and expect to continue to see further progress. We're not going to draw the line in the sand and say, this is the month, this is the day where it's going to -- it's going to cross over. Next quarter, obviously, when we give '25 guidance and have our annual operating plans fully rolled up, we'll give you that color. But it's moving in the right direction; that's the bottom line. I mean this is a food thing; everybody wants to see volumes go in the right direction. I think companies and investors are willing to see investment in order to do that. But what I think people want to see overall is, can you hold your gross margins while you're making those investments and getting the volume results that you want to see. And that's what was particularly encouraging to me in the quarter is we pretty much got -- we made the investments we intended to make -- we got the volume improvements that we wanted to see, we've got continued volume progress into Q4; and we've done all this while maintaining even expanding gross margins that we work very hard to kind of claw back after the initial compression from all the huge inflation we experienced a couple of years ago. So that, I think, is a positive and I think it foreshadows just continued momentum from here."
},
{
"speaker": "Operator",
"content": "The next question comes from Ken Goldman with JPMorgan."
},
{
"speaker": "Ken Goldman",
"content": "Just wanted to ask a quick question about 4Q. Your implied guidance might suggest around minus 2% in organic sales growth. It's pretty similar to what you posted in 3Q. Some might say it's a little prudent though. Just given -- you do have an easier comparison, both on 1-, 2-, 3- and 4-year basis, just looking that through, you have the lapping of the Americold issue. So I'm just curious if it's right to think that's a little bit prudent? Or are there may be some offsets to that, maybe a little bit of less of a help from mix perhaps just throwing that out there? Just trying to get a bit of color on those building blocks as you think about that."
},
{
"speaker": "Sean Connolly",
"content": "Ken, I'll make just a quick overall comment and flip it to Dave. But after the last 9 months of kind of elongated volume recovery, our posture has been one of, let's lean toward prudent because the macro environment has been more volatile than I think anybody expected. And so that's been our posture. That's why we didn't bake in anything heroic in our back half plans and I think that will continue to be our posture until we see a macro that is just inherently bouncer than it's been. But it's going in the right direction and that's good and I think we're in the -- I like the way we're set up for Q4. Dave, do you want to make any additional comments on Ken's point?"
},
{
"speaker": "Dave Marberger",
"content": "No, I think you pretty much hit it. I mean, Ken, we're expecting sequential volume improvement and we've been talking about that and we've seen it through but we also expect to continue investing. So obviously, both of those things impact the top line and you referenced mix, we do have mix impacts in this portfolio and they can be slightly positive or slightly negative any quarter. So as Sean mentioned, we want to be prudent but they are the 3 key drivers that get us to the -- towards the low end of the sales guidance range for the year."
},
{
"speaker": "Sean Connolly",
"content": "Yes. And just also to think about it this way too, Ken, is our fiscal ends in May which is kind of an odd month. But what's happening for us in May is our new innovation is rolling into the marketplace. We are focused at that point of the year, always on the next fiscal year and how do we build momentum in the next fiscal and peak events like Fourth of July, back to school. And so we're really getting so late in the year now that a lot of our attention is focused on getting these annual operating plans finalized and trying to set up next year to be as strong as possible, including around key dates and holidays and things like that."
},
{
"speaker": "Ken Goldman",
"content": "And then while we're talking about next year, I realize it's too soon to provide any kind of quantitative numbers, I wouldn't ask for them or quantitative information rather. But at CAGNY, you said you're doing what you can to be as close as possible to be on algo. And I was just curious where your level of confidence on that topic stood today? How you're thinking about maybe balancing what might continue to be a challenging consumer environment, I guess, with maybe what also could be some friendly top line comparisons, progress on cost savings, cash flow and so forth. Just trying to think directionally how you guys are thinking about that now?"
},
{
"speaker": "Sean Connolly",
"content": "Well, you're 100% right. We will give you our complete and total view of fiscal '25 on our next call. I think for this call, I think the key messages to our investors are. We are getting momentum on the volume line. We are moving kind of toward that Mendoza line here that everybody wants to see us cross over at some point. Exactly when that happens, as you've heard from other companies, I think you'll get more perspective on that in the coming months as people finalize their plans. That will be true of us. But make no mistake about it, we've been watching the consumer for their readiness to kind of re-establish well, their typical behaviors. And we've said we're willing to kind of nudge them along if we see that readiness. And so we've been methodical in not only monitoring their readiness but putting the investment out there to nudge them and measuring the response we very carefully. And we're getting a good response we're getting close. It's not as if the momentum is slowing, if anything, had accelerated in the last quarter. So I think all I can say at this point is I like the setup. We just have to continue to do more of what we've been doing, continue to drive it which is that mindset of volume is important but so is protecting margin. And that's one of the things in our materials today that you saw is why our supply chain team is so important. That work we've got going on in supply chain to really maximize cost savings, provides critical fuel for growth and we expect that to continue. And that's how ultimately, over the long haul, that's how we're going to drive volumes back positive again. We got a really tremendous stuff going on in supply chain with cost savings right now. And as you saw in our Chief Supply Chain Officer, L.A. Ely's [ph] presentation at CAGNY we are on track to implement our connected shop floor program in half our facilities in the next couple of years. And that is outstanding performance overall. If you look across the industry, that's a leading position in the industry and that will be key to margin expansion going forward. And so we're very excited about that work and the legs that it still has in front of us."
},
{
"speaker": "Operator",
"content": "The next question comes from David Palmer with Evercore."
},
{
"speaker": "David Palmer",
"content": "A question on Frozen. I'm curious, particularly on the frozen entrees which your thought there about a return to growth in sales in that business? And if there's any sort of juxtaposition that you would make between frozen entrees and frozen vegetables and how you view the challenges and opportunities for each and returning to growth?"
},
{
"speaker": "Sean Connolly",
"content": "Sure. David, you saw in the presentation today that in Q3 of '24, our frozen single-serve meal business achieved over a 51% market share which is up 1.7 points versus a year ago. And if you remember Tom McGough's comments from CAGNY, we have just -- we've become the leading frozen food producer in the United States, largely because of the success we've had in frozen single-serve meals over the last 5 years. So our performance there continues to be stellar and we continue to gain share. And by the way, I've made the comment many times that we under-index as a company in terms of competing with private label, Nowhere is that truer than in frozen single-serve meals. So for example, the entire size of private label in frozen single-serve meals is 1.8 points. Our business is 51.2 points of market share. And in fact, our growth in market -- unit market share in the last quarter was 1.7 points which is almost the total equivalent private label. So we like our position, our market and the market structure there. We like our brands and we feel great about it and it's been a growth juggernaut for us for the last 5 years and I see no reason why that won't continue. In terms of Birds Eye and vegetables, vegetables is one of the categories where earlier in the year, we saw consumers exhibit value-seeking behaviors. So for example, we saw some trade down from fresh and frozen vegetables to canned vegetables despite the obvious quality trade-offs. But Birds Eye is also one of the businesses that we are investing against with a clear focus on the superior relative value of frozen vegetables versus other choices. In fact, the advertising we're running now is directly comparative as I mentioned to you previously and features the clear benefit of our Stay Fresh flash freezing process which basically freezes time for the consumer and keeps our vegetables at the peak of freshness until the consumer is ready. So it's a clear advantage. And in the most recent 4 weeks of scanner data Birds Eye grew overall share even though our focus is really on the value-added tier. So we've got investments there. We've got momentum there and it's an important brand and you're not going to see us slow down on the marketing support and the innovation front."
},
{
"speaker": "David Palmer",
"content": "I just wanted to follow up on Ken's question. Maybe one way to ask how is what ways are you going to be really reviewing your business in the coming months as you contemplate how you're going to be guiding fiscal '25? Is it simply just volumes getting closer to flat overall in the business? Or are there any areas of the business you would be particularly focused on that you will be -- that will really help you think about how you guide for '25."
},
{
"speaker": "Sean Connolly",
"content": "Well, I think the way I think about it, principally, David, is we are an ROI-minded management team we are not bashful about putting investments out there to support our brands if they drive the impact that we want to see in the marketplace which in turn drives the return on investment. So where we are in our typical annual operating planning process is brand by brand, looking at the market fundamentals on what's happening within the brand dynamics, the competitive dynamics of the category, what do we know about the need for those consumers in those categories to have some kind of stimulus to kind of nudge them back to their normal behaviors. And what kind of lift can we expect. So we do that on a brand-by-brand basis and that ultimately leads to our investment profile. So we're in the midst of that right now. we are -- we've obviously run a lot of what you might consider to be test markets starting in Q2 in terms of those investments and understanding what those ROIs are. And we're racking it up right now. But I think what's encouraging is we are seeing responsiveness and we are seeing good ROI. And I think that bodes well going forward."
},
{
"speaker": "Operator",
"content": "The next question comes from Chris Carey with Wells Fargo."
},
{
"speaker": "Chris Carey",
"content": "One thing that did stand out was that the inflation impact to margins did get a little bit worse quarter-over-quarter -- can you just expand on that if that's driven by commodities, non-commodities, I think you mentioned tomatoes with respect to some incremental pricing. Just any context on what is driving that and if there are any nuances."
},
{
"speaker": "Sean Connolly",
"content": "Yes, I'll make a quick comment, Chris and flip it to Dave. Obviously, inflation has slowed but we're still in an overall inflationary environment and some things more recently have inflated and that has led to taking some price. So you get the benefit of that. But it also -- there's a lag effect. So we've kind of taken you all through that, the mechanics of how that works. And that's part of it, right? As you get -- when you get new inflation, you take new pricing, you got a bit of a lag effect, so you get a little bit of margin pressure in the early days while you're waiting for that to get reflected. And then you see a pretty rapid inflection from that point on. So that may be a piece of it, Dave, do you want to add more color to."
},
{
"speaker": "Dave Marberger",
"content": "Yes, just a little color. So Chris, yes, we -- our inflation rate as a percentage of cost of goods sold for the quarter was 2.9%. And which drive the 1.9% margin impact that you see in the materials. So we're still on track for -- we said full year approximately 3%. We're still on track for that, maybe a tick above that. But the inflationary areas you mentioned, tomato as we've talked about that, we've taken pricing. That was a big driver of the price mix in Grocery & Snacks for the quarter. We've also seen inflation in more broadly in vegetables in different ingredients and sweeteners starches. We have some inflationary areas. These things ebb and flow. We still -- and we've talked about this in the past, we still have inflation in our manufacturing operations, both with our labor and overhead and transportation is relatively flat, a little bit inflationary. So we're pretty much in line. It is slightly higher but generally, we're managing it to the full year expectation."
},
{
"speaker": "Chris Carey",
"content": "Okay. Perfect. Just -- and then a follow-up regarding the comment on pricing, just you mentioned tomatoes among other things, in the grocery and snacks business. How would you characterize the positive pricing there in the quarter? Was that due to your anomalies in the base period, anomalies in the quarter itself? Or are we looking at what appears to be a more durable positive price mix for that division from here on new pricing or lingering pricing which is now being fully reflected in the P&L. Thank you very much."
},
{
"speaker": "Dave Marberger",
"content": "Yes. I mean we obviously got the biggest benefit was from the tomato pricing and we saw the expected benefits there. The elasticities were good and in line with what we expected. We also did have a benefit of mix in the quarter. So our price/mix which was a little over 4% for the quarter, we did get a benefit of mix which contributed as well. And so a lot of our businesses in Grocery & Snacks are progressing as we expected. And so that's driving a good mix for us. So that was part of the equation as well in the quarter."
},
{
"speaker": "Operator",
"content": "Next question comes from Alexia Howard with Bernstein."
},
{
"speaker": "Alexia Howard",
"content": "Okay. So can I ask to begin with just about the productivity improvements in the food service channels. It seemed as though they were particularly strong this quarter. Is that likely to continue going forward?"
},
{
"speaker": "Sean Connolly",
"content": "It was definitely a strong margin performance for food service. There's been a little bit of weakness in traffic in food service but I'd say overall, it was a very good quarter. And I think that is just an example of the productivity and total cost savings performance we expect across the portfolio, Alexia. So food service has opportunities but we've also got opportunities across the international business and the retail business in the U.S. as well. So we expect strong continued cost savings performance across the total portfolio."
},
{
"speaker": "Alexia Howard",
"content": "Great. And then can I just hone in on private label in the frozen vegetable area. There seems to be some confusion out here about whether private label is becoming more of a problem just broadly or whether it's actually still fairly contained. Is there anything that you're seeing in terms of private label, either in frozen vegetables or more broadly that would suggest it's becoming more of an issue. Or is it really that the supply chain challenges have been overcome on the private label side but there doesn't seem to be any major red flags or anything on the horizon?"
},
{
"speaker": "Sean Connolly",
"content": "Yes. Let me frame that up for you. So you've got the big picture of how that works. Overall, as a company, we under-index, as I mentioned a few minutes ago, versus private label. That is obviously category specific. So there are some categories that have more private label. A good example is canned tomatoes, where you basically got Hunts, you've got private label and then you've got some kind of regional brands that are smaller in the area. One of the other categories where there is a larger piece of private label is frozen vegetables. But as you think about vegetables more broadly, vegetables are sold frozen. They're sold in the produce section and they're sold in the canned food section in the center of the store. And there's been a lot of movement between that as value-seeking behaviors have been out there. And one of that has been actually about 6 months ago, some trade out of frozen into can and we're seeing that come back. Within frozen vegetables Alexia, there are -- there's kind of the commodity vegetable tier -- and then there's the more premium steamer and then value-added tier which is soft season, things like that. For the last 2 years, we have been focused on building our business and our innovation pipeline in the premium value-added space and actually pulling back on the commodity veg space, doing more value over volume, as you've heard us talk before. And the reason for that is because that's a lower-margin business. Not surprisingly, it's more commodity oriented. So there's a role for us to play or there's -- that business plays a role for us as a company in terms of overhead absorption in our vegetable plants but our aspiration is not to be the world leaders and fastest growers in commodity veg tier within frozen because that's just arguably a bit of a misuse of our resources that we could people and otherwise but elsewhere because there's not much of a profit pool there. So it's important for us to maintain a certain scale of business there for overhead absorption purposes but that is not strategically where we play. When we look at frozen vegetables, we are looking -- and you can see in our innovation pipeline and more premium products and more value-added tier."
},
{
"speaker": "Operator",
"content": "The next question comes from Rob Dickerson with Jefferies."
},
{
"speaker": "Rob Dickerson",
"content": "Great. Sean, just, I guess, a question specific to frozen. I mean it sounds like the ROI on the investments have been attractive. You seem very kind of upbeat and encouraged to the momentum on the business. But at the same time, when we think about kind of what's happened in the quarter, doesn't really seem like a lot of that was driven necessarily by kind of upside, so to speak, within that volume component within Refrigerated and frozen. So I'm just curious, as you speak to those investments, are we talking kind of more promotional activity, you're doing better and better and bigger pack sizes. Just trying to gauge kind of what's like your perspective as to why the ROIs are good and kind of what you're doing right because optically, as we look at the number in the segment which does include refrigerated it's not really better and there was, I think, a little bit of an easier compare. So just trying to gauge -- get a little bit more color on that one piece."
},
{
"speaker": "Sean Connolly",
"content": "Yes. I think to not get too twisted up in the optics of the combined R&F segment -- if you look at -- I think it was Page 10 of our presentation today which was consumption in our consumer domains. That's really the key kind of evidence point of what we're seeing from our investments. So our investments have been heavily skewed towards frozen, as I mentioned, because that's a very strategic business for us. And that line -- that consumption line there in terms of volume change has moved from minus 7.8% in Q1 of fiscal '24 to minus 2.8% in Q3 '24 and in the most recent -- in the first month of the fourth quarter, that number is about a minus 1.2%. So that's when I referenced the nearly 7-point swing in consumption that we've seen over the last couple of quarters, that's precisely what I'm talking about. And that is a very, very meaningful move in terms of the category, I think you'll be hard-pressed to find a bigger move more broadly in food. What is creating the noise in the R&F segment data is the refrigerated which I don't have here for you broken out volumes dollars in the absolute which is a function of 2 things that I referenced. One is the rollback in prices because of the deflationary categories there and also the ramp that we had in one of our -- in our table spreads business. So that's really what's behind that. But the movement in the volume is the basis for the ROI comment that I made and you can see how that movement has come out, it's been very material."
},
{
"speaker": "Rob Dickerson",
"content": "And then just a quick question on gross margin, very simplistically. Clearly, I hear all your comments in the prepared remarks around productivity efficiencies, [indiscernible] pricing and grocery and snacks all positive. But I'm just curious like what changed relative to coming out of Q2, right, in early January? Because I think the commentary previously for the year was gross margin would probably be similar back half maybe relative to Q2 but now it seems like it will clearly be better in the back half relative to Q2 and that kind of took place over the course of 2 months. So it seems like something changed to the upside? I just like to know what that's all."
},
{
"speaker": "Dave Marberger",
"content": "Rob. So I think you'd agree that if you look over the last 6 quarters, there's been a lot of volatility in our supply chain. And so when forecasting gross margin, we want to be -- we want to make sure that we're considering all scenarios around operations. The fact of the matter is, is that if you look at a year ago, we had a lot of -- we still had a lot of things going on in supply chain with some recalls and some other challenges that we had that did impact the profitability. So as Sean talked about, our core productivity programs are on track. We're focused on the projects. We're executing -- so we're really seeing that benefit. The inflation is still coming in, we're still investing and you see those as part of margin. And we still have a headwind from absorption. So because the volumes are down. And importantly, we're driving inventory down. So our production in our plants has been down and we're managing that. That's been a headwind. But we haven't had any other disruptions like we've had the last couple of years in supply chain, given the environment that now we're able to -- we're really encouraged that we're able to make -- fund the investments we want to fund and execute our productivity programs and drive the gross margins that we're looking for. So one quarter doesn't make a year but we're really encouraged by what we saw this quarter and we're going to build on it."
},
{
"speaker": "Rob Dickerson",
"content": "All right. Super. Thanks, Dave. Appreciate it."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. And that concludes the conference call. Thank you for attending today's presentation. You may now disconnect."
}
] |
cag | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Conagra Brands Second Quarter Fiscal 2024 Earnings Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Bayle Ellis, Manager of Investor Relations. Please go ahead."
},
{
"speaker": "Bayle Ellis",
"content": "Good morning, and thanks for joining us for the Conagra Brands second quarter and first-half fiscal 2024 earnings call. Sean Connolly, our CEO; and Dave Marberger, our CFO, will first discuss our business performance, and then, we'll open up the call for Q&A. We will be making some forward-looking statements today. And while we are making those statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of our risk factors are included in the documents we filed with the SEC. We will also be discussing some non-GAAP financial measures, including adjusted numbers that exclude items, management believes, impact the comparability for the period referenced. Please see the earnings release and the slides for GAAP to non-GAAP reconciliations, and information on our comparability items, which can be found in the Investor Relations section of our website. I'll now turn the call over to Sean."
},
{
"speaker": "Sean Connolly",
"content": "Thanks, Bayle. Good morning, everyone, and Happy New Year. Thank you for joining our second quarter fiscal '24 earnings call. Let's start with the Q2 headlines, shown here on Slide 5. At a macro level, the industry-wide shifts in U.S. consumer behavior, that we discussed on last quarter's call, persisted into the second quarter. These behavior shifts continued to pressure volume and mix. However, while the consumer is still deploying some value-seeking tactics when they shop, we are seeing clear progress when it comes to volume recovery. In Q2, that progress was most notable in our Refrigerated and Frozen segment, in particular, our Frozen business. This inflection was helped by investments on key brands as we were seeking to understand consumer readiness to revert back to more typical purchase behaviors. We saw outstanding responsiveness that will inform our back-half actions. More on that in a moment. The net result was a clear improvement in volume trends, with domestic retail volume loss that was half of what we saw in Q1. We delivered solid margins and EPS, as well as excellent free cash flow conversion. Our productivity initiatives remain on track. Although, we also saw some absorption impact from our volume declines. As we look ahead to the second-half, we have a robust investment plan in-place, reflecting our increased confidence in consumer responsiveness to brand building levers. Our goal is to continue to build momentum with our consumers as we move through the back-half of the fiscal year, and then, enter fiscal '25 in a position of strength. I will share more on our multifaceted action plan in a few minutes. Finally, we are updating our guidance for fiscal '24, reflecting both the consumer environment and the additional brand investments in the second-half of the year. After tremendous initial resilience in the face of a record inflation super cycle, U.S. consumer behavior shifts did emerge last spring in our industry as the cumulative effect of inflation caused consumers to begin to stretch their budgets. This resulted in a reprioritization of food choices as shoppers adjusted purchase behavior towards more stretchable meals. This slide reprises some of those shifts we discussed last quarter. At that time, we told you that we expected these trends to be transitory. We still believe that to be the case. But the pace of the shift back to normal consumer behavior has been slower than we initially expected, and that pressured our volume, performance and mix in the second quarter. That said, the tide appears to be turning. When we discussed these behavior shifts last quarter, Frozen was one of our most impacted businesses, specifically, our frozen single-serve meals. After five years of consistent strength, we saw some consumers looking to alternatives such as multi-serve meals and scratch cooking to stretch their budgets. We didn't expect that trend to be lasting as the unshakable consumer demand for convenience, combined with Conagra driven product innovation, has generated strong Frozen demand for a long-time now. As I noted in my opening remarks, we believe it's important to understand consumer readiness to resume more typical shopping behaviors before more fully ramping-up investments to facilitate the process. We want to be confident that our investments will have the desired impact. With that in mind, during the second quarter, we did invest in certain key businesses to assess consumer response to increased brand building stimulus. Most noteworthy was our largest Frozen business, single-serve meals, where we deployed high-quality merchandising nationally. The results were very encouraging, with lifts up 60%. These lifts ultimately drove meaningful gains in our market share. As you can see on this slide, our Q2 share in this business approached 51%, eclipsing last year's gains and also setting a new record. The net of this is while the consumer is still stretched, they are responding to high-quality brand building stimulus. And when you look at volume trends, while not yet positive, you can see that progress is clearly underway. Slide 9 shows volume results in our key U.S. retail segments, both separately and combined. I'll draw your attention to the chart on the left, where you can really see the impact of our investment actions. As a result of these investments, Refrigerated and Frozen segment volume went from minus 10.5% in the first quarter to minus 3.3% in the second quarter, coming in-line with volumes in Grocery and Snacks. Overall, our targeted investments in Q2 helped cut the total domestic retail volume decline in half compared to the first quarter, not all the way back, but good progress. I'm also pleased to report that we continued to deliver momentum in our International and Foodservice businesses, which together account for approximately 18% of total Q2 revenue. International grew organic net sales by 5.6% in the quarter, while our two largest markets, Mexico and Canada, delivered organic net sales growth above 9%. This was a result of our International team's outstanding execution, including strong brand activation, improved point-of-sale performance, innovation that is resonating with our customers, and expanded distribution in Mexico. Our Mexican business has now delivered four consecutive quarters of volume growth. In Foodservice, we delivered organic net sales growth of 4.3% in the quarter, driven largely by favorable price mix as well as expanded distribution in our Frozen portfolio, which accounted for roughly half of our total Foodservice business. Slide 11 details our second quarter results, including organic net sales of approximately $3 billion, which is down 3.4% compared to last year. Adjusted gross margin of 26.9% was down 129 basis points from last year, reflecting our targeted investments and the absorption impact associated with the volume decline. Adjusted operating margin of 15.9% was down 108 basis points compared to last year and adjusted earnings per share of $0.71 was down approximately 12% versus last year. Importantly, we delivered strong free cash flow during the second quarter. Dave will cover this in more detail shortly. But as you can see on Slide 12, free cash flow in the first-half of fiscal '24 was almost six times what it was in the first-half of fiscal '23. We used some of that free cash flow to paydown debt, bringing our net leverage ratio to 3.55 times in the second quarter. As I mentioned earlier, we have a robust and multifaceted investment plan in-place for the second-half of the year, reflecting our confidence in consumer responsiveness to our brand building efforts. On Slide 13, you can see images from our new advertising investments, focused on our biggest brands, including Birds Eye, Healthy Choice and Slim Jim. You may have already seen some of the terrific work we've done this year with Slim Jim and the WWE, building on the heritage and built-in awareness of our long-term partnership with Wrestling Legend, Randy Macho Man Savage. Fiscal '24 is one of our biggest innovation slates yet. We are backing those launches with meaningful increases in slotting in-store and other sales support versus the prior year. Slide 14 highlights some of the exciting innovation we've recently launched. If we have any chili lovers on the call, I highly recommend our Wendy's Chili. You can get the true restaurant taste of this beloved Chili at home. Finally, Slide 15 highlights the investments we're making in high-quality merchandising. Our efforts are focused on reengaging consumers with our existing products to capture market share as well as introducing consumers to our new innovation. The targeted investments we made during the second quarter give us confidence that our multifaceted brand building investments in the second-half of the year will drive momentum going into 2025. We're updating our guidance for fiscal '24, reflecting both the consumer environment and the additional brand investments in the second-half of the year, our new guidance includes organic net sales decrease between 1% and 2% compared to fiscal '23, adjusted operating margin of approximately 15.6%, and adjusted EPS between $2.60 and $2.65. Overall, we remain confident in our brands, plans, people and agility, as we continue to navigate this shifting consumer environment. With that, I'll pass the call over to Dave to cover the financials in more detail."
},
{
"speaker": "Dave Marberger",
"content": "Thanks, Sean, and good morning, everyone. Slide 18 highlights our results from the quarter. Overall, our team executed well as we continue to navigate consumer behavior shifts that pressured our volume and mix. In Q2, net sales were $3.2 billion. As Sean discussed earlier, this reflects a 3.4% decrease in organic net sales, driven primarily from lower year-over-year volumes. However, this is the third quarter in a row, where the rate of volume change versus the prior year quarter improved. Amid these broader macroeconomic challenges and increased brand investments, we delivered solid margins and EPS, along with strong free cash flow during the second quarter. Adjusted gross profit decreased by 7.6% in the quarter as the positive impact from productivity initiatives was offset by cost of goods sold inflation, unfavorable operating leverage, lower organic net sales and increased trade investment. Adjusted operating profit decreased 9.3% and adjusted EBITDA decreased 7%, largely driven by the decrease in adjusted gross profit, partially offset by an increase in equity earnings, driven by continued strong operating performance in our Ardent Mills joint venture. We delivered Q2 adjusted net income of $341 million or $0.71 per diluted share. Slide 19 provides a breakdown of our net sales for Q2. The 3.4% decrease in organic net sales was primarily driven by the consumer dynamics just discussed. Further contributing to the decline was a 0.5% decline in price mix, which reflects an increase in strategic trade investments made during the period and an unfavorable mix impact from selling a higher percentage of lower sales dollar per unit items. This was partially offset by price increases taken on our tomato-based products, given the continued high inflation. We also saw a small benefit from foreign exchange, which is reflected in our net sales decline of 3.2%. Slide 20 outlines the top-line performance for each segment in Q2. While organic net sales were down in our domestic retail segments, we delivered sequential volume progress that benefited from the targeted strategic investments Sean discussed earlier. We also continued the strong momentum in our International and Foodservice segments, which delivered Q2 organic growth of 5.6% and 4.3%, respectively. Slide 21 shows our Q2 adjusted margin bridge. While our productivity initiatives remain on track, our margin was negatively affected by the continued impact of overhead absorption from our lower volumes. Cost of goods sold inflation was a headwind of 1.7% and price mix was a 0.6% headwind, which reflects the retailer investments made during the period. These factors, combined, drove the decline in adjusted gross margin for the quarter. Our adjusted operating margin benefited from small year-over-year favorability in A&P and SG&A. Slide 22 details our margin performance by segment for Q2. Adjusted operating margin in both our Grocery and Snacks and Refrigerated and Frozen segments decreased due to the margin drivers I just discussed, although inflation impacted the Grocery and Snacks segment at a higher-rate than Refrigerated and Frozen. We were pleased that our Foodservice adjusted operating margin expanded 193 basis points and our International segment's adjusted operating margin expanded 30 basis points, both driven by higher organic net sales and productivity, as both segments are showing consistent improvement. Foodservice also benefited from comparison to prior year Q2, which included supply chain disruptions. Our Q2 adjusted EPS performance of $0.71 was $0.10 below the prior year quarter, primarily from the decline in adjusted gross profit and pension income and higher interest expense. This was partially offset by slightly lower A&P and adjusted SG&A expense, along with increased equity method investment earnings driven by Ardent Mills. The A&P change was timing-related, as we expect to increase A&P spending in the second-half, and the decline in SG&A was primarily the reduction in incentive compensation versus the prior year. Slide 24 displays the significant progress we made in the quarter and first-half on free cash flow and our net leverage ratio. Over the first-half of fiscal '24, we delivered a $532 million improvement in free cash flow with a conversion rate of approximately 97%, the highest first-half conversion rate over the past five years. Our focus on managing inventory levels and improvement in accounts payable directly contributed to these strong results. In addition, we had strong cash distributions from Ardent Mills in the second quarter, reflecting the strong profit and cash flow performance of Ardent Mills the last few years. Our strong free cash flow has helped us deliver debt reduction during the period. At the end of Q2, our net leverage ratio was 3.55 times, reflecting debt repayment of more than $500 million over the last 12 months. Looking ahead to the remainder of fiscal '24, we expect to continue our debt reduction efforts as we prioritize our long-term leverage target of 3 times. We chose not to repurchase any shares in the quarter as we continue to prioritize paying down debt this fiscal year. We will continue to evaluate the best use of capital to optimize shareholder value as we progress through the fiscal year. As mentioned, we are updating our guidance for fiscal '24 to reflect our year-to-date results, expectations for the slower pace of volume recovery and the additional brand investments in the second-half. Slide 25 outlines our expectations for our three key metrics, including organic net sales to decrease between 1% and 2% compared to fiscal '23, with volumes continuing to improve through the back-half of the year. Adjusted operating margin of approximately 15.6% and adjusted EPS between $2.60 and $2.65. Turning to Slide 26. I'd like to take a minute to walk-through the considerations and assumptions behind our guidance. We expect net inflation to moderate through the remainder of the fiscal year, resulting in an inflation rate of approximately 3% for fiscal '24. Regarding pricing, there are a few dynamics currently at play. With our estimated 3% inflation rate, we are seeing areas that are still highly inflationary such as tomatoes and starches, which are up above the average, and areas that are deflationary such as edible oils and dairy, which are below the average. These dynamics have resulted in both inflation justified pricing actions and select pass-through price reductions included in our outlook. We expected - expect that these dynamics, combined with our increased second-half investments, will result in price mix being down versus prior year in the second-half. We now anticipate CapEx spend of approximately $450 million in fiscal '24, as we continue to make investments to support our growth and productivity priorities with a focus on capacity expansion and automation. As a result, we continue to expect to achieve gross productivity savings of approximately $300 million by the end of fiscal '24. We expect interest expense to approximate $440 million, primarily due to a higher weighted average interest rate on outstanding debt. While we do not expect to receive any benefit from pension income, we expect Ardent Mills to contribute approximately $170 million to our bottom-line due to its continued strong performance. Our full-year tax-rate estimate remains approximately 24%. As I discussed, we are prioritizing our debt reduction efforts and expect to further reduce our outstanding net debt in the second-half. Longer-term, we remain on track to reach our 3 times net leverage ratio target by the end of fiscal '26. That concludes our prepared remarks for today's call. Thank you for listening. I'll now pass it back to the operator to open the line for questions."
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Andrew Lazar of Barclays. Please go ahead."
},
{
"speaker": "Andrew Lazar",
"content": "Hi, good morning, everybody."
},
{
"speaker": "Sean Connolly",
"content": "Morning, Andrew."
},
{
"speaker": "Dave Marberger",
"content": "Morning."
},
{
"speaker": "Andrew Lazar",
"content": "Hi, Sean, I know that - I think, investor concern for the Group as a whole, right, has been sort of building that there would ultimately be a need for sort of greater price investment to deliver volume improvement, and that it could get to the point where it could start more negatively impact sort of margin profiles. So, I guess, my question is, how can we be comfortable that the investments being made are sort of ROI or value-enhancing rather than, let's say, money being spent to simply flatter volume at the expense of margins and sort of disrupt the broader competitive environment?"
},
{
"speaker": "Sean Connolly",
"content": "Well, I think, Andrew, in terms of how we think about return on investment, let me be very clear around what we are and what we're not doing in support of our brands. Number one, as you heard in our prepared remarks, we've got a multifaceted investment plan that spans advertising, innovation support, merchandising support and more. Number two, we've got an ROI mindset in everything we do. This Company has worked very hard to expand our operating margins over the last nine years and we did not get there by being frivolous. Number three, with respect to merchandising, I've consistently pointed out that there was room to do more in a high-quality way, operative words high-quality, now that the supply chain is humming again, especially on key brands and around key merchandising windows. And as you know, Conagra's merchandising today is very different from a decade ago. Our overall merchandising levels are below peers and our depth of discount is extremely reasonable. It's been, over the last several years, more of a frequency strategy. The last point I'll make is that part of our ROI mindset is understanding where the consumer is in terms of their readiness to reengage with more typical purchase behaviors and it was important that we test that a bit in Q2. And as you heard in our remarks, we liked what we saw. So, I think, all of this adds up to a deliberate plan in the second-half to smartly invest to build momentum with consumers, set ourselves up for a nice fiscal '25 and be very responsible in terms of the types of activities we engage in, and, again, it's everything from merchandising to advertise. But that - I think that's kind of the response I give it to the - that question."
},
{
"speaker": "Andrew Lazar",
"content": "Thank you for that. And then, the assumption, I think, it was that consumer behavior by now - or the initial assumption anyway, was that consumer behavior by now would have started to improve, and as you talked about, it seems the timing of that has been pushed out a bit. I guess, what are you embedding in terms of consumer behavior into your sort of new guidance at this stage?"
},
{
"speaker": "Sean Connolly",
"content": "Yes. Great question. Here's how to think about where we are big picture. Yes, the macro-environment has challenged volumes for the Group a bit longer than expected. And yes, we would all like to get back on growth algorithms ASAP. But in the simplest sense, before you can return to volume growth, you have to sunset the volume declines and get them into your base. And that's why we've been very focused on tracking volume trends. And as you saw in our deck, those trends have improved significantly, particularly, where we have invested to reengage lapsed consumers. In fact, Conagra's trend bend in Q2 has been one of the better ones in the Group. So, given the consumer response we saw in Q2, the associated increase in H2 investments and the easier comps we've got in H2, we fully expect that the volume declines will further sunset in the second-half. But to be clear, and to answer your question, we are not banking on a major improvement in the macro or are we signing-up for huge volumes. The goal at this juncture is to build momentum, move the volumes back toward growth as we approach fiscal '25, and make sure that we deliver along the way without signing-up for anything heroic. And I think that kind of best describes where we are."
},
{
"speaker": "Andrew Lazar",
"content": "Got it. Thanks so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Peter Galbo of Bank of America. Please go ahead."
},
{
"speaker": "Peter Galbo",
"content": "Hi, guys, good morning. Thanks for taking the question."
},
{
"speaker": "Sean Connolly",
"content": "Morning, Pete."
},
{
"speaker": "Dave Marberger",
"content": "Morning."
},
{
"speaker": "Peter Galbo",
"content": "Dave, just in your commentary around kind of price mix, both on the quarter and into the back-half of the year, I think, you spoke a bit about not only the incremental investment, but also just some of the pass-through nature. Just is there any way to elaborate more dimensionalize, just how much of the price mix decline is really that pass-through component relative to maybe some of the incremental investments you're making at retailers?"
},
{
"speaker": "Dave Marberger",
"content": "Yes. Let me try to give you some color, and kind of unwind the price mix. Let me start with Q2. So, our price mix for the quarter was minus 0.5%. There were several dynamics to that. So, if you start with our tailwinds. As I mentioned, we did take pricing. We thought we have high inflation in tomatoes. We took tomato pricing in our domestic retail and Foodservice business. We did have some other pricing in International. That was partially offset by some pass-through pricing we have basically in our oil-based businesses, which is our spreads business. So, when you net those together, pricing was actually a tailwind. So, it was positive in that price mix. The other component was investment in slotting. Slotting was pretty significant. This quarter, it was about 30 basis points year-on-year of investment to support our large slate of innovation, which we talked about in the prepared remarks. And other piece that was negative this quarter was mix. And this is simply selling a higher percentage of our lower sales dollar per unit item. So, for example, lower sales on a multi-serve meals like Bertolli relative to higher sales on the Banquet pot pie, that is just a negative sales mix. That's the timing thing, Peter. So, over the course of the year, that tends to work-out, but quarter-to-quarter it can flip a little positive or a little negative. So, that was negative in this quarter. And then, the remaining piece is the trade and merchandising investment. And that was less than the slotting investment for the second quarter. So, there is a lot in there that gets to that 0.5%. I did comment that in the second-half, we do expect price mix to be down. Those dynamics are pretty much the same. We would expect less negative impact from mix in the second-half and more increase in the, kind of, the trade and merchandising investment. So, the second-half price mix will be a little bit down a little bit more than we saw in Q2, but directionally in that in that area. So, that - hopefully, that gives you some color on price mix."
},
{
"speaker": "Peter Galbo",
"content": "Yes. No, that's very helpful. Thank you for that. And then, maybe just - secondly, like, on the leverage piece, guys, you have the bond that comes due in May. The leverage at least has kind of stabilized, but with the earnings coming down. Just how are you thinking about debt paydown on that $1 billion relative to refinance at this point as we kind of go-forward here?"
},
{
"speaker": "Dave Marberger",
"content": "Sure. So, we're always looking at all of our options. Obviously, we have our commercial paper. We have a lot of liquidity. As you saw in the first-half, our free cash flow was very strong. Usually, this Company, we don't deliver really strong free cash flow in the first-half. Our conversion is usually very low with all the free cash flow coming in the second-half. Well, given our focus on working capital and Ardent Mills cash distributions, we had a very strong first-half, and we expect the second-half free cash flow to be very strong as well. So, it puts us in a nice position, where come May, when the bond is due, we're going to have strong free cash flow. We have access to our commercial paper and then, obviously, we're always looking at the capital markets to see if there's an opportunity to refinance. Rates seem to be coming down. We watch them very closely. So, we look at all the options and we figure out what's the best combination. Maybe, we use our free cash flow to paydown some of it and refinance the other part. But we'll look at all our options as we go-forward. But - I like where we are, given our strong free cash flow."
},
{
"speaker": "Peter Galbo",
"content": "Great. Thanks, guys."
},
{
"speaker": "Operator",
"content": "The next question comes from Robert Moskow of TD Cowen. Please go ahead."
},
{
"speaker": "Robert Moskow",
"content": "Hi, thanks for the question. I guess, it's a two-parter. One is, I think, the guidance at the start of the year for advertising was to grow it as a percentage of sales to be consistent with what it was last year. And so, I guess, the first part of the question is, now that you've cut your sales guide, does that mean that the advertising - it sounds like you're keeping advertising the same, so does that mean that it will be higher as a percentage of sales for the year, or do you have to cut the A&P commensurate with the sales growth?"
},
{
"speaker": "Dave Marberger",
"content": "Yes, Rob. So, let me answer that a couple different ways. So, if you just look at the total year, our guide - our operating margin guide is approximately 15.6%, that's where we came in, in fiscal '23. And when you look at gross margin, you look at A&P and SG&A, we generally expect to be in-line with where we were prior year. So, to your question, if - we were 2.4% last year, if we come in again at 2.4% dollar-wise, that's a little bit lower than where we were, and we're still looking at that. There is opportunity to spend up if we want to. The way we look at it though is if you look at A&P first-half versus second-half, our A&P spending is going to be up around 20% in the second-half relative to the first-half. So, we're just looking at what's the run-rate on spend now and what is it going to be in the second-half to support the advertising that Sean talked about in our other kind of digital advertising that we've been doing. So, we feel good about the second-half and the trajectory of the A&P relative to the first-half."
},
{
"speaker": "Sean Connolly",
"content": "Rob, it's Sean. I'll just add a point on there. As we talk to our team about delivering this year, we said at the beginning of the year two things we're going to have to demonstrate as a team and those things are agility and resilience. And part of the agility piece, from the beginning of the year, has been really trying to understand the consumer readiness to resume more typical purchase behaviors after we saw some of the shifts emerge in the spring. And so, you may recall on last quarter's call, I mentioned that our assessment was that consumer wasn't quite ready to engage in that. So, we were fairly conservative in Q1 and Q2 in terms of deploying some of these dollars, because we wanted to kind of keep those funds for the back-half of the year where we had more confidence that the consumer was really going to be ready. And we - as we mentioned in our prepared remarks, we deliberately tried to assess that readiness in Q2. And we really - we're quite encouraged by what we saw. So, now that we've got - a lot of our powder is still dry for the back-half of the year, we've got some easier comps and we've got consumers that are demonstrating a real willingness to kind of reengage their more typical purchase behaviors with a little bit of a nudge from us across this multifaceted investment plan. We like where we sit in terms of the fullness of the support for the back-half of the year."
},
{
"speaker": "Robert Moskow",
"content": "Got it. Second part is, it sounds like you're very happy with the lifts you've seen in the promotional activity behind Frozen. Sean, can you speak more broadly about whether the food industry and retailers overall are happy with the lifts that they're seeing on a more broad-based basis? I think I hear kind of some dissatisfaction from certain big retailers about the lifts, and that the rollbacks haven't gotten the response that they fully expected. Is it possible to speak more broadly about what you're seeing?"
},
{
"speaker": "Sean Connolly",
"content": "Yes. I'll give you a sense of it, Rob, because we've got a pretty - we've got a pretty large scope here at Conagra. And so, if you look at where we invest and where we want to get good lifts, we're super selective, right. We pick our spots. We're not out there spending money trying to drive lifts on Manwich or business like that. We're driving lifts, we're focusing our dollars on those categories where we know the consumer really wants to buy the category. But for other reasons, particularly, the objective of trying to stretch their budget, they've made a short-term sacrifice, and that's the way they describe it to us when we talk to them. They're depriving themselves, they're sacrificing particularly on convenience items. So, if you look at a product, like Frozen single-serve meals, where we saw such tremendous lift in Q2, what you've got going on here is some consumers who were really financially stretched were basically forced to give up on some of that buying rate. They didn't stop buying the category. They reduced their buying rate and they started doing things like scratch cooking rice and beans and ground beef. They do not want to do that. I can assure you. I have been in food for 30 years. That's the last thing they want to do, and they don't like to cook, they don't like to clean, they don't like any of that. They'd rather be buying our stuff. But when they've got to make some short-term trade-offs, especially, over the course of the summer when they were spending their money on things like travel, they'll do it short-term. But when you give consumers with that kind of a headset, a bit of a stimulus to reengage, they're super responsive to it. But, again, not every category is created equal. So, if it's a - if it's more of a staple category, where there's another alternative, where they were trading down to a store brand, maybe you're not going to get a lift. But that's not the kind of investments we're talking about. Those are not the kind of events or categories where we're focusing our energy."
},
{
"speaker": "Robert Moskow",
"content": "Makes sense. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Pamela Kaufman of Morgan Stanley. Please go ahead."
},
{
"speaker": "Pamela Kaufman",
"content": "Hi, good morning. Happy New Year."
},
{
"speaker": "Dave Marberger",
"content": "Morning."
},
{
"speaker": "Sean Connolly",
"content": "Hi, Pam."
},
{
"speaker": "Bayle Ellis",
"content": "Happy New Year, Pam."
},
{
"speaker": "Pamela Kaufman",
"content": "Can you give some more color on the drivers behind your reduced top-line guidance for the year? How much of it is a change in your expectation for volumes versus greater price investment? And then, just - you mentioned that in the second-half, you'll see price declines. Can you frame the magnitude of the declines relative to the second-quarter?"
},
{
"speaker": "Sean Connolly",
"content": "Yes. Pam, it's Sean. Let me make just a quick comment upfront. I'll flip it over to Dave. The macro-environment that we talked about in Q1, I mentioned again today, it persisted into Q2. So, we've just seen fewer purchases in our first-half than we would have assumed at the beginning of the year. So, that's part of the call down the top-line. The second part of it is, I don't want to sign us up at this point for any kind of heroic volume recovery in the back-half of the year, because I think the mood of our investors is, let's be prudent, let's be up the middle of fairway, let's put some targets out there that are not making any grand assumptions that we can meet or beat. And that's kind of what's behind it, because we like the momentum we saw in the second-quarter. We have every intention of further driving that momentum in the second-half. And we have a high degree of confidence that we're going to get what we expect. And that - at this point, that's really what we're focused on, is fiscal '25 - setting up a really nice fiscal '25 and exiting this year with momentum. And the sales outlook that we've given for the balance of the last year, kind of, is right in that vein. Dave, over to you."
},
{
"speaker": "Dave Marberger",
"content": "Yes. So, Pam, if you just take the midpoint of our guide for the year on organic net sales, that implies a second-half organic net sales of minus 1%. And that's going to be a combination, based on the way we forecasted it and incorporating the comments - the important comment Sean just made, is a combination of price mix - slightly negative price-mix and slightly negative volume. The combination of those two to get to the minus 1% organic, that's H2. And that's improvement on total sales and volumes as we've seen Q1 to Q2, and then H2, we expect that improvement to continue, so that as - we continue to track towards growth by the time we get to the end of fiscal '24."
},
{
"speaker": "Pamela Kaufman",
"content": "Okay. Thanks. That's helpful. And then, just to clarify on the reduction in your operating margin guidance for the year. How much of that is a reflection of your expectations for lower gross margins versus increased operating expenses and more brand investment?"
},
{
"speaker": "Dave Marberger",
"content": "Yes. So, if you look at the second-half, gross margins - if you look at where we landed the first-half in gross margins, we were at 27.2%, I think, is our first-half gross margin. Our second-half should be generally in-line with that, maybe a little bit below that. So, the second-half, where you're going to see the reduction in operating margin is coming from the higher investment in A&P as a percentage of sales and the timing of SG&A being higher in H2 than it was in H1. So, that's really the second-half reduction in operating margin. So, when the dust settles and you look at the full-year, we've guided to 15.6% operating margin, that will be in-line with fiscal '23. And if you look at kind of where we land with margin A&P and SG&A, we'll be pretty close to where we were prior year."
},
{
"speaker": "Pamela Kaufman",
"content": "Got it. Thank you. That's helpful. I'll pass it on."
},
{
"speaker": "Dave Marberger",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Alexia Howard of Bernstein. Please go ahead."
},
{
"speaker": "Alexia Howard",
"content": "Can I ask about innovation, in terms of - I guess during the pandemic and also during the period of supply chain disruption, I imagine that the pace of innovation was dramatically reduced. How quickly is it recovering? Can you give us any numbers on how quickly the pace of innovation is likely to pick-up over the course of the next few quarters?"
},
{
"speaker": "Sean Connolly",
"content": "Sure, Alexia. So, let me take us back to kind of the pandemic for a minute. When we guide - hit with the pandemic, we fully expected that we would hit the pause button on innovation even though we had the pipeline ready to launch. To our surprise, our customers asked us in a very convincing way not to do that. And so, we slowed innovation launches modestly during the pandemic, but only modestly. And in fact, if you look at the amount of innovation we continued to put into the marketplace through the pandemic, it was probably the highest or among the highest in our peer group. So, we really didn't pause the way we expected. When we kept - we kept the momentum there since then. Last year was a much bigger launch, it was one of our biggest launches yet, and we had tremendous performance in terms of productivity per TPD and overall TPDs. And this year is perhaps our biggest innovation slate yet. So, the - we'll share some metrics when we're at CAGNY. Just to give you, kind of, what we track historically, we track this thing called renewal rate, which is a percentage of our annual sales. It comes from items we've launched in the last three years. 10 years ago, we were probably at 8%. And then, over the last five years, we probably hit a high watermark of 15%. So, that's kind of the ballpark we like to be in, is that 13% to 15% depending upon what we've got coming into the marketplace. And, again, this year is our biggest launch year yet. And we've also, as Dave pointed out, backed that with customer investments and slotting investments, both in the front-half and, very materially, in the second-half of this year. And we'll do the full parade of innovation for you in a month or so at CAGNY, so you can see it. We hit some of the highlights today in our prepared remarks. I think the fun one is this Wendy's chili business, because we're always focused on Frozen and Snacks around here. And this thing has just emerged from zero to be a major player in that category. So, more to come on that in CAGNY. But net-net, it's a very significant year for us on an innovation front."
},
{
"speaker": "Alexia Howard",
"content": "Great. Thank you very much. I'll pass it on."
},
{
"speaker": "Sean Connolly",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Nik Modi of RBC Capital Markets. Please go ahead."
},
{
"speaker": "Nik Modi",
"content": "Thank you. Good morning, everyone. So just two quick questions. Just - I don't think it's an impact, but all the drama going on in the Red Sea, I just want to make sure there's no issue with freight rates or some of the temporary specs that we're seeing that's the first question. And then the second question is just, Sean, I'd love your kind of observation of out-of-home versus in-home. It seems like it's a very mixed bag depending on what category or meal occasion we're talking about. But I just love your view because the thought is if the consumer is coming under more pressure, we should start seeing more in-home consumption, which should benefit you as the year kind of goes through. So I'd just love your thoughts on that."
},
{
"speaker": "Sean Connolly",
"content": "All right. So Nik, the first one is easy. The answer is no, no impact there. And on the second one, that is a very keen observation because I mentioned how our volume outlook for the back half of the year does not assume anything heroic. Part of not assuming anything heroic, we're not assuming that some of the away-from-home dollars begin to shift into at home, and you're 100% correct. If that happens, that's a tailwind for us and probably for the group. What's very interesting is how sticky some of this away-from-home spending has been even though we've seen a challenged consumer who is making trade-offs to stretch their household balance sheet. The one place that they've been fairly resilient is in their away-from-home spending. Should consumers stress increase from here. That is historically the first place that you would see an additional behavior shift is, you would see a reduction in away-from-home spend and you would see an equal and opposite response in home eating. That has not happened yet. But as we think about calendar year 2024, certainly, that is a potential positive if the environment remains stressed and the consumer decides they need to make further shifts."
},
{
"speaker": "Nik Modi",
"content": "And so just a follow-up on that. When you think about price gaps, right, with your strategic investments, is it really just kind of thinking about what goes on within the center of the store within the frozen unit or are you also thinking about kind of some of the price gaps between what you guys sell versus what maybe some low-end QSR would be priced at?"
},
{
"speaker": "Sean Connolly",
"content": "The price gaps versus away-from-home tend to take care of themselves. When the consumer reaches a point and they say, look, my burrito and my coke to go have now gotten too expensive, they first make the switch to stop doing that. Second, they switch to buy in the grocery store. And third, hopefully, they're buying our products. But we do look at our categories and look at this volume malleability as if it is an open set, meaning it's not just what's on shelf and then what's to the left or right of it that's switching, but it could be other categories. So an example would be, I referenced in our prepared remarks today that we are going to be - one of the things we're going to be investing behind is advertising on our Birds Eye business. Well, that is in the marketplace right now. It is running, and it is directly comparative advertising to canned vegetables. And it is focused on delivering a superior relative value message because while it might be tempting to trade down to a canned vegetable in the current environment, the trade-off on quality is simply not worth that trade down, and you end up actually in a worse value proposition. So that's an example of where we're thinking about the competitive set more broadly than what's immediately to the left or right of our products in any given section, and we're thinking about where consumers might go elsewhere, and really getting after that in a very targeted hard-hitting way with a focus on quality and superior relative value."
},
{
"speaker": "Nik Modi",
"content": "Excellent, very helpful. Thank you."
},
{
"speaker": "Sean Connolly",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Max Gumport of BNP Paribas. Please go ahead."
},
{
"speaker": "Max Gumport",
"content": "Hi. Thanks for the question. Turning back to gross margins, so a year ago, you were really the first packaged food company to begin to sunset the inflation super cycle and start to post sizable gross margin expansion. But with price mix turning negative now, partly due to the increased trade investment, it seems like productivity is now fighting against inflation, absorption and the negative price mix to hold up gross margin. Are these trends still in line with the mechanical nature of how these inflationary cycles typically have played out in the past? Or are there nuances starting to develop this time around? Thanks."
},
{
"speaker": "Sean Connolly",
"content": "Well, Max, I'll kick it off and then flip it to Dave. All the mechanical rep stuff should work the way it always does unless there is something new going on with the consumer. And what we saw right after Easter was that something new did start emerging with the consumer as they started making some of these behavior shifts. So that dynamic is not assumed in the typical mechanics of a wrap, right? So that's why - and by the way, as soon as that dynamic begins to either be embedded in the base or just improving the outright, then the mechanics of a typical wrap go right back to what they would always be. So that's why we've been focused on these volume trends because right through last quarter, when you looked at the group, you didn't see the bend when you looked across 15 weeks, 13 weeks, five weeks. Now, particularly for us, you've seen that bend. And that bend is getting pretty close to being kind of embedded in the base. And once it does, then you're set up to be back on algorithm, so to speak. Dave, do you want to add anything to that?"
},
{
"speaker": "Dave Marberger",
"content": "Yes. So if you just look at the guidance and you kind of say, okay, where are we going to land? We guided to operating margin of 15.6%. In that is gross margin, and gross margin is going to come in pretty close to where it landed in fiscal 2023. So you look at that and you say, okay, we kept gross margin flat to prior year when we've wrapped on pricing, our sales are going to be down for the year based on our guidance, and we've had a pretty significant impact from negative absorption, right, because volumes were down all of last year and they're down first half of this year. So being in manufacturing when you start to get your volumes more stable and actually start inflecting them to be positive, that negative absorption headwind goes away. So the focus now is we keep gross margins flat this year, we're increasing our investment, which gets our total investment when we finish this year back to more normalized trade levels. So we're going to have a business where the margins are consistent with last year, our investments back to where it was, and we have a lot of negative absorption that's in our base. So in fiscal 2025, we can get back to growth. We have some opportunities to leverage our cost base. We have an investment base that's where it should be, and it sets us up well for fiscal 2025. So there's a lot of things bouncing around, but when you copter up and you just look at where we're going to finish the year, that's how I think about it."
},
{
"speaker": "Max Gumport",
"content": "Great. And then turning to the investments, it's good to hear about the favorable response you saw in the second quarter and what that means for your increased investment in the second half. I'm just curious, are you expecting that investment to help category volumes or if other companies are seeing the same response that you're seeing, are we really just talking about a share fight and doesn't really improve category volumes. Thanks. I'll leave it there."
},
{
"speaker": "Dave Marberger",
"content": "Yes I - really interesting question. Basically, what we're saying is that, yes, the consumer is still deploying some value-seeking tactics to stretch their balance sheet, and that has had some impact on how they prioritized categories. And not every category is equal there, Max, in terms of what we've seen in the category. So we've seen tactics like this from consumers before, and they tend to serve their purpose over a short horizon and then they tend to disappear. But interestingly, even in some of the categories that remain softer than usual, we are seeing volume malleability via investments that drive share. But over time, frankly, we will take what the field gives us in the moment, whether that's improved volumes through share gains or improved volumes through improving category momentum. I think we're going to see both going forward."
},
{
"speaker": "Max Gumport",
"content": "Great. Thanks very much."
},
{
"speaker": "Operator",
"content": "The next question comes from Chris Carey of Wells Fargo. Please go ahead."
},
{
"speaker": "Chris Carey",
"content": "Hi, good morning."
},
{
"speaker": "Sean Connolly",
"content": "Hi, good morning."
},
{
"speaker": "Chris Carey",
"content": "So clearly, investment and promotions are topics that have been well discussed on this call rightly so. I think for me, the question on that is just - and you've given a lot of great detail. The question is really the step-up in investment that you expect in the back half of the year, which sounds quite strong. Are you seeing the lift in your volumes so far this quarter to give you the confidence on sequentially improving volumes into fiscal Q3 and to get into fiscal Q4 or is it more kind of conceptual? You've seen the uplift that these investments have had on certain of your businesses, which is giving you confidence in the back half. So more - are you seeing it versus the confidence piece if that makes sense?"
},
{
"speaker": "Sean Connolly",
"content": "Yes. Let me try to kind of re-hit what we touched on our prepared remarks for us, I'm not going to comment on Q3. We're in Q3, so we'll stick with Q2. We saw clear evidence in Q2 that where we deployed investment to kind of help the consumer with this process of kind of reengaging in the more typical purchase behaviors, we got the response we were looking for. And because that was real empirical evidence that, of course, inspired confidence that if we do more of that in the second half of the year, we will get a similar type of response. But from a planning posture standpoint, we are not banking on major improvement in the macro consumer environment or signing up for a huge consumer response. So one might interpret that as we've got the investment in there, but what we're banking on in return is conservative. Look, in this current environment, that's probably not a bad posture to be in because this volume recovery has been more elongated than people expect. But I think that's that is a fair characterization of kind of what we're looking at."
},
{
"speaker": "Chris Carey",
"content": "Okay. All right. Perfect. And one just quick follow-up. You mentioned, I believe, earlier in the call that incentive comp was a favorable SG&A item for fiscal Q2. Is there any way to dimensionalize that for the full year with the lower guidance for the year? That's it for me. Thanks."
},
{
"speaker": "Dave Marberger",
"content": "Yes. We - really almost all of the delta and SG&A in the quarter was driven from incentive comp. So that really drove the delta in the quarter. We do expect SG&A as a percentage of net sales to be higher in the second half. So it will get our SG&A as a percentage of net sales, close to where it was a year ago. So, there's some timing elements to this, especially with incentive comp, because it can it really can be a timing item relative to where you were in the prior year in your forecast. But as it relates to Q2, it drove all the variance in SG&A."
},
{
"speaker": "Chris Carey",
"content": "And just to clarify, that SG&A is higher in the back half, excluding advertising spending or with…"
},
{
"speaker": "Dave Marberger",
"content": "Yes, that's excluding adjusted SG&A, which we exclude A&P."
},
{
"speaker": "Chris Carey",
"content": "Great. Okay. Thanks, so much."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to the company for any closing remarks."
},
{
"speaker": "Melissa Napier",
"content": "So it's Melissa Napier. We thank you again for joining us this morning for the call, and we're looking forward to seeing everyone at CAGNY next month."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation and you may now disconnect."
}
] |
cag | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Conagra Brands’ First Quarter Fiscal Year 2024 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, today's event is being recorded. I would now like to turn the conference over to Melissa Napier, Senior Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Melissa Napier",
"content": "Good morning, and thanks for joining us for the Conagra Brands first quarter fiscal 2024 earnings call. Sean Connolly, our CEO, and Dave Marberger, our CFO, will first discuss our business performance, and then we'll open up the call for Q&A. On today's call, we will be making some forward-looking statements. And while we are making these statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of our risk factors are included in the documents we filed with the SEC. We will also be discussing some non-GAAP financial measures. These non-GAAP and adjusted numbers refer to measures that exclude items management believes impact the comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found in the earnings press release and the slides that we'll be reviewing on today's call, both of which can be found in the investor relations section of our website. I'll now turn the call over to Sean."
},
{
"speaker": "Sean Connolly",
"content": "Thanks, Melissa. Good morning, everyone, and thank you for joining our first quarter fiscal ‘24 earnings call. Let's start with what we want you to take away from our presentation shown here on Slide 5. At an industry-wide level, macro dynamics have clearly impacted consumer behavior across the board. I will cover this in more detail shortly, but ultimately, this behavior shift has elongated the volume recovery period across the industry, which is reflected in our Q1 top-line results. As we've navigated these macro dynamics, I'm proud of the team for delivering another quarter of strong margin improvement and EPS growth. We also continue to strengthen our balance sheet, improving our leverage ratio during the quarter while investing in our business and returning cash to shareholders. Our team's execution supported a strong supply chain recovery during the quarter, hitting pre-pandemic service levels as we exited Q1. Looking toward the remainder of the year, we will work to drive volumes and top-line growth through targeted and disciplined investments behind prudent merchandising and continued support for our strong innovation. Finally, we are reaffirming our guidance for fiscal ‘24, reflecting confidence in our plans, people, and agility as we navigate a shifting consumer environment. As I mentioned a moment ago, the timetable for volume recovery has been elongated across the industry due to near-term consumer behavior changes. After three years of unprecedented inflation, along with other macro dynamics, consumers have felt increased financial pressure and used a variety of strategies to stretch their balance sheets. This resulted in a near-term reprioritization of their typical purchase behaviors in order to make their budgets work. We've seen shifts like this before and expect these near-term changes in behavior to also be temporary. In fact, recent trends suggest this is already underway. Let me provide a bit more color on the kinds of behavioral shifts we've observed. As you've seen for some time now, with the notable exception of summer travel, discretionary purchases have been down almost across the board. Consumers have also been actively reducing remnant household inventory from the pandemic. Within food, convenience-oriented items, typically a top consumer priority, have lagged as shoppers have turned to more hands-on food prep to get additional bang for their buck. And as they've done this, not surprisingly, they have shifted from meals per one to meals per many, even if not everyone is home at the same time to eat together. And the last shift I will mention is a reduction in wasted food and an increase in the use of leftovers. Collectively, these short-term behavior shifts act as a sort of cheat code to help these consumers spend within their means. Slide 8 demonstrates the elongated volume recovery across the industry. As you can see, through the four-week period ending August 26, the entire peer group was showing volume performance within a very tight band with Conagra in the middle of the pack. As I mentioned a minute ago, more recent trends are showing the first signs of improved performance. With that backdrop, let's dive into our results shown on Slide 9. As you can see, in the quarter, we delivered organic net sales of approximately $2.9 billion, which is down slightly compared to last year as a result of the slower volume recovery we discussed. Adjusted gross margin of 27.6% was up 272 basis points from last year. Adjusted operating margin of 16.7% was up 297 basis points compared to last year. And adjusted earnings per share of $0.66 increased almost 16% versus last year. Diving further into our top-line performance by retail domain, you can see on Slide 10 that sales in our staples domain were flat compared to the prior year. As consumers shift toward more stretchable meals, our staples categories, such as canned chili and canned tomato are well positioned and have gained unit share compared to last year. Despite the macro headwinds, our snacks domain has continued to grow as shown on Slide 11. We're building unit share as consumers continue to respond positively to our microwave popcorn and ready to eat pudding and gel brands. Looking at Slide 12, you can see that our frozen domain has been the most significantly impacted by recent shifts in consumer behavior, particularly in areas like single-serve meals, given the headwinds we discussed a moment ago. As we look at the frozen domain, it's worth noting a few key points. First, despite the recent impact on volume, we continue to gain unit share in important frozen categories like single-serve meals. This dynamic demonstrates the relative strength and strong position of our brands. Second, the year-over-year performance figures do not properly represent the broader trend within frozen food. In fact, if you look over a four-year period, Conagra's frozen retail sales have increased 22%. Frozen meals has been one of the fastest growing categories in in-home consumption over the past 40 years. Its 4% CAGR is in the top tier of foods growing in at-home consumption. This expansion has been fueled by the long-term sustained consumer demand for convenience as well as the addition of innovation and quality ingredients. This 40-year trend demonstrates the critical role that frozen plays in providing convenient, high-quality foods for every occasion which consumers have come to increasingly rely on. This is central to why we believe the current softness is temporary. Turning to Slide 14, I'm pleased to share that we continue to advance our supply chain initiatives during the quarter, allowing us to return our service performance back to pre-pandemic levels. Our productivity initiatives remain on track, and we plan to maintain and capitalize on this strong recovery during the rest of fiscal ‘24. As a key piece of our action plan for the remainder of the year as outlined on Slide 15, in addition to our ongoing supply chain execution, we will continue to focus on executing our Conagra Way playbook as we make targeted and disciplined investments behind our brands. Help protect share and drive the top line, while focused on investing behind quality, high ROI merchandising and A&P to support our brand. We'll also continue to prioritize reducing our debt and improving our net leverage ratio. We are reaffirming our fiscal ‘24 guidance that we shared last quarter, including organic net sales growth of approximately 1% compared to fiscal ‘23, adjusted operating margin of 16% to 16.5%, and adjusted EPS between $2.70 to $2.75. Overall, we remain confident in our plans, people, and agility as we continue to navigate this shifting consumer environment. With that, I'll pass the call over to Dave to cover the financials in more detail."
},
{
"speaker": "Dave Marberger",
"content": "Thanks, Sean, and good morning, everyone. Slide 18 highlights our results from the quarter. Overall, we are pleased with our profit and cash flow delivery and remain confident in our ability to achieve our full year guidance targets. In Q1, net sales were $2.9 billion, reflecting a 0.3% decrease in organic net sales, driven primarily from the elongated recovery of volumes due to the industry-wide slowdown in consumption that Sean discussed earlier. Gross margin recovery was a key priority for us in fiscal '23, and we delivered another strong result in Q1. Adjusted gross profit increased by 10.9% in the quarter, primarily from the pricing implemented in the prior year and strong productivity, which more than offset the negative impacts of cost of goods sold inflation and unfavorable operating leverage. Adjusted gross margin increased 272 basis points, and adjusted EBITDA increased 12.1%, largely driven by the increase in adjusted gross profit. Slide 19 provides a breakdown of our net sales. The 0.3% decrease in organic net sales was driven by a 6.6% decrease in volume which was partially offset by a 6.3% improvement in price mix, a result of fiscal '23's inflation-driven pricing actions. A small benefit from the impact of foreign exchange contributed to reported net sales coming in flat for the quarter. Slide 20 shows the top line performance for each segment in Q1. Our Grocery & Snacks segment achieved net sales growth of 1.2% in the quarter. We gained dollar share in snacking categories, including seeds and microwave popcorn, as well as in staples categories, including chili and canned meat. As Sean discussed earlier, our Refrigerated & Frozen segment was the most impacted by recent consumer behavior shifts, with net sales down 4.6% in the quarter. Our International and Foodservice segments combined are slightly below 20% of our net sales. Both are important to Conagra and contributed meaningfully to growth this quarter. Our International segment delivered year-over-year volume growth in addition to improved price mix, which helped support strong organic net sales growth of 8.2% during the quarter. Our two largest international regions, Mexico and Canada, delivered double-digit organic net sales growth over prior year. We also saw low single-digit volume growth in Mexico, which contributed to the segment's overall positive volumes. For the remainder of the year, we expect volume growth to continue in International. Our Foodservice segment delivered 5.2% net sales growth in Q1 from strong price mix, and we expect to see positive net sales growth in Foodservice for the fiscal year. Foodservice also delivered a strong gross margin in Q1 versus a year ago due to the reduction of supply chain disruption costs incurred in the prior year. This benefit is not expected to extend beyond Q1. Our Foodservice segment supplies a diverse set of clients beyond restaurants, including healthcare, travel and leisure, and educational institutions, and we are well positioned to compete in these markets. Slide 21 highlights our adjusted operating margin bridge. We are pleased to have delivered a fourth consecutive quarter of strong gross margin improvement, up 272 basis points in Q1. We drove a 4 percentage point improvement from price mix during the quarter. We also realized a 1.8 percentage point benefit from continued progress on our supply chain productivity initiatives, along with the wrap of some supply chain disruptions in the prior year. These price and productivity benefits were slightly offset by cost of goods sold inflation, a margin headwind of [3.1%] (ph). Those factors, combined with small year-over-year favorability in A&P and SG&A, drove the 297 basis point improvement in operating margin for the quarter. Slide 22 details our margin performance by segment for Q1. Overall, continued progress on our productivity initiatives and positive price mix contributed to an increase in adjusted operating profit and adjusted operating margin across all four operating segments. It is worth noting that our Refrigerated & Frozen segment continued its very strong operating profit and margin recovery in the quarter with adjusted operating margin improving 294 basis points versus a year ago. Our Q1 adjusted EPS increased to $0.66, representing a 15.8% increase over the prior year. Higher adjusted gross profit and slightly lower A&P and adjusted SG&A were the positive contributors to our adjusted EPS performance in the quarter. These positives were partially offset by lower pension and post-retirement non-service income, decreased equity method investment earnings and higher interest expense. Slide 24 includes our key balance sheet and cash flow metrics. At the end of the quarter, our net leverage ratio was 3.55 times, down from the end of fiscal '23. We will continue to prioritize reducing our debt and lowering our net leverage ratio in fiscal '24. Net cash flow from operations increased $180 million in the quarter, primarily driven by reduced investment in inventory versus the prior year. While CapEx investment increased by approximately $20 million, Q1 free cash flow more than doubled from a year ago, coming in at $300 million. This strong free cash flow enabled us to pay down approximately $130 million of net short-term debt while also funding $157 million for the Q1 dividend, highlighting our focus on balanced capital allocation. We did not repurchase any shares in the quarter as we continue to prioritize paying down debt. As mentioned, we are reaffirming our guidance for fiscal '24, given the strong Q1 profit and margin performance and the confidence in our investment plans year-to-go as we continue to navigate a shifting consumer environment. Slide 25 outlines our current fiscal '24 expectations for our three key metrics, including, organic net sales growth of approximately 1% over fiscal '23, adjusted operating margin between 16% to 16.5% and adjusted EPS between $2.70 and $2.75. Let's take a closer look at how we expect to achieve that guidance during Q2 and the back half of fiscal '24 shown on Slide 26. During Q2, we expect to continue seeing low single digit organic net sales decline, but volume decline should improve versus Q1 as we wrap inflation-driven pricing actions from fiscal '23. As Sean mentioned, we will redeploy some of our strong gross profit into strategic investments behind quality, high ROI merchandising and increased A&P to support our brands. We also expect operating margins to be down from Q1 with adjusted EPS approximately flat to Q1. In the back half of the year, we expect volume trends to return to year-over-year growth, which will help drive low single digit organic net sales growth. We expect our trade and A&P investments to be higher than the first half, with margins flat to Q2 and second half fiscal '24 adjusted EPS approximately flat to the same period in fiscal '23. That concludes our prepared remarks for today's call. Thank you for listening. I'll now pass it back to the operator to open the line for questions."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today's first question comes from Andrew Lazar with Barclays. Please go ahead."
},
{
"speaker": "Andrew Lazar",
"content": "Great. Thanks so much. Sean, I realize, as you talked about a lot of near-term sort of macro dynamics impacting sort of the industry volume recovery right now. And it's logical that ramping up the marketing investment in the second half now that service levels have returned to normal should logically start to improve volume trends sequentially. And I assume you forecast as best you can. But I guess my question is, do you think you've given yourself enough latitude to sort of do what's needed while also being able to reiterate the full year guidance on both the top line, which assumes a healthy positive inflection in the second half and on EPS, given the year is now more back-end weighted there as well?"
},
{
"speaker": "Sean Connolly",
"content": "Good morning, Andrew. Yes, I believe the answer is yes, we have. Like others, we're essentially now putting our emphasis on the back half where we expect to have the most impact. If you copter up and look at the back half between more favorable comps, increased investment, a very strong innovation slate and a move back toward a more typical consumer behavior, we do expect meaningful top line progress in H2. And with productivity strong and excellent margin progress over the past several quarters and a good start to the year at EPS, we feel good about the profit call for the year even with that added investment. I probably also will give a nod to our Foodservice and International teams for the excellent job they're doing, working their plans."
},
{
"speaker": "Andrew Lazar",
"content": "And then I guess on the targeted and sort of disciplined spend. I assume much of this goes to the frozen arena. I guess, what form will this take like more specifically? And I guess, how do you ensure it will be disciplined? And I guess what are you seeing competitively?"
},
{
"speaker": "Sean Connolly",
"content": "Great question. As you point out with our supply chain now, clicking on all cylinders, we're once again in a position where we can selectively add promotional activity to drive sales. As I've said before, selectively means highly incremental, high ROI events at critical calendar windows like the holidays as an example. So frozen is certainly in the mix, but so are other categories. Just to give you some perspective, and I'll give you more on this in just a minute so you have the detail. In Q1, only 21% of our sales were on promotion, which was below the peer group and also below the pre-pandemic baseline. So if you look at Q1, the last couple of years, not this year, but the last couple of years, Conagra was around 18% of our volume was on promo and the pre-pandemic baseline, the number was 24%. So this year, in Q1, we were at 21%. So we're still below the baseline, and we've got some room to pick our spots and invest smartly to engage further with consumers. But let me be clear, we are not talking about deep discount, low ROI promotional activity like you might remember from Conagra 10, 15 years ago. That is not part of our playbook."
},
{
"speaker": "Andrew Lazar",
"content": "Great. Thanks so much."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question today comes from Ken Goldman at JPMorgan. Please go ahead."
},
{
"speaker": "Ken Goldman",
"content": "Hi, thank you. Sean, to Andrew's question right there, one of the drivers you mentioned for the second half was, I think, maybe a little bit of a directional return to more typical consumer behavior. I just wanted to know if we could hear a little bit more about which elements of this behavior maybe you expect to improve, what will drive it? Or in the comment more just -- look, we have more -- we have less pricing, we have more trade, we have more A&P, more new products. So that altogether will help our business. I just wanted to get a little bit more color there, if I could."
},
{
"speaker": "Sean Connolly",
"content": "Yeah. Ken, it's a mix of all the above. The comps are clearly much more favorable. We're clearly going to have some stronger merch investment in the back half. And we've got A&P focused on our largest brands with good margins. So those are all well positioned to have an impact. But I think the key here is this consumer behavior shift. And I do think when you see all the competitors in such a tight bandwidth, which is frankly a tighter bandwidth than I'm even accustomed to seeing, you know it's a macro dynamic. And the way to think about what we saw in the first quarter with respect to the behavior over the summer was, it was this paradoxical combination of selective splurging and broad-based belt tightening. So as an example, consumers may have simply said, I'm taking that summer trip and it's not up for debate. And then at the same time, said, I'm going to change some things up to create an offset. And so in our line of work, it's what we call compensating behavior. But one of the other things we know about consumer habits and practices is that they are very hard to change long term. So these shifts tend to be temporary tactics that people use to get through a period of time when they've committed more of their cash to something else. And I think the summer travel example is illustrative of what I'm talking about there. And so this is a bit of a different animal than what we would call normal elasticity effects because normal elasticity effects are really brand level elasticity effects that are consumer judgments about the value of a particular brand versus another close-in alternative following a price increase. These macro behavior shifts are a bit of a different animal. Here, the consumer is not passing judgment on the value of a specific brand following a price increase, rather, they're temporarily reranking how they prioritize entire categories in order to live within their means for a period of time. So why does it matter to understand the difference between this versus normal elasticity? Well, in our experience, it's because behavioral shifts at a category level tend to be shorter in duration. And it's -- a simple way to think about it is consumers are creatures of habit. So it's very difficult for them to deprioritize things like convenience benefit. So this is one of the key reasons we expect these shifts to be temporary. They have been in the past, and that's what we expect again. And it's also why we're really loading up our resources in the back half where we think the market conditions will be much more favorable to driving the kind of impact we're seeking."
},
{
"speaker": "Ken Goldman",
"content": "Thanks, Sean. I’ll pass it on."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question today comes from Pamela Kaufman with Morgan Stanley. Please go ahead."
},
{
"speaker": "Pamela Kaufman",
"content": "Hi, good morning. You talked about your plans to step up A&P and trade spend over the rest of the year. Just wanted to get a sense for -- if this was kind of consistent -- the amount was consistent with your initial expectations heading into the year? Or if you're now planning for greater reinvestment compared to your initial plans given volume trends?"
},
{
"speaker": "Sean Connolly",
"content": "It's higher, Pam. It's obviously -- the consumer dynamic in the first quarter was tougher than we planned for. We do think the conditions -- the macro conditions will be more favorable in the back half and we're in a fortunate position where we got off to a strong start in the year on profitability. So we've got some room to invest back. So we're talking about a higher investment posture on Merch, in particular, in the back half of the year as now we've got the supply chain working."
},
{
"speaker": "Pamela Kaufman",
"content": "Okay. Thanks. That's helpful. And then I guess, do you feel like there are areas in the portfolio where you've taken too much pricing and do you envision a scenario where pricing growth turns negative?"
},
{
"speaker": "Sean Connolly",
"content": "Yeah. I don't really see that, Pam. The volume impact we are seeing, and frankly, the peers in the space are really not a function of individual brand level prices and a consumer judgment that it's much more of this macro thing where they're reprioritizing entire categories and consumer domains in order to stretch their budget short term. There are -- there was very little interaction in our portfolio with private label. There are some categories in our portfolio, albeit very few, that are more pass-through in nature and are more prone to a rollback in price if the key ingredient cost deflates. So products like Reddi Wip, where you've got basically dairy in there, products like our sausage business or our hotdog business where it's pretty much a particular meat block that's in there, those products -- kinds of products tend to move with the commodity. But for most of our portfolio, a, we haven't seen that kind of singular judgment around the value of the product being too expensive, and we just haven't seen any cost basis for rolling back price in terms of deflation. We're still net-net in an inflationary position."
},
{
"speaker": "Pamela Kaufman",
"content": "Thank you. That’s helpful."
},
{
"speaker": "Operator",
"content": "And our next question today comes from David Palmer at Evercore. Please go ahead."
},
{
"speaker": "David Palmer",
"content": "Thank you. It looks like you're assuming 2% to 3% organic sales growth in the second half as implied by the guidance. I guess what gives you the most confidence that you can get there? What are the key improvement areas that we would see? I would imagine frozen entrees would be one, but perhaps you can give a sense of where we should be expecting the most energy and improvement going into the second half?"
},
{
"speaker": "Sean Connolly",
"content": "Sure, Dave. Let me hit that. we're going to focus, as we always do, on our frozen and snacks businesses because those are the centerpiece of our strategy. But we also do have businesses within our portfolio now that are typically reliable contributors that are working really well in terms of meal creation, simple meals and things like that in our staples business, which tends to be a good mix. But I think between an improving consumer environment, more aggressive but smart and selective merchandising environment, a really good innovation slate and then A&P on some of our biggest businesses, not to mention, we've got very favorable comps on some of our big businesses in the back half of the year. I think all of that gives us a line of sight to delivering the kind of numbers that you just quoted. Dave, do you want to add anything to that?"
},
{
"speaker": "Dave Marberger",
"content": "Yeah. Just a little more color on the disruptions in the prior year, which were mostly second half last year, Dave. We had a fire at our Jackson plant, which significantly impacted our frozen fish business. Obviously, Lent is the big time for that. So we'll be in a much better position this year on that. We had canning issues in our beans and chili business second half last year. And then as you remember, we had the can meat recall, which impacted Q3 and Q4. So more specifically, we should see strong improvement on those categories."
},
{
"speaker": "Sean Connolly",
"content": "And one other point I'll make, too, Dave, because you brought up our frozen business. It's not an inconsequential point that one slide in our prepared remarks today that showed the 40-year trend on frozen. It is literally not counting commodity category like frozen fruit, it is in the top two, I think, of packaged goods in terms of long-term growth in the category, and it's been particularly strong in the last six or seven years as we've driven innovation. So we remain incredibly bullish on our frozen business. And by the way, our unit share in frozen has grown consistently over the last seven or so years. And that included Q1. I saw it, David, you pointed this morning and thought we were losing share in our frozen meals business. That is actually not the case. Even with the consumer environment the way it is right now, consumers making some of these trade-offs, we grew our unit share in our frozen meals business once again. And that is with some additional promotional activity from a larger competitor in the space during Q1. But frankly, that had no impact on us on a national basis. It impacted a different competitor in the space that happens to be a value-oriented play, but had no impact on Conagra where we again gained unit share in our frozen meals business."
},
{
"speaker": "David Palmer",
"content": "Thanks for that and we're certainly seeing that promotional activity. And I'll pass it on. Thanks."
},
{
"speaker": "Sean Connolly",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question today comes from Max Gumport with BNP Paribas. Please go ahead."
},
{
"speaker": "Max Gumport",
"content": "Hey, thanks for the question. Just wanted to come back to the commentary around the improved outlook for the second half, the low single-digit organic sales growth. I hear what you're saying, but a lot of the factors that you've called out feels like they would have been knowable a couple of months ago in terms of the easier comps and the innovation and the advertising and lapping the supply chain disruption. So I'm just curious what's changed over the last couple of months that's given you this increased confidence in the second half because before it sounded like we were going to see organic sales would be strongest in the first quarter and then work its way down. Thanks."
},
{
"speaker": "Sean Connolly",
"content": "Sometimes when you run in businesses like this and you're servicing consumers, you take what the field gives you. And I think what we're saying is in Q1, the consumer environment is -- was more challenged. People were trying to create these offsets to cover expenditures that they were determined to make over the course of the summer. And we do believe that the consumer environment is going to be more favorable. There will be a bit of pent-up demand here for some of the things that people have traded out of as they've created these kind of short-term hacks to make their household balance sheet work. And having the supply chain in the position it's in and getting off to a strong start on profit and having the ability to invest more, we think these are high ROI investments that are going to enable us to have the kind of consumer engagement impact that we want to have, but also be profitable by the way we want to be at the same time, and that's kind of our outlook."
},
{
"speaker": "Dave Marberger",
"content": "Yeah. And just -- and our International and Foodservice businesses are off to a really strong start and they're really tracking ahead."
},
{
"speaker": "Max Gumport",
"content": "Got it. And then one on gross margin, if I can. So you talked about how you expect a step-down in gross margin from the first quarter to the second quarter and then to remain at a similar level in the second half. And so I'm getting that might imply a gross margin of around 27% for the year or roughly in line with last year. A few months ago, it sounded like you were expecting some improvement in fiscal '24, given price mix and productivity, the lapping of supply chain disruptions, all outweighing negative overhead absorption and business investment. I didn't see an updated inflation number today, but assuming it stayed at around 3% for the year, I'm just curious what's changed? I'm assuming it's maybe a bit more business investment that has moved up. I'm just curious for any color there. Thanks. I’ll leave it there."
},
{
"speaker": "Dave Marberger",
"content": "Yeah. So yes, we're holding our inflation assumption at 3% at this point. We've had some categories, some items where there is more inflation than we expected, but we have some that have gone the other way. So we're still holding to the 3%. That's important that, that remain that way for us to hit the margin guidance that we gave. We were impacted in Q1. We were really pleased with our productivity in the first quarter. Embedded in the productivity numbers are actual headwinds from absorption. So the second half with volumes, us being confident that our volumes will be up, we'll have a benefit in absorption. So the incremental investment can drive incremental volume and help with absorption offsets, which benefits margin. But I would just remind you, we gave a range for margin for a reason because of that. We're not going to get precise with an absolute gross margin number. You're directionally correct, but that's why we gave a range on operating margin for our guide."
},
{
"speaker": "Max Gumport",
"content": "Got it. Thanks very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question today comes from Robert Moskow with TD Cowen. Please go ahead."
},
{
"speaker": "Robert Moskow",
"content": "Hi, thanks for the question. Sean, I think you said in your script that in the Nielsen tracking data, you had started to see signs of some sequential improvement. I didn't quite see it in the slide, and I haven't seen it in our data yet. So I was wondering if you could give a little more color on that."
},
{
"speaker": "Sean Connolly",
"content": "Sure. Happy to do that, Rob. If you look at the slide we shared today, notably, it's units, it's not dollars. And that's the metric that we are looking at, is units, not dollars because to us, that is going to be the marker of when we start to see this change. Frankly, if you look at the slide that I shared today, it's got 52 weeks, 13 weeks, four weeks. What the competitive set would expect to have seen is that as you move from 52 weeks to 13 weeks to four weeks, you see improvement in trend. And as you could see on that slide, it was fairly flat. So what we're looking for is bend in the trend in unit movement as a proxy for this consumer behavior shift beginning to move. So if you look at the more recent period, which is -- it just came out, I think, this week, which is the four-week period following what we shared today, you see the first noteworthy change in unit movement for Conagra and there may have been one or two other competitors that saw some movement there as well. That's important because that's the kind of movement that we thought we would see across the industry back at our Memorial Day or so, and it didn't materialize. And we've got our first data point now that's showing it's going in the right direction. That's the metric we need to move. If units move the way that we expect them to move, everything else will take care of itself at dollars. And so that's why we're focused on that."
},
{
"speaker": "Robert Moskow",
"content": "Okay. And a quick follow-up for Dave. You mentioned a lot of little supply chain issues that affected last year, Dave, like the frozen fish issue and then the beans and the Chili. Is there any way to add it all up and help us understand like what kind of easy comp this provides either on sales, profits in the back half?"
},
{
"speaker": "Dave Marberger",
"content": "Rob, I would just go back to what we said last year. We didn't quantify everything exactly, so I wouldn't want to give you a number here. But if you go back and look at what we communicated last year second half, I think you'll get a pretty good feel for the magnitude, generally speaking. But we didn't give a precise number on that."
},
{
"speaker": "Robert Moskow",
"content": "Okay. All right, thanks."
},
{
"speaker": "Sean Connolly",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from Nik Modi with RBC. Please go ahead."
},
{
"speaker": "Nik Modi",
"content": "Yeah, thank you. Good morning. Sean, it's clear your brands within frozen are doing well, and you see that in the share gains. But I'm just curious if you have made any observations regarding the perimeter, right, some of the things that we're seeing through our channel work is deflation happening in the perimeter is putting pressure on frozen the category. So when you think about the competitive landscape, are you kind of factoring that in? And do you think that could put more pressure on potential pricing and promotional spend over the next several quarters?"
},
{
"speaker": "Sean Connolly",
"content": "Nik, can you say more about the specific things in the perimeter that you're seeing that are growing? Anything might be impacting Frozen?"
},
{
"speaker": "Nik Modi",
"content": "Yeah, just fresh vegetables, fruits, primarily, right, the gaps between frozen and some of the fresh areas of the store."
},
{
"speaker": "Sean Connolly",
"content": "Well, I'm not sure we're having a lot of interaction there. Even our Birds Eye business is kind of behaving similarly with the balance of our frozen business. But what you're seeing in frozen [Technical Difficulty] most of the frozen items we sell are frozen convenience items. And what you've seen over the last quarter are more of this consumer pivot to what we'll call meals for many instead of meals for one. It's more of a speed scratch type of thing where you can stretch your buck and feed more mouths, but that's a laborious effort, and it's also not exactly the food that people are habitually accustomed to eating. So when I look back over the last 50, 60 years and you look at consumer trends, by far, the most unshakable trend in the consumer packaged goods space is the trend toward convenience. And so we know, and you saw it in the long-term frozen data that I put up, that consumers don't have the time to make stuff from scratch. They don't have the culinary skills and they don't want the waste associated with it. Does that mean they won't do it from time to time and buy a bag of rice and a can of beans and some ground beef? No, they will do that. Those are the kind of the short-term cheat codes that I referenced. But they tend not to be very lasting behaviors because, as I pointed out, consumer habits and practices are highly entrenched. So really, we're focused on that. We know that this is a short-term dynamic, and we expect it to change. And we certainly, within frozen, have the brands that drive the growth and drive the share with the innovation we've delivered. I think our categories over the last five years have accounted for about 70% of the growth in all of frozen, and we expect that kind of highly competitive performance to continue."
},
{
"speaker": "Nik Modi",
"content": "Great. And then maybe one for Dave real quick. Just wage inflation, obviously, has been a big issue as it relates to conversion costs in terms of finished goods that you may buy and you have all these union negotiations going on in other industries. And I'm just curious, like, what are you seeing right now in terms of conversion costs kind of coming upstream in terms of how your cost of goods is shaping up?"
},
{
"speaker": "Dave Marberger",
"content": "Yeah. Our inflation assumption for 3%, we had assumptions on conversion costs, which kind of in that mid to upper single-digit area. So that hasn't changed. We're very -- we spend a lot of time on our compensation benefits working hard to be competitive as part of our overall strategy for all of our employees. So we feel like we've captured it in our estimates for inflation."
},
{
"speaker": "Nik Modi",
"content": "Excellent. I’ll pass it on. Thank you."
},
{
"speaker": "Operator",
"content": "And our next question today comes from Jason English with Goldman Sachs. Please go ahead."
},
{
"speaker": "Jason English",
"content": "Hi, good morning folks. Thanks for slotting me in. And congrats on the momentum in International and Foodservice. Great to see. Sean, a lot of questions, obviously, today on your back half guidance, and I'm sure it's not lost on you, there's clearly some skepticism on your ability to get to the volume growth you're promising in the back half. If that doesn't come to fruition, what, if any offsets, are in your P&L to allow you to get to the bottom-line guidance?"
},
{
"speaker": "Sean Connolly",
"content": "Well, look, it is -- [a quarter] (ph) of the year is behind us. And as I've said many other years, a quarter doesn't make a year. So we are on or ahead of pace on most of our goals after one quarter. And the challenge has been this consumer behavior shift, which, as I mentioned, we view as a temporary dynamic. Between that are favorable comps, the increased investment, we do expect meaningful top-line progress in the second half. And that's our playbook, we feel good about it. We are investing more to drive the business. We are trying to do a couple of things here, which is deliver a strong '24 but also set our business up to have excellent momentum as we go out of '24 into '25, which we're confident will be a very different environment. Dave, do you want to add anything to that?"
},
{
"speaker": "Dave Marberger",
"content": "Yeah, sure. So, Jason, obviously, we're looking at our cost very closely. If you look at the quarter, our productivity performance was really strong. Our supply chain organization does a phenomenal job especially now that we're back to a kind of more accommodative operating environment to drive our productivity, and we're seeing that. So that's a big driver, obviously, for us. You look at SG&A, we're -- 9.1% is where we came in last year, we'll be around that again this year. We're very efficient, we're as efficient as any food company out there, but we're always looking for opportunities. And then we obviously have our Ardent Mills joint venture, which continues to do really well. We're holding to our guide for the year there, but there's still really strong momentum in Ardent Mills. And that generates cash for our business. And so there are places we're always looking, but we're always looking to just make sure we're finding opportunities to drive savings so that we can continue to invest in the business."
},
{
"speaker": "Jason English",
"content": "So Dave, I'm going to put words in your mouth to see if I'm understanding this right. I appreciate what your guidance is predicated on, that's top line acceleration. But I think I heard if that doesn't come to fruition, there could be some more opportunities on cost and there could be some upside opportunity in Ardent Mills. Did I hear that correct?"
},
{
"speaker": "Dave Marberger",
"content": "That's what we're always looking for. So we're -- productivity coming and Ardent is off to a good start."
},
{
"speaker": "Sean Connolly",
"content": "Yeah. Part of it, Jason, is culturally the way we operate. We are wired to be a very lean, very adaptable, very agile team. We don't have a lot of orthodoxies around here or things that we're not willing to do to get to where we got to go. So we'll -- we've got a great team. They're going to get us to do what we need to do throughout the balance of the year and we'll be super agile as we always are in an environment that's highly dynamic."
},
{
"speaker": "Jason English",
"content": "Yeah, I would definitely recognize and respect that. Thank you very much."
},
{
"speaker": "Sean Connolly",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "And our next question today comes from Steve Powers with Deutsche Bank. Please go ahead."
},
{
"speaker": "Steve Powers",
"content": "Hey, thanks. Good morning. So I kind of wanted to build on what Jason just asked about because it sounds -- I guess the question I'm left with is, if the consumer behavior shift that you're expecting doesn't play out as we go through the balance of the fiscal year, are you committed because of looking forward to '25 and beyond, are you committed to the investment spend that you've articulated in 2Q and 2H? Or does that itself become a lever to pull to preserve bottom line dynamics? And it sounds like in the first quarter, given what the environment gave you, you delayed some of the spending. Maybe that's the wrong read, but it feels like you delayed some of the investment spending because the demand was weaker. Now you're planning it later in the year as you expect demand to pick up I guess the question is, if that consumer behavior shift doesn't happen, do you keep spending?"
},
{
"speaker": "Sean Connolly",
"content": "Yeah, Steve, I think the easy answer to your question is we manage this business for long-term value creation and long-term success with the consumer. When you get caught up in these short-term windows of consumer behavior shifts, people always ask the question, well, in this window, what's more important, sales or profit? And obviously, you always want both. But when you see short-term behavior shifts, sometimes you have to be smart and you've got to ride the way in a patient and pragmatic way. And that means not trying to force things before they're poised to pivot. Otherwise, you can end up with either metric working for you. And as I said, we will invest smartly. We'll pick our spots. We'll focus on quality merch, A&P and our biggest brands and awesome innovation and we'll keep a strong determination to drive brand health and value creation for the long term."
},
{
"speaker": "Steve Powers",
"content": "Okay. That makes sense. Is there any -- I mean I guess the -- is there any validity to the thought that because there was less spending in the first quarter, it exacerbated some of the weaker demand trends and [indiscernible]."
},
{
"speaker": "Sean Connolly",
"content": "No, I actually would say the opposite. We did see in one of our categories, a competitor try to do some promotional things to kind of force the issue and force and it didn't work, and it didn't have any impact on our business. And I can't imagine what their bottom line looks like with such an inefficient spend. But it's just -- that's what I mean by you have to be sometimes be smart, ride the wave in a patient a pragmatic way. If you get impatient and you try to do something irrational and force the consumer to do something they're not ready to do, you know what you're going to do, you're going to spend a lot of money without having a lot of impact. And so we want to put our dollars and our investment out there in the marketplace on the right levers at the right time when the consumer is going to be responsive to it. And that's why we've got the cadence of our spend laid out the way we've got across the full year."
},
{
"speaker": "Steve Powers",
"content": "Understood. Okay. That’s very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from Alexia Howard with Bernstein. Please go ahead."
},
{
"speaker": "Alexia Howard",
"content": "Good morning, everyone."
},
{
"speaker": "Sean Connolly",
"content": "Good morning."
},
{
"speaker": "Alexia Howard",
"content": "So it seems as though the industry this year has been caught fairly flat footed with the surprising lack of recovery in volumes as price growth has slowed. Now it's obviously still way too early to tell where the impact of the GLP-1 drugs is going to go, what the uptake is going to be over the next five, 10, 15 years. But in a similar vein, how can you start thinking about different scenarios for how that could play out, which parts of your portfolio might be most affected either positively or negatively? And how do you start getting data to decide which of those parts you might want to pursue? I mean, how do you plan for another potentially big consumer behavior shift that might be coming down the pipe over the next few years?"
},
{
"speaker": "Sean Connolly",
"content": "Alexia, I view that one a little bit differently. If you think about it, we've got an entire department of demand scientists here who are every day studying changes in consumer behavior, particularly -- a particularly important one for our company has been the ever-evolving consumer definition of what constitutes healthy and how they want to eat in order to be responsive to health. Back in the '90s with Snack Wells, it was all about fat and calories. And if you just look in the last few years, we've gone from grain-free to cauliflower to keto. I mean it's constantly evolving. So what our demand science folks do is they're constantly studying the trends that consumers are chasing, figuring out which of those need to be designed into our products and then adapting our products through our innovation program relentlessly so that we're staying up with consumer trends. So if we end up seeing changes in consumer eating patterns, let's say they go to smaller portions, then we evolve the innovations, and we design smaller portions. If they switch to different types of nutrients, we evolve the innovation, we switch to different types of nutrients. If they change the kind of pack sizes they snack on, we'll change that. So this is the kind of stuff that will happen over five, 10, 15 years, not over the next six months. But I think the key to navigating these kinds of just constantly evolving consumer environment is you have to be externally focused, you've got to study these consumer trends and you've got to rapidly design in what the consumer is looking for into your products and that's what we do every year."
},
{
"speaker": "Alexia Howard",
"content": "Great. Thank you very much. That's very helpful. And just as a quick follow-up. Your leverage is obviously coming down. It's expected to come down further. Appetite for additional M&A and what parts of the portfolio you might be focused on for that? And I'll pass it on."
},
{
"speaker": "Sean Connolly",
"content": "Yeah. Let me say this first because I never want our investors to misunderstand this. We always follow kind of a balanced approach to capital allocation. But we've said now for some time, and I'll continue to say it, our top priority is de-levering. The importance of having a clean balance sheet in the current strained external macro environment is very important to our investors, our ratings agencies, and that is our top priority. When the time comes that we've got our balance sheet where we want it to be, M&A has always been part of it. We've always said there are two kinds of big picture M&A. There's big synergistic acquisitions that rarely come along once in a blue moon, and then there are bolt-on more growthy smaller acquisitions, they tend to happen more frequently. So we'll always, over the long term, keep an eye on both of those things. But right now, our focus is on continuing to pay down debt. And then when we get to the time when we can add something to the portfolio, odds are it would be in our key strategic domains of frozen and snacks."
},
{
"speaker": "Alexia Howard",
"content": "Perfect. Thank you very much. I’ll pass it on."
},
{
"speaker": "Sean Connolly",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes our question-and-answer session. I'd like to turn the conference back over to Melissa Napier for closing remarks."
},
{
"speaker": "Melissa Napier",
"content": "Thank you, everyone, for joining us this morning. Investor Relations is available if anyone has any follow-up questions. Have a great day."
},
{
"speaker": "Operator",
"content": "Thank you. Ladies and gentlemen, this concludes today's conference call. You may now disconnect your lines, and have a wonderful day."
}
] |
cah | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the fourth quarter and FY 2024 Cardinal Health Incorporated earnings conference call. My name is George and I’ll be your coordinator for today’s event. Please note that this conference is being recorded and for the duration of the call, your lines will be in listen-only mode; however, you will have the opportunity to ask questions at the end of the presentation. This could be done by pressing star, one on your telephone keypad to ask your question. In order to allow as many people as possible to ask a question, we ask that you please limit yourselves to one question each. If you require assistance at any point, please press star, zero and you will be connected to an Operator. I’d now like to hand the call over to your host today, Mr. Matt Sims, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Matt Sims",
"content": "Welcome to this morning’s Cardinal Health fourth quarter and fiscal ’24 earnings conference call, and thank you for joining us. With me today are Cardinal Health’s CEO, Jason Hollar, and our CFO Aaron Alt. You can find this morning’s earnings press release and investor presentation on the Investor Relations section of our website at ir.cardinalhealth.com. Since we will be making forward-looking statements today, let me remind you that the matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to our SEC filings and the forward-looking statements slide at the beginning of our presentation for a description of these risks and uncertainties. Please note that during our discussion today, the comments will be on a non-GAAP basis unless specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the supporting schedule attached to our press release. For the Q&A portion of today’s call, we kindly ask that you limit questions to one per participant so that we can try and give everyone an opportunity. With that, I will now turn the call over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Thanks Matt and good morning everyone. Fiscal year ’24 marked a year of strong operational execution and record financial results for Cardinal Health, delivered in tandem with significant strategic progress across the portfolio. On that note, we have three key headlines today. First, we finished the year with momentum, growing EPS 29% in both Q4 and fiscal year ’24. Our results exceeded guidance and full-year EPS of $7.53 was $0.96 above the midpoint of our original outlook from investor day. We also delivered nearly $4 billion of adjusted free cash flow for the year, positioning us with approximately $5 billion of cash at year end, even after $1.25 billion of capital returned to shareholders this year and funding our growth investments. Second, we have managed through the transition of a significant customer and are raising our guidance for fiscal year ’25, while also reconfirming our long term financial targets. Finally, we continue to advance our strategy to build upon the growth and resiliency of pharma and specialty, execute our GMPD improvement plan, and accelerate our growth in key areas while optimizing our portfolio to maximize shareholder value creation. More on that momentarily, but first some brief reflections. This year, we continue to take decisive actions to simplify our business and drive performance, highlighted by the reorganization of our operating and segment reporting structure to enhance management focus while enabling efficiencies, accountability and transparency. We grew our largest and most significant business, pharmaceutical and specialty solutions, above our targeted long term growth rate. We saw ongoing stability in pharmaceutical demand, strong performance from our generics program, and our specialty business grew revenue 14% for the year. As of fiscal year ’24, our specialty business is now over $36 billion and we anticipate continued growth next year despite a large contract expiration. We prioritize key growth areas in specialty with organic investments across therapeutic areas and the acquisition of specialty networks. In GMPD, we executed our improvement plan initiatives, returning the business to profitability and delivering approximately $240 million in year-over-year segment profit improvement. Notably, we achieved our year-end inflation mitigation target, a critical milestone for the business. Across our other operating businesses, we collectively grew revenue 12% and segment profit 7% in fiscal year ’24. We’ve seen strong demand across nuclear, at-home solutions and OptiFreight, and our purposeful investments and focus on performance excites us about how these businesses are positioned for the future. Overall, these results were achieved through our team’s commitment to execute against a focused set of priorities to create value for our shareholders, our customers, and ultimately for millions of patients. As we turn the page to fiscal year ’25, our confidence is reinforced by our strong and resilient business with positive industry trends supporting our growth, and we continue to take actions to optimize not only the performance of our businesses but also the financial strength of the broader enterprise. Before I hand the call over to Aaron, let me provide an update on our business and portfolio review which, as a reminder, kicked off in September of 2022. Last June, we concluded our review of the former pharma segment highlighted at investor day with our enhanced organizational focus on specialty and decision to retain and further and invest in our nuclear and precision health solutions business. Then in January, we finalized our review of the growth businesses within the former medical segment, determining the best course of action for shareholder value creation was to invest in and further develop at-home solutions and OptiFreight for long term growth, while also completing our re-segmentation. All along, management in collaboration with the business review committee and board has been reviewing GMPD from every angle as the team executes our turnaround plan. We deeply understand the business’ opportunities and complexities and today have some preliminary conclusions to share through the lens of our portfolio review framework, as seen on Slide 20. In short, we remain committed to executing the GMPD improvement plan and our fiscal year ’26 target of $300 million in segment profits. We were pleased and unsurprised to see significant interest in GMPD during our review. The business is core to the operations of so many healthcare providers and features not only our formidable distribution expertise but a broad set of Cardinal Health brand products that are critical to patient care. Following our extensive review, we have gained confidence that we are best positioned to continue capitalizing on the meaningful growth and operational opportunities on the horizon for this business. Ultimately, we see more value creation potential ahead for our shareholders by continuing to drive the GMPD turnaround plan. Even more, our analysis uncovered additional opportunities to unlock near term value through further simplification actions and working capital improvements while continuing to drive the plan. From these initiatives, we plan to generate at least $500 million in cash over the next two years to be deployed according to our disciplined capital allocation framework. In recognition, we’re raising our share repurchase expectations for fiscal year ’25 to a total of $750 million, which is beyond our $500 million baseline. In terms of the mechanics of future reviews as the business continues to improve, the business review committee of our board sunset in July as planned, and the ongoing value creation efforts are now being overseen by the board as a whole. As always, we take a thorough, objective and open-minded approach focused on maximizing long term shareholder value creation while continuing to invest in the business to ensure that our customers receive the products and service they expect. I’ll go deeper into our strategic plans for our segments later in my remarks, but first let me turn it over to Aaron to review our results and guidance."
},
{
"speaker": "Aaron Alt",
"content": "Thank you Jason, and good morning. Before discussing our Q4 success and our raised guidance, I want to highlight that today, we are providing revised prior period financials for fiscal year ’22 through Q3 fiscal year ’24, reflecting slight net increases to non-GAAP EPS. During the preparation of our annual financial statements, management identified a longstanding accounting error in part of our at-home solutions business related to revenue recognition from third party payors. As a result, we have corrected this item in prior periods and also updated the timing of other previously recognized immaterial out-of-period items across the full enterprise. The net impact of these changes increases non-GAAP EPS by $0.07 in fiscal year ’24, $0.06 in fiscal year ’23, and $0.01 in fiscal year ’22. To be helpful, we’ve included supplemental schedules in our press release along with further detail in our fiscal year ’24 10-K. Moving to our results, I am pleased to reinforce that Q4 produced a strong finish to a year in which the Cardinal team made tremendous progress against our financial and strategic priorities. For both Q4 and the year, our EPS results reached historical high points with operating profit growth across pharma, GMPD and other, also supported by improvements below the line in the form of lower interest costs, better tax rates, and lower share count. We delivered strong gross margin growth and matched it with well controlled SG&A, even in an inflationary environment. In Q4, revenue increased 12% to $59.9 billion, reflecting revenue growth in the pharmaceutical and specialty solutions segment, the GMPD segment, and in all of the businesses making up other. Gross margin grew 5% to $1.9 billion, outpacing consolidated SG&A which increased only 2% to $1.3 billion in the quarter, reflecting our disciplined cost management. This translated to total company operating earnings of $605 million, up 14% versus last year. Below the line, interest and other improved $6 million versus prior year to $10 million, benefiting from the quarter’s strong cash outperformance. Our fourth quarter effective tax rate finished at 24.6%, 4.5 percentage points lower than the prior year. Fourth quarter average diluted shares outstanding were 245 million, 4% lower than a year ago due to our previously announced share repurchases. The net result was fourth quarter EPS of $1.84, growth of 29%. Moving into our segment results, beginning with the pharma segment on Slide 11, fourth quarter revenue increased 13% to $55.6 billion, driven by brand and specialty pharmaceutical sales growth from existing customers. We continue to see broad-based strength in pharmaceutical demand spanning across product categories: brand, specialty, consumer health and generics, and from our largest customers. Excluding GLP-1 sales, the segment’s Q4 revenue growth would be 9%. As we have commented previously, GLP-1 sales do not meaningful contribute to the bottom line. Segment profit increased 8% to $482 million in the fourth quarter, driven by positive generics program performance. Within our generics program, we continue to see volume growth and consistent market dynamics, including strong performance from Red Oak. Pharma segment profit growth in the quarter was 8% despite an approximate $15 million margin headwind related to the unwind of the previously announced large customer transition. This unanticipated impact in the quarter was the primary difference between pharma’s Q4 results and the midpoint of our prior guidance. Recall that we’d previously observed that the impact of the contract loss would be offset by new customers, specialty networks, and cost controls as part of our contingency planning. Consistent with these mitigation plans, the team began implementing cost control measures and started to see offsetting savings. We also saw strong growth from biopharma solutions in the quarter, including contributions from specialty networks. Turning to the GMPD segment on Slide 12, we are quite pleased by the Q4 GMPD results which confirmed our team’s continued progress against the GMPD improvement plan. Fourth quarter revenue grew 2% to $3.1 billion, driven by volume growth from existing customers. We again saw growth in Cardinal brand volumes during the quarter. GMPD delivered Q4 segment profit of $47 million, generally consistent with our expectations and our prior guidance of approximately $65 million for the year before the prior period revisions. The $40 million year-over-year increase in Q4 was driven by an improvement in net inflationary impacts, including our mitigation initiatives as we achieved our target of offsetting the gross impact of inflation by the end of fiscal year ’24. We continue to be encouraged by the tenacity of the team in driving improved execution in customer satisfaction and service levels while identifying additional opportunities to optimize the business. Finishing with the businesses that aggregate into other, as seen on Slide 13, fourth quarter revenue increased 15% to $1.2 billion, driven by growth across all three businesses: at-home solutions, nuclear and precision health solutions, and OptiFreight logistics. Segment profit grew 11% to $111 million primarily driven by the performance of OptiFreight logistics. The OptiFreight business continues to hit on all cylinders as increasing customer demand for our logistics management services is met with strong execution. In nuclear and at-home solutions, we continue to invest strategically to supercharge growth. All three businesses as key parts of our growth story have received and will receive going forward access to capital for expansion of their business models in support of our customers. I will be brief on the full-year commentary. Fiscal ’24 revenue increased 11% to $227 billion, with growth from all five operating segments. Gross margin increased 8% to $7.4 billion while SG&A increased a more modest 4% to $5 billion, reflecting our year-long efforts to control costs. Together, this resulted in fiscal ’24 total operating earnings growth of 16% to $2.4 billion. All-in, it was an excellent year across the business. Below the line, interest and other decreased 52% to $42 million, driven by increased interest income on cash and equivalents. Our annual effective tax rate finished at 21.7%. Average diluted shares outstanding were 247 million, 6% lower than a year ago due to share repurchases. The net result was fiscal ’24 non-GAAP EPS of $7.53, growth of 29%, well above our long term target of 12% to 14% growth. Now before I turn to fiscal ’25, let’s cover the balance sheet. For fiscal ’24, our ending cash balance was $5.1 billion. The cash position includes $200 million earmarked for the November 2024 debt maturity, with an additional $200 million to be paid through the time deposits held in prepaid assets and other on the balance sheet. To get there, we generated robust adjusted free cash flow, nearly $4 billion in fiscal year ’24. Recall that at our investor day last June, I commented that cash flow remained an area of opportunity for us. Our excellent adjusted free cash flow result in 2024 was almost entirely a result of the team’s year-long effort to optimize each element of our working capital while remaining focused on our service levels. To a much lesser degree, the results reflect balanced preparation for the Q1 contract expiration, which has now occurred in July largely as we expected. We attribute only a couple of hundred million dollars of our fiscal ’24 cash flow to beneficial timing related to the large contract unwind. I’ll talk about the impact of the contract unwind on cash flow shortly as part of our guidance. Also this year, we strengthened our balance sheet and achieved our targeted leverage ratio, which resulted in three positive outlook updates from the credit rating agencies. We also continued to deploy capital in a shareholder-friendly manner, returning more than our baseline commitment of capital returned to shareholders through $750 million of share repurchases and $500 million in dividend payments, and we increased our dividend for the 35th year in a row. Now let’s look forward and discuss our updated fiscal ’25 guidance on Slide 15. Today, we are increasing our fiscal ’25 EPS guidance to a new range of $7.55 to $7.70. This is an increase from the preliminary guidance during our Q3 call of at least $7.50. Slide 16 shows our fiscal ’25 outlook for pharma. On revenue, we expect a decline between 4% and 6%, reflecting the nearly $40 billion revenue headwind from the large customer contract expiration. Normalizing for the large customer, fiscal ’25 revenue growth would be between 15% and 18%. This reflects underlying growth generally consistent with our long-term targeted rate of 10% due to strong overall pharmaceutical demand, as well as significant growth from the on-boarding of new customers and existing customer expansions, primarily in the second half of the year. We are on track to address the segment profit impact of the large contract expiration with this incremental volume, contributions from specialty networks, and additional operational efficiencies. Note that all three of these offsets will have some level of a ramp to them throughout our fiscal ’25. We expect consistent market dynamics for our generics program to continue. We also expect increased contributions from brand and specialty products, including biosimilars. We are assuming a modest year-over-year headwind related to the distribution of COVID-19 vaccines. On brand manufacturer price increases, we expect an environment generally consistent with the past several years. Summing it all up, we anticipate pharma segment profit growth in the range of 1% to 3%, a testament to the strength and resiliency of this business. It is the case that segment profit growth will be more back half-weighted than usual. We expect first half segment profit to be slightly lower to flat versus the prior year, with profit growth in the back half. Q3 should again be the highest absolute dollar profit quarter for the business. Turning to GMPD on Slide 17, on the top line we expect growth between 3% and 5%, aided by low single digit utilization growth as well as incremental volume from the on-boarding of net new distribution customer wins. On the bottom line, we are reiterating our expectation of approximately $175 million in segment profit for fiscal year ’25, on our path to approximately $300 million in segment profit by fiscal year ’26 by executing the GMPD improvement plan. The plan is unchanged from what we shared a quarter ago. After successfully offsetting inflation at the end of this year, the annualization of these benefits will be a fiscal year ’25 tailwind. The team remains focused on continuing to drive Cardinal brand growth through our five-point plan. In fiscal year ’25, we expect Cardinal brand sales growth between 3% and 5%. Simplification and cost optimization also continue with further opportunities in the pipeline to drive efficiencies and streamline our operations. Recognizing that while GMPD’s plan may be simple, that does not make it easy. We once again expect a back half-weighted profit year in fiscal ’25, just like fiscal ’24. The quarterly cadence will be driven by seasonality and the ongoing commercial and operational improvements in the business. Additionally, we expect unfavorable manufacturing cost timing in the first half of the year, which unlike last year includes some start-up costs and timing associated with expanding production at Cardinal Health-owned domestic manufacturing plants to enhance our supply chain resiliency. Q1 should be the low point of the year due to these factors. Last year’s updated Q1 shows $12 million of profit, and this year we expect Q1 to increase to up to $20 million, with sequential improvements thereafter. Turning to other on Slide 18, for each of nuclear, at-home solution and OptiFreight, we expect profit to be aided by the continued strength in demand, execution of our growth strategies, and benefits from our increased prioritization of these businesses with investments. Collectively, we expect revenue growth in the range of 10% to 12% and segment profit growth of approximately 10%, with all three businesses contributing to these targets. Stepping back, we are pleased to see anticipated profit growth across all of our operating segments in fiscal year ’25. Moving below the line, we expect interest and other in the range of $140 million to $170 million. The large year-over-year increase continues to be driven by lower average cash balances, lower short term investment rates on our cash, and higher rates on our debt resulting from the refinancing of our calendar 2024 maturities. We continue to expect our fiscal year ’25 effective tax rate to be in the range of 23% to 24%. With our near term GMPD value creation initiatives, we have increased our fiscal year ’25 share repurchase expectations beyond our baseline to $750 million on the year, leading to a share count guidance of approximately 243 million shares. Finally, we expect fiscal year ’25 adjusted free cash flow of approximately $1 billion, reflecting the Q1 negative impacts from the large contract unwind as well as quarter and day of the week timing. While these dynamics will significantly affect our cash flow in Q1, our strong investment-grade balance sheet positions us well to manage through these fluctuations and continue making strategic investments in the business consistent with our disciplined capital allocation framework. To close, fiscal year ’24 was a standout year filled with notable milestones. With adjusted EPS growth of 29% and adjusted free cash flow of nearly $4 billion, the Cardinal team delivered. With six weeks of fiscal ’25 behind us, I’m pleased to say that the team is managing adeptly. Between the leaders we have throughout the organization, our dedicated team working tirelessly to serve our customers, and our clear strategy, we are confident that we will deliver once again. With that, I will turn it back over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Thanks Aaron. Now I’ll go deeper into our strategic priorities, beginning with pharma and specialty solutions, where we remain focused on building upon our strong core foundation and expanding in specialty. Everything we do starts with the customer. Recently we hosted our 32nd annual retail business conference, the largest in the industry, bringing together 5,000 attendees from across the country. As the trusted partner to retail pharmacy, we understand the critical role retail independent pharmacies play in caring for their communities as they continue to expand their services as community healthcare destinations and demonstrate their remarkable value and resiliency. We continue to invest in our full suite of clinical, business and reimbursement solutions to support our customers and provide industry advocacy to empower retail pharmacy, now and into the future. Our consumer health logistics center slated to open in 2025 will offer a comprehensive selection of over-the-counter medications, treatments and diagnostic solutions. Additionally, our new vaccine alliance program offers cost savings and other benefits from participating manufacturers to help pharmacies engage more patients and expand their immunization programs. We are constantly evaluating ways to bring innovative solutions to our pharmacy and manufacturer partners through the breadth of our offerings and capabilities. As part of that commitment and in collaboration with CVS Health, we have formed Averon, a joint venture to source biosimilars. Averon builds upon our company’s successful partnerships like Red Oak Sourcing with similar overall objectives for biosimilars. Simply put, we are increasing access to additional therapy options that will provide more choice for patients at a lower cost. Averon began by contracting a couple of products, including Humira biosimilars, and we see opportunities for the program to expand over time. Continuing in specialty, we’re pleased with how quickly specialty networks has integrated with our business, and we continue to be impressed with the PPS analytics platform’s insights generation capabilities and the team’s clinical, technology and operational expertise. As expected, we are leveraging specialty networks’ demonstrated capabilities in neurology, the largest area of its fully integrated model, to enhance our offering in oncology. The fully integrated specialty networks market offering is directly aligned with our strategy for Navista, our oncology practice alliance providing advanced technology and services. Over the course of the last year, we’ve built a world-class Navista team consisting of industry experts, defined our offerings and go-to-market strategy, and completed our foundational technology build. The Navista team is engaging with an active pipeline of customers across the oncology marketplace, demonstrating to community oncologists how Navista can help them remain independent for good. Upstream with manufacturers, our leading specialty 3PL has continued its track record of growing faster than market with nearly 20% growth during the year. We’re leveraging these services as part of our comprehensive offering that further facilitates the commercialization and delivery of critical cell and gene therapies to providers and patients. Our new advanced therapy solutions innovation center features a specialized deep frozen storage suite to handle the logistical challenges associated with cell and gene therapies. Additionally, the dedicated space provides opportunities for collaboration and improved process design supporting the ordering, invoicing and accounts receivable process for pharmaceutical products. Across classes of trade, our commitment to service and solutions-oriented commercial approach has resonated with customers. A new health system customer on-boarding that we recently completed and a few in the earlier phases of ramp-up are going smoothly, and we expect over $10 billion in total incremental revenue in fiscal year ’25 from committed customer wins and expansions. Turning to GMPD, when we originally introduced the former medical improvement plan, we consistently highlighted that the first key to turning around the performance of the business was addressing the significant impact of inflation and global supply chain constraints on our business. Our team got to work with urgency, executing various mitigation actions to cover the significant operating losses we incurred. Fast forward to today, after two years of hard work, the GMPD business is on solid ground. We delivered an approximate $240 million year-over-year improvement in segment profit in fiscal year ’24. We exited the year successfully offsetting the gross impact of inflation. We’ve seen three consecutive quarters of year-over-year segment revenue growth and four consecutive quarters of Cardinal Health brand volume growth. We grew Cardinal Health brand revenue 3% overall for the year and 4% in the U.S. Our customer loyalty index score for U.S. distribution remains up over 20 points from its pandemic low, and we’re successfully retaining key distribution customers along with some recent wins. As we continue to dive into the business through our portfolio review, it’s clear there are still significant opportunities to capture. I’ll highlight a few. First, as Aaron mentioned, our progress on inflation mitigation in fiscal year ’24 will annualize and be a significant year-over-year tailwind to our results next year, even with the slight headwind expected from the recent cost increases in international freight. Between the actions we’ve taken to improve our resiliency, the diversity of our global supply chain, and some offsets across our broader portfolio of commodities, we’re confident in our ability to continue to effectively mitigate supply chain inflation. Second, Cardinal Health brand leading indicators remain positive and continue to predict an acceleration in growth. We’ve seen a healthy overall utilization environment for a number of quarters now and our five-point plan continues to produce encouraging results. Third, the disciplined execution of our simplification strategy has driven improved operational performance. With the business stabilized and only recent turned free cash flow positive, we see opportunities to drive targeted working capital improvements over the next two years. Additionally, we can broaden our simplification efforts such as further optimizing our real estate and geographic footprint, while always prioritizing the needs of our customers as our north star. Our team is energized to execute on the next phase of the improvement journey focused on commercial excellence and continued simplification to create additional value for our customers and shareholders. In nuclear and precision health solutions, our leading positioning with 130 nuclear pharmacies and 30 PET sites across the country feeds our differentiated ability to partner with manufacturers in order to bring cutting edge therapies to patients exactly when they need them. Our excitement continues to build around the opportunities to improve patient lives through the use of precision medicine, which we have been investing into heavily with our center for theranostics advancement. We’re seeing the results with our theranostics business growing over 20% in fiscal year ’24, driven by strong demand for prostate cancer theranostics products such as [indiscernible]. In fiscal year ’25, we expect similar theranostics growth and will continue to invest to meet the growing pipeline of opportunities, which includes cardiology and neurology, but overall is largely dominated by oncology. As an example, we will be expanding our support of novel prostate radioligand therapies with Novartis’ Pluvicto in fiscal year ’25. We are also investing in increasing our cyclotron capacity and PET manufacturing geographic footprint to meet increasing demand for PET diagnostics, with a majority of emerging radiotherapeutics requiring a companion PET scan. Fiscal year ’24 was a foundational year for our $2.9 billion at-home solutions business as we laid the groundwork for future growth and efficiency. This business continues to grow revenue faster than market, not only aided by care moving into the home but also our team’s commercial execution. To drive operating leverage, we’ve been investing our technology capabilities such as new warehouses with state of the art automation. Just last month, we opened our brand-new 350,000 square foot warehouse in South Carolina featuring the fastest order fulfillment system in the market. This system is also operational in our central Ohio facility and planned for the new Texas distribution center we’d previously announced and expect to open in 2025. We’re seeing fruits from our investments with our fill rates currently the highest they’ve been in over three years and our patient net promoter score up over 16% year-over-year. The OptiFreight logistics team delivered this year with exceptional performance. Our TotalVue insights platform continues to help customers uncover shipping inefficiencies and optimize delivery through data-driven insights. As a result, our customer loyalty index is at an all-time high. In fiscal year ’25, to put it simply, we expect to continue our track record of great execution, helping our customers expand and bringing on new customers to benefit from our program and value. Across the enterprise, we are confident in the Cardinal team to continue our momentum and deliver our targeted growth in fiscal year ’25 and beyond. Before I wrap up, the former CEO in me can’t help but acknowledge our team’s tremendous progress on cash flow this year. With the record results in fiscal year ’24, we’re positioned to exceed the adjusted free cash flow expectations we outlined at investor day with at least $7 billion over the fiscal ’24 to ’26 period, even despite the large contract expiration. We possess the financial flexibility to continue investing our business, returning capital to shareholders and maximizing long term shareholder value creation. In summary, fiscal year ’24 was another great year and we are excited to continue driving our company and healthcare forward. I want to thank our dedicated employees who serve our customers and continue our work to be healthcare’s most trusted partner. With that, we will take your questions."
},
{
"speaker": "Operator",
"content": "Thank you very much, Mr. Hollar. [Operator instructions] Today’s first question is coming from Lisa Gill, calling from JP Morgan. Please go ahead."
},
{
"speaker": "Lisa Gill",
"content": "Thanks very much, and good morning. Thanks for all the details, Jason. I just want to better understand two things. One, nice driver of the margin going into next year, you had originally said roughly 1%, now you’re talking 1% to 3%. I think you called out a couple of things - the specialty network, new customer, cost mitigation, but I’m just curious, especially in the new customer, is there anything unique about that contract or anything else that you would call out as we think about the margin improvement throughout ’25?"
},
{
"speaker": "Aaron Alt",
"content": "Lisa, good morning, thanks for the question. Happy to talk about it. We are really pleased to raise our guide for the pharma business for fiscal ’25 - it really reflects our continued confidence in the team and continued confidence in the resiliency of that business, notwithstanding some of the puts and takes that we’ve been talking about over the last couple of quarters. I’ll touch on the profile in a second, but I do want to emphasize on the revenue side of the house from a guidance perspective that we guided down 4% to 6% all-in, reflecting the $40 million headwind on the low margin contract non-renewal, but it’s really up 15% to 18% on an adjusted basis if you take out the impact of that customer loss. Within that 15% to 18% is $10 billion of new revenue, new customers and expansions of service with existing customers - that’s on top of a 10% underlying growth with the existing business, and so from that you can tell that we are growing the portfolio and doing what we said we were going to do with our existing customers and adding on both new customers and expansions with existing customers to get to that revenue base. That supports the increase in guide, the 1% to 3% on the profitability side of the house. The thing we called out during the earnings call is the consistent market dynamics, it’s the generic volume growing, the low single-digit growth in core and the high single-digit growth in specialty, the strong overall Rx demand. There’s a lot of things going on, but we are confident in our plans as we carry forward. Now, we don’t comment on the margin profile of any particular customer, particularly in the context of a new customer, and we were delighted to announce formally the Publix win today in our earnings release. I’m not going to comment on their profitability, but I will observe that we have publicly commented on the low margin nature of the business that we’ve lost, and that certainly doesn’t hurt us as we carry forward. Jason, anything you would add to that?"
},
{
"speaker": "Jason Hollar",
"content": "No, nothing to add."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will be coming from Eric Percher calling from Nephron Research. Please go ahead."
},
{
"speaker": "Eric Percher",
"content": "Thank you. I think it’s fair to say there was some concern coming into the quarter on the increase in macro freight trends and other input costs, and I know you mentioned you’re able to offset that. Can you give us a sense of how this looked to you in terms of the size of that increase versus what we’ve seen in the past, was it material, and how it looked under the current or new contracts versus legacy contracts, and the ability to pass that along to your customers?"
},
{
"speaker": "Jason Hollar",
"content": "Sure, thanks for the question, Eric. I think it’s important to just go back in time a little bit, this last 12 months. A year ago when we were sitting here, certainly the freight costs had gone all the way back down to historic levels, so we were enjoying--really, the run-up had come all the way back down, and it was the beginning of the calendar year, so in our third quarter when the Red Sea issues first began, and that’s when we saw the first spike, and the reason I remind you of that is that first spike was known come springtime, when we gave our initial guidance for GMPD, and so we knew about that first step-up already, and that’s been factored into the guidance from day one. Yes, there have been further increases since then, but when you look at the combined two increases, the two different steps, first in January, then in the spring, they still are woefully short of where we were a couple of years ago when the whole supply chain was under pressure, where even when we were spending two, three times the current level, we were having difficulty in actually getting reasonable service. So yes, the costs are higher, but not nearly as high as they used to be, and most importantly is the supply chain is functioning a lot more efficiently than it was before. Long way of saying, Eric, that yes, there is a little bit of an increase here, it’s something we monitor and manage very, very tightly, but it’s not the point where it requires widespread price adjustments accordingly, at least not yet. In addition to that, it’s important that we look at the overall inflationary environment, and we talked about this a couple of years ago. At the peak, we had a lot of oil and petroleum-based products, including fuel and other type of freight, that was also a big issue. Those are actually a little bit softer in terms of the cost, so overall net-net, we’re managing through it better than we have before, and overall we have some puts and takes that are all very manageable. We’ll continue to evaluate the pricing necessary within that, but at this stage we haven’t had to exercise that lever to near the extent that we did in the past."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, our next question will be coming from Michael Cherny calling from Leerink Partners. Please go ahead, your line is open."
},
{
"speaker": "Michael Cherny",
"content": "Good morning and thank you for taking the question. Maybe if I could dive a little bit more into the underlying pharma growth, if you can. You did a good job outlining some of the moving pieces on lost contract versus new. Is there any way you can give us a bit more color on where you expect the profit streams to lie from specialty, and then also a bit more color on the COVID hangover, just so that we can have a better understanding. I guess maybe the simple, straightforward question is where will you be on an exit run rate on pharma growth exiting the year, given all the moving pieces you have to start the year?"
},
{
"speaker": "Jason Hollar",
"content": "Yes, let me try to address a few of those pieces. Specialty is absolutely a key part of this story and why we still anticipate being able to grow this business next year. We highlighted in our comments that in fiscal ’24 for the year, we saw another year of 14% growth. You may recall at our investor day last year, the specialty business CAGR over the prior three years was anticipated at that time to be 14% as well, so another year of strong growth driven by the widespread investments that we have made and continue to make. We talked today about a couple of interesting growth drivers for the future, whether it’s our advanced therapy solutions business, the new venture with CVS for Averson focused on biosimilars. Biosimilars in general has been a rising tide type of benefit over the last several years, and of course then our acquisition of specialty networks, which closed in March and has an eight, nine-month type of year-over-year benefit tailwind, so these are all areas that are driving our specialty business to some degree in fiscal ’24, but they’re all examples of where we would expect that to continue to grow over fiscal ’25 to help mitigate for that contract non-renewal, that we think while that growth will be slower in ’25 due to that. I also made the comment in the remarks that even in spite of this overall revenue reduction for the enterprise for the pharma segment and the impact of that contract non-renewal, we still expect our specialty business to grow in fiscal ’25 in spite of that. That tells you that our run rate as we lap fiscal ’25 and that non-renewal, we would anticipate it to be very consistent with the long term algorithm that we’ve highlighted in the past, which from a profit perspective has been defined as low single-digit type of profit growth for our PD core business and double-digit growth for specialty, so we’ll continue to look at other opportunities to invest organically, as well as inorganically to continue to feed that growth."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Our next question today will be coming from Erin Wright calling from Morgan Stanley."
},
{
"speaker": "Erin Wright",
"content": "Great, thanks. In terms of the fiscal ’25 guide, are there any changes in terms of how you were thinking just the Optum unwind in terms of stranded costs or otherwise, and just given the building contributions, whether it’s specialty networks or the new customer win with that Optum offset, I guess, how should we think about that cadence in terms of the split of first half versus second half, or however you want to define it, on an EPS perspective, given some of those moving pieces in the first half? Thanks."
},
{
"speaker": "Jason Hollar",
"content": "Yes, I’ll have Aaron walk through some of the cadence [indiscernible], to your question, but I wanted to stress just upfront, what you should have heard from these messages are very, very similar words and phrases that we used last quarter. The plan is unchanged. Of course, we get a little bit smarter, we sharpen our pencils a little bit and we get a better understanding of where our exit rate is for ’24, but all the factors that we are talking about today with this business are very similar to what we walked through in the past, and of course all the investments that we made this last year. Aaron, a few thoughts on the cadence?"
},
{
"speaker": "Aaron Alt",
"content": "Sure, so the way to think about it is Optum was an existing customer with us until the end of our Q4, and you can see the results in Q4, we don’t need to go deeper on that. But what did also happen in Q4 was us being incredibly planful around the impacts to our operations, as well as to our financials of that customer unwind. We’ve talked in the past and we talked during our last earnings call around the three offsetting actions, the contribution of specialty networks, of course the new customer win, the expansion with existing customers as well as further cost optimization opportunities, and we’re pleased the team got on it, got ahead of it, and they’ve already been executing in that respect, and so the guidance we’re able to provide today, we view as relatively consistent with what we’ve provided in Q3, but with an additional degree of confidence because the plans are behind us and now we’re acting in that way. The non-renewal will impact our Q1- there’s no way to avoid that. They were a large, low margin customer, and as we’ve talked about, the new customers coming on board are largely back half-loaded, and so we will have a timing difference relative to prior years and that will impact certainly our revenue and profitability timing over the course of the year. There’s also a cash impact, right? The unwind of the negative working capital position there is a Q1 impact for us and a key reason why we are carefully monitoring our cash flow during the first quarter, of course balanced with the fact that we are delighted with the strong adjusted free cash flow and the strong cash balance at the end of our Q4. Look - on balance, the cost optimization is already in play, specialty networks is already in play, and we continue to work on the customer expansions and the new customer on-boarding, and we will make that successful as well."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question today will be coming from Allen Lutz calling from Bank of America. Please go ahead."
},
{
"speaker": "Allen Lutz",
"content": "Good morning, and thanks for taking the questions. One for Aaron. Can you talk about how gross profit performed relative to your internal model, and then are you seeing any impact from insulin pricing changes or Humira share shifts to gross profit dollar growth? Then are there any insights or thoughts around a biosimilar launch for Stelara? Thanks."
},
{
"speaker": "Aaron Alt",
"content": "I’ll start. Look, I would observe that our gross margin progression went largely as we anticipated over the course of the quarter and the year. We have a very complicated business managing between the various parts, and no real surprises from my chair in that way. The second part of the question was--?"
},
{
"speaker": "Jason Hollar",
"content": "Yes, let me take that. It was related to, I think, just the general impact of insulin pricing, but there’s also the Humira element there, so it’s probably a couple different questions. Within the quarter, we did, as Aaron had highlighted before, we saw of course the ongoing benefit of the GLP-1 growth, but we did have a similar offset as it relates to the pricing change for the WAC insulin adjustments that happened at the beginning of the calendar year. Until we get through the second quarter of fiscal ’25, we’d anticipate there to be a bit of an offset related to that price change. There was also a question around Humira and, I assume, just the biosimilar type of migration. We see that it’s started to move a little bit more. Certainly some of the actions that CVS has done more broadly in the marketplace seem to have moved things along a little bit further. It’s still fairly low penetration throughout the broad industry, but generally speaking, we have seen that start to pick up a little bit, I wouldn’t say meaningfully, within the quarter, maybe a little bit even afterwards, but it’s still at fairly low penetration rates. It’s one of the reasons why we’re so focused on biosimilars and with our joint venture with Averon, is just to continue to look for ways to increase access for patients that need that therapy at an affordable cost, so we’ll continue to do our part there. Next question please."
},
{
"speaker": "Operator",
"content": "Our next question today will be coming from Kevin Caliendo of UBS. Please go ahead."
},
{
"speaker": "Kevin Caliendo",
"content": "Thanks for taking my question. I’m just trying to triangulate some of the things we’ve learned this quarter about the GMPD business. You’re talking about winning more share of pocket. We’re seeing you make investments in domestic plants, we’ve seen shipping costs go higher. At the same time, we’ve seen Owens & Minor and Medline put up stronger than expected results, and McKesson and Henry Schein put up worse than expected results and guide lower in those segments. Is it maybe fair to say that you and your peers on the hospital side are moving downstream at all to try to capture greater percentage of the health system business that’s not just in the acute care side? Is that a trend that’s happening, and I guess the second part of that is the investments in domestic driven by the idea that now you could be more--because shipping costs are higher, costs overseas, tariffs are coming, that the domestic manufacturing can be more competitive in a price basis versus importing?"
},
{
"speaker": "Jason Hollar",
"content": "Yes, so it’s certainly true that GMPD is more acute focused customers, and we do benefit from the migration towards more of an ASC model. We do not participate widely in physician offices, so that’s an element. It’s nothing that we’ve called out as broad trends, so I don’t have much more to go on there, other than on a same store sales basis, we’re seeing the utilization fairly consistent this past year, generally speaking, that low single-digit type of range, so we are seeing that there’s like-for-like growth. What we’ve highlighted fairly consistently is that this last year was--or the end of ’23, beginning of ’24 was the inflection point for us. We were not growing with the market at that point. Over the course of ’24, we’ve largely grown with the market, plus or minus a point here or there, so very consistent with that low single-digit type of growth over--especially after our first quarter. We don’t think there’s widespread shifts there, but we definitely have an ASC presence that we do think we benefit from, but I wouldn’t call that a main driver of what we’re looking at. In terms of the investments we’re making, we did call out some domestic investments, but they’re not limited to domestic. We believe in a very diversified, competitive geographic footprint. We’ve stressed that specifically we don’t have manufacturing, direct manufacturing in China - that’s one of the related questions here as it relates to certainly the ongoing tariff risk, and I can also let you know that we only source less than 10% of our total Cardinal Health branded product in China, so specifically to China, we don’t have a large exposure. But we do have exposure beyond China, and Asia and near-shore Central, South America, we believe a diversified, broad supply base is important, as well as a domestic footprint. We have increased our investments across the supply chain to improve the resiliency, and there’s a couple of areas within the U.S. specifically - you’ve seen some of the tariffs related to syringes is a specific area of focus, and we happen to have that capability in the United States. That’s just one example of where we’re really doubling down on that investment. So yes, costs and freight are always a consideration - you know, we build a financial model behind all that and we look at the risks, but on this particular example, one example of where we’re really leaning in on that investment, that’s more about just ensuring our customers get the product they need. This is more of a volume opportunity than a pure cost and margin opportunity, so you’ve got to look at all those factors. Next question, please."
},
{
"speaker": "Operator",
"content": "Yes sir. The next question today will be coming from Eric Coldwell of Baird. Please go ahead."
},
{
"speaker": "Eric Coldwell",
"content": "Thank you very much. I wanted to ask quickly about Medicaid disenrollment and the extent you’ve seen impacts in consumer or channel behavior as a result of that, and if so, could you specify where and possibly quantify those impacts? I think specifically, I’m probably tagging onto Kevin’s question and wondering if some of the shifts we’re seeing in the medical segment could be related to roughly 25 million people coming off of Medicaid here in the last several months. Thank you very much."
},
{
"speaker": "Jason Hollar",
"content": "Yes, thanks for the question, Eric. Again, I think my answer is going to be fairly similar to what I said before, but in a different context. We have a very broad base of customers, very broad base of payors behind those customers, so we don’t have necessarily even the insight all the time as to where those reimbursements are coming from. The same store sales type of information, what we see more broadly is just not a lot of fluctuations and variations, and we’re not talking again of any type of growth rate above and beyond what we believe that underlying utilization is. Generally speaking, if there are some of those trends, at this stage I’m not seeing that as a meaningful driver to where our business is going."
},
{
"speaker": "Matt Sims",
"content": "Next question please."
},
{
"speaker": "Operator",
"content": "Yes sir, our next question today will be coming from George Hill calling in from Deutsche Bank. Please go ahead."
},
{
"speaker": "George Hill",
"content": "Hey, good morning guys, thanks for taking the question. A two-parter. Number one, I guess Aaron, would you be willing to provide any more color on earnings cadence expectations for the year, particularly Q1 and Q2 versus the back half, given the large number of moving pieces? Then a quick one for Jason is we know you’ve got the new business coming on, we’ve got the United loss. Would just love an update on the competitive environment in drug distribution. This has been a pretty stable space for a while now. Just want to make sure that nothing’s changed, or nothing should be changing in the dynamic that we should be aware of. Thanks."
},
{
"speaker": "Aaron Alt",
"content": "I’ll start. I would just observe that we’re being very thoughtful in the planning we’re doing for the year, given the number of moving pieces we have both within the pharma business and within the GMPD business, and of course keeping an eye on the three growth businesses within other. Within pharma, what we’ve reference is first half from a cadence perspective will be slightly down to flat versus prior year. That’s only natural given the customer unwind and the back ended nature of the new customer on-boarding. Largely, the drivers within the pharma business are consistent with what would have been true in previous years - Q3 will be where we see the branded inflation rolling through, and so not a lot of different news there that I would call out. From a med perspective, we’re very focused on executing against the plan. We’ve tried to be transparent every quarter about how we’re doing and where we see it going, which is why we were purposeful in calling out Q1 specifically as we push ahead. We’ve had great success during fiscal year ’25 and accomplished what we told you we were going to do, and we plan to do that again. Just want to be clear that we are investing in the business and there are some near term Q1 drivers that will make that rough number, what we call the up to $20 million as we carry forward. There’s no magic here, though - I want to be clear. The plan and the cadence is generally consistent with how we’ve described the GMPD improvement plan in the past. Of course, we have the benefit of the inflation mitigation now lapping as we push ahead, and of course we can’t forget the important topic of seasonality from a Q4 to Q1 perspective - we’ve called that out before, and that’s why you see a dip from the great results in Q4 into Q1."
},
{
"speaker": "Jason Hollar",
"content": "As it relates to the second question, I’ll say what I said before - we’re 1% industry, so it’s competitive but stable. I would say that the vast majority of contracts don’t change hands period to period. These couple, several that have that more notable, there’s been several that have long term five-year types of agreements, so every five years there is the chance, opportunity or risk for that to occur, but again I’ll just stress the vast majority don’t. We feel really good about our positioning, competitive positioning. We know we’re competitive, we know that our message and our work and our results resonate with our customers. We’re very much focused on that experience, the service levels, the value initiatives and propositions behind it, the tools and platforms. We’ve talked about our InteLogix and our Atrix platforms for health systems as one example of not just going at them with price but going at them with value, and having true value components to those offerings, and we feel really good about where that positioning is, and that’s why we’ve been able to offset to the degree that we have."
},
{
"speaker": "Matt Sims",
"content": "Next question please."
},
{
"speaker": "Operator",
"content": "Yes sir, the next question will be coming from Stephanie Davis of Barclays. Please go ahead."
},
{
"speaker": "Anna Grasinsky",
"content": "Hi guys. This is Anna Grasinsky [ph] on for Stephanie. Congrats on the quarter, and thank you for taking our questions. I was hoping to hear more about your AI road map. You’ve highlighted AI and machine learning deployments within the InteLogix platform, and just wondering how we should think about additional AI use cases to improve efficiency and potential cost savings."
},
{
"speaker": "Jason Hollar",
"content": "Yes, thanks for the question. It’s broad-based, it’s varied. We don’t call it out in every call in all areas, but it’s so broad, it really is everywhere. It’s in the core of how we operate. Examples of what we talked about today, without using the phrase AI, especially networks - you know, their PPS analytics is a great example of taking that data, electronic medical records and synthesizing that for manufacturers, as well as providers, and getting actionable insights. I mean, that is AI. When you look at some of the automation I’m commented on in our at-home solutions network, this is now over 25% of our sites just in the last 12 to 18 months. We’re launching a new footprint that is bringing in technology and automation in various forms into the manufacturing--or I’m sorry, into the distribution setting to be even more innovative, even more efficient and productive. As you mentioned, those other platforms, InteLogix, Atrix, working with Palantir and other partners to create value, and then I’m not even getting into the more basic use cases like customer service and back office. I guess I don’t want to just hit the same drumbeat everyone else is. What we’re trying to do in our communication is get beyond the buzzwords and really talk about the essence of where we’re driving our business, and we feel really good about that, and it’s definitely [indiscernible]."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes sir, we’ll now move to Elizabeth Anderson calling from Evercore. Please go ahead, your line is open."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hey guys, thanks so much for the questions. I was wondering if you could maybe expand on your prior comments about two things. One, you talked about customer expansions a couple of times across the course of the call. Can you talk about what those are - generally speaking, are they people moving from pharma to increase in medical, are they moving across different pharma categories? How do we think about that? Then if we think about the cost cutting, obviously there’s some right-sizing for the contract change that you guys mentioned, but how do we think about some of the more--it sounds like some of those changes you’re putting through are sort of more structural, so how do we think about the long term benefits of those going forward? Thanks."
},
{
"speaker": "Jason Hollar",
"content": "Yes, I’ll start. On the customer expansions, these are existing customer relationships where we are already a primary distributor for them, and they are expanding their footprint, whether it’s acquisitions or just taking on more of the business themselves, and we’re supporting their growth, so it’s an existing relationship and expanding upon that, so it’s committed in that sense, where we’re already there, and you can use BioPlus as one of the examples of what I’m talking about there. Perhaps Aaron, you can go into a little bit more detail on the [indiscernible]?"
},
{
"speaker": "Aaron Alt",
"content": "Sure, so as I commented earlier, the team did a great job of assessing our opportunities in the face of the customer non-renewal, but I guess I would go back and point out that at the end of the day, we operate a 1% operating margin business, so it’s important for us to always be mindful of the cost structure around us, but with a north star of how do we continue to ensure our customer service. We have been pleased that the reviews we undertook during Q4, the actions we identified will help us to offset the near term impact of customer loss, but more importantly they create a more efficient operational structure for us, and the changes are broad ranging across the enterprise with that north star ensuring we continue our customer service focus as we push ahead. Many of the changes have already been implemented and we’re operating in that new framework already. We continue to assess what are the productive opportunities, and I also would emphasize that the ideas for these changes are coming from our broader teams as they look around and say, okay, how can we operate better in support of our existing customers and the new customers on the line."
},
{
"speaker": "Matt Sims",
"content": "Next question please."
},
{
"speaker": "Operator",
"content": "Yes sir, we’ll now move to Stephen Baxter of Wells Fargo. Please go ahead."
},
{
"speaker": "Stephen Baxter",
"content": "Yes, hi. Thanks. I just wanted to ask a couple about the restatement to GMPD. It sounds like you’re saying the higher GMPD base post-restatement in 2024 doesn’t’ change the run rate, because you’re removing out-of-period items. Is that the right way to think about it, so there’s no comparability issue with the $175 million target on that higher base? I guess that’s the first question. Then based on the restatement that you provided, I think the cumulative profit in the business from 2022 to 2024 is $25 million or $30 million higher than previous. I’m just trying to understand why those things don’t net out if we’re thinking about timing issues here. Thank you."
},
{
"speaker": "Aaron Alt",
"content": "Yes, appreciate the question. The answer is there is no comparability issue. The 175 is unimpacted by the revisions that we provided in the financials today. The revisions we provided were for the three-year period. There will be--there is an impact of shifting of income or expense into the prior periods as well, which is why you’re not seeing direct comparability as we carry forward. I do want to emphasize, though, that part of our operation here is building and maintaining a strong [indiscernible] environment, and as we identified the issue in the Edgepark part of our at-home business, which is part of other, it was a revenue recognition issue tied to a business which does less than half a percent of our overall revenue base. We were careful to do the right thing and disclose, and at the same time in partnership with our auditors decided that we would reflect the feedback we’ve gotten from this community and others around comments around non-recurring adjustments in prior periods, etc., and so now we walk into fiscal ’25 not only with comparability but with a clean set of financials, unimpacted by timing to be able to talk about our progress as we carry forward."
},
{
"speaker": "Matt Sims",
"content": "Next question please."
},
{
"speaker": "Operator",
"content": "Yes sir, the next question will be coming from Charles Rhyee with TD Cowen. Please go ahead."
},
{
"speaker": "Lucas",
"content": "Hi, this is Lucas on for Charles. Thanks for taking the questions. I wanted to ask about the other segment. Can you talk about what’s expected from OptiFreight, nuclear and at-home in fiscal ’25 in terms of growth? Should we be thinking about any of these businesses outperforming the 10% segment target that you’ve set?"
},
{
"speaker": "Aaron Alt",
"content": "Well from a guidance perspective, we provide guidance for other on an aggregated basis, but I do want you to take away the enthusiasm present in Jason’s comments and his tone of voice around the opportunity we think that each of these three businesses presents to Cardinal Health as we carry forward. The businesses are unique. They are managed differently. We aggregate them from a financial perspective. It’s also the case that we are investing in each of those businesses, we have in ’24 and we are in ’25. At-home has recently opened two new distribution points and is investing in automation. OptiFreight has continued to invest in its digital platform and service of its customer experience. The nuclear business, we’ve talked at length about expanding the PET network as well as our excitement about the theranostic opportunities that that business presents. Again, as I go back to the financial guide, part of what you’re seeing in the other basis is we are presenting a consistent picture on an aggregated view, which reflects in some cases we’ll be investing in a year or a month while reaping the benefit in the same year or month from other parts of the portfolio. Jason?"
},
{
"speaker": "Jason Hollar",
"content": "Yes, I would say the one thing we did clarify in the prior comments is that all three businesses are expected to contribute to that growth in fiscal ’25, and we are investing--you know, fiscal ’24 was an especially heavy investment period, but we are continuing to invest across the range. Just one example to put into perspective is we talked a lot about our investments in our nuclear and precision health solutions business. This is a business that we’ve highlighted, theranostics now just with our second phase of expansion that we announced about a year ago, or this last year, and then we also have talked about some PET expansion. From a fiscal ’24 to ’26, that’s about $100 million, mainly capital that we’re investing into that business, but it’s representative of the big investments that we’re making in addition to the three different distribution centers in at-home solutions that Aaron had mentioned are very representative of the inputs that we’re putting into these businesses, because we deeply believe in their ability to continue to grow, benefit from the secular trends they each enjoy, but then also reflecting the leadership position we have in each, and that is then further bolstered by these very specific investments."
},
{
"speaker": "Matt Sims",
"content": "Next question please."
},
{
"speaker": "Operator",
"content": "Thank you sir. Ladies and gentlemen, our last question today will be coming from Daniel Grosslight of Citi. Please go ahead."
},
{
"speaker": "Daniel Grosslight",
"content": "Hi, thanks for taking the question, and congrats on a strong quarter. Was hoping to get a bit more detail on Averon. Will that just be serving CVS at this point, and how does that kind of interact with Cordavis, and then are there any purchase obligations or quarterly payments associated with that? Then lastly, when does that agreement renew?"
},
{
"speaker": "Aaron Alt",
"content": "Okay, so you crammed in about four there. Averon, the first specific question on Averon was--?"
},
{
"speaker": "Jason Hollar",
"content": "Just broadly speaking, more color."
},
{
"speaker": "Jason Hollar",
"content": "Yes, so I referenced it a few different times, so I think maybe there’s a more specific question behind it. Oh - I think the question was, does it just service CVS? The answer is no. It’s a consistent concept as what we did with Red Oak Sourcing, reflecting that we both have different needs, different customers if you will, and can jointly benefit those patients through combining our capabilities in this space, so we would expect to operate it in a similar way, where we have different benefits associated with that. There are--I think what you’re talking about, there’s not the same type of payment structure and schedule that we have for Red Oak Sourcing, kind of equalization payments if you will, so that structure does not exist with this. It is structured quite a bit differently in that regard. Then in terms of--I think there was a renewal question there about CVS, and so the contract goes through--the distribution contract goes through ’27, and then the Red Oak agreement goes through ’29, so this is certainly outside of those agreements and it’s very much an example of the type of partnership that we look to have with any and all of our customers in various ways to ensure that we’re thinking about how better to serve those underlying patients."
},
{
"speaker": "Operator",
"content": "Thank you, Mr. Hollar. We don’t have any further questions, so I’d like to turn the call back over to you for any additional or closing remarks. Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Yes, thank you, and thank you all for joining us. In addition the usual pleasantries I have at this point in the call, I do want to step back for just a minute, reflecting that given it’s our year-end as well as additional guidance, I know that there was a lot to digest within this, but I hope that we clarified many of your points today. I do want to end where I started and just re-emphasize those same three key points I had at the very beginning of the commentary today. First of all, we finished the year with terrific momentum. We grew our earnings per share by 29% for both the quarter and the fiscal year. You add that on top of the growth that we saw last year, that’s a nearly 50% increase in our EPS over the last couple of years, driven by performance across the board but really strong performance in our largest, most significant business, our pharma segment, growing despite having some of those impacts in the quarter from that contract unwind. But we’re also seeing very good utilization across the enterprise, whether it’s pharma as well as GMPD. We see that this industry continues to have a lot of need within the marketplace. That in part is driving our GMPD, but really that $240 million improvement that we saw for that business this year is being driven by the successful mitigation of inflation, a long hard journey but we’ve gotten there, and now we’re able to focus on driving the business going forward. Our other businesses, we’re seeing robust demand across the board, utilization but secular trends as well. Really excited about the ongoing growth there - double digit 10% growth in 2025 while continuing to invest in the business. Cash flow - really strong, not only $4 billion nearly this year but when you take last year and this year in combination, that’s nearly $7 billion that position us very well for financial flexibility going forward. All right, the second point was because of that momentum, we feel very confident about our fiscal ’25, and that’s why we raised our guidance, both in our largest business with pharma but also driving EPS growth in fiscal ’25, despite that customer transition. Then thirdly and lastly, we’re doing all that operational and cash flow focus while also driving our strategy going forward, optimizing our portfolio, very consistent transparent dialog we’ve had with you. This management team is focused on those key priorities and will continue to communicate. We’re excited about the progress across a number of areas that we talked about, whether it’s furthering our partnership with our largest customer or the ongoing integration of our largest acquisition of specialty networks that we’ve done in quite some time, and we’re well positioned to continue to grow the business even in spite of any of the headwinds that we’ve identified. Of course, behind all that, we will continue to responsibly prioritize shareholder value creation, and we’ve communicated some additional near term actions specifically within the GMPD business today, and that is translating to even more opportunistic share repurchases in fiscal year ’25. So a lot there, but a lot to be excited about, and we appreciate your time and attention, and look forward to keeping you updated on our progress."
},
{
"speaker": "Operator",
"content": "Thank you very much, sir. Ladies and gentlemen, that will conclude today’s conference. We thank you for your attendance and you may now disconnect. Have a good day, and goodbye."
}
] |
cah | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to the Third Quarter Fiscal Year 2024 Cardinal Health Incorporated Earnings Conference Call. My name is George. I'll be your coordinator for today's event. Please note, this conference is being recorded and for the duration of the call, your lines will be in a listen-only mode. [Operator Instructions] I'd like to turn the call over to your host today, Matt Sims, Vice President, Investor Relations. Please go ahead, sir."
},
{
"speaker": "Matt Sims",
"content": "Welcome to this morning's Cardinal Health third quarter fiscal '24 earnings conference call, and thank you for joining us. With me today are Cardinal Health's CEO, Jason Hollar; and our CFO, Aaron Alt. You can find this morning's earnings press release and investor presentation on the Investor Relations section of our website at ir.cardinalhealth.com. Since we will be making forward-looking statements today, let me remind you that the matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to our SEC filings and the forward-looking statements slide at the beginning of our presentation for a description of these risks and uncertainties. Please note that during our discussion today, the comments will be on a non-GAAP basis, unless specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the supporting schedules attached to our press release. For the Q&A portion of today's call, we kindly ask that you limit questions to one per participant, so that we can try and give everyone an opportunity. With that, I'll now turn the call over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Good morning, everyone. A year ago at our Investor Day, I reflected upon what attracted me to Cardinal Health, our strong culture, values, and mission to be healthcare's most trusted partner; how the company was uniquely positioned with its breadth and scale to navigate the complexities of the healthcare ecosystem and serve the needs of customers, manufacturers and ultimately, patients. At the same time, I was open about some of the opportunities in front of us as an organization. Together, we laid out a clear but aggressive strategic plan, streamlined our focus, and the team got to work, all the time prioritizing on our core business to emerge as a stronger, more resilient company. And we have a recent proof-point. Over the last several months, we deeply focused on preparing for a variety of alternatives regarding a particular large, low margin customer contract, which has allowed us to quickly navigate the upcoming contract change and confirm that we expect to grow our earnings in fiscal '25. By driving improvements in our core operations, investing to expand our offerings in key areas like specialty and evolving our commercial approach in ways which have resonated elsewhere in the marketplace, we demonstrated that we have made progress on positioning our business for sustained success and growth. As we look ahead, the current quarter's results reinforce our confidence. We're operating from a position of growing strength and resiliency, with industry trends that remain stable and in our favor. In Q3, we delivered broad-based growth, while executing on our four strategic priorities; building upon the growth and resiliency of pharmaceutical and specialty solutions, executing our GMPD improvement plan, accelerating growth in key areas, and maintaining a relentless focus on shareholder value creation. In our most significant business, Pharmaceutical and Specialty Solutions, we again drove solid profit growth on top of a difficult comparison to last year's strong performance. We've seen ongoing stability in pharmaceutical demand, consistent market dynamics in our generics program, and strong performance in specialty, both downstream and upstream, all of which enables us to raise our fiscal '24 profit outlook for the segment to a midpoint of 9% growth. In GMPD, we are pleased to see the strong topline and bottom line performance, with an acceleration in growth reflecting further progress against the business' turnaround plan. GMPD's quarter was overall consistent with our expectations and the team is already working hard on the continued ramp-up in Q4. Among our other operating businesses, our new reporting structure implemented at the start of Q3 is reinforcing our focus on performance and purposeful investment in growth. The strong demand we are seeing across Nuclear, at-Home Solutions, and OptiFreight, fueled by favorable industry trends, excites us about the long-term potential as these markets and businesses continue to develop. And as we've optimized the financial strength of the broader enterprise, we've seen meaningful benefits below the operating line this year. Putting it all together, we're pleased to be in a position to raise our fiscal '24 EPS outlook, provide preliminary guidance for fiscal '25 of profit growth in each of Pharma, GMPD, and Other, as well as overall EPS, and reiterate our long-term targets for our businesses and enterprise. Our strategy and long-term outlook are unaltered and our team remains focused on executing our plan as we serve our customers and continue to drive our company forward. With that, let me turn it over to Aaron to review our Q3 results, fiscal '24 guidance, and early fiscal '25 outlook in more detail."
},
{
"speaker": "Aaron Alt",
"content": "Thank you, Jason. This morning, we are reporting our financial results on the new financial reporting segment structure we implemented at the beginning of Q3. To that end, we released an 8-K on April 23, which provided the recast historical quarterly results for fiscal year '22, fiscal year '23, and fiscal year '24 through Q2, reflective of the new segmentation for Pharmaceutical and Specialty Solutions, GMPD, and Other. As we called out at the time, the new segmentation is designed to provide greater transparency, focus, and accountability across our businesses, and we are already seeing those benefits. Overall, Q3 was a strong quarter with double-digit operating earnings growth and 20% EPS growth. We accomplished that growth, while at the same time leaning in and making significant investments of time, expense and capital against our longer-term strategic plan. With both continued confidence in our strategies and a resilient business and team, we are pleased to once again raise our EPS guidance for fiscal year '24, more on that shortly. As seen on Slide 4, total company revenue increased 9% to $55 billion, reflecting revenue growth in the Pharmaceutical and Specialty Solutions segment, the GMPD segment, and in all of the businesses making up Other. We were particularly pleased to see the second consecutive quarter of revenue growth in GMPD at 4%. We are also pleased that gross margin increased 9% to $1.9 billion. While consolidated SG&A also increased just under 9% to $1.3 billion in the quarter, the increased amount reflects technology and other purposeful investments against the future of the business and higher costs to support sales growth. With strong broad-based profit growth, we delivered operating earnings of $666 million, 10% higher than last year. Moving below the line, interest and other was generally consistent with the prior year at $26 million, and our third quarter effective tax rate of 20.4% was better than we expected due to positive discrete items. As a result of our prior share repurchases, Q3 average diluted shares outstanding were 245 million, 5% lower than a year ago. As I mentioned earlier, the net result for Q3 was EPS of $2.08, reflecting growth of 20%. Now turning to the segments, beginning with Pharmaceutical and Specialty Solutions on Slide 5. Third quarter revenue increased 9% to $50.7 billion, driven by brand and specialty pharmaceutical sales growth. We continued to see strong pharmaceutical demand across product categories, brand, specialty, consumer health and generics, and from our largest customers. While we again saw robust demand for GLP-1 medications, recall that we had guided that the revenue growth rate would moderate this quarter, as it did, given the acceleration that we started to realize last year during Q3. Excluding GLP-1 sales, the segment's Q3 revenue growth would be 7%. As we previously noted, these sales did not meaningfully contribute to the bottom line. Segment profit increased 4% to $580 million in the third quarter, driven by positive generics program performance. Our generics program continued to see both volume growth and consistent market dynamics. Within our brand and specialty products, demand for COVID-19 vaccines in the quarter was, consistent with our expectations, not a meaningful contributor. As anticipated and guided, lower branded inflation than last year's relative high point was a year-over-year drag on profit growth. So, overall, we were pleased to deliver 4% segment profit growth in Pharmaceutical and Specialty Solutions, solid growth on top of an exceptionally strong quarter a year ago, which grew 23%. Turning to the GMPD segment on Slide 6. Revenue grew for the second quarter in a row by 4% in Q3 to $3.1 billion. This increase was driven by volume growth from existing customers. The GMPD segment delivered segment profit of $20 million, a $66 million year-over-year increase, driven by an improvement in net inflationary impacts, including our mitigation initiatives. GMPD continued its strong turnaround trajectory, achieving its highest level of quarterly profitability in the last two and a half years. We continue to be encouraged by the underlying improvements in the business, driven by the team's efforts against the GMPD Improvement Plan. As a reminder, the components of the former Medical Improvement Plan are now split between GMPD and Other, and the plan continues to be on track. The team achieved notable progress on inflation mitigation in the quarter, and we again saw a year-over-year improvement and growth in Cardinal Health brand volumes, providing continued fuel for the business' ongoing turnaround. Finishing with the businesses that aggregate into Other, as seen on Slide 7. Third quarter revenue increased 14% to $1.2 billion due to growth across all three businesses, at-Home Solutions, Nuclear and Precision Health Solutions, and OptiFreight Logistics. Collectively, the businesses grew segment profit in the quarter by 5%, with OptiFreight Logistics showing particular strength as we worked during the quarter to create the foundations for future profit growth in all of the businesses. Jason will further discuss our excitement around these businesses and some of the recent trends momentarily. Now turning to the balance sheet. We ended the quarter with a strong cash position with $3.7 billion of cash and equivalents on the balance sheet. Year-to-date, we've generated $2.1 billion of adjusted free cash flow and have continued to deploy capital according to our disciplined capital allocation framework, including investing approximately $320 million in CapEx back into the business to drive organic growth and funding the $1.2 billion acquisition of Specialty Networks. Over the past several years, we've made tremendous progress with our balance sheet. At the end of the quarter, we received a further update to our ratings outlook with Moody's moving our outlook to positive. We issued $1.15 billion in new notes during the quarter to refinance our upcoming June and November debt maturities. We plan to hold the cash proceeds and time deposits until the calendar year 2024 maturities come due. I'll note, due to the nature of these contracts, only about half of the total cash received is reflected in our Q3 ending cash balance. The remaining $550 million is recorded in prepaid expenses and other on the balance sheet. We have returned over $1 billion total to shareholders year-to-date, which includes approximately $375 million of quarterly dividend payments and $750 million in share repurchases, which is in excess of our committed baseline repurchase of $500 million. Now for our updated fiscal '24 guidance on Slide 9, beginning with the enterprise. We are raising and narrowing our fiscal year '24 non-GAAP EPS guidance. Our new range of $7.30 to $7.40 reflects a midpoint, which is 27% above our fiscal '23 EPS results. We started the year working to deliver our guidance of 14% EPS growth at the midpoint. What a year it has been so far. Before we turn to the segments, a few comments on our enterprise assumptions. With the year-to-date results, we are improving our fiscal '24 effective tax rate guidance to an updated range of 22% to 23%. And we are reiterating our fiscal '24 expectations for adjusted free cash flow of approximately $2.5 billion, for CapEx of around $500 million, for diluted shares of approximately 247 million, and for share repurchases of $750 million which, consistent with our framework, does not assume further repurchase activity this year. Now turning to the fiscal '24 outlook for our new segment reporting structure, as seen on Slide 10. With another solid quarter from Pharmaceutical and Specialty Solutions, we are raising and narrowing our segment profit guidance for the full year to 8.5% to 9.5% growth, which at the midpoint implies continued mid-single digit profit growth in the fourth quarter. We are reiterating our guide for GMPD segment profit of approximately $65 million for fiscal year '24. We continue to expect to address the impact of inflation as we exit fiscal '24, along with continued Cardinal Health brand volume growth and benefits from our continued cost savings initiatives. Additionally, we anticipate a positive impact from seasonality in Q4 compared to Q3. We are also reiterating our segment profit guide for the Other businesses, 6% to 8% segment profit growth for the full year, given that we expect a strong Q4 for those businesses. On the topline, we now expect Other full year revenue growth of approximately 12%. So, as I highlighted earlier, we are raising our guidance for fiscal year '24 to $7.30 to $7.40. Finally, let me conclude my remarks by providing a guidance preview for fiscal year '25. We will provide formal fiscal year '25 guidance during our Q4 and full year earnings call in August. However, with the benefits of our raised fiscal year '24 expectations and the action plans already underway in response to recent market changes, here is our preliminary perspective. For our largest business, Pharmaceutical and Specialty Solutions, while revenue will reset in the year as we offset a recent customer non-renewal, we notably expect to deliver at least 1% segment profit growth in fiscal year '25 before returning to more normalized growth in fiscal year '26. Looking forward, our commercial and operational teams have been busy, and our value proposition is resonating in the marketplace. Over the past several months, we have had some attractive wins with new customers and some existing customers are expanding their own footprints with us. Some of these are already under contract and ordering and others are scheduled for implementation in the second half of next fiscal year. So, over the course of the upcoming year, we expect new volume coming our way at sustainable margins. We completed the Specialty Networks acquisition quickly, which will be additive to our efforts in fiscal year '25. Separately, we have turned a further eye to optimizing our cost structure across our corporate functional footprint and across the Pharmaceutical and Specialty Solutions portfolio. Regarding environmental factors, we are expecting brand inflation to be roughly equivalent to fiscal '24 levels, while we remain watchful relative to the contribution of COVID-19 vaccines. For the GMPD segment, we expect continued growth in fiscal year '25 on our path to approximately $300 million in segment profit by fiscal year '26, driven by the annualization of inflation mitigation, progress with Cardinal Health brand growth, and continued simplification and cost optimization. We expect approximately $175 million in GMPD segment profit in fiscal year '25. And for the businesses included in Other, we expect the strong demand we've seen across these businesses to continue. With positive industry trends and the strength of our competitive positioning, we expect collective segment profit growth in fiscal year '25 at the top end of our long-term target approximately 10%. During fiscal '25, we will be investing across all of our businesses, with key examples being new facilities like our Consumer Health Logistics Center, at-Home Solutions facilities in Texas and South Carolina, and further geographic reach of our Nuclear and Precision Health Solutions' PET network. We will also continue our build-out of Navista and investments in GMPD supply chain resiliency. Now a few call-outs below the line and with the balance sheet. We anticipate a significant step-up in interest and other next year, primarily due to much lower average cash balances due to cash already deployed for Specialty Networks and due to the one-time unwinding of negative net working capital from the large contract non-renewal. We also expect lower short-term investment rates on cash and higher interest rates on debt resulting from the refinancing of our calendar 2024 maturities, leading to an interest and other range of $160 million to $190 million in fiscal year '25. We expect our fiscal year '25 effective tax rate to be in the range of 23% to 24%, slightly higher year-over-year due to discrete favorability seen this year. Partially offsetting these impacts, we would expect a lower share count between 244 million and 245 million due to the $500 million of baseline share repurchases we've previously outlined. Finally, while we continue to expect to generate adjusted free cash flow of approximately $2 billion on average from fiscal 2024 to 2026, we think it is important to call out that fiscal 2025 will be lower than that average, primarily due to the large contract unwind, as well as quarter end day of week timing. These dynamics will significantly influence our cash flow in Q1 of next year. However, our strong investment grade balance sheet positions us well to manage through these fluctuations. With respect to the long term, it is full speed ahead. We are reiterating our fiscal year '24 through '26 targets for the enterprise and segments and expect to deliver at least $7.50 of non-GAAP EPS in fiscal year '25, which reflects at least 30% total EPS growth on a two year basis. With that, I will turn it back over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Thanks, Aaron. Now for some additional perspective on our businesses, beginning with Pharmaceutical and Specialty Solutions, where our focus remains executing in the core to build upon our strong foundation. We're continuing to invest in our core business to drive operational efficiency and provide improved customer focus capabilities. At the same time, we have been evolving our commercial engagement strategies to get closer to the customer, better understand their complex needs, and provide proactive solutions. As an example, we've highlighted our first to market clinically integrated supply chain, the Cardinal Health InteLogix Platform, which deploys AI and machine learning through the Palantir Foundry platform to analyze real-time clinical and purchasing data to help providers reduce costs, optimize drug inventories, and streamline medication supply. We've also developed the Cardinal Health Atrix Elements offering, which is a suite of hospital reimbursement services that help improve hospitals' workflows and efficiencies. We've driven tremendous progress in our services for health systems, leading to the successful onboarding of a new key customer and additional new health system business coming in fiscal '25. We recently broke ground on our new 350,000 square Consumer Health Logistics Center in Central Ohio that we see as a differentiator in the marketplace. Over the past several years, we've experienced growing demand for over the counter consumer health products, which are an important part of our offering for retail pharmacy customers, particularly among our valued retail independent community pharmacies. With innovative technology and automation solutions powering the new facility, which will serve as a centralized replenishment center, we anticipate improved inventory efficiency across our network and providing unparalleled supply chain responsiveness for our customers. We see the rapid development of advanced automation technologies as an ongoing opportunity for our business. During the quarter, we deployed new sortation systems in a number of our distribution centers with a continual focus on employee safety, customer service, and operational efficiency. Turning to specialty, where we have and will continue to invest to accelerate our growth. As Aaron noted, our integration of Specialty Networks is underway and the reaction from the providers we serve and the energy from our new teammates has been extremely encouraging. Specialty Networks' mission as part of Cardinal Health remains creating clinical and economic value for independent physicians by lowering costs, operating more efficiently, and helping them deliver best-in-class care to their patients. We see greater opportunities together with the business' multi-specialty platform, proprietary technology, and deep clinical expertise being a natural extension of Cardinal Health's suite of solutions for specialty practices across the country. Specialty Networks expands our offerings with physicians in the areas of urology, GI, and rheumatology, while providing a proven platform in PPS analytics that we'll further invest into in fiscal '25 and look to extend to other therapeutic areas such as oncology. The platform's insight generation capabilities for clinicians are robust, which accelerates our upstream data and research opportunities with biopharma manufacturers. We see these and other capabilities as supporting our ongoing build-out of Navista, our clinician-designed oncology practice alliance, offering advanced services and technology. Navista's mission is to unlock the power of community oncologists to secure their independence and revolutionize patient centered cancer care. This build-out continues to progress according to plan as we actively pilot next-generation technologies and capabilities with select oncology practices. Upstream with manufacturers, we saw a strong performance from our biopharma solutions business during the quarter. With scaled assets, differentiated solutions, and a tenured team of experts, our leading specialty 3PL has supported 23 launches year-to-date through March with more anticipated in the coming quarters. Our 3PL and regulatory consulting capabilities helped pioneer the commercialization of the first CAR T-cell and gene therapies years ago, and we continue to bring innovative services to the market. Opening in May, our Advanced Therapy Innovation Center that features a deep frozen storage suite will support the complex storage requirements of cell and gene therapies. And we've seen our Advanced Therapy Solutions and Nuclear, Precision Health Solutions businesses successfully collaborating in support of cell and gene manufacturers. Turning to the GMPD business, where we're executing our GMPD Improvement Plan. We continued to drive momentum across the business in Q3 with strong sequential segment profit growth and significant improvement versus prior year. During the quarter, we offset approximately 90% of the gross inflation impact on our business, through the execution of our mitigation initiatives, commercial contracting efforts, and the continued realization of reduced costs for international freight, we're on track with our target to address these impacts by the time we exit fiscal '24. We are pleased to achieve 4% topline growth in the quarter, reflecting the improving health of our business. We saw growth across Cardinal Health brand and core distribution and in our domestic and international businesses. Specifically, our 5 point plan to grow Cardinal Health brand volumes continues to show positive trends across the key leading indicators. Our customer loyalty index score for U.S. distribution has increased by 14 points in the past two years and is up over 20 points from its pandemic low a few years ago. We successfully retained key distribution customers and the team is gearing up for some new customer implementations in the months ahead. Our product back orders remain near multi-year lows and we've continued to develop and commercialize new products, such as our Kendall pediatric sleeve to prevent deep vein thrombosis risk in young patients. We've noted our investments in the resiliency of our supply chain to better service our customers. In Q3, our efforts were recognized as the first distributor to achieve the highest rating by Healthcare Industry Resilience Collaborative's resiliency badge program, a key industry benchmark of our progress. Finally, we are executing our simplification initiatives across our business with a continued focus on optimizing our cost structure and global manufacturing and supply chain. In Nuclear and Precision Health Solutions, we're realizing continued double-digit growth in Theranostics, driven by the successful launch execution of new and advanced Theranostics in oncology. For example, we have realized meaningful growth in fiscal '24 from the adoption and growing demand of prostate cancer radio diagnostics, which are an important tool for healthcare providers to assess and properly treat the disease. We see a large, growing, and diversified pipeline, positioning our business to deliver value long into the future. The pipeline consists of more than 60 opportunities across oncology, cardiology, and neurology that are either contracted, in negotiations, or being actively explored with pharmaceutical companies. As an example, in oncology, we look forward to expanding our support level of novel prostate radioligand therapies in fiscal '25. As we look into the future, when you consider the strength of the Theranostics pipeline, only a handful of successful products are needed to deliver the strong growth outlined in our long-term targets. Our at-Home Solutions plays an instrumental role in providing patients and caregivers the critical products and services they need for care in the home. We continue to see strong demand for home healthcare and over the past decade, we've grown from servicing about 1 million customers annually to around 5 million today. Our business is positioned to accelerate in the coming years as we invest to expand the capacity of our network, the breadth of our offering, and deploy new automation technology. We're excited that our new distribution center being built in South Carolina, featuring the fastest order fulfillment system per square foot in the market, is scheduled to open by early next fiscal year. In OptiFreight Logistics, we continue to hear from our customers the value of our TotalVue Insights technology platform is providing as they seek to control their shipping spend and drive performance. Our technology provides action driving analytics and benchmarks with shipping status and delay visibility. We continue to invest in new technology driven solutions, and true to our commitment to innovation, we collaborate side-by-side with customers. For example, this quarter, we successfully co-developed and introduced a tailored pharmacy shipping solution with a strategic customer across multiple facilities. Across our businesses, opportunities are everywhere we look. We've affirmed our long-term targets for the enterprise and segments, which reflects Cardinal Health's ability to achieve sustained growth and deliver attractive returns for shareholders through an ongoing focus on value creation. We continue to prioritize the prudent management of our balance sheet and responsible capital allocation. We remain well-positioned with the financial flexibility to continue investing in our business and returning capital to shareholders. As part of our simplification journey, we are taking proactive actions to optimize our future cost structure and enhance our ability to grow well into the future. During the quarter, we took substantial steps to reduce our corporate real estate footprint and reorganized certain teams for greater efficiency and effectiveness. Our business review committee continues to make progress on our ongoing review of the GMPD business. We have no further updates to share today, but plan to keep you apprised of our progress. Driving the improvement plan remains our near-term priority and the team is making excellent progress. To close, we've had a strong first-three quarters of the year and are focused on sprinting through the tape. Plans are in place to deliver growth in fiscal '25 and beyond, and we're eager to continue delivering for our many stakeholders. None of this would be possible without our highly engaged and talented team, who continues to lean in, drive our company forward, and fulfill our critical role as healthcare's most trusted partner. With that, we will take your questions."
},
{
"speaker": "Operator",
"content": "Thank you very much, sir. [Operator Instructions] Our first question today is coming from Lisa Gill coming from JP Morgan. Please go ahead."
},
{
"speaker": "Lisa Gill",
"content": "Good morning, and thanks for taking my question. Jason, I just really want to dig into the 2025 guidance that you've given, especially when we think about Rx and specialty business. We clearly know that revenue will be down because of the change Rx, I'm sorry, because of the OptumRx contract, but..."
},
{
"speaker": "Operator",
"content": "Very sorry about that, gentlemen. Her line appears just to have dropped. So if she could just maybe dial back in, I will put her back in the queue. But now, we will move to Michael Cherny. Please go ahead."
},
{
"speaker": "Michael Cherny",
"content": "Good morning, and hopefully, my line won't drop. I probably had a similar question on Lisa, so hopefully you can address this directly. Relative to the '25 segment EBIT, as you think about the moving pieces here, maybe a two-part question. First, is there any way you can give us an underlying growth rate beyond the loss of Optum? And then second, as you think about the at least 1% segment performance, can you give us just a further breakdown on how much of that is volume growth versus mix versus new customers? Any more color you can provide on that as we think about the jumping off point and then how that factors into '26 would be great. Thanks so much."
},
{
"speaker": "Aaron Alt",
"content": "Good morning. This is Aaron. I appreciate the question, and happy to provide a little more context. I want to start by observing that the PS&S team has got -- have strong plans for '25 as they continue to deliver against what was a very strong fiscal '24. We had provided long-term guidance for PS&S of 4% to 6% profit growth. As we now think about that in comparison to the guidance we provided today of at least 1% profit growth within that segment, the delta, you should think about it is really the impact of profit -- net impact of profit so far relative to the Optum business. And the simple math I do is, if you take the midpoint of our long-term guidance, the 5%, each percentage point is worth about $20 million. You take it down to the 1% -- at least 1% that we've guided, that's about an $80 million net impact so far that we are working through. So that's the profit guide I would give you. On the revenue side, I would observe that we've already provided the impact that fiscal '23 was about 16% of our revenue. Fiscal '24, not yet done, will land somewhere between $35 billion and $40 billion of revenue. Back that out, but recognizing that the portfolio is still growing 10% or so as we push ahead. And then lastly, on the cash flow side of the house, I hope you noted my comments that we are holding to our average of $2 billion of adjusted cash flow each year in the '24 to '26 period. It will be lower in '25 as we work-through the negative working capital position from that non-renewed contract and a days of week impact. But this is manageable and as you -- I hope you take away from the fact we're calling growth as we push ahead for PS&S. We have plans in place. Jason, anything you want to add?"
},
{
"speaker": "Jason Hollar",
"content": "Yeah. Just I'll build out a little bit further the puts and takes for '25. As Aaron highlighted and scoped it, the delta is a net approximately $80 million when you look at the -- those different reference points. So, that obviously implies an Optum impact of something greater than that, that's being partially mitigated through several different items that we've called out. One is the other customer progress that we've had. So this value proposition is definitely resonating well with our customers and so we've had good win rates in other areas. And so, that would allow us some opportunity to partially offset that, that's included in that net $80 million, as well as the inclusion of Specialty Networks. So overall, specialty growth, we expect to continue to be strong. And then we have the Specialty Networks acquisition that closed last month. So we'll get kind of a three quarter type of year-over-year benefit, because we'll have it in our fourth quarter as well and the ongoing growth with that. And then there's some opportunity to further reduce cost by streamlining our processes even further, simplifying even further. So, overall, we feel really good about those offsets and that gets us to that net about 4 percentage points that we're calling out right now."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Thank you, sir. We'll now move to George Hill of Deutsche Bank. Please go ahead. Your line is open."
},
{
"speaker": "George Hill",
"content": "Yeah. Good morning, guys. And Jason, I kind of have a question around the intersection of the competitive environment in specialty. The industry has been pretty stable without any large contract switches for a while, though, we saw two kind of in the last handful of months. And my question is, like, given the composition of assets in the pharmaceutical business right now, are you seeing more of a demand for what I would call like cross functional service where people want to see core pharmaceutical distribution with other parts of specialty with -- as it relates to oncology and just trying to figure out, like, how do you guys deal with the breadth of solutions that you offer as the competitive environment evolves?"
},
{
"speaker": "Jason Hollar",
"content": "Yeah. There's a couple of things I think about this, George. First of all, thanks for the question. As I step back and think about just the backdrop of your question on the competitive environment, there -- while there are a couple changing hands, as you highlighted, I think the overall market continues to behave in a very rational way. We continue to be very thoughtful and disciplined in how we participate within it. And it's the exception of those contracts changing hands. The vast majority of contracts don't change hands as they come up for renewal. So I don't think that that -- it changes things. And you -- while you're still stepping back from everything, our role ultimately on the distribution side is to safely, securely, and efficiently deliver these products for our customers, that hasn't changed. Now, I think your question is, are there other elements that make that evolve further. Hey, we've got the full suite of services. We are building those out further. I think our customers always are looking for opportunities where we can add additional value. That hasn't changed either. It just evolves as to where they are most focused, and each customer has a little bit different value proposition from which to build from. So that will resonate better with some customers than others. And our objective is to continue to build out those capabilities, both upstream and downstream, so that we can be that full service supplier and partner to ensure that we can help them grow their business."
},
{
"speaker": "Aaron Alt",
"content": "George, I would add one further thought, which is, as you see from examples like our acquisition of Specialty Networks, of course, we continue to work to get closer to the ultimate practitioner, so that we are prepared to offer the incremental services that the industry is demanding."
},
{
"speaker": "Operator",
"content": "Thank you. We'll now move to Lisa Gill of JP Morgan. Please go ahead again."
},
{
"speaker": "Lisa Gill",
"content": "Good morning, and thank you, and hopefully, this time it will work. So my question was actually asked, but I wanted to just really dig in just a little bit deeper. As I think about the cadence for 2025, I know you're not giving specific guidance, but maybe even first half, second half, as we think about some of the comments you made, for example, simplifying costs, right, that'll..."
},
{
"speaker": "Operator",
"content": "Okay. Very sorry about that. It would appear we're -- I'm very sorry, gentlemen. It's just that her line has dropped."
},
{
"speaker": "Jason Hollar",
"content": "Well -- yeah, I think we can understand where she was going with trying to build out further for first half versus second half. So, the one thing I would stress, let's talk about the puts and takes and the timing of the puts and takes. So this customer migration will be somewhat of a cliff event at the end of the fiscal year. So, the June 30 to July 1, which is exactly the beginning of the fiscal year. So, that first quarter, we'll see that volume drop off fairly precipitously. And then the other business that we've won, some of it is already feathering in, some of it will continue over the course of the year, and we've highlighted in our comments a lot of it will be in the second half of fiscal '25. So, the timing of that, that piece of the puts and takes will be a little bit more second half weighted. Especially networks I referenced, that is a nice tailwind that is going to start benefiting us. It's included in our guidance for the fourth quarter, but we'll have three quarters of year-over-year performance driven by that business being added in and the continued just overall growth of utilization over the course of next year that we expect as well. The other cost actions will be varied. There's some things we've been planning for this for quite some time. And so, some of those cost actions will be in place by the end of the year. Some of those will need to take time to allow our operations to settle with that lower volume. So this is a customer that beyond it being -- it's a large and growing customer. So we definitely liked that volume. At the same time, it was a customer that had a lot of non-standard and customized processes and the demand profile was a bit more volatile. So we'll be able to operate more efficiently as this volume exits, but that won't necessarily be a day one type of thing. It will take us a little bit of time to get the each of the individual sites to be flowing with the new product that is coming in, but also just optimizing with the existing product. So the puts and takes there are all items that we start to see some mitigation at the very beginning of the fiscal year and then build over the course of the year."
},
{
"speaker": "Operator",
"content": "Thanks."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Thank you, sir. We'll now move to Allen Lutz, calling from Bank of America. Please go ahead."
},
{
"speaker": "Allen Lutz",
"content": "Good morning, and thanks for taking the questions. We've heard anecdotally that generic prices are a little bit firmer this time versus maybe last year. Can you talk a little bit about buy side and sell side pricing here of generics and maybe how gross profit dollars in that part of the business in generics are trending versus..."
},
{
"speaker": "Aaron Alt",
"content": "So, thanks for the question. What we would tell you is, as we continue to be in an environment of consistent market dynamics, where we see stability on the buy and the sell within our generic business. As we've talked about in the past, the stability that comes with that is when we see a rising tide of volume and a strong prescription demand environment, which we have, we continue to see strength in the generics portfolio, and that's where we are. We are aware that others have made comments somewhat variant from that over time, but we see consistent market dynamics and view that stability as a strength of our portfolio."
},
{
"speaker": "Operator",
"content": "Thank you. We'll now move to Kevin Caliendo, calling from UBS. Please go ahead."
},
{
"speaker": "Kevin Caliendo",
"content": "Thanks. I'll try to ask quickly before it gets dropped. Can you help us bridge on the medical side sort of the inputs to get to your fiscal '25 operating income from sort of where we are today? What are the most important factors that will get us from sort of where we are with the run rate through fiscal 3Q of '24 to the expected numbers in fiscal '25? And then just a quick follow-up. Does the loss of Optum and your partner in Red Oak also lost a large payer contract. Has that affected Red Oak in any way, shape, or form or your purchasing power or your economics there? I'm just wondering how to think about that, because it's two sizable chunks of business, but I just don't know how to think about the impact on Red Oak. Thank you."
},
{
"speaker": "Aaron Alt",
"content": "Why don't I start with the med cadence and then turn over to Jason to talk further about Red Oak? Look, the med, the -- or rather the GMPD business, we are executing against the plan that we've now been talking about for several quarters. And a couple of numbers on the page. Fiscal year '23, it was a negative $165 million; in fiscal '24 today, we've confirmed we're calling a positive $65 million. That's about a $230 million swing, which puts us halfway to the fiscal '26 target of $300 million. Fiscal '25, we've called today, will be approximately $175 million, really a midpoint between those. How we get there is how we have gotten -- how we've gotten halfway there so far. The single biggest initiative, single biggest impact to those numbers is continuing to achieve the inflation mitigation that we've been talking about for several quarters. We exited Q3 at about 90%. We expect to achieve full mitigation by the end of the fiscal year. But as we move into next year, of course, we'll be lapping the lower percentage execution. So that will be tailwind. That will be significant tailwind for us certainly in the first half and, indeed, the first -- for the full year. It's also important that we continue to see the good revenue growth and, in particular, the good volume and revenue growth tied to the Cardinal Health brand is that is a broader -- that is a more profitable part of our business. I know you noticed that in Q1, we called out a positive change in trend relative to the revenue in that business. Q2, we saw 2% growth. Q4 we saw 4% growth. And so, we're seeing signs of progress that give us reasons to believe that we can achieve both the $65 million this year and the $175 million next year. Lastly, on the cadence and the importance, the team will continue to do what they've been doing around simplification and cost out, right? It's a very complex business and the team has been doing a good job of simplifying and identifying sources of cost this year, and that will continue into next year as well. Jason, anything you want to add or talk about Red Oak?"
},
{
"speaker": "Jason Hollar",
"content": "Nothing to add on that component. As it relates to Red Oak, we feel very good about the scale and competitiveness of that venture -- joint venture that we have with CVS. The combined volume that we both bring is sufficient to have significant scale in the space. The percentage of volume that was related to the lost customer is quite small relative to the total that we have that remains. So we feel good about our -- continuing our mandate of both continued value for our partners and, ultimately, our customers and as well as the dual mandate aspect of also driving supply as much as possible."
},
{
"speaker": "Kevin Caliendo",
"content": "Thank you, sir."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "We'll now go to Eric Percher, calling from Nephron Research. Please go ahead."
},
{
"speaker": "Eric Percher",
"content": "Thank you. A couple of modest items relative to Pharma that I wanted to tick through. One is, in discussing the headwind, penciling out to $80 million, you used the comment so far once or twice. Is that so far reflecting that there may be more mitigation or that this is influx? That would be one. Number two, is there a contemplation of any incentive comp reduction in '25 that would then reset in '26 in that mitigation? And the last one is, Specialty Networks, it sounds like you're expecting a benefit at the op profit line. I believe the comment when you closed it was it would be accretive 12 months following close. Any commentary on contribution there would be helpful as well. Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Yeah. So I -- the so far comment was simply to highlight that we are guiding to at least 1% growth. And so, that reference is entirely around, of course, we continue to look for other opportunities to mitigate further. And depending upon our success with those additional actions will be the answer to your question about incentive comp. We'll, of course, appropriately define a target with the alignment with our Board to ensure that we are motivated to drive the business forward. And then, as it relates to Specialty Networks, our underlying assumptions are unchanged. The accretive comment was -- you're right, Eric, that the reference point was a year after the close and that was including the dilutive effect on the interest. So, the lost interest on $1 billion, $1.2 billion is the offset to the operating earnings that we see within the Pharma business. So it's really just the geography of the plus and minus with that."
},
{
"speaker": "Aaron Alt",
"content": "Eric, you had also asked about the impact to compensation plans. And the point I would make is, we set compensation plans on an annual basis for the management teams. And -- but we also have a long-term element, which is highlighted in our proxy, the targets there, and we'll continue to -- the teams will be continually motivated to hit those objectives."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, gentlemen. The next question will be coming from Stephanie Davis of Barclays. Please go ahead."
},
{
"speaker": "Stephanie Davis",
"content": "Hey, guys. Thank you for taking my question. You called out a few new wins and expansions in the prepared remarks and you did highlight some customer progress that offsets the Optum headwinds. So I was hoping we can dig in there a little bit more. Can you tell us about the nature of these wins? Is this more core? Is it onc (ph)? Is it other ologies? And how much the bridge from FY ‘25 to the three year guidance relies on further progress with these wins versus more of the streamlining and cost-out that you've called out?"
},
{
"speaker": "Jason Hollar",
"content": "Yeah. So it's across various classes of trade. So it's broad based wins that we've received. We are not anticipating needing additional new wins beyond what we've already completed or in process of completing. And that's why when you think about the embedded guidance that we're talking about in terms of maintaining our long-term targets of that 4% to 6% growth, some years like this year were at the above the high end and next year, it will be a little bit below the low end, but the average is out to that 4% to 6%. And so, it implies a '26 and beyond type of rate that continues to be in that 4% to 6% range, which is kind of a normal -- normalized ongoing type of earnings level. So what -- how I step back and think about our progress to date, it really comes down to our service levels and our customer service and really listening to what is important to those customers and working with them for a solution that is not necessarily customized, it is standardized, but with their needs in mind. And we're getting fantastic feedback from our current customers in terms of what that service level has been that is translating over to the desire by customers that we're not working with today to consider using Cardinal Health. And so, we have the time, attention, and energy now that we're able to devote even more to those existing customers to streamline those processes in a little bit more of a simplified fashion, and we'll continue to drive that value proposition with those new customers. But it's very much a booked business type of perspective that we're now into execution mode. And after this year, fiscal '25, we'd expect it to be even more normalized at that point."
},
{
"speaker": "Aaron Alt",
"content": "I would add a couple of things to that. First, you asked about cost-out, and my response or our response is that simplification has been a priority of ours for the last couple of years, and we will, of course, continue to go looking for ways we can simplify our operations and optimize our cost. But let me be clear, right, we are not backing away from customer support, particularly the new customers coming onboard, so that we do that seamlessly. And we're not backing away from investing in our future across our enterprise. And so, we will continue to talk about the highlights of those as we make them in future earnings calls, but we will optimize as appropriate, while focused on the long term."
},
{
"speaker": "Operator",
"content": "Thank you, sir. We'll now move to Eric Coldwell, calling from Baird. Please go ahead."
},
{
"speaker": "Eric Coldwell",
"content": "Thanks, and good morning. I wanted to talk a bit about specialty in general and then tie in Specialty Networks. So, in the recent past, you've given a sizing of your overall specialty business in the low-to-mid $30 billion range. You will lose some of that with the Optum roll off, probably $3.5 billion, $4 billion, I'm guessing. You're going to add some with Specialty Networks, and then you have normal market growth. So, netting this all together, what would you anticipate the baseline specialty business to be sized at when you start fiscal '25?"
},
{
"speaker": "Jason Hollar",
"content": "So, those are a number of puts and takes that as you noticed, I'm sure, Eric, we did not provide revenue guidance in this update. We will be providing that in the next update, of course. So, certainly, you're in the ballpark on the Optum piece, as I've highlighted before, that is about 10% of that overall book of business. That specialty, everything else would be, PD, non-specialty. And Specialty Networks, the revenue is quite low, because it's the service revenue, it's not distribution revenue. So that's what I would think of independent is that we, of course, would expect our non-Optum specialty revenue to continue to grow nicely and we will frame that, but don't think about that as something specifically related to Specialty Networks."
},
{
"speaker": "Operator",
"content": "Thank you very much. Next question is coming from Elizabeth Anderson, calling from Evercore. Please go ahead."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi, guys. Thanks so much for the question. I was hoping you could talk a little bit about -- more about GMPD. It seems like the competitive environment maybe is improving in your favor. It seems like maybe there's some benefit from underlying just like utilization demand. Could you please just give us a little bit more color on sort of those underlying changing dynamics in more -- maybe more conceptually and about some of the specific cost-cutting and other inflation offsets that you've already talked about?"
},
{
"speaker": "Jason Hollar",
"content": "Yeah. I think the competitive environment, I'm not sure I'd put much into that. Our performance within this industry has improved dramatically. I referenced in my comments, the customer loyalty scores improve -- have improved consistently and dramatically from the bottom of the pandemic a couple of years ago. So, our performance is noticeable. Our customers are feeling it. That customer loyalty index, the scores behind it improving, because we have -- we have the low back order, we have product availability, we have great service levels. We're very engaged from a sales force perspective. So we're out there now selling instead of reacting to the challenges of the pandemic. So our customers are feeling that. We have very stable win/loss types of rates. We're growing at least with the market now. So it's more of us showing up, I think, the right way than the market being overly growing more or growing less. The market utilization continues to be more and more normalized. So there's maybe a little bit of volatility here and there, but it's much more normalized compared to where it has been in the last several years. So, not -- that -- and that's the environment we like. We like to see predictable, consistent lower-single digit type of utilization rates that we can grow a little bit above that through our mix and other actions. And then, of course, as Aaron highlighted, the single biggest driver, not only this past year, but that -- what we expect at least in the first half of next year, would be just the lapping of the inflation impacts and everything we've done to mitigate that. Which -- that's another thing that's helpful for us to get that behind us so that we're focused on selling and talking to our customers about the value that we can help provide them, as opposed to dealing with inflationary fluctuations that have occurred in the past. So we're well-positioned to now drive the other elements of the medical -- the GMPD Improvement Plan, which is the ongoing simplification, the ongoing cost reductions, but just continuing to really prioritize more than anything the Cardinal Health brand volume growth."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. The next question will be coming from Stephen Baxter, calling from Wells Fargo. Please go ahead."
},
{
"speaker": "Stephen Baxter",
"content": "Hi, thanks. Just one quick confirmation and the actual question. I think what you're suggesting is that beyond fiscal 2025, there is no direct or indirect impact from the Optum contract loss to contemplate. Just wanted to confirm that point, that there's not any kind of earnings contribution from a transitional period inside the 2025 thinking. And then the actual question is just on the Other segment. The revenue growth has been quite strong. It's taken a little bit for the profit growth to kind of catch up to your long-term expectations. Just remind us what the key kind of moving parts are there to accelerate the profit growth in the next couple of years. Thanks."
},
{
"speaker": "Aaron Alt",
"content": "So, an answer to your first question, our guide today does confirm the long-term growth within the Pharma business of 4% to 6%. It will be off a lower base in fiscal '25 as we grow at least the 1%. We've not commented on an absolute dollar basis, but we will provide more context on that when we get to our year end results and final guidance for fiscal '25 during our August earnings call. With respect to the Other business, we are pleased with what we're seeing so far. We re-segmented the operation to create additional transparency, focus, and accountability, and I referenced in my prepared remarks that we are already seeing the benefit of that. The topline results are good, right? And we guided 6% to 8% profit growth for this year. We were a little bit lower than that in Q3 for the businesses aggregating in Other so far. And of course, we had the impact of some of the non-recurring adjustments that we called out in Q2 tied to the at-Home business, which reports into Other in the second quarter. But I want to emphasize, we did confirm that we are expecting to achieve the higher results, the 8% to 10% for fiscal '24 and we confirm the high end of that range for fiscal '25, as Jason digs in with the businesses now reporting directly to them and as we invest as an enterprise against setting those businesses up for a higher growth trajectory."
},
{
"speaker": "Jason Hollar",
"content": "Yeah. Just a couple of things to add. First, on the first question, just to be real explicit, given it's a cliff event customer transition that we are anticipating for July 1, we'd anticipate that that would be largely in fiscal '25 results and there's nothing that we're calling out or indicating at this point that would carry over into '26. And as it relates to the Other businesses, how I think about them, they're each growing very nicely. They each have strong industry, strong sectors of the industry that are benefiting from their own individual secular tailwinds. So, they each have different reasons for their growth. But ultimately, it's because that each of these three areas provide a real interesting value proposition to customers and, ultimately, to the patients. And each of these three, we have a leadership position in. So we're not only benefiting from that secular trend, but we're leading and maintaining or growing our own fair share within it. So we're well positioned for each one of these three and why we have confidence about them. We are investing into them, as Aaron highlighted. That's driving the growth that we believe will be driving long-term profitability as well."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. The next question will be coming from Charles Rhyee of TD Cowen. Please go ahead. Your line is open."
},
{
"speaker": "Lucas Romanski",
"content": "Hi. This is Lucas on for Charles. I wanted to ask about Cardinal Health brand and get a sense of where we're at on the path to realizing $50 million in targeted growth by fiscal '26. I understand that you've expanded the number of products you offer under private label and that you're starting to see momentum in growing volumes. Can you help us understand how much of that $50 million has already been realized? And then how much we should expect you guys to realize in fiscal '25? Thanks."
},
{
"speaker": "Jason Hollar",
"content": "Yeah. So I'd -- the -- it's a -- we inflected a couple of quarters ago, right? You saw that with our overall revenue growth that is partly driven by the Cardinal Health brand volume growth. So we saw, for example, this quarter, our revenue growth of 4% was pro-rated within that national brand, as well as Cardinal Health brand, so, we're seeing distribution stabilize. We're seeing that. We've won some business there that has allowed us to grow at or a little bit better than the market. So, overall, we're seeing that this business has now stabilized at a growth consistent with the market. We expect that to continue. This is something that we do have as a component of that growth. As Aaron highlighted, the single biggest driver of profit performance for '25 -- from '24 to '25 is the annualization, the carryover of the inflationary pressure. So that's the biggest item of that implied $100 million, $110 million year-over-year profit improvement. Then beyond that, you have Cardinal Health brand volume growth, cost reductions, and other actions. And so, it is a component, it's not the biggest component. And then it would be a -- from '25 to '26, the primary components that then drive that growth would be Cardinal Health brand volume, as well as further cost reductions as we continue to look to streamline and optimize our footprint, as well as our other supporting cost. So, we're not going to break out the individual pieces there, but those are the biggest pieces then when you go from '25 to '26."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our last question today will be coming from Daniel Grosslight of Citi. Please go ahead. Your line is open."
},
{
"speaker": "Daniel Grosslight",
"content": "Hey, guys. Most of my questions have been asked, but I was hoping to just get an update on Navista and any metrics you're able to share on the market adoption you're seeing there, number of providers aligned to it, etc. And I know one of the key strategic objectives of the Specialty Networks acquisition was to kind of integrate some of their technology, notably PSS Analytics (ph) into Navista and other specialty assets. I'm also curious if you can provide an update on how quickly you can integrate that technology and Murphy, you've already kind of started on that path. Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Yeah. Thanks for the question, Daniel. And so, with Navista, we are on track to everything that we've laid out first raising this about a year ago. I mean, as I think about the progress we've made, I'd break it into a few key buckets. First of all -- first and foremost, we've hired and brought in a fantastic team, a great mixture of internal and external talent, really drawing from industry those that have done this before and understand what that looks like, but also using our own expertise that have been more focused in other therapeutic areas, but a nice augmentation of the two. And then that new team quickly went to work and defined what went in front of our customers and prospective customers and really listened as to what is it that they need to run their practice, their business more efficiently, more effectively. And it was through that work that we then came to the final point, which is defining the tools, the capabilities that we are building within Navista. So, we didn't just go off and build it. We are building it around what the customers are demanding that they need, those community oncologists, those independent community oncologists, really looking at differentiating for what they need to run their business, both again, efficiently, but also effectively to further improve upon the lives of their patients. So that is the work that's been done, and we are every day building out more elements of this. So I wouldn't think about it as a particular date that everything goes live and we suddenly have this influx of volume. This is the type of thing that builds out our capability over time in different ways and working with our current customers, as well as the prospective ones to layer in when they come into this network and which services they utilize within the network. So that leads you to the Specialty Networks piece, which I would think about it as we now have an internal technology and capability set that's augmenting what we had before. But Navista always approached this in terms of the best of the best in the industry. Using what we have is great, but we also are using a lot of third-party partners to bring in their tools and capabilities, because we're going to put the customers' needs first, the providers' needs first and then build around that. So we do see that there is a role for Specialty Networks and their PPS Analytics platform, but we're not going to make that the priority. We're going to listen to the customers and then determine which pieces of that to bring into that network. So we haven't finalized those decisions as it relates to Specialty Networks. But what I will tell you, on day one, just having that team's insight and expertise has been very beneficial to our own Navista team. So having -- and I mentioned this when we announced the acquisition of Specialty Networks. Yeah, the assets are fantastic. The business is fantastic. But the most important thing for us was the leadership team and the capabilities that they're bringing along with it is every bit as great as what we thought it was when we made the announcement. And we're seeing that with boots on the ground now as we work, not just within Navista, but with the broader business to further improve our capabilities across all the therapeutic areas."
},
{
"speaker": "Operator",
"content": "Thank you very much, gentlemen. Ladies and gentlemen, that will conclude today's question-and-answer session. I turn the call back over to Mr. Jason Hollar for any additional or closing remarks. Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Yeah. Thank you. Just to close, appreciate everyone spending some time with us this morning. We hope the overall message that you took away from the call today is that we have a strong and resilient business and a very clear plan for us for '25 and '26, and we're excited about the opportunities and ensuring that our customers and their patients continue to get fantastic service. So thanks again for joining us today and have a great day."
},
{
"speaker": "Operator",
"content": "Thank you very much. Ladies and gentlemen, that concludes today's presentation. Thank you for your attendance. You may disconnect. Have a good day and goodbye."
}
] |
cah | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to today's Second Quarter Financial Year 2024 Cardinal Health Earnings Conference Call. This meeting is being recorded. At this time, I'd like to hand the call over to Matt Sims, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Matt Sims",
"content": "Welcome to this morning’s Cardinal Health second quarter fiscal ‘24 earnings conference call and thank you for joining us. With me today are Cardinal Health CEO Jason Hollar; and our CFO Aaron Alt. You can find this morning’s press release and investor presentation on the Investor Relations section of our website at ir.cardinalhealth.com. Before I turn the call over to Jason since we will be making forward-looking statements today. Let me remind you that the matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to our SEC filings and the forward-looking statement slide at the beginning of our presentation for a description of these risks and uncertainties. Please note that during our discussion today, the comments will be on a non-GAAP basis, and once they are specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the supporting schedules attached to our press release. For the Q&A portion of today’s call, we kindly ask that you limit questions to one for participants, so that we can try and give everyone an opportunity. With that, I will now turn the call over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Good morning, everyone. In the last few weeks, we've made several notable announcements regarding our company's continued progress, including yesterday's news on our agreement to acquire specialty networks, which will further our specialty growth strategy and create value for specialty providers, manufacturers, and patients in exciting new ways. And as we highlighted at a recent industry conference, we're continuing to take actions to become a simplified and more focused company with further progress achieved on our ongoing business and portfolio review and our updated enterprise operating and segment reporting structure, which will be reflected in our financial reporting beginning next quarter. We plan to go further into our recent updates with you today, but first, let me begin with a few brief comments on our results. In Q2, we delivered strong profit growth in both segments, demonstrating continued operating momentum and execution against our strategic priorities. Pharma again delivered strong performance. Overall, the business is performing consistent with our expectations, and we're pleased to reiterate our outlook for 7% to 9% segment profit growth in fiscal ‘24. We've seen ongoing stability in macro trends, including in our generic program, and continued broad-based strength in overall pharmaceutical demand. Our specialty distribution business also continued to see strong demand, including with COVID-19 vaccines in the first part of the quarter. Turning to medical, Q2 segment profit was consistent with Q1, despite the non-recurring adjustments in the second quarter, which we've reflected in our updated fiscal ‘24 outlook for the former medical segment. We're encouraged by the underlying improvements in operating performance, reflecting further progress with our medical improvement plan efforts, focused on our global medical products and distribution business. Notably, we saw a change in trend in revenue growth for the medical segment in the second quarter. Along with continued growth from at-Home Solutions, we're seeing the effects of our five-point plan to grow Cardinal Health brand volumes yield positive results. And as we continue to optimize not only the performance of our businesses, but also the financial strength of the broader enterprise, we're generating robust cashflow and seeing meaningful benefits below the operating line. As a result of our first-half performance and increased confidence as we look ahead, we're pleased to raise our fiscal ‘24 EPS guidance and our outlook for adjusted free cashflow. Of course, our customers remain at the center of everything we do, and our team continues to prioritize core operational execution to best serve them and their patients with essential products and services as we drive our company forward. Now let me turn it over to Aaron to review our results and updated guidance in more detail."
},
{
"speaker": "Aaron Alt",
"content": "Thanks, Jason, and good morning. Before we begin let me remind you that our Q2 segment commentary will be according to our former segment structure pharma and medical. Let's start with total company results for the second quarter. Q2 delivered another strong quarter across the enterprise with EPS of $1.82, growth of 38%, which included operating earnings growth of 20%. We also delivered strong cash flow and ended the quarter with $4.6 billion of cash, even following incremental share repurchase activity in the quarter. As seen on slide four, total company revenue increased 12% to $57.4 billion, reflecting growth in both the pharma and medical segments. We drove operating leverage for the enterprise despite incremental investments in the business and higher costs to support sales growth. Gross margin increased 11% to $1.8 billion, driven by both segments, and consolidated SG&A increased 8% to $1.3 billion. With the strong profit growth in both segments, we deliver operating earnings of $562 million, 20% higher than a year ago. Moving below the line, interest and other decreased by $26 million to $8 million in income due to increased interest income on cash and equivalents from higher cash balances and higher rates. As we've noted, our debt is largely fixed rate, resulting in a net benefit from rising interest rates in the near-term. Additionally Q2 interest and other benefited from nearly $10 million in income from the quarterly revaluation of our company's deferred compensation plan investments, which as a reminder has a matching offset above the line. Our second quarter effective tax rate of 21.3% was 1.7 percentage points lower than a year ago and better than we anticipated due to positive discrete items in the period. Q2 average diluted shares outstanding were $246 million, 6% lower than a year ago due to share repurchases in each of the last four quarters. And as I mentioned earlier, the net result for Q2 was EPS of $1.82, reflecting growth of 38%. Let's turn to the pharma segment on slide five. Second quarter revenue increased 12% to $53.5 billion, driven by brand and specialty pharmaceutical sales growth from existing customers. We saw strong pharmaceutical demand across product categories, brand, specialty, consumer health, and generics, and from our largest customers. We also continue to see robust demand for GLP-1 medications, which provided a revenue tailwind in the quarter. Segment profit increased 12% to $518 million in the second quarter, driven by positive generics program performance and the higher contribution from brand and specialty products, including distribution of COVID-19 vaccines. Our positive generics program performance continue to reflect volume growth and consistent market dynamics. With respect to COVID-19 vaccines, we saw the strength and demand from September for the fall immunization season carry into October before peaking mid-month and trending to a much lower run rate as we exited the second quarter. The Q2 increase in segment profit includes a partial offset from higher costs to support sales growth driven by increased pharmaceutical volumes. Turning to the medical segment on slide six. Second quarter revenue increased 3% to $3.9 billion, which as Jason alluded to, reflects quarterly revenue growth for the medical segment for the first time in over two years. This increase was driven by growth in both at-Home Solutions and global medical products and distribution, with the GMPD growth primarily related to higher Cardinal Health brand volumes. Medical delivered segment profit of $71 million, a $54 million year-over-year increase, driven by an improvement in net inflationary impacts, including our mitigation initiatives. Consistent with the expectations communicated a few weeks ago, segment profit was generally consistent with Q1, despite some non-recurring adjustments in the quarter. We continue to be encouraged by the underlying performance of the business, which through the first two quarters of the year has tracked consistent with our original plans. Now turning to the balance sheet. We generated robust adjusted free cash flow of $1 billion in Q2, bringing our year-to-date adjusted free cash flow to $2 billion. And as I noted earlier, end of the quarter with $4.6 billion of cash on hand. We remain focused on doing what we said we would, deploying capital according to our disciplined capital allocation framework. Thus far, through the first-half of fiscal ‘24, we've continued to invest against our highest priorities, including investing back into the businesses to drive organic growth with over $200 million in year-to-date CapEx. In the first-half, we have returned $1 billion total to shareholders, which includes our quarterly dividend payments and $750 million in year-to-date share repurchases. These share repurchases are in excess of our committed baseline repurchases of $500 million. And in January, we made certain opioid settlement prepayments of $238 million at a pre-negotiated discount, which is expected to result in a [gap] (ph) only gain of approximately $100 million in the third quarter. Now for our updated fiscal ‘24 guidance on slide eight, beginning with the enterprise. With our strong first-half performance and positive outlook, we are again raising our fiscal ‘24 EPS guidance. Our new range of $7.20 to $7.35 reflects a $0.45 increase at the bottom end and a $0.35 cent increase at the top end from our Q1 guidance range. And a midpoint which is 26% above our fiscal ‘23 EPS results. We are encouraged by the operating performance of our businesses and our strong cash regeneration, which is certainly contributing to the improvements below the line. Interest in other is reduced to a range of $50 million to $65 million, which primarily reflects increased interest income from higher than anticipated cash balances. We expect lower average cash balances in the second-half of the year due in part to the seasonal timing of anticipated cash flows. We are evaluating opportunities to refinance our upcoming 2024 debt maturities in the back half of the year. We are lowering the top end of our effective tax rate guidance to a new range of 23% to 24% to reflect the positive discrete items we've seen in the first-half of the year. We also are lowering our shares outlook to approximately $247 million, which reflects the $250 million accelerated share repurchase program we completed in Q2. No additional share repurchases are assumed in our updated guidance for fiscal year ‘24. Now turning to the fiscal ‘24 outlook for our segments. While we will be transitioning to our new segment structure reporting beginning in Q3, let me start with our former segments as a comparison point for the updated structure. No changes to the outlook for the former pharma segment. We are reiterating the 10% to 12% revenue growth and 7% to 9% segment profit growth. For the former medical segment, the fiscal ‘24 outlook is updated to approximately $380 million a segment profit to reflect the net impact of Q2 non-recurring adjustments. Outside of these, our overall operational expectations are consistent with delivering the prior $400 million in segment profit for the year, as well as the corresponding prior expectation of $650 million in segment profit for fiscal year ‘26. We have consistently highlighted the back half weighting of the medical guidance, driven by progress within GMPD on Cardinal Health brand volume growth, the cumulative impact of inflation mitigation, and some business specific seasonality. Our expectations there continue. For example, with inflation mitigation, we have strong visibility to overall cost improvements in the second-half of the year, driven by reductions we've observed in international freight, which is a reminder reflecting our income statement on a two to three quarter delay and as we exit January the mitigation initiatives necessary to achieve our year-end target are now largely in place. Now as seen on slide 10, let me comment on how this fiscal year ‘24 guidance translates to our updated segment structure. To go along with the preliminary recast fiscal ‘23 actuals and long-term targets we provided a few weeks back. Our new structure went into effect January 1. So beginning in Q3, we will report results and provide drivers reporting to the new segment structure, pharmaceutical and specialty solutions and GMPD and separate from these two segments, nuclear at-Home, an OptiFreight aggregated in other. At that time, we also plan to provide a recast of the results for fiscal ‘22 to ‘24 on the new segmentation. Beginning with the pharmaceutical and specialty solutions segment, the guidance ranges are consistent with the former pharma segment, even excluding our higher growth nuclear business. We expect 10% to 12% revenue growth and 7% to 9% segment profit outlook for fiscal ‘24 and a 4^ to 6% segment profit growth CAGR over the long-term. Turning to GMPD where we remain encouraged by the improvements in this business. For the execution of the medical improvement plan initiatives, we expect to drive GMPD from an operating loss of approximately $165 million in fiscal ‘23 to operating income of approximately $65 million in fiscal ‘24. From the fiscal ‘23 low point, this $230 million year-over-year improvement would position us roughly half way towards our fiscal ’26 target of approximately $300 million for segment profit. Finally we expect the businesses including other, at-Home Solutions, Nuclear & Precision Health Solutions and OptiFreight Logistics to collectively deliver 6% to 8% segment profit growth in fiscal year ‘24. The difference between this fiscal ‘24 growth rate and the long-term CAGR of 8% to 10% for fiscal ‘24 to ‘26 reflects the portion of the Q2 non-recurring adjustments within at-Home Solutions with the remainder residing in GMPD. Before I close a couple of comments on our recently announced acquisition. We've noted that the specialty category has been our highest priority for potential M&A and a primary consideration for our opportunistic capital employment as part of our disciplined capital allocation framework. Given our financial flexibility and strong presence in the other 60% of the specialty market in therapeutic areas outside of oncology, we have evaluated a range of potential acquisition candidates to further accelerate our specialty strategy. We are thrilled to reach an agreement for specialty networks to become a part of the Cardinal Health family. Jason will elaborate on the strategic aspects of the deal, but we plan to include the expected financial impacts of the transaction in our guidance upon closing, which of course is subject to the satisfaction of customary closing conditions, including receipt of required regulatory approvals. For general modeling purposes, we expect the deal to be accretive 12 months following close. So, to wrap up, tremendous progress in the first-half of the year with exciting value creation opportunities still in front of us. We are confident in our plans and grateful for the efforts of our team, who continue to drive our ongoing initiatives and prioritize the needs of our customers. With that, I will turn it back over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Thanks, Aaron. Now for some additional perspective on our strategic priorities beginning with priority number one and building upon the growth of pharma and specialty solutions, our largest and most significant business. Though this segment structure has slightly changed, our focus on executing in the core remains. We're building upon our strong foundation, while investing to accelerate growth in specialty both downstream and upstream. We believe that this new segment structure further enables those efforts by enhancing management focus, leveraging the connectivity between pharmaceutical distribution and specialty, and positioning the business for long-term growth and investment. More on that front shortly. A key component of our strong core foundation is our generics program anchored by Red Oak, which continues to do an excellent job fulfilling its dual mandate, managing both cost and supply. Red Oak leverages proprietary analytical tools and their deep industry expertise to help maximize service delivery for customers. We're continuing to invest in our business to provide customer-focused solutions and evolve our commercial engagement strategies to prioritize addressing the complex challenges our customers face every day. For example, at Investor Day, we highlighted our first-to-market clinically integrated supply chain, the Cardinal Health InteLogix platform. This innovative solution leverages artificial intelligence and machine learning through the Palantir Foundry platform to help providers reduce costs, optimize drug inventories, and generate actionable insights to simplify and streamline medication supply. We've continued to develop our offerings, such as the contract optimizer tool, which drives savings and value through contract compliance, cost controls, and product alternatives like brand generics, blood plasma, and more. Key health system customers are already benefiting from these capabilities, and we see opportunities for further future expansion. Shifting to specialty, where we have also been investing to expand our offering into complementary areas. The acquisition of specialty networks is exciting to us on a number of fronts. This is a business with which we were already very familiar, given the long-standing partnership to service their members through our specialty distribution. Specialty networks is a technology-enabled, multi-specialty group purchasing and practice enhancement organization serving 11,500 total providers today, including more than 7,000 physicians across 1,200 independent urology, gastroenterology, and rheumatology practices. We see their service capabilities as accelerating our efforts in critical ways. First, further extending our reach, expertise, and offerings in key therapeutic areas to provide increased clinical and economic value for specialty providers. Specialty networks is a leader in specialty practice management, research, and technologies that support physicians in lowering costs, operating more efficiently, and delivering best-in-class care to their patients. For example, the company provides solutions that improve clinical and economic outcomes to over 3,000 urologists through its leading euro GPO. Second, creating a platform for our expansion across specialty therapeutic areas. The company's PPS analytics solution is a subscription-based advanced technology platform that utilizes artificial intelligence, such as continuous learning algorithms and natural language processing to analyze data for electronic medical records, practice management, imaging and dispensing systems, and transform it into actionable insights for providers and other stakeholders. We see this complementing our suite of clinical practice management and distribution solutions to specialty practices nationwide. Specialty networks experience and capabilities and clinical engagement are robust, which also accelerates our upstream data and research opportunities with biopharma manufacturers. Third, enhancing the capabilities of our specialty business, including supporting the ongoing build of the Navista network. Specialty networks have a deep understanding of independent physician practices, and we see capabilities and expertise that will accelerate our ongoing development of the Navista network, which is focused on supporting the clinical and operational needs of independent community oncologists. In summary, this transaction enhances our specialty strategy by providing new capabilities that strengthen the link between our downstream and upstream services, enabling us to create further value for customers, manufacturer partners, and patients. Turning to priority number two in the GMPD business, where we're executing the medical improvement plan. While the business and portfolio review of GMPD continues, the team continues to prioritize and make significant progress in turning around the operational performance of this business, as Aaron indicated, with our expectation that the business returns to profitability in fiscal 2024. The number one priority remains mitigating supply chain inflation, where we remain on track to address the impact by the time we exit fiscal ’24. As of Q2 we're approximately 75% to target. On the cost side, while overall still elevated, we've seen lower international freight costs reflected in our results as anticipated, and we have strong line of sight to continued improvement in the second-half of the fiscal year. We've continued to make progress with our mitigation initiatives and commercial contracting efforts and are continually taking additional actions to offset elevated inflation, such as through sourcing initiatives. As Aaron indicated, the work we've accomplished to-date provides increased confidence in achieving our fiscal year-end target as overall cost improvements continue to reflect in our second-half results. We're continuing to invest in the resiliency of our supply chain and our manufacturing and distribution capacity. We have opened three new distribution centers in the past year, adding capacity for growth, while featuring state-of-the-art automation technology to streamline operations. For example, our new Greater Toronto area DC expands capacity to serve Cardinal Health Canada customers, while leveraging autonomous mobile robots to increase picking and packing accuracy and drive efficiencies. We're also continuing to invest in new product innovation and portfolio expansion in key categories in alignment with our disciplined portfolio management approach. As a result of our team's collective efforts, we're seeing our five-point plan to grow Cardinal Health brand volume result in improvements in our leading indicators and most importantly, strong customer retention and product volume growth. Finally, we continue to drive simplification and optimize our cost structure by exiting non-core product lines, rationalizing our network and streamlining our international footprint. We believe our new structure will further enable our medical improvement plan efforts as we continue to execute the plan and deliver value for customers. Now, priority number three, accelerating growth in key areas. We are excited about the strong demand we are seeing in our at-Home Solutions and OptiFreight businesses, and our recent determination to further invest in and develop these businesses for long-term value creation as part of our portfolio. In at-Home Solutions, we continue to focus on enabling and supporting comfortable home-based care for patients with acute and chronic conditions. To support the growing demand for home health care, we're investing to expand the capacity of our network, the breadth of our offering, and a new technology to drive operating efficiencies. We recently announced plans for a new distribution center to be built in Texas with increased capacity, advanced automation technology, and robotics within the facility. And our previously announced 350,000 square foot facility being built in South Carolina is on track to open this calendar year. In OptiFreight Logistics, we're continuing to invest in digital tools to enable healthcare supply chain leaders to better manage their shipping spend and support the core volume growth in our business. We've launched new offerings to give our customers more supply chain visibility, and we are receiving great feedback. For example, we now have more than 1,000 healthcare providers leveraging our total view insights platform to gain valuable insights on their operations. In nuclear and precision health solutions, we're continuing to see above market growth in both our core business and Theranostics, as we're a premier partner of choice due to our strong core foundation and differentiation with pharmaceutical manufacturers looking for commercialization success of their future radiopharmaceutical portfolios. For example, in Theranostics prostate cancer radio diagnostics are important tools for healthcare providers to assess and properly treat the disease. We saw meaningful year-over-year revenue growth in the first-half of fiscal ‘24 from the ramp up in demand of these diagnostics. From a pipeline perspective, we're investing to expand our Center for Theranostics Advancement with demand from pharmaceutical manufacturer partners currently oversubscribed. And we're investing to expand the capabilities and resiliency of our pet manufacturing network to enable portfolio diversification and accommodate growth from the increasing demand for pet agents. This is driven by trends such as an aging population, cancer prevalence, emerging Alzheimer's therapy, availability and reimbursement and increasing clinical trial needs. Finally, priority number four, maximizing shareholder value creation. We're continuing to maximize shareholder value creation through our improved operational performance, robust cash flow, and responsible allocation of capital. As Aaron noted, our robust cash flow generation is not only driving benefits below the operating line, it is enabling our opportunistic capital deployment with additional share repurchases in the quarter beyond our baseline plan and our ability to pursue value-creating M&A in specialty. We remain well-positioned with the financial flexibility to continue opportunistically evaluating disciplined M&A not only in specialty, but in our other growth areas and potential additional share repurchases. With our recent conclusions on our business portfolio review, we do not have further updates to share today, but plan to keep you apprised of our progress. To close, we had a strong first-half of the year and are excited about the many initiatives underway to build upon our momentum. I would like to thank our highly engaged and talented team for driving our progress and prioritizing our customers as we fulfill our critical role as healthcare's most trusted partner. With that, we will take your questions."
},
{
"speaker": "Operator",
"content": "Thank you very much, sir. [Operator Instructions] Our first question is coming from Stephanie Davis, calling from Barclays. Please go ahead."
},
{
"speaker": "Stephanie Davis",
"content": "Hey, guys. Thank you for taking my question and congrats on the continued progress. Jason you already shared a lot of color around the acquisition, but I was hoping you could dig in just a little bit further on specialty networks' mix and capabilities, just given the higher margin nature of both GPO and analytics solutions? And then just following up, given the pipeline that you mentioned, I was hoping you could share some thoughts on hurdle rates for future deals as that becomes a bigger part of the story? Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Okay, great. Thanks. Good morning, Stephanie. Yes, we're really excited about specialty networks. And as I -- I love how you asked the question, Stephanie, because there's a lot that goes into this business, and we love all of it, whether it's the GPO or the analytics and technology behind it. Specifically, PPS analytics is something we thought was really special, not just in terms of how this team has created this capability for their original primary business of urology, but then how they've expanded it into other therapeutic areas, and we felt we could learn from that further and use that technology across potentially other therapeutic areas beyond the three that they're in today. So that was really exciting to us and certainly a key part of the value. So we definitely attributed good value to that technology and where we believe that can go. And not only that good for our business, but importantly we see that technology is really solving a lot of customer both provider and manufacturer challenges and ultimately giving a much better solutions to the end-patient. So it's a win-win across the industry and one that plugs in nicely to our strategy and to be throughout the specialty space. So we feel great about that and I certainly don't want to miss that we are also through this transaction acquiring a fantastic leadership team that will plug in very nicely to our own existing team. And so it's a culture that I think will work very well together. We've had a fantastic, very quick process. We've known specialty networks for quite a while, but from the point that we started talking about a possible tie up, we went from the beginning to the end of course doing a deep and thorough diligence, but nonetheless knowing the business well, so that we could quickly understand the value for us. As it relates to your second question on hurdle rates, I'm not sure exactly which part of the business you're referring to. But generally speaking, I think no matter what part of our business we're talking about it's a competitive, it's stable type of environment and so I'm not normally going to go deeper into that anyways, but generally you know speaking we're not really calling out anything from the overall market perspective today regardless of what our business we're talking about utilization continues to be quite good and predictable so we're in a nice environment for ongoing growth both organically, as well as enable to look optimistically at transactions like this."
},
{
"speaker": "Aaron Alt",
"content": "Probably worth noting that it is a profitable business today and as Jason highlighted we do intend to invest in the business early on to expand the scope of what they are doing across not only their own initiatives, but our initiatives within specialty as well."
},
{
"speaker": "Operator",
"content": "Thank you, sir. Ladies and gentlemen our next question is going to be coming from Lisa Gill calling from JP Morgan. Please go ahead."
},
{
"speaker": "Lisa Gill",
"content": "Thanks very much for taking my question and good morning. Just really wanted to ask two things, Jason. One, on the strategic side as we think about your core medical business. One, do you still feel a commitment to that business going forward? And then secondly, as we think about the shift and the new reporting structure, it does look like you're taking down the margin on the core business. Is there something that's either changing in the timeline of the turnaround? Is there something else that's shifting competitively or incremental cost? If you could just help us to understand that? Thanks so much."
},
{
"speaker": "Jason Hollar",
"content": "Sure, Lisa. Very clear here. No, there's no change in our commitment to this business. It has been there from the very beginning and continues to be. As I highlighted from the first moment when we talked about medical in the context of the business portfolio review, our number one priority has always been and continues to be turning the business around. Everything that we are working on has been in service of, first of all, the five-point plan to drive Cardinal Health plan volumes to mitigate inflation and drive additional value through simplification and cost reductions. That message and the progress we made is entirely consistent with that. The core operational performance of the business is exactly how we've laid it out. So the only update that we've had today were in recognition of some of those non-recurring items, but the plan and the fiscal year ‘26 aggregate targets that we're going after are absolutely unchanged to this resegmentation. We did have to bucket the medical improvement plan into the various buckets, because we did have the growth businesses that were a component of that. But that was just moving the pieces. The pieces are absolutely unchanged and the overall aggregate profitability in that long-term plan is absolutely unchanged and our commitment is absolutely unchanged to this business. And I'm really excited about the progress that the team is making in service of all those goals."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Thank you very much sir. And our next question will be coming from Elizabeth Anderson calling from Evercore ISI. Please go ahead, your line is open."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi, guys, thanks so much for the question. I have two sort of maybe more financial questions going forward. Can you talk us sort of the interest expense. Obviously they had a pretty big step down. Just wanted to understand that in terms of that and your sort of ongoing thoughts on the capital structure? And can you also talk about the free cash flow improvement, that was nice to see that step up in the quarter as well in terms of the guidance?"
},
{
"speaker": "Aaron Alt",
"content": "We're happy to offer some perspective. We're quite pleased with the below the line results of course you know for the quarter. I'm going to start with the fact that as we announced we ended the quarter with $4.6 billion of cash on hand and of course that's driven by the strong cash generation, which was the end part of your question. If you think back to our investor day we had highlighted that further optimization of our cash flow position was something we were focused on doing and the team has delivered against those efforts internally and generated strong cash flow in the first-half for the business thus the balance. Of course the knock-on consequence of that is when we have more cash on hand particularly in the higher interest rate environment, which we've been operating, we'll get a higher return, right? And we have indeed benefited from greater rate of return on the larger cash balances that we've had in place. It's also the case that there is some geography within our statement, because deferred comp was a positive for us below the line. That's an offsetting negative above the line in the quarter as well. And so, it's really the aggregation of those three things, of those several things which led to the results for the quarter. Now you asked about the financing as well. And I should be clear on a couple of things just as we think about our models going forward. We do have maturities coming in June and November. We’re assessing when our opportunities are there, nothing to announce today in that respect that we will address that, you know, at some point as we carry forward. And there is also the case that our cash balances fluctuate seasonally in the back half as well and so we wouldn’t expect the high balance to remain where it is just given the seasonal demand on the business."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. Our next question is coming from Mr. Eric Percher of Nephron Research. Please go ahead."
},
{
"speaker": "Eric Percher",
"content": "Thank you. On the medical side, it’s hard to see through the one-time items. I want to ask what you can give us on the nature of those one-time items? What the trajectory looked like excluding one-timers in the quarter? And any views on the exit trajectory for the year and kind of going from $140 million first-half to $240 million second-half how you're pacing relative to that?"
},
{
"speaker": "Aaron Alt",
"content": "Thank you. We were really encouraged by the underlying performance in Q2 of the medical business. And just to restate the results, the Q2 results were consistent with the expectations we communicated several weeks ago at the JPMorgan Conference and generally consistent with Q1, despite some of those adjustments that we took in the quarter. I want to emphasize that as you move away from the adjustments that we took, the underlying elements of the Medical Improvement Plan, they are on track, right? You heard some of my preferred remarks relative to our progress against the mitigation of inflation and how our cost structure is building. The benefits of each actions we've taken will benefit our cost structure in the back half of the year. You heard us announce that we had revenue growth for the first time in two years in the quarter as well, and we were pleased with the Cardinal Health brand growth that comes with that. And the team continues to execute against the simplification initiatives that have been a core part of the medical improvement plan all along. So let me go back to where I started, which is we were quite pleased with the operational performance in the quarter. I also want to point out that from a guidance perspective, while we updated the guidance for the year to reflect the relative impact of the non-recurring adjustments, that was the sum change of the guidance, to reflect that which is behind us, not that which is ahead. And if you think through how we have guided medical for the year all along, there's always been a very back half focused trajectory for our guidance for the year and that remains unchanged along with how pleased we are with the core operational performance."
},
{
"speaker": "Jason Hollar",
"content": "Yeah, if I could just add, you know, when you think about that first-half, second-half things and why we still anticipate the same step up in the second-half versus the first-half. There's a couple of key points. First of all, inflation mitigation, this is one where it's a significant part of that combined with Cardinal Health brand volume growth, which I'll get to in a moment. But on the inflation mitigation, there's of course two elements. There's the cost side, and then there's a price side. In both cases we have very good line of sight. On the cost side as we've talked really for quite a while now it's been the international freight and that while we have a little bit of noise with the Red Sea it is largely as anticipated so and that cost is already on our balance sheet and is rolling through as expected, especially given our volumes have been as expected. So, we have a very high line of sight and confidence the cost is going to continue to step down in the second-half of the year. And then on the pricing side, as we talked before, there's always the contract roll-through that we then update the pricing on. We do have a little bit more at the beginning of the calendar year of some of the price adjustments. So January being behind us, we have a really good line of sight to the pricing side as well. So there's some time now for the next couple of quarters needed to get that to roll through our income statement. But the actions now are largely behind us as it relates to inflation mitigation. We've always had confidence we would get to this stage, but we're now at this stage and have even more confidence actually seeing it start to come through in the second-half of the year. Now the other component is the Cardinal Health brand volume. You know, part of that's going to be market-driven, and the market volume, that utilization continues to be quite good. And what was exciting about the second quarter is seeing that further inflection and actually participating in that market growth really for the first time at the extent that what the market is growing. So that gives us much greater confidence that we'll continue to see that growth and that stuff as we get over the course of the year. But there's some variables like the market itself that will always be an impact here, good or bad, that will continue to monitor and track. So that those are the key points that I get us from the first-half to the second-half."
},
{
"speaker": "Aaron Alt",
"content": "Eric, it's probably worth offering one additional point of perspective. We're not reporting on the new segment structure this structure that will follow on Q3, but we can offer the observation that the GMPD core part of the medical business has operated at near breakeven levels in the first-half of fiscal ‘24. And I offer you that in contrast with where they were from a fiscal ‘23 perspective and where we're going from an overall guidance perspective, we view that as a key sign of positive progress."
},
{
"speaker": "Operator",
"content": "Thank you very much, gentlemen. [Indiscernible]. Our next question is going to be coming from Erin Wright of Morgan Stanley. Please go ahead."
},
{
"speaker": "Erin Wright",
"content": "Great, thanks. On the drug pricing front, you do continue to mention generics as a key driver. Are you still seeing that using deflationary dynamics that others have noted too? And how material is that for you and also how sustainable is it you know what are some of the key drivers that you're looking at there? And how are you thinking about that for the balance of the year, as well as we think about the quarterly cadence here for that that U.S. pharma or for the pharma segment particularly with the COVID dynamics too? Thanks."
},
{
"speaker": "Jason Hollar",
"content": "Appreciate the question. I think as we called out in commenting on the strong quarter that our pharma business had was that the continued consistent market dynamics within the generic space matched with volume, strong volume was a reason for -- one of the reasons for success in the business. We often talk about the two sides of the equation being in balance and indeed that's what we continue to see within our generic business and that is indeed a core component of our guidance for the pharma as we carry forward. One last reminder, I do want to remind that last quarter we actually took our pharma guidance up from a profit perspective to 7% to 9%. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you, sir. We'll now move to Allen Lutz calling from Bank of America. Please go ahead."
},
{
"speaker": "Allen Lutz",
"content": "Good morning and thanks for taking the question. Can you talk about growth of SG&A in the quarter? You flagged incremental investments in the business and higher selling costs. Can you unpack exactly what those expenses are? And then how should we think about SG&A growth for the remainder of the year? Thanks."
},
{
"speaker": "Aaron Alt",
"content": "Happy to offer some perspective. We were pleased in the quarter to actually achieve operating leverage with gross profit growing faster than SG&A. SG&A did grow, of course volume also grew, and so the primary component of our increase in cost was tied to the variable cost of serving higher volumes. It is also the case though that as Jason has highlighted in his strategic remarks, we are investing against our business and some of the SG&A growth was purposeful relative to the investments we're making in places like the Navista and other elements of our growth plans. But I will end with the fact that we are very focused on SG&A as a whole and the team continues to look for further opportunities as we have in prior years to optimize our cost structure."
},
{
"speaker": "Operator",
"content": "Thank you very much sir. We'll now move to Kevin Caliendo of UBS. Please go ahead."
},
{
"speaker": "Kevin Caliendo",
"content": "Thanks. Thanks for taking my question. I have two. Can you give us an update on the progress of the United contracts renewal timing, any updates you have there? And just to follow-up on that SG&A question, were there purposeful investments made when you saw sort of upside from interest in other things in SG&A in the quarter? I'm just trying to quantify how much was in the original plan versus maybe how much was incremental given some of the upside that you saw below the line?"
},
{
"speaker": "Jason Hollar",
"content": "Yes, sure. I'll touch on both points here. There's no updates with the Optum contracted those through this fiscal year. And as I highlighted before, they are a great customer of ours, long-standing customer, one that brings a lot of innovation to healthcare, and one that we've worked very hard over the years to attempt to exceed their expectations, and we think we're doing a great job of that, and we'd love to keep working with them, of course. Now, I do get a lot of questions around the order of magnitude of this, and I'm not going to go into details, but just a couple of points, you know, given the number of questions I've received, is we have disclosed in the past, and I think it comes through in every K, just the order of magnitude, so last year they were over $30 billion customer of ours, and I see a lot of people attempting to try to model out impacts and things of that nature. And there's a couple things that I'm not sure is real clear about the scope of business we have with them today. It is a prime, the majority of the revenue we have with them is through our base PD business and a lot of that is mail order volume. So what you have here are the typical markers of a large customer, PD majority and mail order. So those are all, you know, markers of lower than average margin type of business and so we do have other business with them of course too. They are very large and have a lot of breadth into various parts of the industry, but for us those tend to be a little bit of the overweight of how we support them. As it relates to the SG&A, the only thing I would say is no it's not like that what we do is we look at the capabilities and the necessities needed both short-term and long-term. Short-term is going to be on volume and making sure we can support our customers in getting that strong volume growth across the enterprise and in place we are then looking to balance that with longer term investments whether it's the Navista network we've called out before as investments, but we also have others that we went through during investor day and have had a number of updates even today, within our at-Home business we have three new facilities that we're bringing online over the course of the next year or two within the medical distribution three facilities I talked about today, we have on the pharma side the consumer health new logistics center. So I also made some comments around some of the IT capabilities within pharma, some of the e-commerce and intralogics capability. So we are investing where it makes sense efficiently, very well aligned to our strategy. And these are non-investments that you can just turn on and off. So it's something that we're going to invest as appropriate, but only what we have to do as well. We want to take away waste and invest it where there's growth is the key objective."
},
{
"speaker": "Aaron Alt",
"content": "For those working on their models, it's probably worth pointing out that with respect to the Q2 profitability in the business, it was the case that last year we called out unusual strength in the overall farm of demand, particularly from large customers, as well as a very strong cough, cold and flu season, so as you're looking at your comparisons keep that in mind."
},
{
"speaker": "Operator",
"content": "Thank you very much sir. [Operator Instructions] We'll now move to Mr. George Hill of Deutsche Bank. Please go ahead."
},
{
"speaker": "George Hill",
"content": "Yes. Good morning, Jason and Aaron. And forgive me if I kind of missed this or if you guys talked through this already, but as it relates to the planned restatement of the other segment, it looks like the growth in the near-term is coming in, but termed kind of the long-term targets. I just kind of wonder if you could address kind of or disagree in which sub-segments you're seeing the softness relative to the long-term expectations for the balance of the year or this year versus what you think kind of accelerates coming out and kind of closes the gap in the longer-term guidance?"
},
{
"speaker": "Aaron Alt",
"content": "The businesses that report through other for us going forward will be our at-Home business, our Nuclear Precision Health Business, and our OptiFreight business. Those are what we have traditionally called our growth businesses as part of other segments. And indeed over the long-term we expect them, the CAGR on their collective growth to be 8% to 10 percent. The disconnect you're referencing which is the 6% to 8% in fiscal ‘24 is only driven by the impact of the non-recurring adjustments from Q2 on the at-Home business that we referenced a couple of weeks ago as we talked about our expectations for Q2. Each of the businesses contribute to the revenue and profit growth for other. For instance, we carry forward in our earlier disclosures, I think you can get pretty close we disclosed the revenue of the individual pieces. And indeed, we've talked about nuclear, doubling its profit off of its fiscal ‘21 baseline by fiscal ‘26 as well. I believe and so you're able to get to that component of other through that."
},
{
"speaker": "George Hill",
"content": "Thanks."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Yes, sir. We'll now take a Stephen Baxter of Wells Fargo. Please go ahead sir."
},
{
"speaker": "Stephen Baxter",
"content": "Yes hi, good morning. Thanks for the questions, a couple of quick ones. On COVID vaccines and commercial channel, I think last quarter you kind of indicated or implied that the contribution was around $25 million. I was hoping you could update it on what the performance was this quarter and whether you factor anything into the balance of the year. And, and then just to try one more time on the non-recurring medical adjustment. Can you just tell us on the $20 million, if what does that actually represent in terms of the underlying accounting or business activity? Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Yes. So for the vaccine, we just kind of walk through the last couple of quarters and I'll give you a flavor of the benefits and the trends and such. So as we talked last quarter, we've highlighted in Q1 with the FDA approval at the beginning of September we were staged to hit the ground running and we had fairly significant volume in that first quarter, but as anticipated we indicated that point that we would expect it to peak within Q2 and so we expected higher volume, higher contribution in Q2 versus Q1 and that was because we saw October as the largest month within that season. And then as expected, we saw that wind down over the course of November and December, still seeing some level of volume in Q3, but I would expect it to be quite insignificant, compared to what we saw in Q1 and then Q2. Overall, I think the key message is that this is consistent with our expectations, as Aaron highlighted in his comments already. We had multiple drivers of growth for the pharma segment in the second quarter. It was strength with the generics program within brand. It was COVID driving that component and then we had these investments and primarily the cost to serve partial offset to those other two drivers. So overall, Phil feel good about the overall health of the business and the contribution of COVID within it."
},
{
"speaker": "Aaron Alt",
"content": "Yes with respect to the non-recurring adjustments. We previewed this back at the JP Morgan conference and when we updated our commentary around the medical business and our comment that -- is our coming out, which is and we have continued to dig deep across the portfolio, we've taken a decision to take some non-recurring adjustments, which the majority of which hit the at-Home business, which now reports or will report as part of other in Q3, as well as component hitting the wave mark business which is part of the new GMPD business. So if you read through the update to our guidance for the year where we moved from approximately 400 to approximately 380 driven by the impact of the non-recurring adjustments you can reach your own conclusions as to the relative quantification and the distribution given those comments. Thanks. Operator Thank you very much, sir. Our next question is coming Charles Rhyee from TD Cowen, please go ahead."
},
{
"speaker": "Charles Rhyee",
"content": "Yes, thanks for taking the question. Just wanted to follow-up on Allen’s question there on the vaccine impact. I understand your saying that it kind of, you expect it to peak in the December quarter. Would you say that the contribution, though, from vaccine was higher than in the first quarter given that you had still three months of overall and if we look at that relative to what you had expected the higher costs that you incurred? Did you use that to fund those kind of investments? Just wanted to get a sense on relative contribution?"
},
{
"speaker": "Jason Hollar",
"content": "Yes, as I highlighted, October was the peak month and since we only had a partial September, it is clearly higher in Q2 than in Q1. We did have November and December contributions as well, but it really tailed off by the time we got to the end of the quarter and that's why you would expect there it be very little it was just typical for vaccines in general, so there's nothing we're seeing there. And again I think that the way you ask the question around the funding of investments I'll just go back to my prior answer to that question. There were costs associated with the vaccine rollout. As you can imagine, that's a lot of volume to ramp up for really two months-worth of support. Our team did a fantastic job working with the manufacturers and our customers to play that role when we were not involved in the vaccine distribution before for COVID. So I feel very good about our role and we did have to incur cost associated with the ramp up and ramp down in such a short period of time. But that was not necessarily used as currency to fund other programs, where the programs are important strategically and all very consistent with the plans and the actions and the forecast we’ve laid out here, so there is no changes as it relates to how we are approaching these both short-term requirements, as well as long-term investments."
},
{
"speaker": "Aaron Alt",
"content": "Probably worth emphasizing that Jason’s point is that September and October were the high points for COVID for us from a distribution perspective would we tailing off thereafter."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "Thank you very much, gentlemen. And our last question today will be coming from Mr. Daniel Grosslight of Citi. Please go ahead, sir."
},
{
"speaker": "Daniel Grosslight",
"content": "Hi, guys. Thanks for taking the question. I want to just go back quickly to the medical profitability question and confirm one thing, that $20 million one-time item that was wholly kind of concentrated this quarter. So without that, the medical profitability would have been around $90 million. And then on your commentary around shipping rates coming down and benefiting you, and the volatility in Red Sea, if you look at the -- China to Westcoast shipping rates, they have spiked materially in January. So I’m wondering how, I guess couple of thigs there; one how that may kind of roll through you contracts. And then given that you capitalize those costs and expenses over two to three quarters post those cost being capitalized. How that might impact the cadence of your medical improvement plan in fiscal ’25? Thank you."
},
{
"speaker": "Aaron Alt",
"content": "So the first-half of that question, you are thinking about things correctly. I'll go back and emphasize we were really pleased with the operational performance of the business and given that we've adjusted our yearly guidance just to reflect the impact of the non-recurring adjustments in Q2, your conclusion on the math would be reasonable."
},
{
"speaker": "Jason Hollar",
"content": "Yes and the second component, you are correct that shipping rates have spiked. I think the word used was materially. And how I would characterize it is yes, that's accurate, but substantially less materially than where they were in the past. So the order of magnitude we're talking about is vastly smaller. It is also something that we do not believe that that will be the permanent level. Yes, we have more flexibility in our contracts, and that will continue to be a lever and a component that will be evaluating, determining on whether, you know, how permanent these are or not. I would also say that our maturity our capability within this space has substantially improved as well as we've invested in the underlying processes and procedures to manage through these types of this type of volatility. So you know overall we feel very good about where we stand and generally don't see this being as a material item, but we'll continue to watch it closely."
},
{
"speaker": "Operator",
"content": "Thank you very much sir. Ladies and gentlemen, that will conclude today’s Q&A session. I turn the call back over to Mr. Jason Hollar for the additional or closure remarks. Thank you."
},
{
"speaker": "Jason Hollar",
"content": "Yes, thanks everyone for joining us this morning. We're clearly excited about the momentum that we have in our business, both the shorter term operational elements that we talked a lot about today, but also about the longer term strategy with the announcement especially networks this week it just highlights that we are looking and acting both short-term and long-term and are really excited about the opportunity still in front of us. So thanks again for joining us today and have a great day."
},
{
"speaker": "Operator",
"content": "Thank you so much sir. Ladies and gentlemen, that will conclude today’s conference and thank you for your attendance. You may now disconnect. Good day and goodbye."
}
] |
cah | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to today's First Quarter Financial Year 2024 Cardinal Health Earnings Conference Call. This meeting is being recorded. At this time, I'd like to hand the call over to Matt Sims, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Matt Sims",
"content": "Good morning, and thank you for joining us for Cardinal Health first quarter fiscal '24 earnings conference call. On the call with me today are Jason Hollar, Chief Executive Officer; and Aaron Alt, Chief Financial Officer. You can find today's press release and earnings presentation on the IR section of our website at ir.cardinalhealth.com. As a reminder, during the call, we will be making forward-looking statements. The matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to our SEC filings and the forward-looking statement slide at the beginning of our presentation for a description of these risks and uncertainties. Please note that during the discussion today, our comments will be on a non-GAAP basis, unless they are specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the schedules attached to our press release. For the Q&A portion of today’s call, we kindly ask that you limit questions to one for participants so that we can try and give everyone an opportunity. With that, I will now turn the call over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Thanks, Matt, and good morning, everyone. Overall, it was a great start to our fiscal year, with strong first quarter results and an improved outlook for the year, we are continuing our operating momentum into fiscal 2024. In the first quarter, we delivered significant profit growth in both segments. In Pharma, the results were driven by the strength across our business, including continued positive performance from our generics program. We also benefited from our role distributing the recently commercialized COVID-19 vaccines, which I'll elaborate on later in my remarks. Macro trends in the core distribution business remains stable, and we continue to see strong pharmaceutical demand, including the GLP-1 medications. And both our higher-growth specialty nuclear businesses tracked ahead of plan in the quarter. In Medical, the first quarter was another proof point of the inflection we began to see last Q2 in this business. Recall, the segment was unprofitable only a year ago. Overall, results tracked slightly ahead of our expectations, and we continue to execute our Medical Improvement Plan initiatives to drive better and more predictable financial performance. In particular, we made notable progress on inflation mitigation in the quarter. At an enterprise level, we realized notable operating leverage from our efforts to manage costs across the segments. And below the operating line, our favorable capital structure and responsible capital deployment provided tailwinds, enabled by our strong cash flow generation. In short, the broad-based performance to-date gives us confidence to raise fiscal 2024 EPS guidance only a quarter into the year. Our team continues to prioritize focused execution to best serve our customers and create value for shareholders. I'll update you on our progress in advancing our three key strategic imperatives shortly, but first, let me turn it over to Aaron to review our results and updated guidance in more detail."
},
{
"speaker": "Aaron Alt",
"content": "Thanks, Jason, and good morning. Q1 delivered a strong financial start to the year, with EPS of $1.73, surpassing our expectations in Pharma and Medical. The strength of our pharma business, the progress on our medical turnaround efforts and our disciplined approach to capital allocation contributed to new first quarter highs for the enterprise on both revenue and EPS. We also delivered strong cash flow and ended the quarter with $3.9 billion of cash. Let's start with the consolidated enterprise results, as seen on Slide 4. Total revenue increased 10% to $54.8 billion, driven by the Pharma segment. Gross margin also increased 10% to $1.8 billion, driven by both the Medical and Pharma segments. Consolidated SG&A was generally in line with the prior year at $1.2 billion, reflecting our disciplined cost management across the enterprise. With the significant profit growth in both segments, we delivered total operating earnings of $571 million, growth of 35%. Moving below the line. Interest and Other decreased by $15 million to $12 million, due to increased interest income from cash and equivalents. As a reminder, our debt is largely fixed rate, resulting in a net benefit from rising interest rates in the near-term. Our first quarter effective tax rate finished at 22.5%, an increase of approximately 5.5 percentage points. We saw positive discrete items in both the current and prior year periods, which were more beneficial a year ago. First quarter average diluted shares outstanding were 250 million, 8% lower than a year ago due to share repurchases. And as I mentioned earlier, the net result was first quarter EPS of $1.73, an all-time first quarter high point, reflecting growth of 44%. Let's turn to the Pharma segment on Slide 5. First quarter revenue increased 11% to $51 billion, driven by brand and specialty pharmaceutical sales growth from existing customers. We continue to see broad-based strength in pharmaceutical demand spanning across product categories brand, specialty, consumer health and generics and from our largest customers. Similar to trends last year, GLP-1 medications provided a revenue tailwind in the quarter. Segment profit increased 18% to $507 million in the first quarter, driven by a higher contribution from brand and specialty products, including distribution of COVID-19 vaccines, which provided a modest contribution as customers stocked up in preparation for the fall vaccination season. We also saw positive generics program performance with continued volume growth and consistent market dynamics. Turning to Medical on Slide 6. First quarter revenue at $3.8 billion was largely flat to prior year and prior quarter. In the first quarter, we saw lower PP&E volume and pricing, including the impact from the prior year exit of our non-health care gloves portfolio, offset by growth in at-Home Solutions and inflationary impacts, including mitigation initiatives. Medical slightly exceeded our expectations in Q1 and delivered segment profit of $71 million, which represents an approximate $80 million increase from the prior year's first quarter loss. Consistent with the expectations communicated at Investor Day and last quarter, we continue to be encouraged by the indicators of improvement in trends with respect to our Cardinal Health brand product sales. In Q1, we saw a slight year-over-year volume growth. As expected, we saw an improvement in net inflationary impacts, including our mitigation initiatives. We also continue to see normalized PP&E margins, which were impacted by unfavorable price/cost timing in the prior year. In the quarter, we also recorded a $581 million non-cash pretax goodwill impairment charge related to the Medical segment, which is excluded from our non-GAAP results. This Q1 accounting charge is due to an increase in the discount rate used in goodwill impairment analysis. Now turning to the balance sheet. As I alluded to earlier, in the first quarter, we generated robust adjusted free cash flow of $1 billion and ended the quarter with $3.9 billion of cash on hand. We remain focused on doing what we said we would and deploying capital in balanced, disciplined and shareholder-friendly manner. In the first quarter, we continued to invest against our highest priorities, including investing $92 million of CapEx back into the business to drive organic growth. We made our third annual payment on our national opioid settlement obligation. We did not draw on our credit facilities and received a positive change to the outlook on our investment-grade rating from Fitch as well as from S&P in Q2. We returned over $630 million to shareholders through payment of our quarterly dividend and the launch of a new $500 million accelerated share repurchase program, which completed in October. Now for our updated fiscal 2024 guidance, on Slide 8. Today, we are raising our fiscal 2024 EPS guidance to a range of $6.75 to $7, the midpoint of which is 19% above our fiscal 2023 EPS result. This $0.25 increase to our EPS range primarily reflects an improvement to our Pharma outlook as well as some improvement below the line. We are raising our Pharma segment profit guide to 7% to 9% growth for the year and are pleased with the momentum in the business. Our updated guidance reflects the strong first quarter performance, higher than originally assumed contributions from COVID-19 vaccine distribution, which continued into October; the ongoing strength of our business, consistent with a 4% to 6% growth trajectory for the segment on a normalized basis. Finally, as a reminder, on the Pharma quarterly cadence, we continue to assume Q3 branded inflation will not repeat at fiscal 2023 levels. In Medical, we are reiterating our outlook of $400 million of segment profit for the year. Recall, that we previously guided that Medical segment profit would be significantly back-half weighted. That assumption remains unchanged. The first half-second half cadence continues to be driven by progress on Cardinal Health brand volume growth, the cumulative impact of inflation mitigation and some business-specific seasonality. While we are encouraged that the business slightly overperformed relative to our expectation in Q1, due to execution against our plans and our cost management efforts, our expectation for Q2 segment profit is unchanged from our original guidance, which reflected some seasonality in Q2-specific expenses like health and wellness. Altogether, Q2 segment profit should be slightly higher than Q1, which benefited from overdelivery. We expect continued progress from our Medical Improvement Plan initiatives over the course of the year. Below the line, interest and other is reduced to a range of $100 million to $120 million, while we are maintaining an effective tax rate in the range of 23% to 25%. We do expect the tax favorability we saw in the first quarter to be offset in Q2. We are also lowering our shares outlook to approximately $249 million, which reflects the already completed $500 million of our baseline share repurchase. I want to reiterate that, as we shared at Investor Day, neither our fiscal 2024 guidance nor our long-term targets reflect M&A, which is difficult to predict in timing or magnitude, or additional opportunistic deployments of capital to share repurchases beyond our baseline repurchase. We will continue to evaluate both opportunistically to drive long-term value. So, an overall successful first quarter. The Cardinal team is a lot to be proud of with respect to our accomplishments. We are confident in the plans we have in place, and we are excited for our team to realize the significant value creation opportunities still in front of us. With that, I will turn it back over to Jason."
},
{
"speaker": "Jason Hollar",
"content": "Thanks, Aaron Now for a few updates regarding our recent progress on our three key strategic priorities, beginning with priority number one and building upon the resiliency of the Pharma segment. The key enabler to the pharma business is outstanding performance over a number of quarters now, has been the team's consistent prioritization of what matters most, operational execution in the core. We're leveraging our scale, efficiency and breadth of essential products and service capabilities to deliver for our customers and their patients. Within the core, our generics program remains a critical component. Our performance is anchored by Red Oak Sourcing, which continues to do a fantastic job fulfilling its dual mandate, managing both cost and supply to help maximize service delivery for customers. I recently saw our customer-focused mindset on display when I visited our specialty pharmaceutical distribution facility in La Vergne, Tennessee, where team worked extensively to prepare for commercial distribution of COVID-19 vaccines, while maintaining their terrific service for our other specialty products. Our team successfully navigated complex cold chain requirements for the vaccines, enabling us to quickly meet demand and begin making shipments immediately following FDA approval in time for the fall immunization season. We're pleased to support our customers in this manner, which patients rely upon for care, convenience and accessibility. We're committed to supporting customers and manufacturers, and our strategic sourcing and manufacturer services team recently hosted hundreds of our supplier partners for our annual business partners' conference. It was energizing to hear the excitement around various industry opportunities, such as biosimilars and emerging areas like cell and gene. We are confident about our ability to continue to be a strategic partner for manufacturers, investing in the important drugs being developed and commercialized in this space. We've continued to see strong momentum across our specialty business, both downstream and upstream, and have reiterated our focus on this space. We are very sizable today in specialty with over $30 billion in fiscal '23 revenue, which we noted at Investor Day has grown at a 14% CAGR over the last three years. We are making progress building out our Navista network offerings, with investments in the platform that will scale over time. Our differentiated model in community oncology is focused on driving practice growth and sharing value, while maintaining practice independence. Our approach is being refined through engagement with clinicians and our customer advisory board. Overall, we are developing solutions strategically aligned supporting the clinical and operational needs of community oncologists that drive long-term practice independence and allow physicians to focus on patient care. In nuclear, the business continues its double-digit growth trajectory, with strong performance across our core categories and Theranostics. We continue to experience increasing demand for our Center for Theranostics Advancement, with more than 60 projects at various stages in our pipeline with our pharmaceutical manufacturer partners. We're progressing on our Phase II investment that we announced at Investor Day. Our innovation center and pre-commercial manufacturing center are already highly utilized. We're underway in progressing according to plan with the expansions of our central pharmacy capability and our commercial manufacturing center. With our strong foundation and continued investment, the nuclear business is well on track to deliver its long-term target of doubling profits by fiscal '26 relative to our fiscal '21 baseline. Now, turning to medical and priority number two. The medical business has now delivered back-to-back quarters of meaningfully improved profitability, and we expect more to come. As part of our medical improvement plan, we've been taking action to address the challenges in the core products and distribution business, with the number one priority being mitigating supply chain inflation. We remain on track to address the impact of inflation and global supply chain constraints by the time we exit fiscal '24, and we're pleased to note we are now over 70% to target. On the cost side, while overall still elevated, we've seen lower international freight costs reflected in our results as anticipated. We continue to execute our mitigation initiatives to offset elevated inflation are making progress with our commercial contracting efforts and are seeing benefits from our additional actions, such as our sourcing initiatives. Additionally, we've been taking action through our five-point plan to grow Cardinal Health brand volume, which has yielded improvements. We are utilizing a balanced portfolio approach and have made important line extensions within our core products to fill portfolio gaps critical to our distribution offering. We've also highlighted investments we're making in new product development and commercialization for our clinically differentiated specialty medical products, which culminated in two notable product launches during the quarter. We launched our anticipated Kangaroo OMNI Enteral Feeding Pump in the U.S., designed to help provide enteral feeding patients with more options to meet their nutritional needs throughout their enteral feeding journey, from hospital to home. We also announced the launch of our next-generation NTrainer System 2.0, a medical device designed to help premature in newborn infants develop with the oral coordination skills to make the transition to independent feeding faster and help reduce their NICU length of stay. I'm excited about what our products can do for patients and the progress we're making as we now turn to playing more offense to grow our Cardinal Health brand portfolio. We're continuing to see the results of our actions benefiting our leading indicators, such as our customer experience metrics and portfolio health for key categories, which gives us confidence that we'll be able to better participate in the growth from an overall improving medical utilization environment moving forward. For example, we've seen further improvement in our Customer Loyalty Index score for U.S. distribution beyond the 13-point increase in the last two years that we noted at Investor Day. And we've seen a continued reduction in our product back orders, which are now at a multiyear low and consistent with pre-pandemic levels. Outside of product and distribution, we're continuing to accelerate our growth businesses. In at-Home Solutions, we continue to see strong demand as care increasingly shifts to the home. Our team's focus on operational efficiency is producing better operating leverage in this business, resulting in increased contributions to the bottom-line. To wrap-up the Medical, we're continuing to execute our simplification and cost savings initiatives across the segment, which contributed to the strong SG&A management in the quarter. Finally, priority number 3, maximizing shareholder value creation. We're maximizing shareholder value creation through our improved operational performance, robust cash flow and responsible allocation of capital. As Aaron detailed, our confidence in our cash flow generation enabled execution of our fiscal 2024 baseline share repurchases, continued evidence of our willingness to return excess capital to shareholders and our value creation through capital deployment. With our financial flexibility, we'll continue to opportunistically evaluate disciplined M&A in specialty and potential additional share repurchases. We continue to actively evaluate a range of potential partners or acquisition candidates for both the downstream and upstream elements for our specialty strategy, but have been clear that our long-term growth targets are not predicated on inorganic investment. We are making progress with our ongoing business and portfolio review focused on the Medical segment. While across the company, our team has made significant progress over the past year realigning our operations for focus and simplicity, there is still work and opportunity in front of us. We continue to work collaboratively with our Business Review Committee to evaluate additional value creation initiatives and expect to provide further updates in the coming quarters. To close, we had a great first quarter and are excited to build upon last year's momentum. This was driven by our highly engaged and talented team, and I would like to thank them for all their efforts fulfilling our critical role as health care's most trusted partner. With that, we will take your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from Lisa Gill from JPMorgan. Please go ahead."
},
{
"speaker": "Lisa Gill",
"content": "Thanks very much and congratulations on the quarter. Jason, I just wanted to understand the COVID-19 vaccines. Can you maybe just talk about the economics of that? Is that substantially better than kind of traditional drug distribution? And I know you said it only goes through October, but are there other vaccine opportunities that would be similar and incremental opportunities for Cardinal?"
},
{
"speaker": "Jason Hollar",
"content": "Yes. Thanks, Lisa. How I think about the vaccines is, again, we're not going to get into, obviously, product and customer level type of detail. But overall, it all comes down to the value that we provide. And so, when you think about COVID-19 vaccines and vaccines in general, you really have to understand what's the requirements. And so with COVID and with some vaccines, it requires more complex distribution, cold chain capacity and capabilities. And of course, there's also - the unique thing about vaccines is that you scale up and down quickly and so you're spreading a lot of that cost over a pretty short period of time. So it's - there's not a one-size-fits-all answer to your question. And we provided a little bit of color for you in Aaron's comments there, so you can get a general understanding of the benefit that we had. And to go a little bit further, I can say that about one-third of the growth for the Pharma segment this quarter was related to vaccines. So it was a component of it, but certainly not the majority of the driver of the business. The core part of the business remained very strong within the segment for the quarter, and our guidance continues that core to continue to be strong. We do expect the vaccine benefit to be a bit greater in the second quarter because, of course, there's more volume in Q2 than in Q1, just given the nature of the October most likely being the peak volume that we would expect to see for vaccine distribution. And then we'd expect that to ramp down as we get the pipeline. We've got the pipeline pretty full here as we exited October. And now the future volumes will be much more predicated on what the actual demand is, which, of course, at this point in time is hard to anticipate."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "We'll now move to our next question from Eric Percher from Nephron Research. Please go ahead."
},
{
"speaker": "Eric Percher",
"content": "Thank you. A question on Medical, specifically the over-delivery this quarter or upside that you showed versus expectations. How much of that is core medical and mitigation efforts. What will carry through to the future versus not? And then were there any one-time items in Q1 we should keep an eye on? Any update on factors driving Q2 to Q4, including the incremental oil price and commodity pressure over the last few months?"
},
{
"speaker": "Aaron Alt",
"content": "Eric, good morning. It's Aaron. Look, we were really pleased to see Q1 results slightly exceeding our external or rather our expectations. The results of the team doing what they had planned to do as well as being good managers and always looking for optimization opportunities across the portfolio, and so they did what they were expected to on the first part - or first part of the year for the medical improvement plan, and there were no notable one-time items contrary to some earlier quarters that complicated the results. So we were quite pleased with the results that we gave. And we do expect that to continue. You will have noted from our guidance for the year that we do expect slight continued improvement quarter-over-quarter. We are not changing our guidance for the year on medical. I want to emphasize that we've taken a balanced approach and believe that the $400 million profit number for the year is the right target and the right guidance for that business. And the plans also haven't changed, right? It's going to start with the continued execution of the Medical Improvement Plan and inflation mitigation elements that we've been talking about. Jason highlighted that we had hit 70% plus in the quarter as well, and they're going to continue to optimize and grow the Cardinal Health brand We're continuing to focus on driving more out of at home and the other growth businesses as well as simplification and cost optimization and so overall, a great quarter and good expectations for the year to come."
},
{
"speaker": "Jason Hollar",
"content": "Yes. The other thing I'd add, Eric, I think the component of your question was just asking about commodities, and there's any impact there. There was not anything significant. So I know we've all been on this long journey as it relates to the impacts of commodities. So let me just spend a moment on that. As I think about the commodity and just general inflation, let me answer the question that way. I'd put our work into a couple of key buckets. The international freight piece is the only component that we've seen a meaningful change. And of course, that started about a year ago, and it was a dramatic reduction. So that reduction is as expected and given the elongated supply chain we had at that time, it took some time for that to work through and hit our P&L, but we're now seeing the more significant benefits of that over the last couple of quarters. So that is certainly a key component of it. What I would say about all the other commodities or all the other inflation, specifically the commodity impacts, whether it's the oil-based products polypropylene, polyethylene or unwovens and other types of inputs, which are varied. I would say that they are generally remain elevated a little bit volatile here and there, but generally elevated and not real different than what we had anticipated. So certainly noise, but how I think about it going forward and what my anticipation is we're just not seeing the volatility that we did back 18 months ago. So there is volatility, no doubt. There will always be volatility, but it's to a much lesser degree and much more balanced and kind of in a normal environment right now. And that's why you don't hear us talking about it is because it's just not meaningful in the context of everything else that we have going on."
},
{
"speaker": "Operator",
"content": "Next question from Kevin Caliendo, UBS. Please go ahead. Your line is open."
},
{
"speaker": "Kevin Caliendo",
"content": "Hi. Thanks. I guess, what we're trying to figure out is in the change in the pharma guidance, how much of it was incrementally coming from the vaccine incremental versus what you had originally expected if you don't want to give us that number specifically, maybe explain there was a 5 basis point improvement in the pharma margin year-over-year. How much of that was coming from vaccines? Or maybe you can just break out where the benefits came from. I assume GLP-1s were negative on the margin. So something had to be better on a year-over-year basis. I'd love to explore that?"
},
{
"speaker": "Aaron Alt",
"content": "We're happy to provide a little more context. Look, it was a strong start to the year, and we remain very encouraged about the runway for the pharma business. And we did raise the guidance to 7% to 9%. It's really a result of three factors. First was just the strong Q1. And as Jason alluded to, we did have a contribution from the COVID vaccine distribution. And it was higher - that contribution was higher than what we had assumed in our original plans, just based on the timing of when the approvals came through. And frankly, our team's ability to jump on it and execute the way they did. Third element, though, was just the ongoing strength of the business under - other than the COVID vaccines, which is really consistent from an outlook perspective with the 4% to 6% guidance that we gave previously on a normalized basis. And just to remind you on that, what we had guided previously is that we expected low single-digit growth - profit growth from the core pharma business. We're expecting stability from the generics business, consistent market dynamics you often hear us say. We are expecting double-digit growth in the Specialty and Nuclear business, and Jason highlighted that progress in his comments earlier. And importantly, we are expecting brand inflation more in line with fiscal 2022, not the modest benefit that we saw in fiscal 2023, right? So look, we are early in the year. As we have done, we'll continue to update as we push ahead, but we're pleased with the results so far and the raise to the guidance."
},
{
"speaker": "Operator",
"content": "The next question comes from Erin Wright from Morgan Stanley. Please go ahead."
},
{
"speaker": "Erin Wright",
"content": "Hi. Thanks. Another question on the pharma business. You mentioned the consistent generics environment, but can you elaborate on that a little bit? I guess, can you speak to the generic drug pricing environment? Are you seeing any easing deflationary dynamics across generics? And how material is that for you in terms of your guidance raise across that segment? And does consistent mean essentially a continuation of those favorable pricing trends going forward I guess, throughout the rest of the year?"
},
{
"speaker": "Jason Hollar",
"content": "Yes. Thanks, Erin. It's very consistent to the prior messages. So we're not seeing any change in the underlying market. And so my comments are going to be very similar to what it's been in the past. So let me just start with just underlying utilization continues to be strong. We've seen - in our commentary this morning, we made a number of comments around just the broad-based utilization being strong in the pharma industry. So we generally benefited from that. So volume is absolutely a key component of that. The consistent market dynamics that Aaron just referenced again is an indication that the buy and sell side continues to be very balanced. So overall, as in the past, I'm not going to break apart all the different pieces. We think it's best to look at them on a net basis. And within that, what I will say, though, is we continue to have very strong performance with our Red Oak Sourcing joint venture. So we continue to have that team, very focused on the dual mandate of, of course, driving down the best cost. But also as important and their mandate is to ensure that service levels are optimized as much as possible as well. So we feel very good about their progress, both in controlling costs, but also in driving great service for our customers. So again, those should be very similar words what we've said in the past. So that's why we used the phrase consistent market dynamics because we're not seeing any significant change in the underlying dynamics of this part of our business."
},
{
"speaker": "Matt Sims",
"content": "Next question, please."
},
{
"speaker": "Operator",
"content": "George Hill of Deutsche Bank. Please go ahead. Your line is open."
},
{
"speaker": "George Hill",
"content": "Good morning guys. And thanks for taking the question. I think like a lot of the other people on the line here, I'm really intrigued by what seems to be going on in the generic drug business. You guys called out Red Oak, GLP-1s were really strong in the quarter, but they have to be significantly margin dilutive. I guess, Jason, I'd love if you could talk about like if anything is changing on the contracting side? Are you seeing like increased rebates for purchasing compliance or supply compliance? Just kind of interesting, any more color that you can provide on what's going on in the generic drug space as it relates to profitability would be super helpful."
},
{
"speaker": "Jason Hollar",
"content": "Yes, so it's a fair question, George. And there's always going to be an evolution customer to customer, contract to contract. The balance of brand versus generic and then within brand and within generic, the mix always is ever evolving. And so over time, I would expect there to be more and more separation between some of these elements as the weighting of the products change. So it's - even though this volume has been dramatic for the GLP-1s, it's also been over a pretty short period of time and probably still early in this journey. So you used the phrase, and I think it was used earlier is significantly margin dilutive. I'm not sure - I'm sure we've never said words like that because it's very rare you hear us talking about margin rates, which you hear us talking about is margin dollars, and I even joked about this at Investor Day. I'm not sure I've ever said the words out loud in my career about the margin rate not being the most important or a significant metric for us. And it's because of products like the GLP-1s, products that are incredibly important to that underlying patient, which means it's important to our customers, which means it's important to us. It is not the most profitable class of progress today, but it's important for our patients and important for the industry what we value more than anything else is innovation in the distribution channel in the industry. Innovation brings good things for us. Maybe not in the short-term and maybe not for every single product, but innovation ultimately brings opportunities, whether it's services or whether it's - when these products become other opportunities to contract or other opportunities over time for them to go generic, there's just lots of different ways in which you can create economic value on a particular transaction, particular product. And so GLP-1s, today, you don’t hear us talk about from revenue, it's not a meaningful contributor to our earnings. And so we're not going to talk about it from an earnings perspective. Contracting back to your original question, we'll continue to evolve underneath that dynamic. But ultimately, we are well-protected customer by customer in certain corridors to ensure that we don't flip upside down on a particular customer. And so that needs to evolve over time as those concentrations evolve over time. But our model has proven very, very resilient over the years and decades because this is the latest mix challenge that there is or mix change, I should say. But it's not the first time that there's been a mix change in our industry. And so our model has proven to be resilient in that regard. So it's unique and different products, but it's not unique in terms of impacts and influences that a particular product category has on the pharma distribution industry."
},
{
"speaker": "Operator",
"content": "The next question comes from Elizabeth Anderson of Evercore. Please go ahead."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi, guys. Thanks for the questions or the comments about the pacing of the year. One thing that was just kind of - I heard what you said about calling out the inflation and how that doesn't quite flow through the same way as it did last year. Can you speak to how you're thinking about the first half of the year versus the second half of the year? Because I would say you had a…"
},
{
"speaker": "Operator",
"content": "Sorry, if I think we lost the previous caller, and we'll move on to the next question from Daniel Grosslight from Citi. Please go ahead."
},
{
"speaker": "Daniel Grosslight",
"content": "Hi. Thanks for taking the question. Maybe we'll go back to the COVID vaccine for a second here. You mentioned that you're seeing talking of vaccine ahead of the season, the winter season. Are you also taking more share in vaccine distribution and perhaps your overall market share would suggest. And then as we think about therapeutics moving into the commercial channel in a couple of months here, how is that factored into your guidance? And then lastly, you've been operating well above your longer-term pharma EBIT guidance of 4% to 6% for a few quarters here. I'm curious if there's been any change to how you're thinking longer term about the business and some of the secular tailwinds that might be driving growth higher than your longer-term 4% to 6% guidance."
},
{
"speaker": "Jason Hollar",
"content": "You're getting all the value out of your one question. So let me see if I can touch on each one. I think there's some connectivity between these. So overall, for vaccines, I think the best way to think about vaccine distribution is more about it from the customer standpoint. So I think what you'll see is that COVID-19 vaccines like other vaccines typically will follow the distribution network. So the real question is, are our customers getting more than their fair share, and I don't necessarily want to talk about them from that perspective other than to say we are very happy with the customers we have. We've often used a phrase for other situations winning with the winners, and we feel very well aligned with great customers. And so - but I think that's how you should think about it. And that it most likely the vast majority of the volume will follow the distribution network. I think your second element of that question was on the COVID therapeutics. How I think about that is a little bit differently than vaccines in terms of just the rollout, where the vaccines were a bit of an obsolete old product, new product type of situation where all that government stockpile. When we were asked about vaccines nearly a year ago, when it was first communicated to be commercialized, that was part of our response as well. We didn't know the FDA approval date. We also didn't know what was going to happen with the in-stock inventory, which seems to not have been a relevant usage at this stage given the variance evolution. As it relates to therapeutics, you don't have that same challenge, right? There's a lot of product out there still and the rollout will be slower. And you're talking about an oral solid type of brand product, which typically does not carry very - the same type of specialization necessary in the distribution channel that does drive higher-margin products like our specialty products. And then the last question is on the long-term growth outlook. I think one of the key messages that is behind your question and behind how we think about it. And partly why we're calling out those elements that may be a little unusual. Again, just like with GLP-1s COVID vaccines, and other form of innovation. We like innovation. It provides us new opportunities and new growth as an enterprise. And so part of the answer to this question is, well, how do these innovative products evolve and transition over time? Is that a continued opportunity. Is it lumpy? Is this year may be higher or lower than what that volume will be in the future? That - those are all hard questions to answer. But what we saw here is a bit of an influx of innovation that we've been able to benefit from while using the same infrastructure. So one thing that's really important to highlight about our performance this quarter, so we had really nice gross margin growth and we had very flat SG&A. I made the comment about the operating leverage in my comments. That's what I'm getting at is that we were able to execute very efficiently this quarter and whether we're talking about vaccines or other products, having that gross margin because it's an incremental product category for us because, of course, we do not participate in that volume last year but we're able to leverage the same capacity, the same team, that's an efficient use of our distribution channel. And as we get more opportunities like that, then there's some opportunity. But one of the key things that Aaron highlighted in a number of his comments, whether it's his comments, whether it's his comments or his answers to the question, is that our underlying growth and we feel very good about that long-term target. And a lot of what we've seen here was the Q1 overperformance both from vaccines, but also just the core utilization being very strong. That's not the same level of strength that we have indicated, we should be thinking about long-term. It's an opportunity for us, but that's not what we're expecting at this point in time. And it's not what we're guiding for the balance of the year in terms of the core growth. We expect that core growth to still be in that 4% to 6% range. But again, innovation can create some opportunities for us. That's hard to see right now, but we're not planning for that."
},
{
"speaker": "Aaron Alt",
"content": "So maybe if I can just wrap a bow around that from a guidance perspective, just to reiterate what our guidance is look for the - as we sit here today, the Medical segment guidance is $400 million of profit for this year, and we've talked about that extensively, leading to $650 million of profit in fiscal year 2026. While we are pleased with the progress on Pharma, one quarter into the year and are raising our guidance for this year for Pharma, the 7% to 9% profit growth. Our longer-term algorithm remains the 4% to 6% profit growth that we had called out at our Investor Day, leading to 12% to 14% adjusted EPS growth long-term as our overall guidance. We're not seeing changes to our long-term guidance as we sit here today. Now some may ask, and I've seen in some of the headlines well, you beat by a particular amount, but your raise is a little bit less than what that amount is. And the short answer to maybe get ahead of the question is that we had above-the-line benefits for which we and below-the-line benefits relative to consensus or expectations. And the real difference between our raise and how you might do that math is just we're not carrying forward the tax benefit that we saw in Q1 into the updated guidance for reasons I called out during my prepared remarks."
},
{
"speaker": "Operator",
"content": "The next question comes from Charles Rhyee from TD Cowen. Please go ahead."
},
{
"speaker": "Charles Rhyee",
"content": "Yes. Thanks for taking the question. Jason, I wanted to follow-up on your comments on commodity prices. And you said that you're seeing less volatility in pricing than before. Would you say that when you look at sort of the increase in oil over the past six months or so, is that - would you say that's within the - your expectations of volatility? And - or would you might expect to see that get reflected into freight and/or some of your other input costs at some point? Thanks."
},
{
"speaker": "Jason Hollar",
"content": "Yes. No, that's a great question. And it's - so when I step back and think about 18 months ago, what the root issue was, of course, we had international freight that was driving up the cost of everything in a multiple that was crazy, but you also had these other commodities that were - okay, so there are some commodities that are oil-based, so the oil input costs, but then you had the supply-demand factors going on too that I think overemphasized that issue because we don't buy oil, we buy products that contain oil. And so as oil goes up and down, that's often absorbed within the supply chain in a normal steady state, unless it gets outside of a certain band. So it did get outside that band, right? Oil went above $100 per barrel. And then you had other demand factors that were driving those commodity costs well beyond what the input cost impacts were. So you had a bit of an exponential increase in a number of commodities. So today, given that we're in a much more muted demand environment, as a broad industry because this is way outside of healthcare, right? This is a general economy not being as hot as it was at that point in time. When you see these types of input costs going up and down, it goes back to a bit more of a normal model, which is they're not being exaggerated and multiplied, they're just flowing through in a much more normalized steady state. So that's the reason why that I would not expect this under this current environment to get outside of normal bounds. So if you see the input costs going up and you see a heated economic environment that can further compound that impact, that's when we need to start worrying more about this. I know the importance of this will certainly be - day-to-day, we certainly spend a lot of time on this, but we'll continue to provide any insight that we see going forward. Of course, when we get into the very significant changes, that's the changes to our contracting structure that we've put into place. That's never going to be perfect. It's never going to be a one-for-one offset, but it's meant to really be active and impactful when you have those more extraordinary types of impacts that really kind of compound these items like I just referenced, and not just the normal types of more muted movements."
},
{
"speaker": "Charles Rhyee",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Allen Lutz from Bank of America. Please go ahead."
},
{
"speaker": "Allen Lutz",
"content": "Good morning and thank you for taking the questions. I want to go after the Pharma margin dynamic a little bit differently. So they were up 5 bps year-over-year. It sounds like the vaccine benefit is going to peak in your fiscal 2Q. So is the right way to think about the margin growth in the Pharma segment year-over-year is it could peak or the growth could peak in 2Q and then kind of more of a normalized lower margin trajectory in the back half? Just trying to get a sense of the seasonality there? Thanks."
},
{
"speaker": "Jason Hollar",
"content": "We really haven't provided quarterly guidance at the margin level for the pharma business. We were - we leaned in a bit in describing the impact to Q1 from the COVID vaccine distribution as well as Jason's comments around the expectations for Q2. Beyond that, I think you just need to take into account what we typically say about our business, which is, first, that we expect the consistent market dynamics from a generic perspective, right? And we are not assuming some of the benefits from a brand perspective in Q3 that we have previously seen. And that's how we are offering up today."
},
{
"speaker": "Operator",
"content": "We will now take our final question today from Elizabeth Anderson, Evercore. Please go ahead."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi, guys. Apologies about the audio issues before. My question was just on the non-operating items, it seems like both on interest expense and maybe on the share count, based on the ASR that you talked about and the interest expense in the first quarter, that there's a little bit of conservatism in that number in those - both of those numbers"
},
{
"speaker": "Operator",
"content": "And it seems we have lost…"
},
{
"speaker": "Aaron Alt",
"content": "I'll answer the question. I think she was seeking to ask. The question from what I heard was interest and other, are we being conservative as well on what's going on with our share count? And I guess I would offer the following. We were pleased to see continued benefit in the quarter from I&O, driven by the fact that we have such high cash balances and the return we're receiving on those cash balances. We are, of course, also benefiting in the quarter from the fact that we are largely fixed rates. We have been now for several quarters. And so we haven't been exposed to the interest rate increases that some other companies may be dealing with, and that's just driven by the good stewardship previously. We do have a maturity coming at the end of fiscal 2024. It's about $750 million or so from recollection. And we've commented that we're likely to refinance that. I haven't commented on the timing of that as we care forward. And so we believe the guide - the updated guide we provided on I&O reflects the benefits and the various trade-offs in that. With respect to the share count, I do think it's important to call out that as we have consistently said, we don't guide for share count changes beyond the baseline share repurchase. We made a commitment at this during our Investor Day in June that our baseline share repurchase was going to be $500 million during fiscal year 2024. We completed that in the first quarter. That is the share repurchase we're talking about today, and our guide reflects the impact of that - of the completion of that share repurchase program. It does not reflect any other changes to share repurchase over the course of the year. As Jason called out earlier, we have the benefit of our cash balance. And having invested, having the plans that we do to invest in the business, CapEx-wise, $92 million in the first quarter, targeting $500 million for the year, and continue to make progress on our investment grade rating and the two outlook changes - positive outlook changes that we received during the quarter, having made our baseline share repurchase during Q1 as well as continuing to pay our dividend. As we are, as a dividend aristocrat and now we have the opportunity and support of the plans to take the resources we have available to us to invest back in the business with that specialty focus that Jason has called out several times to look at M&A in a disciplined manner, as Jason called out, and then to also consider further opportunistic share repurchase in due time as we assess how the year is performing. I think that's where Elizabeth was going."
},
{
"speaker": "Operator",
"content": "Thank you. With this, we conclude today's question-and-answer session. And now I'd like to hand the call back over to Jason Hollar for any additional or closing remarks. Over to you, sir."
},
{
"speaker": "Jason Hollar",
"content": "Yes. Thanks again, everyone, for joining us this morning. As we've said a few times, it was a great start to the year. We're pleased with our broad-based performance and to be in the position that we are today to raise our guidance after just the first quarter. We look forward to, certainly, continuing to update you on our progress against these plans throughout the year. And with that, thank you, and have a great day."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect."
}
] |
carr | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to Carrier's Fourth Quarter 2024 Earnings Conference Call. I would like to introduce your host for today's conference, Michael Rednor, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Michael Rednor",
"content": "Good morning, and welcome to Carrier's Fourth Quarter 2024 Earnings Conference Call. On the call with me today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. Except where otherwise noted, the company will speak to results from operations, excluding restructuring and significant nonrecurring items. A reconciliation of these and other non-GAAP financial measures can be found in the appendix of the webcast. We also remind listeners that the presentation contains forward-looking statements, which are subject to risks and uncertainties. Carrier's SEC filings, including our Form 10-K and quarterly reports on Form 10-Q, provide details on important factors that could cause actual results to differ materially. With that, I'd like to turn the call over to Dave."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Mike, and welcome aboard. Let me start by saying thank you to our team for delivering great results in 2024 while completing such a significant portfolio transformation. I am more excited about 2025 than I have ever been entering a new year. I feel as if all of the work done by so many Carrier over so many years has positioned us for this moment to create outsized value for our customers, people and shareholders. As you can see on Slide 2, 2024 was a strong and transformational year for us. We achieved 3% organic growth by delivering double-digit growth in global commercial HVAC and aftermarket, both for the fourth consecutive year to help offset unexpected weakness in residential light commercial HVAC in Europe and China. Total company orders were up low teens with HVAC Americas supplied up about 40%. Our global commercial HVAC backlog is up mid-teens versus last year, positioning us for another year of double-digit growth in 2025 in that business. For overall Carrier, organic growth and strong productivity contributed to close to 100% core earnings conversion, 180 basis points of margin expansion and 16% adjusted EPS growth. We delivered these strong results while we successfully completed our portfolio transformation. We integrated with Viessmann Climate Solutions and executed on our divestitures, yielding over $10 billion in gross proceeds. And as committed, we paid down debt and returned to roughly 2x net leverage. We also returned over $2.6 billion to shareholders through dividends and share repurchases. Turning to Slide 3. I think of our year since spin in 3 phases. During our first phase, we built the foundation for a new Carrier we promoted and added key talent we launched and have lived a new culture embedded in the Carrier way that has given us tremendous energy and a focus on growth and innovation. We launched Carrier excellence to drive operational execution, excellence and productivity. We invested in our product portfolio and developed and implemented our aftermarket playbook to position us for sustained organic growth. We sold Chubb, added Toshiba, simplified the backed office and paid down debt. 2023 and 2024 were fined by our mantra of performing while transforming. We sharpened our vision and successfully transformed our portfolio. We now have greater bandwidth to create even more value for our customers and thus our shareholders. Focus simplification, differentiation, customers, win, grow. The new phase accelerating growth has begun and there is tremendous energy within Carrier. As we navigated this transition, we have been purposefully increasing our addressable market and value proposition for our customers, as you can see on Slide 4. In 2020, we began to not only increase our investments in our product portfolio, we significantly increased our focus on digitally enabled life cycle solutions market has increased our addressable market, contributed to margin expansion all while creating greater customer stickiness and increasing recurring revenues. Now in addition to driving differentiated products in aftermarket, we are introducing fully integrated systems, which further increased customer value across our 3 targeted ecosystems, homes, buildings and the cold chain. For Integrated Systems and homes, we are significantly expanding and enhancing our European home energy management system offerings. And through a newly created business within Carrier called Carrier Energy, we are bringing similar offerings to the United States. For the U.S., we are actively working with utilities to provide an end-to-end integrated battery heat pump solution with automated controls to run the system using stored energy during peak hours while recharging the system during the trough of energy grid usage. The interest from utilities and other customers have been very encouraging to address grid constraints and resiliency. Within Building Systems, one offering is our integrated cooling solution for data centers that we announced last week under the brand of Quantum Leap. By combining traditional cooling, liquid cooling and our building and server management systems, we provide differentiated, more efficient solutions for our customers in this important and growing vertical. For cold chain solutions, we are transitioning from solely selling reefers to providing end-to-end systems enabled by our Linx Digital platform and Sensitech technologies. Selling complete integrated systems provides us with a new and important opportunity for differentiation, customer value and increased revenue streams. Slide 5 lays out our strategic focus areas and priorities for 2025. In addition to our growth initiatives that we just discussed, we also remain laser-focused on margin expansion through carrier excellence while maintaining disciplined capital allocation. We deeply embed our priorities throughout our organization through a structured goal alignment process. Slide 6 shows how these priorities are reflected in our 2025 guidance. Given our strategic positioning, we expect organic growth in single digits with our fifth consecutive year of double-digit growth in aftermarket and global commercial HVAC. We will continue to drive productivity and expect 100 basis points of year-over-year margin expansion. We expect adjusted EPS to be up 17% at the midpoint and about 100% free cash flow conversion. As we look ahead, we will continue to focus on execution within Viessmann Climate Solutions, which we discuss on Slide 7. Obviously, 2024 was well off what we expected coming into the year. Nevertheless, I am proud that the team controlled the controllables and drove share gains, significant cost synergies and key new product introductions. The team also took the tough but necessary actions to significantly reduce both temporary and structural overhead costs, positioning us for strong margin expansion as growth returns. Looking at our growth algorithm for 2025. Given political and economic uncertainty in Europe, we assume that market volume will be flat to down mid-single digits. In addition, we expect a 5-point full year revenue headwind associated with last year's Q1 backlog reduction, which normalized at the beginning of Q2 of last year. On the positive side, we expect continued positive mix with double-digit growth in heat pumps offsetting a modest decline in boilers. Similar to last year, we expect VCS aftermarket to grow double digits, and we also expect a point or so of price. New products introduced last year, including the 19- and 40-kilowatt heat pumps will see a full year of sales in 2025. We are introducing a full lineup of cascadable heat pumps up to 560 kilowatts with natural refrigerants that we will be selling through the Viessmann channel. As we think about revenue synergies, we are excited for the ISH trade show in Frankfurt in March, where we will showcase our new multi-brand products such as our newly launched carrier branded air conditioning units that we will also be selling through the Viessmann channel. We gained share in key European geographies last year and expect that to continue in 2025. We and the team has been putting all the pieces together to significantly increase our complete home energy management system sales this year and beyond. We also remain confident in margin expansion and cost synergies. So all in, we expect a strong year across carrier with accelerated organic growth, margin expansion, EPS growth and strong free cash flow. With that, let me turn it over to Patrick. Patrick?"
},
{
"speaker": "Patrick Goris",
"content": "Thank you, Dave, and good morning, everyone. Please turn to Slide 8. In short, Q4 earnings were ahead of our expectations and the guide we provided in October. Reported sales were $5.1 billion, with 6% organic sales growth, including about 2 points of price and 4 points of volume. We had a favorable 13% net impact from acquisitions and divestitures. Organic sales were in line with expectations, driven by continued strength in global commercial and the North America residential HVAC, partially offset by weakness across residential and light commercial HVAC in Europe and China. Q4 adjusted operating profit was up 65% compared to last year, driven by the contribution of Viessmann Climate Solutions, the benefit of organic growth and productivity. As a result, adjusted operating margin expanded by 370 basis points compared to last year. The absence of commercial refrigeration was about 0.5 point tailwind to margin. Adjusted EPS of $0.54 was up 50% year-over-year. Operational performance was in line with our guide, and we benefited from discrete tax items. Net interest expense was a bit light versus our guide given the earlier close of the commercial and residential fire business. Free cash, and I'll now refer to both continuing and disc ops, was an outflow of about $90 million in the quarter. Full year free cash flow of $30 million was about $200 million better than we guided. Having closed residential and commercial fire in early December, we picked up the pace on share repurchases, and we ended 2024 with about $1.9 billion of share repurchases, about $1 billion more than our October guide. Moving on to the segments, starting on Slide 9. The HVAC segment had another strong quarter with organic sales growth of 11%. Organic sales in the Americas were up high teens. Within the Americas, Commercial was up mid-teens and light commercial was a little better than expected and down around 10%. In the fourth quarter of 2023 light commercial was up about 20%, so certainly a tough comp. Residential was up 35%, mostly driven by strong volume compared to a very weak Q4 last year which was about minus 20% as our channel was in destocking mode a year ago. On the last earnings call, we mentioned that we expected no material prebuy in Q4. The actual prebuy was in line with expectations and movement was stronger than expected, movements that is sales from our distributors to installers has continued to be strong in January this year. Organic sales in EMEA were flat, driven by double-digit growth in commercial, offset by a decline in residential and light commercial HVAC reflecting continued market weakness. Organic sales in Asia were slightly positive, driven by strength in Japan and South Asia, partially offset by declines in our residential and light commercial business in China. The HVAC segment adjusted operating margins were up 250 basis points, driven by the benefit of organic growth and strong productivity. As you can see at the bottom of the slide, 2024 was another great year for our HVAC business with continued growth and margin expansion. Transitioning to Refrigeration on Slide 10. Q4 was the first quarter without commercial refrigeration given its exit on October 1. Overall, results for this segment were as expected. Our global truck and trailer business was down around 10% and with North America down about 25% and Europe down low single digits, only partially offset by high single-digit growth in Asia. Container was down low single digits. Our aftermarket and Sensitech businesses were both up mid-single digits. Operating margin expanded by 160 basis points year-over-year. For the full year, this segment was down 1% organically with container up roughly 25% and mostly offset by declines in North America truck and trailer. Margins expanded 20 basis points. Turning to Slide 11. Total company orders total company organic orders were up low teens. Overall, HVAC orders were up about 5% with continued strong orders growth in the Americas at about 10%. EMEA and Asia organic orders were down mid-single digits. In Asia, weak orders in China residential light commercial HVAC were partially offset by China Commercial HVAC orders and strength in other countries. Globally, commercial HVAC orders were up about 10%. Refrigeration orders were up around 55% in the quarter, mostly as a result of very strong growth in North America truck trailer on an easy comp. Truck and trailer orders in Europe were up over 20% and Asia orders were up mid-single digits. Overall, we entered 2025 with robust longer-cycle backlogs in commercial HVAC and orders momentum in key businesses. Moving on to Slide 12 and shifting to 2025 organic sales guidance. We expect mid-single-digit organic growth and reported sales of between $22.5 billion and $23 billion. This also includes a $750 million year-over-year headwind from the commercial refrigeration exit. We expect roughly a 1 point, we expect roughly 1 point of price and the remaining organic growth to come from volume and mix up. We expect currency translation to be at about 1 point of headwind. The organic growth for Board segments is expected to be up mid-single digits for 2025. Within HVAC, we expect the Americas to be up high single digits driven by continued double-digit growth in commercial high single-digit growth in residential, driven by the new refrigerant mix up and low to mid-single-digit growth in light commercial. We expect Europe to be up low single digits with commercial up double digits and flat sales growth in residential and light commercial. Dave just walked you through our assumptions for flat sales growth in this market segment. Finally, within Asia, we expect low single sales growth with China sales flat and mid-single-digit growth outside of China. Within Refrigeration, we expect Global Truck and trailer to be up mid-single digits with North America truck trailer returning to growth in the second half of the year. We expect mid- to high single-digit growth in container and double-digit growth in Sensitech. Moving on to Slide 13, profit and cash guidance. Total company adjusted operating margin is expected to be up about 100 basis points compared to 2024 and with half of the increase driven by volume, price and net productivity, partially offset by investments. The absence of commercial refrigeration contributes 50 basis points of margin expansion. Core earnings conversion that is excluding the impact of acquisitions, divestitures and FX is expected to be about 30%. We estimate free cash flow to be about $2.4 billion -- to be between $2.4 billion and $2.6 billion, reflecting roughly 100% conversion with normal seasonality. We Finally, we intend to repurchase about $3 billion in shares. Through last week, we repurchased about 900 million of shares so far this year. We estimate that average diluted share count for 2025 will be down about 5% from 2024. Moving to Slide 14. We expect adjusted EPS between $2.95 and $3.05, up 17% at the midpoint. The building blocks are identical to what we shared with you on the last earnings call, except for currency. Adjusted EPS growth includes about $0.30 of operational performance driven by volume leverage, price and net productivity and about $45 million of corporate stranded cost elimination, partially offset by investments. We expect foreign currency translation to represent a headwind of about $0.05. As a result of debt paydown, we expect net interest expense to be a $0.05 to $0.10 tailwind. Finally, we expect a lower share count, partially offset by a 22% tax rate and NCI to provide another $0.10 to $0.15 of EPS benefit. With respect to capital deployment, we'll pay down $1.2 billion worth of debt this quarter. The dividend per share increases by 18%. And as I mentioned earlier, share repurchases are expected to amount to $3 billion this year. As usual, additional guide items are in the appendix on Slide 17. Finally, let me provide some additional color on the first quarter. We anticipate Q1 revenues to be about flat sequentially, a little more than $5 billion, with first quarter organic revenue growth flat, up low single digits. This reflects continued strength in global commercial HVAC and a tough comparison in resulite commercial HVAC in Europe and China. We expect organic growth for refrigeration to be about flat. We expect about 100 basis points of margin expansion in Q1 and adjusted EPS to be between $0.55 and $0.60. So overall, we ended 2024 on a strong note and expect 2025 to be another year of strong financial performance. With that, we'll open it up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Jeffrey Sprague with Vertical Research."
},
{
"speaker": "Jeffrey Sprague",
"content": "Patrick. Mike, good to hear you're there, too. Can we just drill a little bit more into resi and what you saw in the quarter. So you're characterizing it, I guess, as no prebuy or no significant prebuy. Maybe you can just kind of elaborate on that. Does that suggest your holding inventory that you sell into the dental in Q1? Or any other kind of color on how the kind of pieces moving parts together?"
},
{
"speaker": "David Gitlin",
"content": "Yes, Jeff, we'd say that we had a bit of prebuy basically what we thought back in October, we shipped about $75 million to $100 million worth of 410 unit -- 410A units that we would characterize were pull ahead from this year into last year. And we calculate this by looking at the inventory levels that are held by our distributors, which were just slightly elevated versus the same time last year. And as Patrick said, movement was very strong in 4Q. Movement was up about 15% from our distributors to our dealers, and we were up about that same amount in January, first week of February was a little bit lower than that. So look, inventory in the channel, not too high, movement goods. So we think that nearly everything we shipped was underlying true demand with maybe 75 to 100 of prebuy."
},
{
"speaker": "Patrick Goris",
"content": "And Jeff [indiscernible] inventory in Q1. So we did help inventory. Yes, we will sell some 4 in Q1 from inventory."
},
{
"speaker": "Jeffrey Sprague",
"content": "Right. And then so getting to high single digit for the year, we got in 410A in Q1. And then we've sort of got price-related mix effect for the balance of the year getting us to high single digit. What do you think the kind of realized prices on the 454 units on an all-in basis?"
},
{
"speaker": "David Gitlin",
"content": "Yes, Jeff, about 10%. But let me walk you through the high single digits. It's really along the lines you were saying. So we think that volume will be flat to down low single digits, which includes that modest prebuy that I just mentioned. Then we expect base price to be up low single digits. So between those 2, you're about flattish the benefit of the mix up of the transition to be high single digits. So 80% of our volume is impacted by the refrigerant transition. 20% is not affected because they are either furnaces or things we ship to Canada. Of that 80%, Jeff, we expect about 90% of that to be 454 and about 10% to be the 410. And of that 454B, we expect a 10% -- to realize a 10% price increase. So that mix up alone, that gets you to about 7% sales growth. And then we expect modest growth in the remaining 20% of the business."
},
{
"speaker": "Jeffrey Sprague",
"content": "Grand. Maybe just a quick one, and I'll pass it on. Just on the share repurchase, I think many of us thought you might do an ASR, it looks like you bought a lot the way in Q4. Is that the plan for the balance of 2025 also as the regular way our repo."
},
{
"speaker": "Patrick Goris",
"content": "Yes, Jeff. Exactly, as you said, we achieved the same thing without NSR. And not until the balance of the year, we'll expect to be in the market throughout the year."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andy Kaplowitz with Citigroup."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Dave, so maybe just a little more color into your outlook for [indiscernible]. I know for a while, you were talking about a stronger potential revenue growth possible in '25 and now you're talking about this 24% backlog reduction headwind. Of course, German elections are coming up. So maybe just talk about the visibility to get to that flat growth. And is it derisked now in your opinion in the guidance when you look at the items that are in your control, aftermarket synergies, how much visibility do you have in getting those pieces of growth?"
},
{
"speaker": "David Gitlin",
"content": "Yes, I think so. I think that it's a very balance guide, perhaps conservative, but we'll see. I mean, look, we -- when we look at the total market, we just have to be honest that there is a fair amount of economic and political uncertainty in Europe. So we put that volume at flat to down 5%. And we did see -- I think first quarter of last year was the last quarter that I think we shipped out of some level of excess backlog. So that now normalizes in the second quarter of this year, but that will cause us about points of total full year headwind. The stuff that -- so that kind of walked us down to, say, down 5 to 10. But when we look at what's in our control, 3 to 4 points of mix up, that assumes double-digit heat pump growth and down a bit in boilers. And we have pretty good visibility to that. If you look at the second half of last year, just in Germany, or the subsidy applications were up around 65% year-over-year, up 60% on a 2-year stack. Viessmann heat pump orders in the half were up about 40%. So some early indications that there's underlying demand for heat pumps in Germany. So 3 to 4 points of mix up, we'll get a point or 2 of aftermarket with double-digit growth, a point or so of price. And then that bucket of revenue synergies, we're looking at $100 million of revenue synergies this year around the globe, probably 70% in Europe. And I could tell you, Andy, we have that like line by line, the air conditioning units with Carrier brand going through the Viessmann channel. We have Hydronics, we have system-level sales that we're taking from Europe to use for HEMS in the United States. We have multi-brand strategy in China. So details on the revenue synergies. System in could be a new frontier for us this year as we really put the wheels in motion to drive that. Share gains, again, this year, NPI again this year. So we feel good about what's in our control, and we'll keep an eye on the market."
},
{
"speaker": "Andrew Kaplowitz",
"content": "And then David, Patrick, it looks like you're forecasting something like low 30s incrementals for HVAC in '25 maybe puts and takes to get there, especially because it's topical around tariffs. How do you account in your bridge? Do you put the China in there? And then there's obviously steel and aluminum, I just got passed, can you remind us of the cost structure on that side of the business?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. I'll just talk very high level on the tariffs. We have embedded into our guide what's happened with the tariffs related to China and those are fully mitigated in our guide for this year. With respect to what has happened more recently about some of the materials. Most of the materials we purchase such as steel actually come from U.S. vendors. In addition to that, we are pretty well blocked for the full year. In North America, I think we're blocked for about 80 -- close to 80% of our steel volume. So generally, we think we're in a pretty good position there. With respect to your questions on the margins for next year, and I'll talk at the overall company level because given the size of HVAC, it applies to that as well. What you can think about is differently than in '25, we expect a bigger contribution from organic sales growth, that's both volume and, of course, the mix up. That, combined with strong productivity. Those are the main drivers of margin expansion, and that then would be offset by reinvestments in our business. And so it's really driven by organic growth, continued strong productivity the impact of the mix up, of course, offset by reinvestments in our business."
},
{
"speaker": "Operator",
"content": "Our next question comes from Julian Mitchell with Barclays."
},
{
"speaker": "Julian Mitchell",
"content": "Maybe just first off on the organic sales guide for the year. So you're starting out with sort of flat to up slightly in the first quarter. Total company, the year is up mid-single digits. So maybe walk us through kind of how we think about growth for the rest of the year after Q1 and maybe put a finer point on the cadence of a couple of the businesses most in focus, which are Viessmann and the Americas resi HVAC, please?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. So Julian, from an overall company point of view, I said flat to low single digits in Q1. And that would also, as I mentioned, mean refrigeration flattish and HVAC, therefore, low single digits. Within Q1, VCS because of the tough comp that Dave referred to likely between 10% and 15% down in Q1. And then starting in Q2, we expect sales growth to be in the high single-digit range for the overall company and that include or is particularly the case for the case for HVAC and also for Viessmann. We expect Viessmann in Q2 to be mid-single digits of growth and then the rest of HVAC to be pretty strong as well. And so that takes you Q2 in the high single-digit range that we expect that to continue into Q3 and then the Q4 sales growth to maybe taper down a little bit to the mid-single digits."
},
{
"speaker": "Julian Mitchell",
"content": "That's very helpful. And then maybe if you could focus for a second just on the light commercial business in the Americas. There's often a lot of investor concerns around decline there. And obviously, the orders quarter-to-quarter are lumpy. You're guiding for revenue growth, I think mid-single digits for this year ahead in Americas like commercial. So maybe just help us understand kind of how you see the market dynamics there? Any concerns around the education vertical given ESRA funding moving lower, any color on that vertical would be great."
},
{
"speaker": "David Gitlin",
"content": "Yes. Let me just say in terms of the latter piece, specifically with the ESR funding, even though that will start to obviously come to its end, it's going to be replaced with the bond funding from the states, which could be about billion of the bond referendums that have been passed in 30 states or so. So I'll tell you, Julian, we've seen great growth in K-12. Orders for us last year were up 20%. So we feel good about the growth in '25, '26. When we look at light commercial overall, we expect sales growth to be up low to mid-single digits. And kind of like resi, it's driven by the mix up of 454B. We assume a flattish market. Actually, the first quarter will be our toughest compare. So we think that will be down, say, 5% to 10% in light commercial. And then when we think about the full year, the benefit from the mix up is somewhat similar to what we said on resi, but 90% of our volume is impacted by the refrigerant transition. So that 10% excludes sales, for example, the Canada, other sales outside the U.S. Of that 90%, we expect 80% of that to be 454B, and we expect mid- to high single-digit price increase there and then the 20% will be 410A in 2025. So like I said, K-12 looks pretty good. Some of the other verticals are good. Some are in decline that have been in decline like commercial real estate and warehouse. So we feel balanced on the year at that low to mid-single digits."
},
{
"speaker": "Operator",
"content": "Our next question comes from Steve Tusa with JPMorgan."
},
{
"speaker": "C. Stephen Tusa",
"content": "Just on the resi side, the HRI data is obviously up pretty substantially. You guys are talking like others about a more modest degree of pre-buy. Is there. Do you think you're kind of in line with the industry? Is there somebody else that may be selling more? And maybe just talk about how you see the competitive environment playing out in the first half?"
},
{
"speaker": "David Gitlin",
"content": "Well, look, we have tools where we look at by distributor exactly how much inventory they're holding. And we're looking at inventory levels, underlying demand driven and looking at movement. And when we do not a tops-down assessment but a true bottoms-up assessment of what we think in the market and what we think the true demand is from our distributors, that's how we got to the $75 million to $100 million. I will say that on a 12-month roll, when we look at last year, we did gain around 100 bps of share, but that's our assessment of what we think the prebuy was."
},
{
"speaker": "C. Stephen Tusa",
"content": "And as far as heading into this year, and pricing in the marketplace. Do you see anybody, obviously, there were some big share shifts last year with 1 of your major competitors. What are you seeing in the channel there? And are you concerned at all about any efforts there to regain that share?"
},
{
"speaker": "David Gitlin",
"content": "Look, that's something that's come up every year for like the last 5 years, we get a variation of that question, which is we've announced pricing. Do we think it will stick because someone else may end up being more aggressive. And every year about what we thought we'd get in price, we've gotten in price. So we think we'll realize about 10% from 454B. Whether or not everyone in the industry is at that level, it's hard for me to say."
},
{
"speaker": "Operator",
"content": "Our next question comes from Joe Ritchie with Goldman Sachs."
},
{
"speaker": "Joseph Ritchie",
"content": "Can you guys give us just an update on your capacity additions on Americas Commercial I think I recall you guys pretty significantly increasing your capacity. And then ultimately, what does that ultimately mean for like being able to maybe convert your backlog faster in the next like 12 to 24 months?"
},
{
"speaker": "David Gitlin",
"content": "Yes. It's a really big deal for us, Joe. I honestly could not be more proud of our operations team because we basically stood up a brand-new facility in North America for commercial HVAC, something that would normally take maybe 18 to 24 months, we did in about 7 to 8 months. So we're ready, we're shipping our first units out of our new North American facility. We're maxing out our Charlotte, North Carolina facility. So with the capacity that we've now built, we have the ability to significantly increase our Charlotte output probably by about 50%. And then we have the ability to get to that same level, if not more, from our new facilities. So we can more than double our output for North America. And the demand has been great. The only thing, frankly, as that's been constraining our demand has been our capacity. And now with the increased capacity, we're starting to bid out of it, assuming that increased capacity, which really positions us for great growth in commercial HVAC out of North America."
},
{
"speaker": "Joseph Ritchie",
"content": "Great to hear. And then just my quick follow-up on Viessmann. You guys gave a lot of color around your growth expectations for the year. Can you maybe give us a little bit more on just the margins and the work that you've done from a cost structure standpoint and how we should expect those margins to improve in 2025?"
},
{
"speaker": "David Gitlin",
"content": "Yes. We ended last year with our EBITDA ROS in the low teens. We think that with the actions that we've taken and will take, that will get to the mid-teens this year. We're looking -- last year, we were looking at about $75 million of cost synergies on a run rate basis. We expect that to be $150 million this year. So Thomas and the team took out, as I mentioned, a lot of temporary and structural costs. And we're continuing to drive cost. And then again, we won't see the kind of top line growth that we know we'll see in future years, but the cost takeout has been significant and will continue to be significant."
},
{
"speaker": "Operator",
"content": "Our next question comes from Nigel Coe with Wolfe Research."
},
{
"speaker": "Nigel Coe",
"content": "Got a lot of ground here. So just a couple of quick cleanups. I think, Patrick, you said 10% of the units this year will be 410A versus 454B. So I'm guessing that the cluster of 410A units held inventory, that's the 10% that happens in 1Q. Just wanted to confirm that. And then the mid-teens movement is something that's getting a lot of attention out there in the market. So just maybe just -- why do you think that's so strong? Maybe just talk about some market share gains, perhaps. So maybe do you think that there's contractors of prebought units and holding them in the inventory or install them? Just wondered if there's any intel on what's happened at the contract level."
},
{
"speaker": "David Gitlin",
"content": "Nigel, I was mentioning to Steve that yes, we do think with high confidence that we gained about 100 bps of share last year. And credit goes to the transition we did back in '23 and '25, a very seamless transition with the [indiscernible] change and the team did a great job with the refrigerant change leading into this year. We had the capacity. We had the 410A unit so we were able to produce both sets of units. We have near perfect visibility into the inventory in our distribution channel. We do not have perfect visibility into the inventory in our dealer channel. We have anecdotal visibility. In general, we have -- we can have about 100,000 dealers and many of them typically hold very, very little inventory for a whole bunch of reasons. But can I tell you what certainty exactly how much they're holding? No, but it would be unusual for them to stock too much. So we feel very balanced on the mix that we've laid out for this year versus last year."
},
{
"speaker": "Patrick Goris",
"content": "Then Nigel, the answer to your first question is yes, we expect all 410A to be flushed out in Q1 for resi."
},
{
"speaker": "Nigel Coe",
"content": "Okay. That's 2 questions to leave it there."
},
{
"speaker": "Operator",
"content": "Our next question comes from Deane Dray with RBC."
},
{
"speaker": "Deane Dray",
"content": "I would like to drill down a bit on Quantum LEAP initiative, if we could. Just give us a sense of the contribution from data center for '24. How much did it grow with expectations for 25? And anything you can give us an update on the SLA partnership, how that's going? And it looks like you've broadened some of the product lines within that business as well."
},
{
"speaker": "David Gitlin",
"content": "Yes. Let me start with data centers overall, Dean. Last year, it was about $0.5 billion of sales for us for data centers and this year, we think it will double. So we're looking at $1 billion of data center sales this year. So it went from about 10% of our total sales to probably around 15% this year. And remember, the really exciting thing down the road will be the aftermarket sales. So we've done I got to give credit to the team that we stood up our first programmatic team that's focused on a single vertical data centers, Christian and the team under Geron's leadership have 1 -- had great wins with the hyperscalers, and we're applying that same intensity to the colos not only in the United States but globally. So I think we're really in the first inning of some of the key wins that we've had there, and I just see an opportunity for outsized growth in data centers in '25 and beyond. The STL partnership that you mentioned is exciting because we're starting to do more in liquid cooling. STL in our single phase, we have a new investment that we're making in a 2-phase solution, which is a refrigerant-based solution. And then we recently launched -- we announced Quantum Leap, which is very exciting because the whole idea is that we can be a one-stop shop for all the cooling needs that you would have for a data center. So you're looking at traditional cooling, the chillers and the air handlers you're looking at NLI, which you can do server management, you're looking at BMS through our ALC business and then combining the traditional liquid cooling loop with the traditional cooling loop, with liquid cooling that we're now introducing our own CDUs right now. So the idea for hyperscalers and certainly the colos is to say, you worry about running the data centers, let us worry about all the cooling you need by having optimized integrated cooling systems. So we're excited about data centers. We're very excited about the orders growth that we've seen we feel really well positioned for this year. And frankly, that's going to continue to grow as we get into '26 and '27."
},
{
"speaker": "Deane Dray",
"content": "Yes. That's all really good to hear, especially because that's what we're hearing from the hyperscale players who want an end-to-end solution on the cooling side. So if you have that with global scale, then you should see those -- that type of growth. And just as a follow-up for Patrick, it's just -- it's a headwind for everyone, but just kind of give us a sense of the setup on FX, the headwind? And just remind us about any type of hedging that you do."
},
{
"speaker": "Patrick Goris",
"content": "Yes. So for this year versus the prior year, the sales headwind is about $200 million. And then as I mentioned, it's about $0.05. That's mostly translation. And then on the transaction side, we do hedge the transactions. And so there is some protection, of course, there given all the transactions we go through. And then, of course, given some of the currency streams we have going on in the world, we do also some natural hedging as well that's taking place as well. So I'll leave it at that."
},
{
"speaker": "Operator",
"content": "Our next question comes from Joe O'Dea with Wells Fargo."
},
{
"speaker": "Joseph O'Dea",
"content": "Could you just talk about the sort of tariff considerations. I think you touched on China and said actions have been taken there. But as it relates to Mexico, just how you're approaching that situation and size it for us?"
},
{
"speaker": "David Gitlin",
"content": "Yes, Joe, let me start more broadly and just say that we're proud to be the largest U.S. domiciled company in our industry, period. Also, I do want to mention that we have about 10,000 people in the United States, which is up about 20% over the last 5 years on a comparable basis, and we just recently launched an initiative to add 1,000 technicians. So we are invested in the U.S. and will continue to be heavily invested in the United States. I think the tariffs right now in 3 categories. The first is what's been implemented, which is what Patrick talked about. We know about China. We know about the deal in aluminum, and we're confident that we have that mitigated. The second I would put in the category of things other than Mexico that have been discussed like Canada and Europe. And based on what we know on these categories, we feel confident that we can and will mitigate those as well. As you mentioned, the big 1 that we have to keep an eye on is Mexico because we have operations down there. And we purchase a lot from there and do export into the United States. Here's the deal. We do not know -- there's so much we don't know. We don't know if they will go in place. We don't know if there will be exemptions at all. So there's a lot that we don't know. What I can tell you is the team is all over it. We are looking at price actions that we clearly would have to take. We're looking at operational actions that we would take, especially with our suppliers. And we're also looking at that we would contemplate other actions that we would take unrelated to tariffs to make sure that we could mitigate any impact that we can't fully mitigate through pricing and supply chain issues. So what I'll tell you, Joe, is this is not the first time that we've dealt with tariffs. The team is incredibly focused on making sure that we deliver that $3 a share no matter what comes our way. So do we have everything figured out if there's a 25% tariff in Mexico. We don't have it geared out exactly yet. But what I will tell you is that this team will go to tremendous lengths to make sure that we do mitigate it and ensure that we hit the $3 a share. I will also tell you that we are leaning into our factories in the United States. So for example, we're significantly increasing our output out of Charlotte this year."
},
{
"speaker": "Joseph O'Dea",
"content": "I appreciate all that color. And then I wanted to ask on the HVAC margin bridge, so the up 50 to 75 bps. Can you just give a little bit more color on puts and takes there. When we think about Viessmann synergy, 454B mix, I presume at a pretty decent incremental productivity. It would seem like there's some building blocks to do better than that 50 to 75. And so just any offsets to that?"
},
{
"speaker": "Patrick Goris",
"content": "Sure. The way you can think about it is the benefit of productivity, the price, including the mix up. Think of these as being about 150 bps year-over-year. And we're making significant investments as we do each year. And the investments this year actually are going to be more focused on the sales side than just on the R&D side. So it's pretty well balanced this year. And that offsets those tailwinds to get to the margin expansion that I just referred to."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andrew Obin with Bank of America."
},
{
"speaker": "Andrew Obin",
"content": "Yes. You sort of highlighted this 1 percentage point of price for 25, if I'm correct. Are there any regions where you do not expect to get price or any verticals where price is flat to negative I appreciate that the mix is in a softer bucket, but just any sort of discrepancy or pricing between regions or vertical."
},
{
"speaker": "Patrick Goris",
"content": "I'd say there are probably 2 areas where pricing might be a little less than that. One would be rough generally in that segment, we think it's going to be flattish this year. There will be some differences by region. The other 1 is in Asia, given, of course, what's happening in residential, like commercial in China, the price might be a little lighter there as well."
},
{
"speaker": "Andrew Obin",
"content": "And just a follow-up on aftermarket progress. I think you guys have provided some KPIs, but can you just give us an update, just a more thorough update on the progress and attachment rates, maybe service as a percent of commercial HVAC business. How is that initiative evolved because before on the debate about resin Viessmann, that was a key focus. It seems like you guys are making very good progress. If you could give us some numbers there."
},
{
"speaker": "David Gitlin",
"content": "Sure, Andrew. I will tell you that it still is the key focus. There are all hands on deck on us driving double-digit aftermarket growth forever. Everyone that joins the company or within the company knows that that's our mandate as a team. And all the underlying metrics on our control towers have been positive. We have nearly 50% attachment rate. It was up from 44% in earlier. Our total coverage for chillers. We said it was -- it'd be around 80,000. It's in that range. I think it was just under by 1,000 or 2, so it's in that range. We talked about getting number of connected chillers out there. We continue I think we connected around 45,000 chillers last year. So all of the underlying things, driving a bound in length as our digital platforms, driving attachment rates, driving coverage, driving connectivity, we feel really good about it, and we feel really good about double digits in this year."
},
{
"speaker": "Andrew Obin",
"content": "So where are we as a percent of commercialized [indiscernible] revenues to date?"
},
{
"speaker": "David Gitlin",
"content": "I would say for Carrier, we are in the range of 7%. I think it's just there. And I think we're pushing to get it closer to 30% over these next few years."
},
{
"speaker": "Patrick Goris",
"content": "In commercial [indiscernible]."
},
{
"speaker": "David Gitlin",
"content": "And then Patrick just added, I guess, it's a little bit higher for Commercial HVAC Yes, as a percent."
},
{
"speaker": "Operator",
"content": "Our next question comes from Chris Snyder with Morgan Stanley."
},
{
"speaker": "Christopher Snyder",
"content": "I wanted to ask about Americas resi, which, I think, a bit stronger 35% this quarter, I think the expectation was 20 to 30. It sounds like the prebuy would moderate, I guess, did that come in maybe a little bit ahead of where you thought 3 months ago? Was just kind of end demand stronger with some of the movement in the channel you're highlighting?"
},
{
"speaker": "David Gitlin",
"content": "Yes. I think, Chris, it's really a combination of the higher movement than we did that we had expected. We had some share gains and I think just the overall underlying demand was a bit higher than we thought. And just remember, we were coming off such an easy compare from the fourth quarter of 2023, where we were down -- I think our volume was down something like 28%. Our total sales were down around 18%. So we had an easy compare and the underlying demand was a bit more positive than we thought."
},
{
"speaker": "Christopher Snyder",
"content": "I appreciate that. And then, Dave, I guess when you either talk to kind of your channel partners or the dealers, is there any concern around the consumer and the homeowner and maybe pushing a little bit more towards repair versus replace or just trading down. Obviously, we're pushing through return change over 10% this year, normal price, low single digits. The whole resi ATEC industry is relying on Mexico. So it seems like there's probably another price increase potentially coming over the next 12 months. Are you hearing any of that? Is that a concern in your conversations?"
},
{
"speaker": "David Gitlin",
"content": "We -- Chris, we look at that very deeply. We look at our elasticity curves. And the homeowners been through a lot of price increases over these last few years, for sure. So it's something that we watch carefully and certainly, tariffs would not help on the pricing side. So the first thing we look at is, are we seeing a big switch over to repair versus replace. We have not seen that. We ask that of ourselves and our channel partners every month, every quarter. we've been paranoid about it, but we honestly have just not seen that. We will see an occasional mix down at the margin, but nothing overly material. So it's something that we watch. We watch carefully. We I think it's appropriate with price increases and to always look at the consumer, but we feel -- right now, we feel very good. Patrick, you want to add something?"
},
{
"speaker": "Patrick Goris",
"content": "No. Just a reminder that cost to the homeowner, only about 1/3 of that or less is actually the cost of the equipment. That's ours."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tommy Moll with Stephens."
},
{
"speaker": "Thomas Moll",
"content": "Dave, I wanted to start on the comment you made about the movement for your resi channel in the quarter, up 15%. We've hit this from a couple of different angles, but I think it will attract a lot of attention today, so worth revisiting here. Are you able to share what the comp was last year? Or any other context that might help explain that comment you made."
},
{
"speaker": "David Gitlin",
"content": "I don't think I have [indiscernible] movement in the fourth quarter of '23, unless..."
},
{
"speaker": "Patrick Goris",
"content": "No. I don't think we have that number handy, Tommy."
},
{
"speaker": "David Gitlin",
"content": "I don't have that at my fingertips, Tommy, but the best that we can do is when you think about resi for the full year, it ended up being up high single digits. I think that we were up around 9% last year. And it's basically to the team's credit, the algorithms they've used to anticipate things like inventory and movement orders and the translation into total sales, I could tell you that in my 5 years of Carrier, our algorithms around being able to anticipate thing, it's far from a perfect science in a very short-cycle business, but they're far better now than they were even just a handful of years ago. So we're guiding to the HSD for this year. We think that 1 thing that people would worry about with a big prebuy would be that we would be talking down 12%, which were not. In fact, I think the first quarter should be up double digits. So I think we feel calibrated between the share gains, the inventory levels, the movement, the orders that we've seen and the sales into our channel we've gone out of our way to try to be as judicious and balanced as we can, and we feel good about the guide for this year because basically, that HSD is really driven by mix and price realization. So we think the volume assumptions for the year are fairly balanced."
},
{
"speaker": "Patrick Goris",
"content": "And Tom, we had that number. The movement in Q4 of '23 was down low teens and then Q4 2024, up mid-teens."
},
{
"speaker": "Thomas Moll",
"content": "Thank you, Patrick. Dave, just to anticipate another line of questions for all of us today. On your ATL commentary for the 10% price. There's been a lot of confusion there just because of things that is what's the base year we're all using and all kinds of noise around this one. But just to give you the opportunity, has anything changed there versus what you expected a quarter a couple quarters ago. And there's also been some questions around 1 of the larger players in the market potentially getting a little more aggressive on price. But really, the core of the question is what, if anything, has changed?"
},
{
"speaker": "David Gitlin",
"content": "Nothing. I mean from our perspective, I think that Steve asked the variation of that as well, Tommy. Look, I've heard the same things listening to some of our peer calls as well in chatter in the marketplace. But what I can tell you is that every year, we've seen -- we've been paranoid about 1 thing or another, and things that have sort of manifested themselves on the price side the way we anticipate. And the 10% is fairly straightforward. If you take the list price for a 410A unit, we're pricing a 454B unit in that same category is 10% higher. And then we've said 15 to 20 over 2 years, which is on top of the base 10%, 2 to 3 points of base pricing. So we think that we're fairly balanced on a market volume being flat to down a little bit, then a little bit of pricing, a little bit of growth on the furnace side. And then we expect that to stick, and we think that we've tried to even build a little bit of contingency into that 10%. So we feel good about the price sticking exactly what every competitor will do, I don't know, obviously, but we feel good about how we've calibrated our pricing and our pricing with our channel partners."
},
{
"speaker": "Operator",
"content": "Our next question comes from Noah Kaye with Oppenheimer Company."
},
{
"speaker": "Noah Kaye",
"content": "You gave some good color on the VCS sales walk by line of business. I wonder if it would be possible to get a little bit better view at sort of country level dynamics or at least how you think about the rest of Europe versus Germany in the outlook just kind of given the swing factor and policy for turn specifically?"
},
{
"speaker": "David Gitlin",
"content": "Yes. Look, Germany, we clearly have a watch on right now. I think that the good news about the pull-up of the election to February '23 is that 1 way or another, we're going to get more certainty. And uncertainty has not been our friend in Germany about policy. So having some level of certainty is good. I think, if I may, at a high level in Europe, say that regardless of what's happening country to country because we will watch France, where France and Poland, where there is some suspension of subsidies, which we expect to resume as we get into the summertime. We know that there's going to be things that happen in Germany that we have to keep a watch on. I will say at a high level, number one, the European Union remains committed to the 2030 goals, 55% renewables by 2030. Remember, in 2027, there's going to be the fossil fuel costs across Europe will start to increase then because we see the expanded scope of the emission trading system, which is introduced for CO2 emissions across all European countries, which is going to trigger I think, a heightened transition from boilers to heat pumps. There is uncertainty in Germany right now. We did see that increase in subsidy applications and orders the second half of last year was a little bit slower, I think, in January. But I do think people were trying to get their subsidy applications in before the election. So we'll see if that translates into positivity as we get into 2Q and 3Q. But I do know that with a potentially new government we'll have to see exactly how things play out. What I will tell you at the highest level, when you hear us at our Investor Day as we get into May, is that we want to get to a point where we are not talking about elections in Germany or France. We are talking about driving solutions for the customer that are independent of regulation and subsidies. So if you start looking at complete PV heat pump battery digital overlay sales in Europe, which are going to be hearing us talk a lot more about, that's driving solutions for the customer, potentially with bank financing that are independent of subsidies or regulations that is good for the consumer, and it's good for the environment and it's good for us. So we'll continue to try to influence and monitor policy from country to country. The EU is going to continue to move in this direction. We've seen gas prices going up more recently. That could continue. I don't think the EU wants to be reliant on importing gas from the United States or from Russia. So that electricity to gas ratios start to come down a little bit. And we're going to continue to push solutions that are independent of policy from country to country."
},
{
"speaker": "Noah Kaye",
"content": "I'm glad you mentioned that because you started the call by talking about really this emphasis and the opportunity around the home energy management offerings. It was something you talked about even in sort of the initial deal announcement. But if you could just give us a little bit more color on what you think this means for your wallet share or your expansion opportunity among the different channels that you always have it would be helpful. Not to steal too much thunder from Investor Day."
},
{
"speaker": "David Gitlin",
"content": "Yes. I -- look, I think -- at the end of the day, when we look at BCS, we'll be the first to say that obviously, not only were we not pleased that last year was down more than we thought but we dropped it a few times during the course of the year. We've tried to come into this year very calibrated, very conservative. Patrick and I are very deeply tied in with Thomas and Chris Sheppard and the team over in Europe. So we've tried to be very balanced and very bottoms up on our assumptions. When we look at VCS overall, we're very, very happy that we are in residential in Europe, not necessarily last year, but overall, this is a great, great market to be. And the underlying dynamics are exactly what we see in the United States of a highly customized configured, differentiated product offering that is very reliant on a differentiated channel. So we like the market. We like the transition to heat pumps. We like the transition to overall system solutions over time and there's no better company in this space in Europe than Viessmann, hard stop, the most differentiated channel that there is. So when we start putting some of our commercial HVAC products through that channel or a newly branded carrier air conditioning product through that channel, our ability to drive revenue synergies, share gain, new product introductions is unparalleled. So we're excited to have them part of the family, they have made carrier such a better company. And 1 small example is the Head of Engineering for Viessmann Climate Solutions is leading engineering for all of carrier with respect to our centers of excellence, and it's making us a more platform company and a better technologically differentiated company across all of carriers. So we feel balanced for this year. We're going to control the controllables, and we're going to see growth for years to come. So Mike, welcome to Carrier. It's great to have you on board, Patrick. Thank you. And thanks to our 50,000 team members globally. Last year, everyone performed while transforming, and we feel very well positioned for a very strong year in '25, and thank you to our investors as well. Thank you all."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program. You may now disconnect. Good day."
}
] |
carr | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to Carrier's Third Quarter 2024 Earnings Conference Call. I would like to introduce your host for today's conference, Sam Pearlstein, Vice President of Investor Relations and CFO of the Fire & Security segment. Please go ahead, sir."
},
{
"speaker": "Samuel Pearlstein",
"content": "Thank you, and good morning, and welcome to Carrier's third quarter 2024 earnings conference call. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier's website at ir.carrier.com. The company reminds listeners that the sales, earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties. Carrier's SEC filings, including Forms 10-K, 10-Q and 8-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Before turning the call over to Dave, please turn to Page 3. And with the commercial and residential fire businesses qualifying as held-for-sale during the third quarter, the Fire & Security segment in aggregate, met the criteria to be presented as discontinued operations. Historical sales margins and earnings per share are in the appendix on Page 27 and 28 to help for comparisons to help you interpret the results, continuing operations include the HVAC segment, the Refrigeration segment, including commercial refrigeration and the corporate expenses and eliminations guidance now includes the corporate expenses that were previously allocated to the Fire & Security segment as well as the controls business that was part of the Fire & Security segment. Results discussed on this call will be continuing operations only with the exception of preliminary free cash flow unless stated otherwise. Once the call is open for questions, we ask that you limit yourself to one question and one follow-up. And with that, I'd turn -- I'd like to turn the call over to our Chairman and CEO, Dave Gitlin."
},
{
"speaker": "David Gitlin",
"content": "Well, thank you, Sam. And let me start by saying a heartfelt thanks to you for everything that you have done for Carrier over the past five years. We wish you the best as the CFO of the Commercial and Residential Fire business. I'd also like to welcome Mike Rednor who will succeed Sam and join Carrier on November 4. Our team continues to perform while we put the finishing touches on our transformation. Organic orders were up 20% -- above 20% compared to last year, and we continue to increase our backlog, positioning us for continued growth as we head into 2025. The team drove 4% organic sales growth by leaning into verticals of strength to help offset continued headwinds in residential and light commercial HVAC in Europe and China. Importantly, we delivered double-digit aftermarket growth, and we are on a path for our fourth year in a row of double-digit growth. Organic sales growth, combined with productivity drove very strong core earnings conversion of about 40%. We repurchased roughly $400 million worth of shares in Q3. And with our new reauthorization, we expect to repurchase approximately $5 billion worth of shares between the second half of this year and the end of next year. We had said that we wanted 2025 to be a clean year. We are on track to do just that. We closed on the sale of the commercial refrigeration business on October 1, and we are on track to close on our final divestiture commercial and residential fire by year-end. In addition to completing our portfolio moves, we have reached settlement subject to court approvals that we are confident will largely put the inherited AFFF potential exposure behind us. We're pleased with the outcome, which Patrick will discuss in more detail. Turning to Slide 5. Our vision remains unwavering to be the global leader in intelligent climate and energy solutions. Global leadership entails winning and winning the right way through differentiation and customer solutions. We have gained share in nearly every business. In commercial HVAC, we are achieving outsized growth in key verticals, including data centers, decarbonization-related infrastructure spend and mega projects. For example, we had a recent win for a new semiconductor fab facility on the West Coast of the United States. In data centers, our orders year-to-date are up more than 3x, and we expect continued momentum. Data center equipment growth will drive aftermarket growth where there is a 5x to 10x multiplier opportunity versus the installed base over time. Our commercial HVAC business is far better positioned now than it has ever been. Everything connected, everything intelligent. In Q3, we connected an additional 5,000 new chillers in the field and are on track for 50,000 connected chillers by year-end. We also continue to expand our overall number of connected devices and offerings for our Abound and Lynx Digital platforms. Climate is at our core as a company. We achieved the U.S. Department of Energy's cold climate heat pump challenge by validating that our Infinity variable speed heat pumps with dream speed intelligence can operate in the field at 100% capacity at 0 degrees Fahrenheit and reliably at negative 13 degrees Fahrenheit. We also introduced a new version of the Vector Trailer Refrigeration unit, which will reduce CO2 emissions by 73% while maintaining best-in-class performance. With our increased investments and expanded HVAC portfolio, we are now running a year or two ahead of our goal to reduce our customers' carbon emissions by one gigaton by 2030. On energy, we are focused on introducing complete home energy management solutions. In Europe, we remain confident in the sustained transition from boilers to heat pumps where we see a mix-up factor of more than 3:1. Adding integrated solar PV and battery can more than double the mix-up factor. In North America, we are making great progress working with major utilities validating that our technology can help them manage peak hour demand which would also result in savings for our customers. We will be introducing pilots into the field this next year. And finally, on solutions. Our aftermarket growth formula continues to yield results. Coverage for our chillers is about 75,000 units, and we remain on track for more than 80,000 by the end of this year. Our aftermarket playbook continues to gain traction across the portfolio. As we look ahead, there is no question that we are a new Carrier, as you can see on Slide 6. In just the four years since our spin, our HVAC business revenues will have nearly doubled from $10 billion in 2020. We are focused and simpler and now positioned as a higher growth profile company with our complete portfolio exposed to sustainability-related secular talents. In addition, we have leading positions in all our targeted HVAC-R markets globally to help us drive consistent profitable growth through geographic and vertical cycles. Turning to Slide 7. I am very excited about the benefits that focus will bring. Since our spin, we have made great progress on culture, talent, winning, innovation, customer centricity, growth and margin expansion. We have done this while navigating COVID supply chain challenges and a significant portfolio transformation. With that behind us, our portfolios going forward are clear. Laser focus on our customers and share and margin gains in our core businesses, double-digit aftermarket growth, complete ecosystem solutions for our customers and continued balanced capital deployment. I am so excited for 2025 as we can double down on our focus on execution and growth, benefiting our customers, our people and our shareholders. Last, before I turn it over to Patrick, a few words on Viessmann Climate Solutions on Slide 8. For the first time this year, we are seeing encouraging market indications. The backlog, which was still elevated coming into the year, is now back to traditional levels. So this business has returned to being a book and ship business with about a month of backlog. Orders for much of the year in Germany were constrained in large part because the government declared in February that subsidies would not be paid until October. We thought orders would start to pick up in Q3, which they did just later in the quarter than we anticipated. Therefore, Q3 sales were down about 25% rather than our estimated 20%, resulting in the full-year expectation now being down in the high teens rather than our previous estimate of down in the mid-teens. Encouragingly, recent trends around orders and subsidy applications have improved. Heat pump subsidy applications in Germany in Q3 were up about 50% sequentially and up 2x versus last year. VCS orders overall turned positive, up low-single-digits, and it was the best quarter in over -- best orders quarter in over a year. Orders were up about 10% in September, and that strength has continued in October. More broadly, the integration has exceeded our expectations. There are so many obvious and some less obvious benefits to this game-changing combination. Consider technology development and now having best of the best approaches to scalable global platforms. We are now harmonizing our electronic control board designs around the Viessmann platform. Cost per board is projected to decrease significantly and we will also benefit from avoiding duplication across the network supply chain management, obsolescence management and quality. The same is true for our embedded software. We will be harmonizing standard embedded software for all of our electronics around the Viessmann One-based ecosystem, which will shorten time to market and decrease development costs. We are also working on implementing best of the best digital connectivity with our customers. For revenue synergies, we are targeting over $100 million in revenue synergies next year. These include new Carrier cooling and heat pump offerings through the Viessmann channel and a new Carrier-branded propane heat pump for light commercial applications. And we know we will drive cost synergies. We remain on track for over $200 million in cost synergies in 2026. And of course, we are driving internally to do better than that. By controlling the controllables and leveraging this phenomenally differentiated company, I am confident that we will together drive tremendous value for decades to come. With that, I will turn it over to Patrick. Patrick?"
},
{
"speaker": "Patrick Goris",
"content": "Thank you, Dave, and good morning, everyone. I'd like to start by thanking some of my colleagues in the corporate finance team. So far this year, the team has successfully integrated Viessmann Climate Solutions financials, manage the accounting for five different exit transactions and more recently, has transitioned our financial statements back to 2022 to reflect disc ops treatment for the Fire & Security exits. Just one of those moving pieces would be a big project. The combination of all of these in less than a year is truly an enormous and complex undertaking. So a big thank you to our Chief Accounting Officer, Kyle Crockett, our Tax and Treasury lead Mike Cenci and our Corporate Planning and IR leads, Gen [indiscernible] and Sam Pearlstein as well as their entire teams. Very much appreciate it. Please turn to Slide 9. A reminder that with the exception of preliminary free cash flow, all these results refer to continuing operations. Reported sales of $6 billion were up 21% with organic sales up 4%. Viessmann Climate Solutions contributed 17% to year-over-year sales growth. Q3 adjusted operating profit of over $1 billion was up 19% compared to last year, driven by the contribution of Viessmann Climate Solutions, the benefit of organic growth and price and productivity. Adjusted operating margin was down 40 basis points. The consolidation of Viessmann Climate Solutions represented about 130 basis point headwind to adjusted operating margin in the quarter. On a year-to-date basis, adjusted operating margin is up 120 basis points, driven by the benefit of organic growth and strong productivity. As Dave already mentioned, core earnings conversion that is excluding the impact of acquisitions, divestitures and currency was about 40% in the quarter and over 100% year-to-date. Adjusted EPS from continuing operations of $0.77 was up 3% year-over-year, driven by organic growth, price and productivity, partly offset by higher net interest expense, a higher tax rate and higher share count. We have included the year-over-year adjusted EPS from continuing operations bridge in the appendix on Slide 22. Including the $0.06 adjusted EPS from discontinued operations, overall adjusted EPS of $0.83 was better than our guide by about $0.03. Q3 Fire & Security sales now excluded from our reported results were about $500 million. Preliminary free cash flow for the company, which includes the results of both continuing and discontinued operations, was an outflow of about $370 million in the quarter. This figure includes roughly $1.1 billion of cash taxes on the business exit gains, transaction costs and restructuring costs resulting in preliminary underlying free cash flow performance in the quarter of about $700 million. On a year-to-date basis, preliminary free cash flow is $120 million with preliminary underlying performance of about $1.4 billion. Moving on to the segments, starting on Slide 10. HVAC reported sales growth of 26% reflects organic sales growth of 6% and the contribution of Viessmann Climate Solutions. Organic sales in the Americas were up high-single-digits, driven by an almost 20% increase in commercial HVAC and double-digit sales growth for residential HVAC. Light commercial was down mid-single-digits. Organic sales in EMEA were up low-single-digits, driven by double-digit growth in commercial HVAC partially offset by a decline in resi and light commercial sales, reflecting continued market weakness in that segment. Sales in Asia-Pacific were down low-single-digits, driven by continued weakness in our residential and light commercial markets in China, partially offset by continued strength in the Rest of Asia. The HVAC segment operating margins were down 100 basis points as we expected. The benefit of organic growth and productivity were offset by the consolidation of VCS, which represented about a 200 basis point margin headwind in the quarter. Overall, another solid quarter for HVAC. Transitioning to Refrigeration on Slide 11. A reminder that commercial refrigeration results are included in continuing operations as they do not qualify for disc ops treatment. Reported and organic sales were up 1%. Transport refrigeration was up 3%. Within transport, container was up 30% year-over-year, while global truck and trailer was down mid-single digits, driven by North America truck and trailer, which was down over 15%. European truck and trailer was down low single-digits, while Asia truck and trailer continues to perform very well with about 20% growth. Our Sensitech business was up double-digits. Commercial refrigeration was down low-single-digits. Q3 is the last quarter to include the commercial refrigeration business as we closed the sale transaction on October 1, through three quarters, commercial refrigeration sales were about $750 million with immaterial adjusted operating profit contribution. Adjusted operating margin for this segment expanded 50 basis points compared to last year, driven by productivity. Turning to Slide 12 for orders. In the interest of time, I will just mention a few highlights. Total company orders were up close to 20% on an organic basis. North America resi HVAC orders were up 30% year-over-year, and recent movement has been stronger than we expected. We're not counting on any material 410A prebuy this year. We see continued strength in global commercial HVAC with orders up about 15%. Data centers remain particularly strong, and global truck and trailer orders are up 85% held by a very easy compare. Turning to Slide 13, guidance. Our guidance for 2024 now reflects continuing operations with the exception of free cash flow. There are a few moving pieces, but our new adjusted EPS guide is essentially unchanged compared to the July adjusted EPS guide, except for the impact of discontinued operations. We now expect reported full-year sales of roughly $22.5 billion compared to the prior guide that included Fire & Security with underlying organic growth of about 3%. Our adjusted operating margin guidance remains roughly 15.5%, up 150 basis points year-over-year, and we continue to expect full-year core earnings conversion to be well north of 50%. Our guide for adjusted EPS of continuing operations is now about $2.50. As I mentioned earlier, the change versus our July guide of $2.85 is all related to be transition to disc ops treatment of the Fire & Security exits. In the appendix, we have included a guide-to-guide bridge on Slide 23 as well as on Slide 24, a bridge from what we called core adjusted EPS to the $2.50 guide of continuing operations. As you will recall, we estimated earlier this year that 2024 full-year adjusted EPS of the businesses we are retaining would amount to $2.60. As you will see on the bridge, the difference between the $2.60 and $2.50 adjusted EPS is all related to disc ops. And more specifically, the treatment of costs previously allocated to the Fire & Security segment and net interest expense in disc ops accounting. As I mentioned earlier, commercial refrigeration has an immaterial adjusted EPS contribution in 2024. Hence, it is not included on the bridge. Our free cash flow outlook is now an outflow of $200 million versus an inflow of $400 million in the July guide reflecting about $600 million of cash tax payments related to the business exit of commercial and residential fire. This was not in our July guide given timing of the definitive agreement. Our underlying free cash flow outlook remains about $2.4 billion, and we now expect capital expenditures about -- of about $500 million and cash restructuring closer to $150 million. From a capital structure perspective, we expect to be at about 2x net leverage at the end of the calendar year, consistent with the commitment we made earlier in the year. In the appendix on Slide 26, there is a summary of additional items, which were also updated as part of the new guide. Moving on to Slide 14. While we plan to issue 2025 adjusted EPS guide, when we report earnings in early February, I want to update you on some of the building blocks, starting with our current 2024 guide of $2.50 of adjusted EPS. Consistent with our value creation framework, we expect to deliver double-digit adjusted EPS growth from organic revenue growth. In addition to that, we expect tailwinds from the elimination of costs previously allocated to the Fire & Security segment. As Sam mentioned, these costs are included in the $2.50 adjusted EPS of continuing ops. We started addressing these costs at the very beginning of calendar 2024, and we'll have eliminated about $200 million of run rate costs throughout 2024 with some residual benefit in 2025, as you can see on this slide. Moving on to an expected tailwind from lower net interest expense. Debt pay down throughout 2024 means that 2025 net interest expense is expected to be a $0.05 to $0.10 tailwind. Finally, we expect second half 2024 and 2025 share repurchases to amount to about $5 billion, eliminating the dilution from shares issued from the VCS acquisition by the end of 2025. In short, given these building blocks, we expect to have another year of strong adjusted EPS growth in 2025. From a capital deployment perspective, we expect to continue to target a growing and sustainable dividend, representing about a 30% payout. We also expect to pay down the $1.2 billion maturity early next year and refinanced the €750 million debt tranche subject to market conditions. Moving on to Slide 15. At the end of last week, we announced important settlements related to AFFF. Let me start with estate claims or claims that Carrier is responsible for any liabilities of KFI including all those related to the manufacturer or sale of AFFF. Upon court approval, this settlement will permanently resolve all such present and future claims with a water, personal injury, airport or anyone else. Moving on to direct claims, or claims for UTC's actions between 2005 and 2013, when it owned the AFFF business. We believe the settlements will resolve substantially all current and future AFFF-related claims by public water providers and airports. We also believe that any potential remaining claims black [ph] merit. Cash settlement payments amount to $615 million, which we estimate will be paid over time, as you can see on the slide. Importantly, we expect insurance payments received in the aggregate, will cover the full amounts paid by Carrier under the settlements, though timing is not expected to match the timing of outflows in the early years. The settlement enables Carrier to receive up to $2.4 billion from shared insurance recoveries. In addition to the $615 million of cash payments, the settlement also provides that the KFI net sales proceeds of $115 million are contributed. This is a noncash item for Carrier as is the $125 million contribution from insurance recovery. The settlements will not impact our capital deployment plans, including dividends and share repurchases. In short, we had another good quarter. Transformation is substantially behind us, and we are optimistic about 2025 and beyond. With that, we'll open it up for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And the first question comes from Jeff Sprague with Vertical Research Partners. Your line is now open sir."
},
{
"speaker": "Jeffrey Sprague",
"content": "Hey, thank you. Good morning everyone."
},
{
"speaker": "David Gitlin",
"content": "Good morning."
},
{
"speaker": "Jeffrey Sprague",
"content": "Patrick, I don't know at you're going to do with all your spare time now. You've got all this fun and the finance team there. But Dave, on Viessmann, obviously, it's been sort of a moving target here trying to find the bottom. It looks and feels like we're likely there. But can you share your view on kind of what the bottoming process in turn might look like and give us some indication of how you're expecting things to kind of travel from a revenue standpoint into 2025?"
},
{
"speaker": "David Gitlin",
"content": "Yes, Jeff, it's been -- there have been a lot of moving parts. I feel that with Thomas and the team, we're in a rhythm now of looking and they have been throughout. But we look together at weekly orders, it's really orders translate into sales almost overnight. So we're looking at all the underlying factors and they seem to have now been solid. I mentioned that September orders were quite strong. They were up about 10%. Orders so far, it's only been two or three weeks during October. But so far this month, they've been even stronger than that. So it feels like we've seen some level of turning. Now we are, of course, entering the season and throughout Europe and in Germany, in particular, they're starting to now pay the subsidies. So that could be contributing. We obviously don't feel confident enough that we can call a bottom. But when we look at subsidy applications over the last three months in Germany. We look at the orders that we've been seeing, not only in Germany but throughout VCS, it does feel like we've turned a corner."
},
{
"speaker": "Jeffrey Sprague",
"content": "And then just shifting completely to the pre-buy question. I think either you or Patrick said you're not expecting a prebuy. It sounds like one is happening real time. So maybe just elaborate on that and do you have the capacity to meet the demand for 410A prebuy if you're getting that impulse from the channel?"
},
{
"speaker": "David Gitlin",
"content": "We definitely have the capacity. What we did is we went out to our distributors and said, \"Look, tell us how much you think you're going to need to have on the shelf at the end of this year going into next year because we're going to run out of capacity to produce it\". So we don't look as much at the orders. You saw our very strong orders in 2Q around 100% this quarter, around 30%. So I think some of that had to do with folks having -- wanting some level of 410A on the shelf as we enter into next year, we're looking at sales. What we're trying to do is build the inventory that we think we need going into next year. To determine whether it's a predelivery, which I think is the right word, are you delivering in 2024 for demand that would otherwise occur in 2025? You look at the movement, you look at the underlying demand for our end consumers. So the good news is that movement was strong coming out of 3Q, movement has been very, very strong in October, much higher than we anticipated. So we will enter next year with some level of 410A inventory within Carrier. We think it's for the underlying demand that there will be for the first quarter of next year. But as it looks right now, we don't see any material predelivery of 410A this year."
},
{
"speaker": "Jeffrey Sprague",
"content": "Understood. Thank you."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Jeff."
},
{
"speaker": "Operator",
"content": "And our next question comes from Julian Mitchell with Barclays. Your line is open."
},
{
"speaker": "Julian Mitchell",
"content": "Hi, good morning."
},
{
"speaker": "David Gitlin",
"content": "Good morning, Julian."
},
{
"speaker": "Julian Mitchell",
"content": "Good morning. First off, I just wanted to circle back to slide sort of 24 and 25. So just trying to understand if you could clarify a little bit more that $0.10 delta sort of what exactly is moving on Slide 24 between the core and the continuing ops guide? And also, I guess, on Slide 25, you have that $0.40 operational tailwinds guided. I think last quarter, that number was about $0.55. So just trying to understand kind of the moving pieces on those two items, please?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, Julian, good morning. This is Patrick. So the $2.60 on Slide 24 was our estimate of the EPS in 2024 of the businesses that we are retaining. And so that is -- that was our estimate back then. The $2.50 is 2024 according to continuing operations with continuing operations charges that were allocated to the Fire & Security segment from corporate and other functions, unless they were direct charges are allocated to continuing operations. That was not the case in the $2.60 because we looked at $2.60 from a core clean company going forward. So the difference between the $2.60 and the $2.50 is basically allocation of headquarter charges to the segments that we assumed would not be there. The second and that's about $0.05. The other $0.05 is basically how interest expense is treated in disc ops. This explains when you look at our bridge from the $2.50, the building blocks for next year, you'll see that is a $0.05 pickup from disc ops treatments of some of the stranded costs. That's part of the $0.10 you see here. And you also see there is a $0.05 to $0.10 pickup from net interest expense next year versus this year. That also is part of the $0.10 you see here on Slide 24. With that, I'll move over to 25. On 25, again, this is based on the $2.20 continuing operations, the operational performance is an improvement of $0.40 of adjusted EPS. I think you're referring to last quarter, $0.55 of operational performance improvement that included the Fire & Security segment. Of the $0.55 of last quarter, about $0.15 to $0.20 related to Fire & Security. So the core operational performance of our business has been unchanged, current guide versus the prior guide."
},
{
"speaker": "Julian Mitchell",
"content": "That's really helpful. Thank you, Patrick. And then maybe just one last clarification one, just on the fourth quarter kind of core assumptions there. It looks like, I think it's about a just under sort of $0.50 or so and you've got about mid-single digit organic growth year-on-year and a mid-teens operating margin. Just wondered if you could flesh out any of the guideposts for fourth quarter on the go-forward basis?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. The way you can think about it is the mid-single digit organic growth, we expect HVAC to be close to 10% in the quarter with continued strong double-digit growth in commercial HVAC. We also believe that refrigeration will be down about mid-single digits, mostly driven by North America truck and trailer. Adjusted EPS expected to be a little less than 50%, as you mentioned..."
},
{
"speaker": "Julian Mitchell",
"content": "$0.50."
},
{
"speaker": "Patrick Goris",
"content": "A little bit less than $0.50. Yes, what did I say?"
},
{
"speaker": "Julian Mitchell",
"content": "50%."
},
{
"speaker": "Patrick Goris",
"content": "So less than $0.50. But up about 33% year-over-year, and our operating margin is expected to be up about 300 bps year-over-year, a little bit more than that actually. And so the margin expansion is really outcome of stronger volume and mix, good price and productivity. And actually, in Q4, we expect the net impact of acquisitions and divestitures and our margins to be about neutral."
},
{
"speaker": "Julian Mitchell",
"content": "That's great. Thank you."
},
{
"speaker": "Patrick Goris",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "And our next question comes from Andrew Kaplowitz with Citigroup. Your line is now open."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Good morning, everyone. David or Patrick, as we think about the bridge to '25, interestingly, you gave us the 6% to 8% organic growth profile for the new Carrier, which I know it's not a '25 guide per se, but would you say at this point, you have above average visibility of that growth profile in '25, given the double-digit increase in backlog exiting Q3? And then you mentioned core incrementals in Q3 of 40%. I know you've been focused on improved productivity. So can you continue that kind of performance into '25?"
},
{
"speaker": "Patrick Goris",
"content": "So you're right, Andy. We're not going to provide guidance on this call. But what we -- what I said in my script was that we would expect double-digit EPS growth from organic growth, and that's the first building block. And based on what we see today in our businesses, Commercial HVAC, as you mentioned, very strong performance this year, a big increase in backlog. We continue to see our backlog increase. Residential HVAC, as Dave mentioned earlier, we do not expect a big prebuy this year, maybe a preorder, but not a big prebuy. That business for the last several quarters has returned to growth. And so we have some big elements of our portfolio, and Dave just mentioned about Viessmann as well. We have some big elements of our portfolio that either are returning to growth or continuing to perform quite well. So at this point, we would be very disappointed if at least that first bucket of or first building block for next year if that does not represent double-digit adjusted EPS growth. And on top of that, you can see the benefit of stranded cost elimination, net interest tailwinds and then, of course, the tailwinds from our significant buyback."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Got it. That's helpful. And then just following up on like commercial and residential. Obviously, there seems to be some market share movement. But could you help us separate a bit how much better, for instance, Americas like commercial markets are maybe residential markets versus your initial expectations? I know you have more 410A maybe than competitors. How might that also translate into '25. Forgetting about the prebuy for a second, it seems like there's some market share movement as well."
},
{
"speaker": "David Gitlin",
"content": "Yes. Andy, I think on both, we've gained share, both resi and light commercial. Resi more share, our resi share has been -- share gains have been north of 100 bps. I think in part because, yes, we were able to support our customers with the 410A and we may have had a peer or two that we're not as able to do so. What we're watching light commercial, this year has been better than we thought. We thought we'd be down low-single digits, we'll be up low-single digits. And that even assumes Q4 being down something like 15%. Now we'll see what ends up happening. But we're trying to do in Q4 is, number one, continue to support our customers. We've been coming off years of very strong growth, in part due to share gains in part due to new product introductions, some national accounts we've picked up. So I think the good news as we go into next year is that we want to make sure we end this year with balanced inventory. So we've assumed down 15% in Q4, which would have put us up low-single digits for the year. Again, I'm talking light commercial, and for the first time in now a few years, we'll have an easier compare next year than we've had over these last few years. So the team is performing well. I think we'll end up low-single digits there. And on the resi side, hats off to the team. We continue to see high-single digits this year. We've taken share. We've managed the 23 SEER transition very well. We're managing the 454B transition very well. We have the 410A to support our customers, obviously, this year and then probably next year, about 90%, probably more than 90% of our deliveries will be the 454B, which we still expect the benefit of pricing on. So I think that as we go into next year, if we continue to see the kind of movement we've had, inventory levels in the channel are low. They ended up last quarter, down about 10%. We want to make sure we end up this year with balanced inventory. So we feel good about the growth next year in resi for sure."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Appreciate all the color."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Andy."
},
{
"speaker": "Operator",
"content": "And our next question comes from Nigel Coe with Wolfe Research. Your line is now open."
},
{
"speaker": "Nigel Coe",
"content": "Yes, thanks. Good morning, everyone."
},
{
"speaker": "David Gitlin",
"content": "Good morning, Nigel."
},
{
"speaker": "Nigel Coe",
"content": "Lots going on here. That's for sure. So Patrick, I just wanted to pick up on the 4Q moving pieces. I just want to confirm, 12% adjusted operating margin for 4Q. Maybe just help us on how that divides between the segments and perhaps the below the line just given the core per costs moving around with the discontinuation?"
},
{
"speaker": "Patrick Goris",
"content": "If I look at operating margin for Q4, I think it's going to be about 12.5% for the overall company. And I mentioned the growth rates earlier between refrigeration and HVAC. I think HVAC margins will be close to 15%, 15.5% and refrigeration about 13% or so in that range."
},
{
"speaker": "Nigel Coe",
"content": "Okay. That's helpful. And then you think Viessmann will be another 20 basis points impact there?"
},
{
"speaker": "Patrick Goris",
"content": "No. Actually, I think the margin impact of Viessmann in Q4 on the overall company will be flat. And on the HVAC segment would be a headwind of about 0.5 point."
},
{
"speaker": "Nigel Coe",
"content": "Okay, because of the ramp up sequentially. Okay. And then just on the buyback, you said -- I think the term in the slides is buyback underway. Does that imply that you're already in the market buying back stock? And on that $4.7 billion between now and year end '25, is that -- are you planning regular way buybacks in the open market? Or would you consider some form of an ASR or tender?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, Nigel. So we repurchased about $400 million in Q3. And our current outlook for this year is about $1 billion, so about $600 million or so more to go this quarter. Depending on the timing of the proceeds from our last exit, which we expect to close by the end of this year, we may decide to do more this calendar year. We are looking at open market purchases as well as an ASR. And so it could be a combination of all of the above. It is not clear yet this year, we will do more than $1 billion. That will mostly depend on the timing of the proceeds and, of course, on market conditions."
},
{
"speaker": "Nigel Coe",
"content": "That's very helpful. Thank you."
},
{
"speaker": "Patrick Goris",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from Deane Dray with RBC. Your line is open."
},
{
"speaker": "Deane Dray",
"content": "Thank you. Good morning, everyone."
},
{
"speaker": "David Gitlin",
"content": "Hey, Deane."
},
{
"speaker": "Patrick Goris",
"content": "Good morning, Deane."
},
{
"speaker": "Deane Dray",
"content": "Hey just want to wish Sam best of luck. Thanks for your help, and welcome to Mike. Just first question on data center. A couple of points here. One is, can you elaborate on that 5x multiplier because that's right in the range of what we've been looking at. It's much better to sell HVAC equipment is a data center than a onetime electrical equipment that doesn't have that kind of aftermarket. So what are the assumptions in the 5x multiplier? And Dave, are there differences in the equipment that you're providing to the hyperscalers today, because they require significant redundancy. So are there any complexities in the equipment or how standardized is that as it looks today?"
},
{
"speaker": "David Gitlin",
"content": "They are -- the equipment can be a bit customized depending on the specific requirements. Obviously, we start with the baseline of our existing water cooled and air cooled chillers, but then they may have unique bespoke requirements and our applied engineering team has done a phenomenal job understanding the specific requirements, especially of the hyperscalers, passing our first-of-kind units with in many cases, exceeding the requirements. And I think we're working very closely with our customers to satisfy the specific requirements. It may be that they have a requirement for operating at very low output levels, capacity requirements, but not having a complete turn off of the chiller are continuing to operate at, say, 5%, so they don't have a complete cold start-up, and our team has been able to manage requirements like that. So generally, more than 80% common, I would say, with our existing chillers, but with some modifications. I would say our team Deane has done a phenomenal job. We've seen great wins. You won't see all of it in our orders, because we may have a commitment from our customers that hasn't made its way into our orders number. But I mentioned orders up 250% year-to-date. We've made great progress not only in the United States with the hyperscalers and for their facilities outside the United States, but with the colos as well, folks like Vantage and others. So we're very pleased with the progress that we've made, and we're very confident in our continued wins. We started this journey with a target of how many chillers that we felt we needed to win to increase share, not only in North America, but globally and support our customers, and our target now is orders of magnitude higher than anything we established upfront. So very, very pleased with the progress. And I think that the aftermarket opportunity is going to be transformational for Carrier in terms of how we think about supporting those customers, but customers in Chicago or Shanghai because we're going to have -- if you picture having anywhere from 50 to 200 chillers at a single site, now you're dealing with a rotable pool, real-time monitoring of the equipment prognostics to anticipate failures, diagnostics, technicians on-site with multi-shifts. So you may have two technicians in the day, two technicians at night. So all hands on deck to support them, and we're going to be pricing it as kind of one of our most elite offerings in kind of a power by the hour type agreement. So very excited about the new wins and the aftermarket opportunity. Again, that won't kick in for a few years, of course, but we believe that will be at least 5x the equipment value."
},
{
"speaker": "Deane Dray",
"content": "Great. That's exactly what I was looking for. And then for Patrick, on the -- congrats on the AFFF settlement. I know that's a difficult process and it still needs court approval. What would the circumstances be where you would be able to collect above that 615 has referenced the $2.4 billion. What would the circa, would there have to be new claims filed? How might that play out?"
},
{
"speaker": "David Gitlin",
"content": "I'll take it, Deane. It's really going to be a function, we have the policies. We have coverage that certainly exceeds the $2.5 billion that Patrick mentioned. So we have the ability to collect more. We just then forego some of the policy. So it will be a function of how we decide to navigate this with the plaintiffs because they have access to the insurance recoveries as well. So look, when we look at it, and I want to thank Kevin O'Connor and the legal team because this was obviously difficult to navigate where we've -- I think we're the only company in the world that can say that we've put the underlying liabilities, we call them the estate claims, because KFI is of course, in bankruptcy. But when we look at the underlying claims associated with the manufacturer sale of AFFF, we have now put those effectively in the rearview mirror subject to final court approval. So we feel really good about that. We feel really good that even on these direct claims, which you would call tenuous at best, these are claims that over a decade ago, something UTC would have done during its ownership of this business that's unrelated to the sale or manufacturing of AFFF. Those are those claims. And we've even settled assuming we get court approval, a big chunk of those. So we feel that between the insurance recovery, the settlements that we've had we can start 2025 with our portfolio transformation behind us, AFFF fundamentally behind us. And now we can just focus on good old-fashioned customers growth, execution, innovation, the real exciting stuff."
},
{
"speaker": "Deane Dray",
"content": "Congratulations. Thank you."
},
{
"speaker": "David Gitlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And the next question comes from Joe Ritchie with Goldman Sachs. Your line is open."
},
{
"speaker": "Joe Ritchie",
"content": "Hey, good morning guys."
},
{
"speaker": "David Gitlin",
"content": "Hey Joe."
},
{
"speaker": "Patrick Goris",
"content": "Good morning."
},
{
"speaker": "Joe Ritchie",
"content": "Hey, so real quickly on just the resi for 3Q, 4Q, I know you talked about resi HVAC being up double-digits in the third quarter. I'm curious like how much was it up specifically? And what's embedded in the HVAC up 10% in 4Q for your resi business?"
},
{
"speaker": "David Gitlin",
"content": "The resi business was up double-digits in the third quarter. And when we look at the fourth quarter, again, we're not assuming that there's a significant -- any kind of prebuy in the number. No, I think -- yes, go ahead."
},
{
"speaker": "Patrick Goris",
"content": "Yes. So Q3 was up 11%. And then Q4 is going to be a lot more than that. But frankly, remember last year, Q4 was really weak. And so Q4 is going to be up probably 20%, 30%. But again, that's more of a function of weak last year with the destock rather than us having a lot of prebuy, as we said in our guide, we do not assume a material prebuy."
},
{
"speaker": "David Gitlin",
"content": "Yes. Remember, Joe, as Patrick mentioned, we had a pretty easy compare. Last year, it was down about 20% in resi."
},
{
"speaker": "Joe Ritchie",
"content": "Got it. That's super helpful, guys. And then as you're thinking about the dynamics for next year, Dave, with this SEER transition that's happening, I know you mentioned that 90% of what you're going to sell is going to be R-454B. I guess, like do you have any concerns around the 410A units just perhaps like being, I know you mentioned that like your distributors aren't really stocking in, but basically having enough inventory on hand for the first half of the year, such that the R-454B units are a little bit slower to pick up. And then as you're thinking through pricing specifically for R-454B, I know that you guys are expecting double-digit pricing. But how do you think about the net realized price associated with those units?"
},
{
"speaker": "David Gitlin",
"content": "Well, on the first piece, yes, we fully expect there to be 410A sold in the first quarter. I think that we'll be selling 410A to our distributors and certainly our distributors will have 410A on the shelf going into next year. So we expect a fair amount of 410A to be sold into distribution and into the market in the first quarter. I think the question that folks are trying to wrestle with is are we selling more 410A this year, pulling from 2025, and we just don't see much of that. Could there be a couple of percent once all the dust settles perhaps, but we just -- it's all a function of the true underlying demand. And the only way we can understand that is by looking at underlying movement, which again has been very strong here in October, and look at the inventory levels that we see in the channel. And again, those have been down 10%, we expect the year to end in balance. So we don't think it's a pull forward, but we certainly expect 410A to be sold a fair amount of it in the first quarter. I think in terms of pricing, we've been very clear that the base price of 454B will be 10% higher than the base price 410A. And then to get to the 15% to 20% over two years, you get escalation. And I think that, that's appropriate. And I think that once our customers and others, I assume, see the underlying cost impact of having to put additional parts into the 454B system and different controls and algorithms to associated with the A2L, I think others will price it however they decide to price it, that's how we've determined it is appropriate for us to price it. And we think that that's going to stick."
},
{
"speaker": "Joe Ritchie",
"content": "Got it. That's very helpful. Thanks guys."
},
{
"speaker": "David Gitlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from Stephen Tusa with JPMorgan. Your line is open."
},
{
"speaker": "Stephen Tusa",
"content": "Hey, good morning."
},
{
"speaker": "Patrick Goris",
"content": "Good morning."
},
{
"speaker": "David Gitlin",
"content": "Hey, Steve."
},
{
"speaker": "Stephen Tusa",
"content": "Sam, thanks again for all the help and best of luck."
},
{
"speaker": "Samuel Pearlstein",
"content": "Thank you."
},
{
"speaker": "Stephen Tusa",
"content": "So just on this light commercial business, how are you kind of looking at that into next year? And any impact you're seeing from the ESSER cliff?"
},
{
"speaker": "David Gitlin",
"content": "Well, a little bit early to say next year, Steve. I think our goal right now is to end with inventory levels in balance. That's why we assume down 15% in the fourth quarter of this year. ESSER has been very, very helpful, but that continues. The actual spend associated with ESSER will certainly continue throughout 2025. What happened with ESSER is the $190 billion of ESSER funding is now behind us. There was about $20 billion that I think get returned from the states of the Department of Energy. But that has to be spent. Currently, the requirement is to get spent by March of 2026. So we'll still be continuing to spend on our wins throughout all of next year into the 2026. And there's about 30 states that are looking to extend their spend requirement beyond March of 2026. We've had some really big wins on K-12, in particular, there are states like California and Arizona, where we've had very, very significant wins. So that's been a big part of our success. It's not just K-12, but some of the other verticals. So it's been a good news story for us. I think this year, we'll be up, as I mentioned, low-single digits. Early to say, Steve, exactly what we see for next year. But our whole focus now is, especially on the small rooftop units, making sure inventory levels come down a bit in the channel."
},
{
"speaker": "Stephen Tusa",
"content": "That's helpful. And then just for Viessmann, there's a little bit of math required here, which is always a challenge, I guess, early in the morning. But it looks to me to be about, I don't know, like 10% margin for adjusted OP margin for 3Q and then for the year now, you're at like more like 11%. Is that about right for the margins?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, Steve, for the full-year, 11% is certainly in the ballpark and then EBITDA it's mid-teens actually."
},
{
"speaker": "Stephen Tusa",
"content": "Mid-teens EBITDA, but the adjusted OP that's running through your adjusted P&L."
},
{
"speaker": "Patrick Goris",
"content": "Yes. As I mentioned [indiscernible] certainly in the ballpark and full-year EBITDA is close to actually mid-teens actually."
},
{
"speaker": "David Gitlin",
"content": "We know you'll want to get to the lowest number, Steve."
},
{
"speaker": "Stephen Tusa",
"content": "Okay. Thanks a lot guys."
},
{
"speaker": "Patrick Goris",
"content": "Yes, thank you Steve."
},
{
"speaker": "Operator",
"content": "And our next question comes from Noah Kaye with Oppenheimer. Your line is open."
},
{
"speaker": "Noah Kaye",
"content": "Thanks, good morning. Could we spend a minute on refrigeration. I think first, can we sort of level set what the margin profile ex CCR looks like just to have a base as we enter '25. Is this sort of like a 14% type or a little bit lower EBIT margin business, since CCR is immaterial? And the second part of the question is, it's good to see orders in truck trailer in flex. So maybe just talk a little bit about the business trends and how those might set up for growth entering '25?"
},
{
"speaker": "David Gitlin",
"content": "Maybe -- no, let me take the second one first, and Patrick will take the first one. We're not reading anything into the orders numbers that you saw for NATT. There's some easy compares there, we're just looking at the underlying business. It's going to be a tough year for North American truck trailer, because some of the -- we don't think we've necessarily gained or lost any share there, but it's just a tough business for the market. The key for us is to make sure that we close out the year, but really position ourselves for growth next year. We're confident we'll get growth going into next year. ACT has relatively modest growth, I think mid-single digits going into next year. But we have some other things that we want to push to kind of get outsized growth on top of that. But yes, we're -- the orders number was very high, but we're sort of discounting it because of the comparison."
},
{
"speaker": "Patrick Goris",
"content": "Yes. And then, Noah, on the first question, this year, refrigeration margins, excluding commercial refrigeration, would be up about 300 basis points, give or take. And then as I mentioned, for Carrier going forward or think Carrier 2025 versus 2024, we will lose $750 million of revenue related to CCR. But basically, as I said, immaterial operating profit. So if you do that math, basically, our operating margin next year will be up 50 basis points just because of the absence of commercial refrigeration."
},
{
"speaker": "Noah Kaye",
"content": "Last quick question. The $200 million of cost synergies for VCS by year three, you could see that reiterated. Where do you expect that to pencil out for this year specifically, is it still $75 million or so? And then should we think about kind of a ratable amount of synergies capture in '25 as well?"
},
{
"speaker": "David Gitlin",
"content": "Yes, I think it's a good way to think about it. I think this year, we've said $75 million, it may end up being a bit more than that, but it's kind of in that zone. And I think it will be a bit ratable. And look, hats off to the team in the category of controlling the controllables, we've seen very strong savings on the material side, both direct and indirect. The team has been very aggressive at taking cost out. It's never fun. It's never easy. But I would say if there's been anything good in the midst of the sales being down much further than we planned is it's forced us to take a bunch of costs out of the system. So if we can keep that overall cost down as we go into next year, it should drop through at higher margins than we had anticipated."
},
{
"speaker": "Noah Kaye",
"content": "Great. Thanks guys."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Noah."
},
{
"speaker": "Patrick Goris",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from Andrew Obin with Bank of America. Your line is now open."
},
{
"speaker": "Andrew Obin",
"content": "Hi, guys. Good morning."
},
{
"speaker": "David Gitlin",
"content": "Hi, Andrew."
},
{
"speaker": "Patrick Goris",
"content": "Good morning, Andrew."
},
{
"speaker": "Andrew Obin",
"content": "Just to follow-up on Steve's question on ESSER running over. What we've been hearing is that sort of folks have been able to tap into other sources at the IRA. So that's what's smoothing out the process. Would that be consistent with what you're hearing in the channel?"
},
{
"speaker": "David Gitlin",
"content": "I think so, Andrew. I think the way we're looking at it, frankly, is that there has been more funding available for this segment, K-12 than ever basically. And the way we see it is that, that's really been driving a lot of the strength that we've seen in that segment for the last couple of years leading into the next couple of years. What we think will happen and the reason we don't see -- the strength we've seen there a discontinuing as we get into the second half of 2026, is that the school budgets themselves have -- but they've been having budgets. They have not been spending, because they've been spending federal money. So I think that there's going to be pent-up capacity of the local school budgets to spend as we get into 2026 and beyond. So we think the strength we've seen will continue because, frankly, there's long overdue requirements in the school system."
},
{
"speaker": "Andrew Obin",
"content": "Got you. And just a follow-up question. I know you've sort of provided initial framework for '25. Just a question. As it relates to free cash flow, any onetime items that we should consider within that framework that were maybe related to Viessmann acquisition, how you treat it some of the items on the balance sheet. Anything that we should think about it for '25? Or should we just model normal free cash flow conversion rate within historical range for '25?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. At this point, Andrew, there is nothing that I would call out. Obviously, we would target to get to 100% of adjusted income taking into account restructuring charges that are cash that we adjust out. So obviously, our target would be to get to that level."
},
{
"speaker": "Andrew Obin",
"content": "Thanks very much. And, Sam, congratulations."
},
{
"speaker": "Samuel Pearlstein",
"content": "Thanks Andrew."
},
{
"speaker": "Patrick Goris",
"content": "Thank you, Andrew."
},
{
"speaker": "Operator",
"content": "And the next question comes from Chris Snyder with Morgan Stanley. Your line is open."
},
{
"speaker": "Chris Snyder",
"content": "Thank you. I wanted to ask on orders. Obviously, the -- I guess, nearly 20%, a very strong mark. But you guys said at the Laguna conference that the first few months of the year were tracking up 20% to 30%. So I guess, my question is, did anything soften in September, anything get pushed out? Or is there some impact from the move into discontinued ops?"
},
{
"speaker": "David Gitlin",
"content": "No. What it really was, Chris, is just frankly was resi that there's been some swings in ordering some of the resi orders. We mentioned resi was up 30% in the quarter. A lot of that was in the first two months. And a lot of our resi orders for the 410A really stopped or slowed as we got into September. So we had said at Laguna Beach that it was up 20% to 30%, we ended up right around 20%. And I think the only delta had to do with resi orders in September."
},
{
"speaker": "Chris Snyder",
"content": "Appreciate that. Thank you. And then, Dave, you also talked recently about an aftermarket 2.0 strategy. So maybe can you talk a little bit about how that differs from the existing aftermarket go-to-channel approach? And is there cost associated with the new strategy? And then ultimately, what opportunity does that bring for Carrier?"
},
{
"speaker": "David Gitlin",
"content": "Yes. I think when we energized with Ajay Agrawal on the team, our 1.0 strategy, going back to like 2019, 2020, it was a lot of the basics. It was really making sure, for example, that we had parts flowing through our system and not going around us. It was having a tiered offering. It was having digital connectivity so that we could start to monitor some of the equipment and track the equipment and having a really cascaded set of metrics around attachment rates and conversion rates and total coverage. I think we're now looking at just the next level of sophistication having to do with rotable pools and looking at where we stack our inventory and using better algorithms to make sure that we have the right parts in the right locations to support our customers when we need -- when our customers need us to avoid the high leakage rates we're seeing in parts. When we look at connecting 50,000 chillers now using that data to create value for our customers and looking not only at maintenance uptime and looking at prognostics and diagnostics, but looking at other value-added things we can create looking at things like carbon tracking, so we can give more value-added services. For Lynx, you're getting in -- for our cold chain looking at things like our supermarket customers knowing exactly what's going to arrive when they need it, so they can have the shelf space ready for it. So we're taking the fundamentals that we've had and building on it. There is some modest investments associated with it, but the beauty of the aftermarket is it's 10% higher margin than the base business. It doesn't require huge investments. What it requires is focus every single day on everyone in the business to go drive the results. It's now into the DNA across the enterprise, including Viessmann Climate Solutions that will drive double-digit aftermarket growth this year, we have a bigger percentage of our portfolio residential. So it drives every single part of the portfolio, not just commercial HVAC to live and breathe it every day, and I see that happening throughout 50,000 people."
},
{
"speaker": "Chris Snyder",
"content": "Appreciate that. Thank you."
},
{
"speaker": "David Gitlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "I would now like to turn the call back over to management for closing remarks."
},
{
"speaker": "David Gitlin",
"content": "Okay. Well, thank you all for joining. Patrick mentioned thanking the finance team, which is very appropriate. And again, thank you, Sam, to everything you've done for all of us over these past five years. And thanks to the 50,000 teammates that we have within Carrier. We've had a lot going on in the system, this whole performing while transforming. I can't thank our team enough and I thank our customers and our shareholders for their continued confidence. And we're very, very excited to close out the year strong, and then really deliver outsized results as we get into 2025. So thank you all very much."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
carr | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to Carrier's Second Quarter 2024 Earnings Conference Call. I would like to introduce your host for today's conference, Sam Pearlstein, Vice President of Investor Relations and CFO of the Fire & Security Segment. Please go ahead, sir."
},
{
"speaker": "Sam Pearlstein",
"content": "Thank you, and good morning, and welcome to Carrier's second quarter 2024 earnings conference call. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier's website at ir.carrier.com. The company reminds listeners that the sales, earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties. Carrier's SEC filings, including Forms 10-K, 10-Q, and 8-K provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Once the call is open for questions, we ask that you limit yourself to one question and one follow-up to give everyone the opportunity to participate. With that, I'd like to turn the call over to our Chairman and CEO, Dave Gitlin."
},
{
"speaker": "David Gitlin",
"content": "Thank you, Sam, and good morning, everyone. Let me first welcome Ed Dryden to Carrier, who comes to us from RTX Collins Aerospace to lead our Refrigeration business, bringing extensive experience driving business growth and delivering results. Ed succeeds Tim White has moved into a new Chief Product Officer role responsible for program execution and our increased focus on global platforms, both reporting to me. Welcome, Ed, and thank you, Tim. Pivoting to 2Q, another strong quarter. Q2 organic sales -- or excuse me, Q2 organic orders were up roughly 30% year-over-year and HVAC organic orders were up over 40% with very strong order intake in data centers. Better-than-expected and continued strong sales growth in our Global Commercial and Light Commercial HVAC businesses helped to offset weakness in our RLC businesses in Europe and China. Importantly, our Resi business in North America returned to year-over-year volume growth and given strong orders and low inventory channel levels, we are now poised for a strong second half. Also, we continue to execute well, as reflected by another quarter of significant margin expansion. Q2 adjusted operating margins expanded by 200 points to 18.1% and adjusted EPS was again up double-digits, fueled by strong productivity driven by our Carrier excellence business operating system. While we perform, we continue to transform. We closed on the sales of our Access Solutions and Industrial Fire businesses, KFI closed on its sale, and we expect to close the Commercial Refrigeration transaction around the end of Q3. We are also making great progress on the sale of our Residential and Commercial Fire business. Strong free cash flow in the quarter of about $550 million and our progress on the business exits have contributed to our significant net debt reduction in the quarter and have positioned us to initiate a multi-billion dollar share buyback, $1 billion targeted for the second half of this year. As you can see on Slide 4, we continue to stay laser-focused on and make great progress towards our North Star being the global leader in intelligent climate and energy solutions. Each word of our vision has meaning, and we are purposeful in our investments to prioritize the key elements of our strategy. As a global leader, we have gained share across all major segments. Connectivity is a key enabler to provide scalable intelligent solutions. We now have almost 40,000 connected chillers on track to 50,000 by year-end. Our Abound intelligent building platform now monitors over 1.1 billion square feet, and we currently have over 150,000 paid subscriptions for our Lynx cold chain platform. We have also established an AI center of excellence. Internally, we are targeting increased productivity for everything from contract reviews where we have seen improved productivity of up to 90% to call centers. Externally, we now provide services to customers combining classic and generative AI, analyzing data alongside service and maintenance records to deliver more real-time and proactive chiller maintenance. We continue to innovate and launch differentiated sustainable solutions. In Q2, we introduced a low GWP variant of our award-winning AquaEdge Water Cooled Chiller. Likewise, we are the first to offer 3 ton to 10 ton entry tier rooftop units using our highly differentiated EcoBlue fan technology with low GWP refrigerants. All these offerings provide our customers with energy savings, while reducing their greenhouse gas emissions. We play a key role in enhancing grid resilience. For example, Viessmann Climate Solutions recently launched a battery energy storage system with expanded capacity from 15-kilowatt hours to now 75-kilowatt hours, importantly expanding our addressable market. The solutions concept relates to the unique value propositions that we provide to our customers and greater recurring revenues they provide to us. You see examples of our continued traction on aftermarket on Slide 5. Aftermarket growth in Q2 was 9%, and we are confident that this year, we will deliver another year of double-digit growth. We have further refined our playbook with new digital tools that we have cascaded globally driving both better execution and new solutions for our customers. We are confident that our proven formula works as we continue to target double-digit aftermarket growth forever. Moving to Slide 6. About a year ago, we announced that we would be transforming Carrier into a more focused pure-play higher growth company with significantly higher exposure to the secular tailwinds around sustainability, electrification and energy resilience. I am proud to report that our team continues to do what we say we're going to do. We are successfully integrating with Viessmann Climate Solutions a truly world-class organization. Our divestitures remain very much on track and we are deploying the proceeds as committed. Our first three exits will yield over $7 billion in gross proceeds. Our commercial and residential fire exit is also progressing well, supported by excellent business performance. We plan to announce a signed agreement before the end of Q3 with a transaction closed around year end. Given our progress, we have reduced net debt by over $5 billion in the second quarter and plan to initiate our multi-billion dollar buyback that I mentioned earlier. With the portfolio transformation tracking to plan, we are heads down focused on working with Viessmann Climate Solutions to realize the full potential of this tremendous combination and you can see our progress on Slide 7. This is truly a world-class team and business. Our heat pumps are unquestionably differentiated, providing superior electricity savings for our customers. Noise attenuation, energy efficiency, ease of installation, reliability and aesthetics are all best-in-class. We have added 1,500 direct-to-installer relationships this year and continue to expand our network. The successful launch of our new larger capacity heat pumps will give us a point of growth this year, and we expect more than that next year. Viessmann Climate Solutions has gained share in heat pumps across all primary countries where it sells with particular strength in Germany. We have also realized positive price year-to-date. We have identified hundreds of millions of dollars of run rate synergy savings. The most immediate opportunity is leveraging our respective channels. For example, in Europe, we have already delivered our first Carrier branded air conditioning units and our Beretta-branded boilers through the Viessmann channel. Given that only 20% of homes in Europe have air conditioning, roughly 12% in Germany, we see a unique opportunity for us to grow in the cooling only space. We are also leveraging our combined technology strengths. Examples include deploying Viessmann's One Base digital platform across all residential applications and at a systems level, working to provide unique home energy management solutions for North America using Viessmann's battery and systems integration capabilities. We remain on track to achieve $75 million of cost synergies this year, and over $200 million by year three with particular progress on supply chain, logistics, and value engineering. The team is also taking tough, but necessary additional cost control actions. All of this set us up for higher conversion rates. We are also clear that the residential market in Europe has been weaker than we expected. BCS Q2 sales were down about 30% year-over-year, roughly one third of which was driven by lower solar PV sales. And our revised outlook for 2024 assumes about a 15% drop in year-over-year sales with a typical seasonal pickup in the second half. Importantly, we still have deep conviction in the long-term strategy and growth profile of the business. The EU remains steadfast in its target for 55% reduction in greenhouse gas emissions by 2030 and the shift to heat pumps must play a critical role. Over 25% of greenhouse gas emissions in Europe come from boilers in homes. Heat pumps are clearly the best alternative to fossil fuel home heating. So we remain confident in this continued long-term transition. The reality in our industry is that the macro surrounding certain geographies and verticals will not be strong every year. And the great thing is that we have been very purposeful about constructing our portfolio to provide focus, resiliency, balance, growth and increased exposure to key secular trends all of which you see on Slide 8. We love our positions globally. We are number one or two in most segments with prospects to achieve the same ranking in other targeted segments. Not only do we believe that we have the right presence in the right markets, we have the global scale in engineering operations, aftermarket and other functions to benefit the entire portfolio. The combination of our portfolio and our performance culture gives us confidence that we will continue to consistently deliver on our commitments. As we look ahead to 2025, we are poised for strong growth across a significant percentage of our portfolio. With that, I will turn it over to Patrick. Patrick?"
},
{
"speaker": "Patrick Goris",
"content": "Thank you, Dave, and good morning, everyone. Please turn to Slide 9. We had a good second quarter. Earnings were in line with our expectations and ahead of our implied adjusted EPS guide provided in April. Reported sales of $6.7 billion were up 12% with organic sales up 2%. Acquisitions and divestitures had a net contribution to sales of 11%, substantially all driven by Viessmann's Climate Solutions, partially offset by the absence of one month for Access Solutions. Q2 adjusted operating profit of over $1.2 billion was up 26% compared to last year, mostly driven by the contribution of Viessmann Climate Solutions, price and productivity. Continued strong productivity also led to a 200 basis points adjusted operating margin expansion. Core earnings conversion that is excluding the impact of acquisitions, divestitures and currency, was over 200% in the quarter. Adjusted EPS of $0.87 was up 10% year-over-year. Compared to last year, organic growth price and productivity more than offset the dilutive impact of the Viessmann Climate Solutions acquisition. We have included a year-over-year adjusted EPS bridge in the appendix on Slide 22. Compared to our Q2 expectations, headwinds from lower earnings at Viessmann Climate Solutions and the earlier timing of the Access Solutions exit were offset by stronger sales in commercial HVAC and North America light commercial HVAC, productivity and a few cents from the timing of taxes. Free cash flow of about $550 million was better than expected, mainly driven by working capital performance and on a year-to-date basis, free cash flow is up 35% compared to last year. Moving on to the segments, starting on Slide 10. HVAC reported sales growth of 18% and reflects the contribution of Viessmann Climate Solutions and organic sales growth of 2%. Organic sales in the Americas were up mid-single digits, driven by double-digit growth in commercial and light commercial. North American resi was up about mid-single digits, and we expect volume to be up year-over-year in each of the remaining quarters. Organic sales in EMEA were up low-single digits, driven by about a 15% increase in commercial HVAC, partially offset by weaker residential and light commercial sales. Sales in Asia Pacific were down around 8% driven by weakness in our residential and light commercial markets in China, partially offset by double-digit growth in South Asia. The HVAC segment expanded adjusted operating margins by 110 basis points due to net price and strong productivity. Overall, another strong quarter for HVAC. Transitioning to refrigeration on Slide 11. Organic sales were up 1% and reported sales were flat. Within transport refrigeration, container was up around 35% year-over-year, while global truck and trailer was down mid-single digits, driven by about a 15% decline in North America. European truck and trailer was up mid-single digits and Asia truck and trailer was up over 25%. Our Sensitech business, which provides solutions for tracking and monitoring temperature was up mid-single digits. Commercial refrigeration was down mid-single digits year-over-year. Adjusted operating margin was flattish compared to last year. This was driven by favorable net price and productivity offset by business mix. Moving on to Fire & Security on Slide 12. Reported sales were down 7% with 3% organic sales growth, partially offset by a 10% headwind from the absence of one month of Access Solution and the deconsolidation of KFI in last year's second quarter. The Residential and Commercial Fire business was up mid-single digits and is performing well. Adjusted operating margins were up a significant 310 basis points year-over-year as organic volume growth and strong productivity more than offset headwinds of the business exits. Overall, a very strong quarter for this segment. Turning to Slide 13. Total company orders were up about 30% in the quarter. Overall, HVAC orders were up over 40% with strength across key verticals. Within the Americas, orders were up over 70% with commercial orders up over 40% and light commercial orders about 5%. North America resi orders were up over 100% or around 60% when excluding preordering for late Q3 and Q4 deliveries this year. EMEA organic orders were up over 10% with commercial orders up over 15%. Organic resi and light commercial order intake in EMEA was down low-single digits. Within Asia, weak orders in China were only partially offset by other countries. Globally, commercial HVAC orders were up over 20% and the backlog for that business continues to grow. We booked large data center orders in all regions, positioning us for continued strong commercial HVAC growth. Refrigeration orders were down over 5% in the quarter, with strength in container offsetting some weakness in North America truck trailer. As a reminder, our North America truck trailer orders were up almost 90% in last year's second quarter. Truck and trailer orders in Europe and Asia continue to be strong. Orders in our Resi and Commercial Fire business were up over 10%. Turning to Slide 14, guidance. Before I get into the details, I will share that you will see in the 10-Q later today that we expect consistent with accounting rules that as we get closer to announcing a sale of the Resi and Commercial Fire business, the Fire & Security segment in aggregate, will likely be presented in discontinued operations in future quarters. This could happen as early as Q3, but would not apply to commercial refrigeration. We do not yet know the full impact on reported earnings from continuing operations this year, which is why our July guide is consistent with how we have been disclosing our results. In addition, we plan to continue to disclose actual and projected 2024 results of our core business, that is all the businesses we are keeping, including Viessmann Climate Solutions which we continue to see as the best base to project 2025 financial performance. With that, let me provide our outlook for 2024. With respect to exits, our updated guide now includes commercial refrigeration for nine months compared to six months in our previous guide. We now expect reported full-year sales of roughly $25.5 billion compared to a little under $26 billion in our April guide with underlying organic growth of mid-single digits remaining unchanged versus prior guide. The expected upside from our Commercial and Light Commercial HVAC businesses essentially offsets lower revenue at Viessmann Climate Solutions. Lower residential and light commercial sales in China and a stronger foreign currency translation headwind are only partially offset by having commercial refrigeration for another quarter. We are maintaining our adjusted operating margin guide of roughly 15.5%, maybe a little more. and continue to expect full-year core earnings conversion to be north of 40%. Interest expense is expected to be about $510 million based on the timing of the exits and redeployment of the net proceeds. The end result is that we are maintaining our adjusted EPS guide range of $2.80 to $2.90. Our free cash flow outlook remains $400 million reflecting about $2 billion of tax payment on gains from the business exits and transaction and restructuring-related cash costs. Our underlying free cash flow outlook remains $2.4 billion. Moving on to Slide 15, full-year adjusted EPS year-over-year guidance bridge. Adjusted EPS increases from $2.73 last year to $2.85 at the midpoint. The darker blue represents the business we are retaining, including Viessmann Climate Solutions, whereas the lighter blue represents the adjusted EPS contribution from the businesses we're exiting. You can see that the adjusted EPS from our core business is projected to be up 17% compared to last year. The operational contribution of $0.55 now reflects stronger business performance within our commercial and light commercial HVAC businesses as well as stronger productivity. Increased dilution from Viessmann Climate Solutions reflects lower expected sales. We updated the impact of the exits to include the net effect of losing seven months of earnings from Access Solutions, six months of earnings from industrial fire, and only three months of earnings from commercial refrigeration, all offset by net interest savings from the proceeds. There is a modest benefit from our planned $1 billion in share repurchases in the second half and the headwind from a higher year-over-year adjusted effective tax rate. In the appendix on Slide 23, you will find a full-year adjusted EPS guide-to-guide bridge. And on Slide 24, there is a summary of additional items, which were also updated as part of the new guide. With respect to the third quarter, we expect sales of about $6.6 billion and adjusted EPS of about $0.80 including a few pennies from businesses yet to be divested, and we expect the adjusted effective tax rate to be up 500 bps compared to last year, a $0.06 headwind. In summary, a good second quarter overall and on track for another strong year. With that, we'll open it up for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions]. The first question comes from Andy Kaplowitz with Citigroup. Your line is open."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Good morning, everyone."
},
{
"speaker": "David Gitlin",
"content": "Good morning, Andy."
},
{
"speaker": "Andrew Kaplowitz",
"content": "David, I think you've been saying that as you own Bison for longer that you get more visibility expected orders and sales ramp. Obviously, you lowered your guidance for the business, but how would you characterize the new guidance. I think you're still talking about a typical seasonal pickup. Is that 20% growth off a lower base? Or do you see expectations now as more de-risked for the second half ramp?"
},
{
"speaker": "David Gitlin",
"content": "I would call it more de-risked, but it's also about 15% to 20% growth in the second half over the first half. So we had said that previously, but now we're coming off of a lower base. I think in terms of the typical seasonality, as we start getting into the heating months, we went back a number of years and that number of 15% to 20% is true almost over 90% of the time. So we are -- we do think we've de-risked the forecast for the rest of the year. We do need to see this as we start thinking about '25, what we're really looking at is this inflection point. As we get closer to October, which in Germany is when the subsidies start paying back, we'd like to see orders pick up at the very end of August, leading into September and start building that orders pipeline that gives us the kind of growth that we'll expect for next year, but we do feel balanced for the revised forecast for this year."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Very helpful. And then could you give us a little more color into the order trends you saw in the quarter? I know you had a relatively easy comp and you already talked about some data center orders. But maybe you could talk about the inflection that you saw. Was the inflection bigger than you expected? Was mostly data centers in commercial and the expected turn in Americas residential or is it more broad-based? And I know you've been talking about share gains, are they actually accelerating?"
},
{
"speaker": "David Gitlin",
"content": "Yes. We did get share in -- if I think about U.S. resi, we've gotten about 120 bps of share on a 12-month roll. So to see orders up over 100% is obviously significant. But as Patrick said, if you take out orders that were a little bit beyond our lead time that go into 4Q, they still would have been up about 60%. So really good order trends that we're seeing in resi that position us well for that high-single digit, maybe 10% or so growth for this year for resi. When we look at commercial HVAC, it was strong, particularly in the Americas and in Europe. Commercial HVAC was up over 40% in the Americas, up close to 20% in EMEA and Asia Pac it was up low-single digits. And a lot of that was data centers, but some other verticals remain strong there as well, things like higher edge and health care have been strong for us. And K-12 has been particularly strong. And that helped us in light commercial, where we saw the first positive orders there that we've seen in some time."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Appreciate the color."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Andy."
},
{
"speaker": "Operator",
"content": "One moment for the next question. The next question comes from Jeffrey Sprague with Vertical Research Partners. Your line is open."
},
{
"speaker": "Jeffrey Sprague",
"content": "Thank you. Good morning."
},
{
"speaker": "David Gitlin",
"content": "Hey, Jeff."
},
{
"speaker": "Jeffrey Sprague",
"content": "Hey Dave, can you just -- hi, can you just elaborate on this comment about the preorders into the back half? Is this some kind of jockeying happening, pre-buy happening on the A2L conversion or really kind of what's behind that and why you're calling that out?"
},
{
"speaker": "David Gitlin",
"content": "No. It's just because I do think our distributors are trying to figure out what they want on the shelf at the end of this year, leading into next. And with our -- we put in place a fairly disciplined PSYOP process. So all that really is, is just talking to them about reality. What do you guys feel like you need this year and then we can plan our factories accordingly. So it's all about production planning."
},
{
"speaker": "Jeffrey Sprague",
"content": "And then on the Fire & Security margins, I think, obviously, selling the Lenel business is mix negative beyond has only gone for a month. But that's just a surprisingly strong margin performance. Maybe you could just elaborate, Patrick, on what was going on there? Was there some one-offs happening or kind of something else unusual in the quarter on F&S margins?"
},
{
"speaker": "Patrick Goris",
"content": "In essence, it was very strong performance on both price and productivity in that segment. And so compared to last year, our margins, obviously, were significantly weaker. They were below 15%. This was just a quarter where price productivity, very strong compared to last year. We had a few negative one-offs last year. Also, of course, we're doing a lot of work related to stranded costs, some of that benefits in that segment as well."
},
{
"speaker": "Jeffrey Sprague",
"content": "All right. Sam must be doing a good job in his new role. I'll pass it there. Thanks."
},
{
"speaker": "Patrick Goris",
"content": "Thank you, Sam."
},
{
"speaker": "Operator",
"content": "The next question comes from Julian Mitchell. Your line is open."
},
{
"speaker": "Julian Mitchell",
"content": "Hi, good morning. Maybe just a first question for Patrick perhaps. I just wanted to clarify the third quarter commentary. It sounded like sort of $0.80 of earnings versus maybe we look sequentially, it's easier versus $0.87 you just printed. The revenue number sounded like it was down maybe $100 million sequentially, but -- so it implies a sort of a very large sequential margin drop, unless there's something moving around a lot below the line. So any sort of clarity on that, please?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. Julie, a couple of comments there. The -- we expect margins to be down about 100 bps, maybe a little bit more in Q3 versus the prior year. The way you can think about it is Viessmann will remain a dilutive impact. With the exits, we're losing about $100 million of operating profit and then tax represents about a $0.06 headwind as well. And so all of that is offset by some volume pickup and then price and productivity. That continues to be strong."
},
{
"speaker": "Julian Mitchell",
"content": "That's helpful. Thank you. And then just maybe switching back, Dave, to Viessmann. So I understand you have the second half sort of half-on-half bounce in line with normal seasonality. Just sort of following up on that, is the right way to think about it that you're assuming that year-on-year Viessmann is sort of flattish exiting this year in the fourth quarter? Just trying to understand kind of how you think it looks entering next year? And maybe I missed it, but was there an updated operating margin assumption for Viessmann for the year now?"
},
{
"speaker": "David Gitlin",
"content": "Yes. I think when we look at 4Q, we'll be -- our expectation is we'll be flattish to 4Q of last year. It might be up 1% or so."
},
{
"speaker": "Patrick Goris",
"content": "Yes. We expect Q4 sales to be flat year-over-year and the outlook for margins for the full-year now, Julian, is about mid-teens for EBITDA and a few points below that for operating margin."
},
{
"speaker": "Julian Mitchell",
"content": "That's very helpful. Got it. Thank you."
},
{
"speaker": "David Gitlin",
"content": "With a better EBITDA in 4Q than 3Q as you'd expect."
},
{
"speaker": "Patrick Goris",
"content": "Yes, the exit rate is clearly higher."
},
{
"speaker": "Operator",
"content": "Our next question comes from Noah Kaye with Oppenheimer. Your line is open."
},
{
"speaker": "Noah Kaye",
"content": "Thanks. Good to hear on the progress around resi and commercial fire divestiture. Just curious on the timing between expected agreements and the actual exit. It seems a little bit tighter than some of the divestitures that you've previously executed. So just help us understand what would kind of drive that relatively condensed time frame?"
},
{
"speaker": "David Gitlin",
"content": "It's going to most likely go to a sponsor. So we don't see any real regulatory issues. So we think the time between sign and close should be pretty brief."
},
{
"speaker": "Patrick Goris",
"content": "Yes. And it's something we've seen similar for industrial fire."
},
{
"speaker": "David Gitlin",
"content": "Yes, same amount of time we saw there."
},
{
"speaker": "Noah Kaye",
"content": "That's very helpful. And then just again to clarify on the resi side with the longer lead orders. Maybe you can talk to your updated expectations around the mix of 410A versus 454 for the year. I think that would help us better understand what some of these buying dynamics look like?"
},
{
"speaker": "David Gitlin",
"content": "Yes, we think there's going to be lower 454B this year than we had previously said. We thought it could be closer to 20%. I think it's going to be less than 10%, maybe closer to 5% this year. I don't think a lot of our distributors and dealers are in a major rush to put in the 454B. We have our initial units out there. We're starting with the residential new construction piece because they're not going to want mixed developments. But we think that as you get into next year, it's probably closer to 80% will be maybe a bit more than that 454B, but probably only about 5% this year."
},
{
"speaker": "Noah Kaye",
"content": "Very helpful. Thank you."
},
{
"speaker": "David Gitlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And the next question comes from Joe Ritchie with Goldman Sachs. Your line is open."
},
{
"speaker": "Joseph Ritchie",
"content": "Hey, good morning guys."
},
{
"speaker": "David Gitlin",
"content": "Hey, Joe."
},
{
"speaker": "Joseph Ritchie",
"content": "Hey Dave, maybe just -- it's really encouraging to see that progress with the data center orders. And so maybe talk a little bit more about what's driving that progress. And then secondly, I know that you're planning to increase your North America content as well to sell into that vertical. And so just any update on that would be helpful."
},
{
"speaker": "David Gitlin",
"content": "Sure. I mean we are very enthusiastic about the data center opportunity. It's actually the first time that we put together an entire program team led by Christian Sanu [ph] here with a dedicated team focused just on this vertical, whether it's operations, technical, aftermarket support, everything we need to do to not only secure the orders, but then equally, if not more importantly, is support our customers. So we had a big order in 2Q that we had mentioned and with the same customer, they actually ended up adding a bit more to it. We are in discussions with the other hyperscalers and colos. We have the technical offerings that we're very encouraged by and our customers are very encouraged by. I can tell you for one customer, they gave us some technical requirements that we beat. They gave us more significant technical requirements, which we then beat again. So technically, I couldn't be more proud of our engineering team and operationally, we're ramping up. We have facilities in Asia and Europe. Here in the United States, we're going to put max capacity into our Charlotte, North Carolina facility, adding capacity, multiple shifts to that. And we're building out our Mexico facility to add both air cooled and water cool chiller capacity there. So a really exciting opportunity here. We're going to win more than our fair share. And then excitingly, we're starting to build up our whole aftermarket strategy with a very unique dedicated aftermarket offering that we're going to be offering to these critical customers."
},
{
"speaker": "Joseph Ritchie",
"content": "Yes, that's all really great to hear. I guess my follow-up question, Patrick, I don't know if I missed it earlier, but did you guys give an update to your light commercial expectations for the year? And then given that orders have kind of turned positive in that business, are you guys feeling better about that business more broadly. I know there's been some concern that you see that business start to fall off a little bit."
},
{
"speaker": "David Gitlin",
"content": "Yes, Patrick and I are pointing at each other who takes it. We feel good about light commercial. I mean, we tend to -- my experience over the last two years is we tend to beat what we say we're going to do. But look, in the first quarter, we were up 20%. In the second quarter, we were up 10%. On the full-year, we're saying up low-single-digits. I think we came into the year saying down mid or so. So I think we're balanced in the second half. The verticals that have been good remain good. K-12 is still a unique opportunity. Some of the value-based retail, health care, quick-serve restaurants are still good. We see things that are soft, continue to be soft like warehouse and office space. So it's an area that we've had great technical offerings, great share gains over time. The team is performing well. We think we're calibrated for the year instead of low-single-digits, could it be up mid perhaps we'll have to see how it plays out. But continued strength, and I was happy to see that we had positive orders in the quarter. Our orders in Q2 where the first positive orders quarter we've had in something like five quarters, which was up about 5%, which was encouraging."
},
{
"speaker": "Patrick Goris",
"content": "And compared to the prior guide, Joe, the swing in revenue for light commercial was a little less than $100 million. So from down low single-digit prior guide to now up low-single-digits. So it's a big swing that helps offset some other areas."
},
{
"speaker": "Joseph Ritchie",
"content": "Nice, thanks guys."
},
{
"speaker": "Patrick Goris",
"content": "Thanks, Joe."
},
{
"speaker": "Operator",
"content": "And the next question comes from Nigel Coe with Wolfe Research. Your line is open."
},
{
"speaker": "Nigel Coe",
"content": "Thanks. Good morning, everyone. Congratulations on the orders. That's quite eye-popping growth. Just Patrick, I thought maybe a few more details perhaps on sort of the second half -- on that 3Q margin, I think you said 100 basis points lower Q-over-Q. Maybe just some color on the HVAC margins because that's obviously been very strong. And then on the Viessmann second half, it looks like the exit rate implies maybe down 20% in 3Q. I just want to make sure that's correct with EBITDA for the full-year of about 550, I just want to make sure we've got those right."
},
{
"speaker": "Patrick Goris",
"content": "Yes, I'll start with the second part of your question, Nigel. So your EBITDA number is in the ballpark for VCS for the full-year. And we do expect Q3 sales to be down high teens and then Q4 to be about flat year-over-year from a revenue growth point of view for Viessmann Climate Solutions. In terms of margins for the third quarter, and I think you were specifically about -- you asked specifically about HVAC. We continue to see strong productivity that's almost -- that's over 150 bps of margin. The VCS acquisition, however, offsets that. And besides that, we see some larger investments and some currency that take us about to 100 bps lower margin for HVAC year-over-year in Q3."
},
{
"speaker": "Nigel Coe",
"content": "Okay, thanks."
},
{
"speaker": "David Gitlin",
"content": "And then I'm sorry."
},
{
"speaker": "Nigel Coe",
"content": "Please go ahead."
},
{
"speaker": "David Gitlin",
"content": "Yes, 3Q, you're right. It would be down high teens and then 4Q would be flattish."
},
{
"speaker": "Nigel Coe",
"content": "Okay. Thanks, David. And then my fourth question, sorry. I'm sorry. On the second half -- I didn't mean to interrupt you, Dave, sorry about that. Follow-up question is really around the order strength in HVAC. It does look like there's a prebuy building here in the fourth quarter. It seems like distributors want to have the 410A products, which implies a prebuy. So just wondering sort of like maybe just some more color in terms of like what you're hearing from the channel because it does feel given that one year kind of install window that there should be a fairly meaningful pre-buy here. Just curious on your thoughts there."
},
{
"speaker": "David Gitlin",
"content": "Yes, just Nigel, just not clear how much yet. I think will the distributors go into next year with 410 on the shelf for sure. Exactly how much I think at the end of the day, it won't be that material to either this year or next year. But I do think they're starting to figure out exactly how much do they want going into next year because I think they know and the end customers know that it's going to be a 10% -- just 10% to 15% base price increase. But at the end of the day, with the guide that we've given for today, it assumes just a very modest prebuy."
},
{
"speaker": "Nigel Coe",
"content": "Okay, thanks Dave. That's helpful."
},
{
"speaker": "David Gitlin",
"content": "Thank you. Thanks, Nigel."
},
{
"speaker": "Operator",
"content": "The next question comes from Tommy Moll with Stephens. Your line is open."
},
{
"speaker": "Tommy Moll",
"content": "Good morning and thank you for taking my questions."
},
{
"speaker": "David Gitlin",
"content": "Hey, Tommy."
},
{
"speaker": "Patrick Goris",
"content": "Good morning, Tommy."
},
{
"speaker": "Tommy Moll",
"content": "Dave, a couple of follow-ups there on A2L. Can you -- correct me if I'm wrong here, you just mentioned the 10% to 15% base price increase. But I think that continues to sync up well with the 15% to 20% cumulative increase you've talked to before. Is that correct?"
},
{
"speaker": "David Gitlin",
"content": "That's correct, Tommy. Yes, 15% to 20% over two years. Now that 15% to 20% includes our annual price increase, call it, a few percent a year. So the best -- the rest of that would be just the base price increase on the 454B, which is appropriate. I think that we're doing it. I know it seems like I've heard that just in these public calls that our peers are doing it, and it just seems like it's appropriate and that it will stick."
},
{
"speaker": "Tommy Moll",
"content": "Thank you. Follow-up question for you on the repurchase. With the sizable $1 billion you've now announced for the second half, you've got good visibility to closing the last divestiture by the end of the year. Without putting an exact time line around it, my question is, is it reasonable to think that if all goes according to plan by the end of next year, all of the Viessmann dilutive shares could be taken back out of the float. Is that a reasonable bogey?"
},
{
"speaker": "David Gitlin",
"content": "Yes."
},
{
"speaker": "Tommy Moll",
"content": "Great. Thank you and I'll turn it back."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Tommy."
},
{
"speaker": "Operator",
"content": "And our next question comes from Jeff Hammond with KeyBanc. Your line is now open."
},
{
"speaker": "Jeffrey Hammond",
"content": "Hey, good morning guys."
},
{
"speaker": "David Gitlin",
"content": "Hey, Jeff. Good morning."
},
{
"speaker": "Jeffrey Hammond",
"content": "Hey, just wanted to come back to like the organic growth bridge in HVAC. A lot of good numbers, but maybe the whole is the weakness you're seeing in China and Europe. So maybe if you can bridge that and then just talk about what you see from a visibility in those markets going forward."
},
{
"speaker": "Patrick Goris",
"content": "Yes. If I look at the second quarter growth for HVAC, as I mentioned, I think in my comments, the Americas continued to do quite well with mid-single-digit growth. With the strongest growth there in light commercial and then in commercial HVAC. In EMEA, the growth is a little bit lower, and it's low-single-digits there. And then you have two phenomena: Commercial HVAC, also driven by data centers continues to grow pretty well, mid-teens year-over-year. And then residential and light commercial. And obviously, we see that more broadly in Europe. Residential and light commercial, where we have a business that counts towards organic is down mid-teens. And so that's kind of the dichotomy there in that region. And then Asia-Pacific, frankly is very much all about China, where China is down about mid-teens, and that's a reflection of what we see there in the broader market, including in residential and light commercial. So that's kind of an overview that of overall HVAC organic growth by region in Q2. And we expect that, of course, to pick up in the second half of the year. As we expect resi growth rates to pick up, we think the Americas will be up double-digits in the second half. EMEA and Asia-Pacific both expect to be up about high single digits in the second half of the year."
},
{
"speaker": "Operator",
"content": "Excuse me. It does look like that participant tend to last some want to move on to the next question."
},
{
"speaker": "David Gitlin",
"content": "We can move on."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andrew Obin with Bank of America. Your line is open."
},
{
"speaker": "Andrew Obin",
"content": "Hey, good morning."
},
{
"speaker": "David Gitlin",
"content": "Good morning, Andrew."
},
{
"speaker": "Andrew Obin",
"content": "Just a question. I mean, clearly, data centers are making an impact. Just can you just talk to us as a data center technology evolves, right? We're sort of hearing a lot that some technology changes, sort of air cooled versus water cool centrifugal versus scroll. Can you just sort of elaborate a little bit where do you think technology is going long-term? And what products do you have right now? And you talked about adding capacity, what are the products that you're targeting to add capacity in the data center vertical? Thank you."
},
{
"speaker": "David Gitlin",
"content": "Yes. For almost the entirety of the market, depending on -- regardless of what hyperscaler or colo you're talking about, we have the technology. We have a really broad range of offerings both on water cool in Europe and a little bit more on the air cooled side. But when you look at chillers, we have the technology, and we're adding capacity for both water cooled and air cooled in places like Charlotte and in Mexico to support the customers. I think longer term, what you're looking at is going to be the need for more liquid cooling. So we're in the middle of development for CDUs, coolant distribution units. We have a lot of the capabilities in-house to do many elements of the CDUs and also the air assisted liquid cooling units. We can do those as well. And we're offering some level of hybrid offerings between traditional and liquid cooling for customers today. And in terms of future direct to chip, we have partnership with STL, we have an investment. We're working closely with them. That's a really impressive startup that has a number of former Dell employees that we're working with. And we're also doing a lot of organic development in-house on liquid cooling. But liquid cooling is not a replacement, it's an and. And I think that combination is going to play right to our strengths."
},
{
"speaker": "Andrew Obin",
"content": "Thank you. And just from a regulatory standpoint, [indiscernible] is running out. Where are we in terms of sort of your customers still applying for funding before the deadline? And when do you think we're finally going to start running into tougher comps in education?"
},
{
"speaker": "David Gitlin",
"content": "Well, it's hard to say because as of right now, the funds need to be committed by September of this year, but there's still $40 billion remaining on $190 billion. So we do know that many have applied for extensions to that. And then the funding itself under the current legislation has to be spent by March of 2026. So we still have some time. And we know that there's 30 or so states that have applied for extensions to be able to spend that money well after March of 2026. So this has been a really strong vertical for us. We continue to see strength in orders. There's a lot of funding to be spent. Probably an extension on the front end and probably an extension on the back end."
},
{
"speaker": "Andrew Obin",
"content": "Great answer. Thank you so much."
},
{
"speaker": "David Gitlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from Brett Linzey with Mizuho. Your line is open."
},
{
"speaker": "Brett Linzey",
"content": "Hi, good morning all."
},
{
"speaker": "David Gitlin",
"content": "Good morning, Brett."
},
{
"speaker": "Brett Linzey",
"content": "I wanted to come back to pricing. So you're seeing some puts and takes in some of the metals trends, nonmaterial inflation probably still higher. Is there a need to go back out this year with price? Or are you pretty well set both in HVAC and the other businesses?"
},
{
"speaker": "Patrick Goris",
"content": "I think we're pretty much that they're part of our business where we do annual price increases. And if needed, we do more. That's more on the resi side. I don't expect anything there at this point this year. On different parts of the business like commercial HVAC, where they're really project-by-project, the pricing can be a little bit more dynamic. On the -- what you were mentioning on the commodities, obviously, we've seen copper run up a little bit earlier this year, but it's come down quite a bit. So still probably a few pennies of a headwind compared to prior guide, but we are absorbing that with other parts of our business."
},
{
"speaker": "Brett Linzey",
"content": "All right. Great. Got it. And then just thinking about the divestitures, I guess, as you guys look to disentangle these businesses upon close. Is there anything to think about in terms of stranded costs or excess that needs to get worked down? And then maybe what are some of the actions you're taking there?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. So you're absolutely right. And so we're very focused on ensuring we eliminate any of these stranded costs and you may recall that earlier this year, I think at the February call, we mentioned that we proactively executed an $80 million cost reduction program to get ahead of it. That is all happening. We're doing additional actions on top of that. Some of that, you see, of course, already reflected in our margins before some of these businesses exit, but it is absolutely our intention to ensure that our overhead structure is aligned with a simpler, more focused company that we're basically transforming into. It also means that G&A will be less than '24 and beyond than it was, say, in '20 and '21. And so the S maybe up, but the G&A, we expect to be lower, and that's where we're heading."
},
{
"speaker": "Brett Linzey",
"content": "All right. Best of luck."
},
{
"speaker": "Patrick Goris",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And the next question comes from Steve Tusa with JPMorgan. Your line is open."
},
{
"speaker": "Stephen Tusa",
"content": "Hey, good morning."
},
{
"speaker": "Patrick Goris",
"content": "Good morning, Steve."
},
{
"speaker": "David Gitlin",
"content": "Good morning, Steve."
},
{
"speaker": "Stephen Tusa",
"content": "Could we just get a little more info on -- so these resi orders are huge. How do you, A, I would assume July is looking pretty good as well. I've heard that the cutoff date kind of extended a bit into July. Maybe the cutoff date was June 30, I'm not sure. But maybe like what do you see from orders and sales perspective for resi in 3Q and 4Q given these like still pretty gigantic orders even without the preordering."
},
{
"speaker": "David Gitlin",
"content": "Yes. We don't have a cutoff date, Steve. So we haven't formally said that you can no longer order 410A past a certain date. What we did is we just asked our distributors, look, we got to get a sense of how you're thinking about how much 410A you want for the year. So please start giving us a sense of that. So I would tell you the orders surprised us. They worked very strong in 2Q, I think what we said is if you take out the orders that we got for 4Q that normally would have come later in 3Q, they were still up 60%. Now I will tell you that when we look at the second half of the year, we are very well booked for the second half of the year on the resi side. So if you look at the sales guide up high-single-digits, you're still looking -- we have an easy compare as we get into 4Q, but we still see very strong growth as we get into sales in 4Q, partly because of the order book, partly because the inventory levels out there are very low. They're down a little over 10% year-over-year. And it's nice to see sell-in, sell-out is about equal. So any kind of debate over destocking, we feel confident that's behind us. And I would say on the 454B side, the team has done a great job de-risking that. I would say by the end of the third quarter, we will have produced our first units for every single model that we have. So we've tried to get very much out in front of that, but there has been a lot of strength. I'm sure weather helped a bit, but very strength -- very good strength in orders here in 2Q."
},
{
"speaker": "Stephen Tusa",
"content": "So you said up high singles for the year for resi, basically and then we can kind of figure out the comps for 2Q and 3Q. Is that right?"
},
{
"speaker": "David Gitlin",
"content": "Yes. That's what we said for the year. It's much higher in 4Q year-over-year than in 3Q. It's probably very strong multi-double-digit growth in 4Q and probably high-single-digit in 3Q. But I would say, Steve, the high-single-digits, if it's not 8% or 9%, it could be 10%, it's kind of -- there's just a lot of strength in the system, and we're going to have to see how the second half plays out. But yes, as you said, July has been good."
},
{
"speaker": "Stephen Tusa",
"content": "And then just one on the data center stuff. What percentage now do you expect it to be a sales exiting the year? And where are we, do you think, in the continuum of like the pipeline you see building, like your orders are obviously up a lot. If the total is up that much. The orders are obviously up a lot -- how much is -- just give us context around the order growth versus the pipeline growth and the timing of those orders you expect to come out of the pipeline, like where are we in a baseball analogy, what inning are we in on that?"
},
{
"speaker": "David Gitlin",
"content": "Yes. Let me take the first one first, which is you can think about it, if you think about our new portfolio after we've completed our divestitures, overall commercial HVAC is about 25% of Carrier NewCo, and data centers are a little over 10% of that today. Next year, it's going to be closer to 15% on a higher base. So the absolute value, of course of data centers is increasing exponentially. If you look at orders this year, it's going to -- we have more orders for data centers through the first half than we had for all of last year. So our bookings have been very strong as we enter 2025, we should go into next year with an extremely strong backlog on commercial HVAC overall. It would be our -- next year would be our fifth year in a row of double-digit CHVAC growth, and a lot of that is coming from data centers. When I look at -- we get the question on how long can this continue? We're in the very, very early innings. I mean I think if you think about the hyperscalers, we've had some great wins, but we are currently bidding on a whole lot more. So I don't know if we're in the first or second inning, but it's certainly not the fourth. And the other very, very -- if you think out many years, the aftermarket is going to be significant. If you think about a typical building having three water cooled chillers in it, and now we may have data centers with 80, you think about failure is not an option. They can have no downtime. We're looking at really hyperscale type agreements with parts, with real-time monitoring, technicians on site. So we're thinking about solutions for our hyperscale customers that are very unique that should position us for growth for many years after the initial sales."
},
{
"speaker": "Stephen Tusa",
"content": "Great. Thanks a lot for the color."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Steve."
},
{
"speaker": "Operator",
"content": "And the next question comes from Sahil Manocha with RBC. Your line is now open."
},
{
"speaker": "Deane Dray",
"content": "Hey, good morning. Actually it's Deane Dray. And can I add my congrats to Sam?"
},
{
"speaker": "David Gitlin",
"content": "Yes. Thanks, Deane."
},
{
"speaker": "Deane Dray",
"content": "All right. Dave, a couple of moving pieces in the competitive landscape recently. You've got Bosch now as a competitor and Lennox announced saying this JV with Samsung with a focus on heat pumps. Any changes at the margin that you see competitively on these moves?"
},
{
"speaker": "David Gitlin",
"content": "No, all good competitors, and I don't see any material change to the landscape. Bosch buying JCI's business, Bosch is a great competitor. They're a rational competitor. So we don't see any concerns or issues there? And then in terms of the Lennox, Samsung partnership focus on [indiscernible] and heat pumps, that's a nice combination and both are great competitors. So we don't see a change there. I could tell you, I could not be more proud of our resi team. The margins have been great. The growth has been great. The share gains have been great, the new technology, de-risking the 454B transition, introducing differentiated products. So I love our team. I love the way they're performing, and we have great competitors, and I don't see any real change to that."
},
{
"speaker": "Deane Dray",
"content": "All good to hear there. And then any update on the mega projects, just kind of line of sight, bid activity, any color there would be helpful."
},
{
"speaker": "David Gitlin",
"content": "Yes. We talk a lot about data centers. But between the CHIPS Act and some of these mega projects, we're positioned very well there. I mentioned that dedicated program team. It's not just data centers. It also includes the mega projects. And so our sales force, we have dedicated folks focused on the hyperscalers, the colos and the mega projects. We've had some very important activity in the bid process with some major ones. We've had some key wins as well, and we'll continue at that one. And hopefully, more to announce there, but the team is working it very well."
},
{
"speaker": "Deane Dray",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "And our next question comes from Gautam Khanna with Cowen. Your line is open."
},
{
"speaker": "Gautam Khanna",
"content": "Hey, good morning."
},
{
"speaker": "David Gitlin",
"content": "Good morning."
},
{
"speaker": "Patrick Goris",
"content": "Hey, Gautam."
},
{
"speaker": "Gautam Khanna",
"content": "I had a couple of quick ones. First, any evidence of trade downs by consumers opting for repair over replacement, Lennox made a remark about that yesterday."
},
{
"speaker": "David Gitlin",
"content": "No, we have not seen -- we watch it super carefully, and we have not seen customers opting to repair instead of replaced, no real material trend there."
},
{
"speaker": "Gautam Khanna",
"content": "Okay. And maybe you covered this and I joined late, the VCS kind of maybe the components, what you're seeing between the various business lines you mentioned what's going on in Germany, but in the other product lines, just broadly outside of heat pumps, what you're seeing what are your expectations?"
},
{
"speaker": "David Gitlin",
"content": "Yes. I mean I think what we've been seeing is heat pumps has been down quite a bit year-over-year, if we look at 2Q, we start to see a recovery as we get into 4Q on heat pumps, but boilers has been down quite a bit, too, which has been a bit of surprising. I think the big one, which is probably kind of good news, bad news is that we don't want to see solar PV down, but that's been down the most. So that was down something like 60% in Q2, it's probably down around 40% for the full-year. And again, that comes with lower margins and things like heat pumps and boilers. So we're not thrilled about it, but we'd rather have that be down than some of the higher-margin heat pumps and boilers. Now the good news is that Thomas and the team have been driving mid-teen aftermarket growth, both in 1Q and 2Q. So I have to give that team credit. It's always easy to show leadership when you have huge market tailwind. Leadership really steps up when markets turn against you for a short period of time. And that's what we've seen. But Thomas has been in that team, controlling the controllables, driving aftermarket growth, taking costs out, revenue synergies, that will end up being in the hundreds of billions of dollar range. So the uniqueness of this combination are going to withstand the test of time. So is it the right company, the right market, the right combination to be sure, and we're taking the challenges we see in the market head-on this year. And we're going to be very poised for growth as we come out of this year. So we'll take our medicine this year and come out super strong next year."
},
{
"speaker": "Gautam Khanna",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Okay. And the last question comes from Damian Karas with UBS. Your line is now open."
},
{
"speaker": "Damian Karas",
"content": "Hey, good morning everyone."
},
{
"speaker": "David Gitlin",
"content": "Hey, Damian."
},
{
"speaker": "Damian Karas",
"content": "Just following up on some of the prior HVAC order comments. We had heard that one of your North American competitors was having some notable supply hiccups. So I was wondering if maybe you could just talk more broadly about any industry supply issues that are out there and to what extent that might be impacting the strong orders growth and the 120 basis points of share gains you called out?"
},
{
"speaker": "David Gitlin",
"content": "We hear anecdotal things as well. But I'd rather not talk about the competitors and just talk about our customers and our team, which is that our teams -- as I mentioned, we picked up about 120 bps over the last 12 months. Our goal is having the right products at the right price when they need, what they need. And I'm confident that if we continue to do the right thing for our customers, we'll continue to see outsized growth."
},
{
"speaker": "Damian Karas",
"content": "Terrific. Appreciate it. Thanks for your time."
},
{
"speaker": "David Gitlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "I would now like to turn the call back over to management for closing remarks."
},
{
"speaker": "David Gitlin",
"content": "Okay. Well, listen, thank you all for joining us this morning. We're very pleased with the first half of this year, we're positioned well for a strong second half. '24 is a really important year for us as a team as we finalize the transition of our portfolio, and we position ourselves for sustained growth and margin expansion for years to come. So we appreciate you joining us, Sam and the team, of course, are available for questions throughout the day. And thank you again for your confidence in us."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
carr | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to Carrier's First Quarter 2024 Earnings Conference Call."
},
{
"speaker": "",
"content": "I would like to introduce your host for today's conference, Sam Pearlstein, Vice President of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Samuel Pearlstein",
"content": "Thank you, and good morning, and welcome to Carrier's First Quarter 2024 Earnings Conference Call. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer."
},
{
"speaker": "",
"content": "We will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier's website at ir.carrier.com."
},
{
"speaker": "",
"content": "The company reminds listeners that the sales, earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties. Carrier's SEC filings, including Forms 10-K, 10-Q and 8-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. [Operator Instructions]"
},
{
"speaker": "",
"content": "With that, I'd like to turn the call over to our Chairman and CEO, Dave Gitlin."
},
{
"speaker": "David Gitlin",
"content": "Thank you, Sam, and good morning, everyone. We've had an exciting start to the year. We welcomed 12,000 new team members from Viessmann Climate Solutions to the Carrier family, made great progress on our business exits and delivered very strong financial results, positioning us for yet another year of significant margin expansion and solid growth."
},
{
"speaker": "",
"content": "Starting with the highlights of our strong first quarter results on Slide 3. On low-single-digit organic sales growth, we drove 280 basis points of adjusted margin expansion and 19% adjusted EPS growth. I am very proud of the team. We have made enormous progress on our lean journey and driving sustained productivity, and we are seeing it in our results."
},
{
"speaker": "",
"content": "Our formula is working, drive productivity tenaciously, simplify the business, reduce overhead, invest in growth, all while increasing margins. Our performance and transformation all tied to our clear North Star, to be the global leader in intelligent climate and energy solutions, and we are making great progress on our vision, as you see on Slide 4."
},
{
"speaker": "",
"content": "We provide our customers with differentiated sustainability solutions. For buildings, our North American small rooftop units have the highest efficiency in the market, with the smallest footprint. Our water cool chillers, with magnetic bearings, provide best-in-class efficiency with the ability to match cooling loads with variable demand during the course of the day."
},
{
"speaker": "",
"content": "For homes, Viessmann's newly launched heat pumps expand our addressable market in Europe by approximately $5 billion and in typical Viessmann fashion, deliver 15% to 25% energy savings versus competitors and are the quietest on the market."
},
{
"speaker": "",
"content": "For the cold chain, our new HE19 trailer reefer unit reduces fuel consumption by 30% compared to our previous offerings and by 10% compared to our competition. And our new OptimaLINE container unit consumes roughly 15% less energy than our competitors. Our digital strategy is also a critical enabler and differentiator."
},
{
"speaker": "",
"content": "For buildings, we now monitor more than 1.2 billion square feet through Abound, a 10% increase from last quarter, with additional key scale customers attracted to our new net zero features. For homes, Viessmann's One Base digital platform is the only home energy management system in the world that integrates space heating and cooling, water heating, solar PV with battery storage with a grid interface. Both Viessmann's One Base platform and our North American InteliSense platform enable early detection of potential malfunctions, with notifications to installers, helping address problems before they occur."
},
{
"speaker": "",
"content": "In the cold chain, we have recently introduced new capabilities to help optimize cooling and thus, reduce our customers' operating costs, helping us increase link subscriptions by 50% in just the past year."
},
{
"speaker": "",
"content": "In summary, we are very pleased with our clear traction as the Global Climate Champion, driven by technology and digital differentiation. We also remain very purposeful in driving aftermarket growth as you see on Slide 5."
},
{
"speaker": "",
"content": "In Q1, aftermarket was up 6%, led by another quarter of double-digit growth in commercial HVAC, and we remain on track for another year of double-digit growth. We now have about 75,000 chillers under a long-term agreement, about 35,000 of which are digitally connected. And our attachment rate reached its highest level ever, 48%. We also connected nearly 5,000 chillers, the highest in a quarter since our spin 4 years ago. The playbook works and our KPIs are consistent and cascaded globally, bringing focus and execution to this imperative."
},
{
"speaker": "",
"content": "We remain committed to our goal of $7 billion of aftermarket revenues by 2026. When we made this projection at our 2022 investor meeting, it assumed a high-single to low -- a high-single to low-double-digit CAGR. With our planned business exits and now the addition of Viessmann, we will divest about $500 million of net aftermarket sales. So to achieve the 2026 target of $7 billion, we now require a low-double-digit CAGR. We remain committed to this goal and are accelerating the deployment of our proven playbook to achieve it."
},
{
"speaker": "",
"content": "Turning to Slide 6. We could not be more proud of our combination with Viessmann Climate Solutions. Thomas Heim and his team have been all in on ensuring that our teams work as one, sharing best-of-best product technology, digital solutions, supply chain and operational opportunities and working seamlessly on multibrand, multichannel strategies globally. Viessmann Climate Solutions is a company built on excellence. This is a team that loves to win."
},
{
"speaker": "",
"content": "The opportunities to leverage its excellence in customer intimacy, product design, channel differentiation, brand strategy, sustainability solution, culture and talent development and operations will give Carrier a clear advantage to sustain differentiation and premier customer satisfaction."
},
{
"speaker": "",
"content": "We remain deeply confident in the long-term transition towards electrification and sustained growth in the market sustained growth in the market. With Germany aiming to become greenhouse gas neutral by 2045, and individual federal states like Bavaria as soon as 2040, discussions in major municipalities have started as to when the supply of natural gas to households will be limited or effectively stopped."
},
{
"speaker": "",
"content": "At the same time, 2 weeks ago, the EU adopted the Energy Performance of Buildings Directive, under which each member country must adopt its own plan to reduce building energy usage by 20% to 22% by 2035, with at least 55% of the reduction coming from renovations to the worst performing buildings."
},
{
"speaker": "",
"content": "While the long-term trend towards electrification remains robust, we are clear-eyed about the short-term market headwinds in the European residential market. Despite these headwinds, our team outperformed the end markets in Q1 through share gains, new product introductions, boiler sales and pricing. And our team is poised to continue doing so for the full year."
},
{
"speaker": "",
"content": "Viessmann's sales in Q1 were down 12% overall, more than half of which was driven by lower solar PV sales, which carry lower margins. For the full year, we now see VCS sales flat to down 5%, with Q2 revenues being similar to Q1 and an expected increase in the second half consistent with a typical seasonal pickup. Though heat pump orders in Q1 were down year-over-year, they were up nearly 60% sequentially and were the highest in the year. Despite 2024 sales expected to be lower than our February guide, we only see a modest impact to our full year adjusted EPS because the team is driving to offset reduced volume with increased productivity and synergies and favorable mix."
},
{
"speaker": "",
"content": "Cost synergies are tracking to about $75 million in 2024 and over $200 million by year 3. The cost actions position us for higher earnings conversion when the broader market recovers. We also remain very encouraged by revenue synergies, which we believe will be in the hundreds of millions of dollars. So we could not be more excited by the opportunities presented by this game-changing combination."
},
{
"speaker": "",
"content": "Let me shift gears and talk about the unique opportunity presented by data centers, as you see on Slide 7. Over the past 3 years, we've capitalized on this important opportunity by securing key wins with scale customers globally. The AI movement is driving hyper and sustained growth in this space, not only driving data center growth, but also an outsized opportunity for cooling providers, given that AI chips drive 7x the heat generation versus traditional chips. Today, AI makes up about 20% of the load of a typical data center, and some of our customers project that percentage to increase to 80% in the next few years, thus parting huge demand on the grid and increasing the need for differentiated HVAC and control solutions."
},
{
"speaker": "",
"content": "Accordingly, the data center market for the HVAC business is projected to increase from roughly $7 billion in 2023 to $15 billion to $20 billion in 2027. For us, this vertical represents a low double-digit percentage of our global commercial HVAC applied business, and we see a tremendous opportunity of increasing this segment to well over 20% of our commercial HVAC sales in the next few years."
},
{
"speaker": "",
"content": "We doubled our backlog in Q1 alone, and in April, secured further key wins as we optimize the use of our global footprint to support our customers."
},
{
"speaker": "",
"content": "Turning to our transformation updates on Slide 8. In addition to the Viessmann integration, our business exits also continue to progress well. We are moving with speed and maximizing shareholder value. In March, we announced a definitive agreement for the sale of industrial fire for $1.4 billion in gross proceeds. This deal is expected to close in early 3Q."
},
{
"speaker": "",
"content": "We now have definitive agreements for 3 of our 4 business exits and are within a couple of weeks of issuing or offering memorandum to prospective buyers for our residential and commercial fire business. We are targeting to close that deal by the end of this year."
},
{
"speaker": "",
"content": "We are focused, but not finished. The entire team remains extremely energized as we draw closer to becoming a higher growth, simpler, leaner pure-play climate champion. The pace of our transformation and the net proceeds put us on track to achieve about a 2x net leverage ratio this year and resume share repurchases in 2024."
},
{
"speaker": "",
"content": "With that, let me turn this over to Patrick. Patrick?"
},
{
"speaker": "Patrick Goris",
"content": "Thank you, Dave, and good morning, everyone. Please turn to Slide 9."
},
{
"speaker": "",
"content": "We had a good start to the year. Q1 earnings were well ahead of our expectations and the guide we provided in February. Reported sales of $6.2 billion were up 17%, with organic sales up 2% and a 15% net contribution from acquisitions and divestitures, substantially all Viessmann Climate Solutions. Q1 adjusted operating profit of $927 million was up 44% compared to last year, driven by favorable price and productivity and the contribution of Viessmann Climate Solutions, partially offset by investments. Strong price and productivity also drove adjusted operating margin expansion of 280 basis points compared to last year, despite the about 50 basis point dilutive impact from Viessmann."
},
{
"speaker": "",
"content": "Core earnings conversion, that is excluding the impact of acquisitions, divestitures and currency, was well over 100% in the quarter. Adjusted EPS of $0.62 was up 19% year-over-year and was well ahead of our Q1 guide of $0.50. March was particularly strong, representing 50% of Q1 earnings. Compared to last year, price and productivity more than offset the impact of increased investments and the expected $0.06 dilution from Viessmann Climate Solutions. We have included a year-over-year adjusted EPS bridge in the appendix on Slide 23."
},
{
"speaker": "",
"content": "Compared to our Q1 expectations, productivity came in stronger, and we benefited from the timing of a few items, including tax, amounting to about $0.05. Free cash outflow of $64 million was in line with typical seasonality and also reflects payments of M&A-related fees."
},
{
"speaker": "",
"content": "Moving on to the segment, starting on Slide 10. HVAC reported sales growth of 25% reflects the contribution of Viessmann Climate Solutions and 2% organic sales growth. Organic sales in the Americas were up mid-single digits, driven by continued strength in commercial and light commercial, each up around 20%. This was partially offset by a low-single-digit decline in resi."
},
{
"speaker": "",
"content": "North America resi volume was down mid-single digits, as we guided, and we expect volume to be up year-over-year in each of the remaining quarters. Organic sales in EMEA were down high-single digits, driven by significant weakness in resi light commercial, while commercial sales in EMEA remained strong and were up around 10%. Sales in Asia Pacific were flat, with growth in China, offsetting a decline in Japan as we continue to improve our mix in that country."
},
{
"speaker": "",
"content": "This segment had very strong quarter -- had a very strong quarter, with a 240-basis-point adjusted operating margin expansion due to price and strong productivity and despite the consolidation of Viessmann Climate Solutions that negatively impacted margin by about 80 basis points."
},
{
"speaker": "",
"content": "VCS earnings were broadly in line with our expectations, with favorable mix, productivity and synergies offsetting the impact of lower-than-expected sales. An excellent quarter for HVAC. And based on first quarter operational performance, we now expect 2024 full year HVAC segment margins to be up -- to be about 17.5%, up about 100 basis points compared to last year."
},
{
"speaker": "",
"content": "Transitioning to refrigeration on Slide 11. Both reported and organic sales were down 2%. Within transport, container was up over 50% year-over-year and global truck and trailer was down low teens, driven by North America truck and trailer which was down about 25%, reflecting overall demand and elevated field inventories."
},
{
"speaker": "",
"content": "As a reminder, North America truck and trailer was up over 40% in last year's Q1. European truck and trailer was flat, and Asia truck and trailer was up a strong 20%. Our Sensitech business, which provides solutions for tracking and monitoring performance at temperature was up mid-single digits. Commercial refrigeration was down low-single digits year-over-year. We now expect the refrigeration segment to be up low-single digits in 2024 organically."
},
{
"speaker": "",
"content": "Adjusted operating margin was down 120 basis points compared to last year. This was mainly due to the absence of a $24 million gain related to a sale in last year's first quarter. Excluding that gain, Q1 adjusted operating margins were up 150 basis points year-over-year, driven by price and productivity."
},
{
"speaker": "",
"content": "Moving on to Fire & Security on Slide 12. This segment had strong financial performance in the quarter. Reported sales were up 2%, with 7% organic sales growth, partially offset by a 5% headwind from the KFI deconsolidation. The residential and commercial fire business was up mid-single digits."
},
{
"speaker": "",
"content": "Adjusted operating profit was up over 50% versus the prior year, and adjusted operating margins were up a significant 610 basis points year-over-year as volume growth, strong productivity and currency more than offset the headwind of the KFI exit. Overall, a very good quarter for this segment."
},
{
"speaker": "",
"content": "Turning to Slide 13. Total company orders were down about 7% in the quarter, mostly driven by North America truck and trailer orders due to a tough compare. In Q1 of 2023, North America truck and trailer orders were up 50% year-over-year, 5-0. Excluding North America truck and trailer, Carrier's organic orders were flattish in Q1. Overall, HVAC orders were down between 0% and 5% in the quarter."
},
{
"speaker": "",
"content": "Within the Americas, commercial orders were up mid-single digits and North America resi orders had a second consecutive quarter of year-over-year growth. Light commercial orders were down roughly 35% as order rates are impacted by lead times and a tough compare. EMEA commercial orders were up almost 30%, with applied equipment orders up around 60%, including an over 45% increase in data center orders. Organic resi and light commercial order intake in EMEA remains very weak."
},
{
"speaker": "",
"content": "Within Asia, weak orders in Japan offset growth in other regions. Globally, commercial HVAC orders were up about 10%, and the backlog for that business continues to grow year-over-year and sequentially. Refrigeration orders were down about 25% to 30% in the quarter, mostly driven by the over 40% decline in global truck and trailer, reflecting the trends in North America, I mentioned earlier, along with growth in Europe and Asia. This was only partially offset by continued growth in orders in the container business, where orders were up high teens."
},
{
"speaker": "",
"content": "Orders in Fire & Security were flat. Turning to Slide 14, guidance. Compared to our prior guidance, the only change with respect to exits is that industrial fire is now included for the first half of the year. Our prior guide included a full year of industrial fire as no definitive agreement had been announced at that time. So all 3 announced exits, access solutions, commercial refrigeration, and industrial fire are now included for the first half only of our 2024 full year guidance. Taking that into account, we now expect reported full year sales of a little less than $26 billion."
},
{
"speaker": "",
"content": "Earlier business exit timing represents roughly $400 million of reduction and currency translation, another $100 million. Lower expected revenue at Viessmann Climate Solutions is roughly offset by expected upside in light commercial and commercial HVAC. The underlying organic growth rate in our guidance remains, therefore, unchanged at mid-single digits."
},
{
"speaker": "",
"content": "We are increasing our adjusted operating margin guidance to roughly 15.5%, driven by the strong earnings performance in Q1. We now expect full year earnings conversion to be north of 40%. Interest expense will be about $25 million lower, given the redeployment of the net proceeds from the industrial fire sale."
},
{
"speaker": "",
"content": "We are maintaining our adjusted EPS guidance range despite the earlier exit of industrial fire, which is a $0.05 headwind, given stronger performance in our core business. With the strong performance in Q1 and the exit of industrial fire in the second half, we now expect roughly 50% of full year adjusted EPS to be realized in the first half of the year."
},
{
"speaker": "",
"content": "Before I get to free cash flow, I'd like to remind you that proceeds from the sale of businesses are reflected in cash flow from investing, and therefore, do not impact free cash flow. However, the tax payments on the gains on the sale of businesses are reflected in cash flow from operations and therefore, do impact free cash flow. Whereas this, of course, does not impact overall cash performance for the company, it does impact our free cash flow metric."
},
{
"speaker": "",
"content": "Our free cash flow outlook is now $400 million, reflecting about $2 billion of tax payments on gains from the business exits and transaction-related costs. So no change in the $2.4 billion underlying free cash flow performance versus the prior guidance. The lower free cash flow outlook only reflects expected tax payments on the now announced industrial fire sale."
},
{
"speaker": "",
"content": "Moving on to Slide 15. Adjusted EPS guide to guide bridge. As you can see, our adjusted EPS guide at the midpoint remains $2.85, with stronger operational performance offsetting the $0.05 impact of the earlier exit of industrial fire and the impact of lower expected sales at Viessmann Climate Solutions. The darker blue represents the businesses we are retaining, including Viessmann Climate Solutions, whereas the lighter blue represents the adjusted EPS contribution from the businesses we are exiting."
},
{
"speaker": "",
"content": "At the midpoint of our new guidance, core adjusted EPS increases $0.05 compared to our February guide to $2.60. In the appendix on Slide 24, you will find a year-over-year adjusted EPS bridge at guidance midpoint."
},
{
"speaker": "",
"content": "Given the tremendous transformation in the portfolio this year, Slide 16 may be a helpful framework for 2025. We start with a baseline of $2.60 from the core business at the midpoint of our 2024 guidance. In addition to our double-digit adjusted EPS growth target from our value creation framework, we expect another half year benefit from deploying the proceeds of industrial fire towards debt reduction."
},
{
"speaker": "",
"content": "In addition to that, net proceeds from the exit of commercial and residential fire would be available for deployment, including for buybacks. Finally, an additional lever is 2024 and 2025 free cash flow funded share repurchases. All of this is consistent with our prior messaging that we intend to repurchase at least the equivalent 58.6 million shares issued to the Viessmann family, while maintaining a solid investment-grade credit rating. In short, we have several levers available to deliver meaningful adjusted EPS growth in 2025 and beyond."
},
{
"speaker": "",
"content": "With that, I'll turn it back over to Dave for Slide 17."
},
{
"speaker": "David Gitlin",
"content": "Thanks, Patrick. We delivered very strong results in the first quarter, and are confident that we will continue to perform while we transform. With the integration of Viessmann Climate Solutions, the completion of our exits and the superb progress on our base business, we continue to position ourselves as the global leader in intelligent climate and energy solutions."
},
{
"speaker": "",
"content": "And with that, we'll open this up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Julian Mitchell with Barclays."
},
{
"speaker": "Julian Mitchell",
"content": "In terms of, I guess, the first question, maybe on VCS, no surprise. You talked about sales down low-double digits in Q1 and sort of down low-single digits for the full year as a whole. Maybe help us understand sort of year-on-year, how we should think about the second quarter playing out within that? And then for the year as a whole, how much of that decline is driven by that solar PV business as opposed to the sort of core HVAC part of VCS?"
},
{
"speaker": "David Gitlin",
"content": "Sure, Julian. Let me start and Patrick can add. Well, we did say actually flat to down mid-single digits for the full year previously, of course, up mid-single digits. We expect for Q2 will be -- the absolute sales number should be about the same as Q1, which, in that case, would put Q2 year-over-year down about 10% to 15%. Our forecast assumes in the second half that revenue would be up about 20% compared to the first half."
},
{
"speaker": "",
"content": "So this would be typical seasonality. If that were to happen, that would cause us to be down about 5% for the year. If orders pick up and we see better than seasonality pick up in the second half, then we would get closer to flat. As we think about the full year, we still expect positive growth in heat pumps. That's probably up in the mid-single-digit range."
},
{
"speaker": "",
"content": "We do see boilers down probably in the low-double-digit range. You asked about solar PV, that's probably down more than 30% for the year, which, as we said, has lower margins. And Thomas and the team are doing a superb job with aftermarket. That was up mid-teens in the first quarter, and we think that will continue for the full year."
},
{
"speaker": "Julian Mitchell",
"content": "That's very helpful. And then just a quick follow-up on the HVAC segment. So I think, Patrick, you talked about the full year margins in HVAC being up about 100 points year-on-year. Is that kind of a similar year-on-year rate, we should expect each quarter for the balance of the year? And I just wondered if you made any changes to the assumptions within HVAC? I think you called out stronger growth assumed now for light and applied commercial HVAC?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. Overall, for the year compared to our earlier guide, we think light commercial and commercial HVAC will be a little bit better. In terms of the year-over-year margin for HVAC as a segment, we do expect Q2 to be up about 100 basis points year-over-year. Q3 will probably be somewhat similar, and then we expect Q4 to be better year-over-year as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jeffrey Sprague with Vertical Research Partners."
},
{
"speaker": "Jeffrey Sprague",
"content": "Dave, interesting to hear resi and commercial fire now prioritizing sale with kind of year-end close, right? So it sounds like you're close to something -- and so maybe you could address that? And is there something happening on PFAS to kind of expedite this and get it to kind of a sale process that can close? Obviously, we all saw JCI settled something in the MDL a couple of weeks ago."
},
{
"speaker": "David Gitlin",
"content": "Yes. Look, we feel that we've been progressing with PFAS very well. The Chapter 11 with KFI has gone exactly kind of as we expected and gone well. And we've been in mediation with the plaintiffs, and that's been progressing well. So we looked at the JCI. Of course, their settlement was for the water claims cases. It didn't cover PI. But I think in terms of us, we're very pleased overall with the progress that the legal team has been making on PFAS."
},
{
"speaker": "",
"content": "And then in terms of the sale of our residential and commercial fire business, we should be in the market with an offering memorandum probably in 2 weeks. The business is performing extremely well. The EBITDA this year is tracking higher -- much higher than it was last year, and it's progressing -- the business is performing well. And for a whole variety of reasons, we're prioritizing sell. We're not excluding the possibility of a public market exit, but we're prioritizing a sale. We should be in the market with the offering memorandum in a couple of weeks, and we're hoping to close by the end of this year."
},
{
"speaker": "Jeffrey Sprague",
"content": "Great. And the biggest question I get on Carrier actually maybe, hits a little close to home. But Dave, you have a recent kind of deal with the company incentive program and the like. Are you there for good? Is the door still cracked open to consider something else. Every other day, I get asked if you're going to Boeing."
},
{
"speaker": "David Gitlin",
"content": "Well, Jeff, frankly, I'm really glad you asked that because I do want to address it head on, and I want to be clear that look, I've notified both our Board and the Boeing Board that I am 100% committed to Carrier. I'm really honored to be on the Boeing Board. I'll do everything I can to support that important company as a Board member."
},
{
"speaker": "",
"content": "But given my commitment to Carrier, I've removed my name from consideration as a potential CEO of Boeing. And I'm not only committed to Carrier, I have to tell you, I'm so excited to be part of this journey. I mean rarely in your career, do you get to be part of such a transformational journey."
},
{
"speaker": "",
"content": "And I don't know what inning we're in, but we're in the early innings on what I think will go down as one of the biggest transformations ever, and I'm so excited to be on the journey with 70,000 or so team members at Carrier. So I'm staying put 100% committed to Carrier, and I do appreciate you asking that, Jeff."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andy Kaplowitz with Citigroup."
},
{
"speaker": "Andrew Kaplowitz",
"content": "You talked about data centers, low-double digits, global HVAC sales could be 20% over time. I think you said that data centers doubled this quarter in terms of backlog. So could you talk a little bit more about Carrier's position in the data center market? Maybe what you think your share is, where Carrier is in terms of liquid cooling and how to think about the shape of bookings going forward as '24 evolves? Do you see data center bookings continue to increase from what you booked in Q1?"
},
{
"speaker": "David Gitlin",
"content": "Yes. I think, frankly, we got some really good quarters, Andy, in just even a couple of weeks ago in April. So this is a unique moment in time. It's exponential. Today, I would say in the U.S. We have low share. This is both for water cooled and air cooled chillers, but we think we're incredibly well positioned from a technology perspective."
},
{
"speaker": "",
"content": "The key for us has not been technology. It's all been about expanding our capacity. So we're maxing out all of our facilities globally, and we're also going to be expanding our capabilities to support this in Mexico as well. So we -- our focus is making sure we're there for the -- all of our customers, especially some of the scale customers that are really leaning into this."
},
{
"speaker": "",
"content": "It's not like anything we've seen. In some cases, we sell a few water cool chillers at a time. And here, we're looking at selling hundreds in a single order. So we feel very well positioned. We see the growth being exponential. We've invested in liquid cooling. We made a VC-type investment in SLT, which is strategic thermal labs. So that's really positioning us for the liquid cooling space for direct-to-chip cooling, we're seeing strength globally. Probably 70% of our sales are in North America, but we've done extremely well, both in Asia and in Europe. And this is a market that we have a dedicated Tiger team strictly focused on this space because it is such a unique moment in time."
},
{
"speaker": "Andrew Kaplowitz",
"content": "Very helpful. And Dave, maybe give us just a little more color into the productivity you drove in Q1. And what you're thinking for the rest of the year? I know you've guided to 30% incrementals in pass, but obviously did 100% there. I obviously understand you raised your margin guidance. But how sustainable is the kind of productivity acceleration you saw in Q1? And given rising material costs, how do you think about sort of the offset there with pricing?"
},
{
"speaker": "David Gitlin",
"content": "Yes. I have to tell you that Adrian Button and operations team working with our businesses, it is the best that I have felt since I've been at Carrier about our ability to achieve sustained productivity. We have one single source of the truth. Every single one of our productivity actions globally is in one database. We can sort it 20 different ways. We all are marching to the beat of the same drum."
},
{
"speaker": "",
"content": "I would say materials is doing particularly well. That's probably 50% of our productivity. Logistics is still a tailwind. That's probably 10 or so percent, we're really taking out a lot of overhead, which is a significant piece. And the factories are now resuming to productivity after a couple of years of negative productivity."
},
{
"speaker": "",
"content": "So we're also coming into the year and every quarter with a lot more productivity spoken for. So I feel tremendous about the progress. Yes we've seen some copper headwind. Price is getting up to like $4.50, but we got a little bit of offset from steel and aluminum. So I think we're very -- we're probably about half hedged on copper for the year. So I feel very -- very, very well calibrated on the year on productivity and also calibrated as we go forward beyond this."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tommy Moll with Stephens Inc."
},
{
"speaker": "Thomas Moll",
"content": "Dave, I wanted to start with an update on A2L. What can you give us there in terms of when you plan to start or ramp production on the pricing front? Any revision or a reaffirmation of what you expect to capture over this year and next?"
},
{
"speaker": "",
"content": "And then if there's a bogey you want to throw out, one of your competitors in the U.S. did yesterday, just in terms of how much of the demand the new product might represent next year, that would be helpful as well."
},
{
"speaker": "David Gitlin",
"content": "Yes, I think, first of all, yes, we would reaffirm what we've said about 15% to 20% price increase over 2 years. I mean that includes low-double-digit base price increase, 454B versus the 410A. And then you'll get a few percent of base price this year and next year. So I know there's some skeptics on that. We're already selling the 454B units. We shipped our first in the first quarter. Obviously, it won't be that much over the short term. But we already have a price point in the marketplace for them. We feel confident in the 15% to 20% over 2 years."
},
{
"speaker": "",
"content": "I had previously said that we thought that about 20% of our mix this year would be 454B. I think it's going to be less than that. But to the extent we ship less 454B, I think that for us for the year will be offset by probably a little more prebuy than we thought on the 410A. So we feel good overall about this year calibrated at resi at the high-single digits. I saw what one of our peers said yesterday about the mix next year. I think it -- look, it's early to say. I think they were suggesting in the 60% range for 454B."
},
{
"speaker": "",
"content": "I think it will be more than that. I think you'll have some prebuy at the end of this year on the 410A, and that will cover into some percentage of the volume into 1Q, maybe a tiny bit into 2Q, but I think the bulk of the year will transition to 454B. So I don't know if it's in the 70% range, but it's -- I think it's a bit higher than 60%, but it remains to be seen."
},
{
"speaker": "Thomas Moll",
"content": "And Dave, a follow-up on light commercial HVAC trends in Americas. Orders were down meaningfully, but obviously on a tough comp. Can you just refresh us on your revenue expectation there this year and describe any aspect of the demand environment?"
},
{
"speaker": "David Gitlin",
"content": "It's hard to look at year-over-year quarters, yes. Quarters -- orders in the quarter were down significantly. We look more at how we're positioned for the year. I think that we had said that sales for light commercial would be down mid-single digits this year, which assumed volume down high-single digits. Given that our first quarter was up a little north of 20% on sales, and we still have good backlog."
},
{
"speaker": "",
"content": "Patrick said it. But I clearly think there's upside to that number. And there's still verticals that remain strong. You look at K-12, some of that value-based retail, some healthcare space like some of the urgent care centers, some of the quick-serve restaurants, they're still strong. So even though we expect year-over-year orders to decline, that base business remains very strong. And by the way, we keep -- we keep taking share and taking share of the right way based on technology differentiation. So still a good vertical for us. And again, I think, upside to our original guide on light commercial."
},
{
"speaker": "Operator",
"content": "Our next question comes from Deane Dray with RBC."
},
{
"speaker": "Deane Dray",
"content": "Just circle back on Viessmann. People were holding their breath about destocking. So just kind of where does that all shake out? And your line of sight on the resumption of the various European country incentives. I know you touched on that, in the prepared remarks. But what's the typical lag once the Germany reinstatates, Italy reinstates, I think they have done that already. But what's the typical lag between you start getting those orders?"
},
{
"speaker": "David Gitlin",
"content": "Well, look, I think in terms of the first piece. Because we're direct to installer, we don't see the same destocking that many of our peers do. So I think that the way we look at it is that piece is largely behind us. We're now back to traditional book and ship business."
},
{
"speaker": "",
"content": "So the significant backlog that existed -- like many of us, we saw the same thing in our U.S. resi business, you had just an untypical -- atypical high level of backlog a year, 1.5 years ago, that's now back to normal levels. When we look at what's kind of happening in Germany, and I think it's true in other countries that once the legislation gets promulgated, you do typically see and we're experiencing there's a bit of a lag between the subsidy definitization being finalized and new applications."
},
{
"speaker": "",
"content": "So the question is why would both boilers and heat pumps be down? I think that many customers in Germany know and throughout Europe know that, long term, you're going to transition to heat pumps. They wanted to make sure that the new legislation was going to stick and that there wouldn't be change. Obviously, the market is a little bit tight in Europe overall -- on the overall economy."
},
{
"speaker": "",
"content": "But now that the legislation is clearly firm, we do expect to see orders start to pick up. And what our expectation is orders start to pick up as we get into May and June that position us for the heating season as we get into September and October."
},
{
"speaker": "Deane Dray",
"content": "That's really helpful. And then one of the other questions that we get on the dynamics of the heat pumps in Europe as -- what about this threat of some of the Asian players coming in at a discount product? And would that matter? Would it take share -- and our view is that there's always been a good, better, best stratification of brands in HVAC, and Viessmann is at the high end. You rattled off some of the future comparisons. But just what -- is there a risk about new entrants into the European heat pump market?"
},
{
"speaker": "David Gitlin",
"content": "Well, I think you answered it perfectly well, Deane. I do think that Viessmann clearly plays in the premium end of the market. So I do think that even though there will be more competition at the entry tier level and the mid-tier, we think that because of the brand, the technology differentiation, the unique channel, we don't see that as a major threat directly to Viessmann."
},
{
"speaker": "",
"content": "I will add, by the way, that I was talking to the CEO of a major German company. And he was so impressed with the combination of Carrier and Viessmann Climate Solutions together, he said that if you look at German brands. If Viessmann is not #1, it's in the top 5 most respected brands in the country. And he was saying to me, kind of unsolicited how powerful this combination will be."
},
{
"speaker": "",
"content": "So we'll preserve the Viessmann brand at the very high end. We are introducing Carrier in the mid-tier range both for heating and for cooling. So we think that's a unique space. And of course, we have Toshiba. So yes, there will be some new entrants in the market, but we feel not only is Viessmann protected on the high end, but we're actually seeing a bit of price tailwind as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from Noah Kaye with Oppenheimer & Company."
},
{
"speaker": "Noah Kaye",
"content": "Dave, I'd like to stick with VCS. You highlighted early on the new product introductions, expanding the TAM by $5 billion. Would just love some more color on those product introductions. Curious to know to what extent they were developed in kind of any kind of synergy or technology road map coordination with legacy Carrier? And to what extent that's an opportunity going forward across the portfolio?"
},
{
"speaker": "David Gitlin",
"content": "Yes. Look, no, I wish I could take some form of credit, but this was done well before our watch. I mean this was Viessmann, over a period of time, developing products for the 16 to 19-kilowatt range, which is in that very high-end single-family home which is a new market for them, which they introduced in the first quarter. And here in the second quarter, they introduced 19 up to 40 kilowatts, which gets you into that small multifamily residential space. So very, very attractive new -- very attractive new product introductions. I mentioned this $5 billion TAM that they now position themselves for."
},
{
"speaker": "",
"content": "So again, it's one of the many reasons why you can see headline articles about heat pumps being down in Germany in the many tenth percentage range, while we'll be like flat or even heat pumps could be up for us this year. One of the reasons is the new TAM."
},
{
"speaker": "",
"content": "I will say, though, on the latter part of your question when it comes to revenue synergies, we are actively working on a whole bunch of technologies. And that's why I said that we could see revenue synergies in the hundreds of millions, and we put virtually zero in our business case. I think that's going to -- when we look back 5 years from now, I think we'll look and say that was one of the best upside to the business case that we saw."
},
{
"speaker": "",
"content": "Even in North America, Viessmann has just introduced -- traditionally in North America, Viessmann was a boiler sale company. They've just introduced an air-to-water heat pump for North America, which could be very attractive in places like New England and Canada and some other discrete locations. And we can leverage their technology with our channel to go really attack the market in the United States. So a lot of interesting upside there."
},
{
"speaker": "Noah Kaye",
"content": "Very interesting. And just on applied strength. I mean how much of this is just the data center story? How broad-based is it? Maybe you can talk on some of the other verticals where the demand just continues to sustain?"
},
{
"speaker": "David Gitlin",
"content": "Well, a lot of it is data centers. That's been very, very strong. Higher ed still remains strong. Healthcare, like hospitals, remains strong. When you look at it, it varies a little bit by region. We've seen some changes in China, for example. What was very strong in China was EV, solar production, all things renewables, that's now shifted in China. So we're now seeing strength in China from things like infrastructure and some of the other aspects of decarbonization."
},
{
"speaker": "",
"content": "So some of the areas of strength will move. Data centers is strong globally. And then what's frankly been strong other than some changes within China remains strong. And what's been weak like commercial office has generally remained weak."
},
{
"speaker": "Operator",
"content": "Our next question comes from Nigel Coe with Wolfe Research."
},
{
"speaker": "Nigel Coe",
"content": "I want to go back to the C&R fire sale. I've got to say we were expecting a capital markets transaction, Dave. So just wondering if you had some indication of interest for that asset that gives you confidence in that sale process? And maybe, Patrick, if you could maybe size that business, we've got $2 billion of revenues, about 10% EBITDA margin, maybe it sounds like it's having a good year. So maybe just give us a projection for 2024."
},
{
"speaker": "David Gitlin",
"content": "Yes. Look -- and Nigel, I mean you were expecting it because I said it. So very fair. So we've changed. We are 100% prioritizing a sale. We completed about, I think, a 15-page teaser. We've discussed that with a number of interested buyers. The interest has been very high. So we've been extremely pleased with the reaction because it's a great set of assets."
},
{
"speaker": "",
"content": "I mean you could see our Fire & Security business is performing very well. You're looking at Edwards very differentiated, GST very differentiated, Kidde very differentiated. You have a phenomenal set of brands that are uniquely positioned in their various spaces."
},
{
"speaker": "",
"content": "So we'll see exactly where it ends up, but I am very pleased with the level of interest thus far, and we'll send out our offering memorandum in 2 weeks, Patrick, on the financials?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, Nigel, you can think of that business being roughly $2 billion, I'm rounding. And the current run rate EBITDA is in about the mid-200s now. So much better, and so we're happy with the improvement we're seeing in that business."
},
{
"speaker": "Nigel Coe",
"content": "Okay. That's great color. And then back to VCS. I mean based on the comments, Patrick, you made about the dilutive impact on the segments, I'm backing into maybe a 14.5% operating margin, maybe 15.5% EBITDA margin. For the quarter, is that right? And I'm just wondering if that is correct, if my math isn't too wonky, what is the path to high teens for the full year?"
},
{
"speaker": "Patrick Goris",
"content": "Yes. So from an operating profit margin point of view, Nigel, you can think of Q1 being about 12.5%. And for the full year, again at the EBIT low it will be around 15%. Actually, we think maybe a little higher than that. So in line with the overall company average, but below the average for the HVAC segment. And that's at the EBIT level. And you can probably add a couple of points for that 2, 3 points to get to EBITDA."
},
{
"speaker": "Operator",
"content": "And our next question comes from Stephen Tusa with JPMorgan Chase & Company."
},
{
"speaker": "C. Stephen Tusa",
"content": "Just on that EBIT comment, that's EBITA, right, excluding the amortization when you say EBIT?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, that's right, Steve. We adjust out the intangible amortization and some of the step-ups as well."
},
{
"speaker": "C. Stephen Tusa",
"content": "Yes, you guys said, I think previously, you added a bunch to D&A versus the prior guidance. Is that just truing up some of the financials on Viessmann?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, Steve, you're right. In essence, at the time of the February guide, of course, we didn't have all the detail to provide the best accurate estimate of the DNA. And so inventory and backlog step-up was not yet fully included there. And also since then, we refined the difference between the intangibles and then the goodwill, and that impacts the amortization as well. So you can think of that being the new driver."
},
{
"speaker": "C. Stephen Tusa",
"content": "Got it. And then sorry, just on resi, just to follow up on the 454 A2L. Did you guys -- I think -- you guys are like -- at least we had heard your amongst the earlier movers on that. You already have a product in the channel, which is congratulations on that. That's definitely ahead of some of your peers."
},
{
"speaker": "",
"content": "Did you kind of -- have you been pivoting at all as far as evaluating the market and working the 410A product in there as the demand changes? Like how fluid is that situation? That's kind of the first question. And then just a very quick follow-up for Patrick. Can you just give us the price and inflation for the first quarter? And then just any updates on that for the year for the bridge?"
},
{
"speaker": "David Gitlin",
"content": "Yes. Let me -- yes, Steve, let me start on the A2L. Our strategy is to -- we did it with the SEER change. We're doing it with the A2L change, derisk everything, get way out in front. We don't want any technical producibility, capacity, any issues as we get into the end of this year. Our #1 priority is to support our customers to make this a seamless transition."
},
{
"speaker": "",
"content": "So we are getting way out in front, not only on shipping the product, but on training our dealers. We had 1,000 dealers -- over 1,000 dealers together last week. We had closer to 10,000 together for a discussion probably about 18 months ago. So we are getting all over in terms of the preparation."
},
{
"speaker": "",
"content": "And I do think that -- as I mentioned, I think it will be less than 20% A2L this year, probably a bit of prebuy on 410, but I do think it will be higher than that 60% that I know others mentioned for next year."
},
{
"speaker": "Patrick Goris",
"content": "Okay. And then Steve, following up on your questions about price. Price for the quarter was about 2%. For the overall company, we expect that to be about the same for the full year. So about half of our organic growth price."
},
{
"speaker": "",
"content": "In terms of price and net productivity combined, that includes the headwinds of material inflation, for example, that combined was about $200 million in Q1, and we expect that to be about $600 million for the full year in our current guidance."
},
{
"speaker": "Operator",
"content": "Our next question comes from Gautam Khanna with TD Cowen."
},
{
"speaker": "Gautam Khanna",
"content": "I was wondering if -- just talking about 2025 in that bridge, is the growth algorithm still kind of north of 10% earnings growth off of the adjusted base? If you could just talk through kind of your '25 expectations, given the bridge that you provided on what the remainco is and the like? Just off of what basis, if you will?"
},
{
"speaker": "Patrick Goris",
"content": "Right. So if you look at Slide 23 of the deck that we posted, our core business this year is up 12% -- or in Q1 was up 12%. For the full year, we expect our core business, including the dilution from Viessmann in year 1, the growth to be 17%. And our value creation framework says that we'd like to grow our business double digits every year."
},
{
"speaker": "",
"content": "So management, I think, would be very disappointed if our core business would not grow at least double-digit EPS in 2025. And on top of that, as you can see on that slide, there are the additional levers, redeploying net proceeds from industrial fire for half a year. That's going to be net -- that's going to be debt reducs, [indiscernible] for industrial and commercial fire. I mentioned earlier, run rate EBITDA of $250 million, you can assume a multiple on that and some tax leakage. That would be available for redeployment, including buybacks, plus free cash flow generated in 2024 and 2025 ex dividend, again, available for deployment, including buybacks. And so a long way of saying, we think there is significant earnings growth power available to us."
},
{
"speaker": "Gautam Khanna",
"content": "And what would your opinion of free cash conversion in '25 be off of that approximately $3 number?"
},
{
"speaker": "Patrick Goris",
"content": "We -- I haven't provided the $3 number, but whatever the number is, we target about 100% of net income."
},
{
"speaker": "Gautam Khanna",
"content": "And just a quick follow-up on resi. There's been a lot of chatter about repair versus replace and potential trading down. Have you seen any evidence of that? I know it's early in the cooling season, but any opinion on..."
},
{
"speaker": "David Gitlin",
"content": "Yes, sorry to interrupt. No, we have not seen any evidence of that. We ask that ourselves a lot, and we have not seen evidence of that."
},
{
"speaker": "Operator",
"content": "Our next question comes from Brett Linzey with Mizuho."
},
{
"speaker": "Brett Linzey",
"content": "I wanted to come back to light commercial. Obviously, it's been a source of strength for a few years here, orders did take a step down in the first quarter. But you did talk about the light commercial being a profit outperformer for the year. Maybe just some detail on the expectations on some of those moving pieces."
},
{
"speaker": "David Gitlin",
"content": "Yes. Look, I mean, it's a question we get because it's been so strong for so long. So -- last year, we were up 35%. We knew we'd have a tough comp coming in into this year. But I think it's a very nice combination of share gains, the underlying verticals that have been strong, generally remaining strong, the team performing. And of course, we don't talk about it as much, but we'll have the same 454B dynamic here, where we see the same kind of base price and mix increase that we're mentioning for resi, we see for light commercial. So that 15% to 20% over 2 years."
},
{
"speaker": "",
"content": "There won't be the same kind of prebuy. There might be a little bit on the small rooftop units, but -- so you would expect to see an even higher mix next year for 454B, which gives you a tailwind as you go into light commercial next year. And these verticals continue to be strong. So we think it will be slightly better than down mid-single digits this year, given more than 20% in the first quarter."
},
{
"speaker": "Brett Linzey",
"content": "Okay. Great. And then just shifting over to container up 50%. I guess is the worst behind us here? What are you hearing from some of those customers? And then anything on sort of the sequential trends through the -- in the last couple of quarters?"
},
{
"speaker": "David Gitlin",
"content": "Yes, I do think the worst is behind us, Brett. I mean we were up significantly in the fourth quarter. We were up about 50% in the first quarter. I think for the full year, it's probably up in the 30% range."
},
{
"speaker": "",
"content": "And then you look at -- the other thing that we've done, which is very important, is we've introduced a new digital platform for that space as well called Lynx, which instead of just being an equipment provider, we're now getting subscription-based recurring revenues. And we have 130,000 subscriptions for something that we just introduced a few years ago. So hats off to the team there as well. And that will help smooth some of the cycles in that business."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andrew Obin with Bank of America."
},
{
"speaker": "Andrew Obin",
"content": "Just a question on the buyback. You guys alluded that you have capacity to start the buyback in '24. How is it incorporated in your current outlook? Just trying to understand that? Or is that where the margin of safety comes for the guide?"
},
{
"speaker": "Patrick Goris",
"content": "Yes, Andrew, thank you for your question, and I'll provide some context on this. So since the acquisition, we paid down about $500 million in term loans in Q1. And the 3 exits that we have announced will yield about $5.5 billion in net proceeds. So that's our expectation. And what we communicated is that all of this will be used for deleveraging, although we may keep some as cash as it may be economically more attractive than just paying down some of the debt."
},
{
"speaker": "",
"content": "But excluding -- if I look at the buybacks for this year, we have not included them in our guide for the year. But given the timing of our free cash flow, generally, it would be second half weighted. And as you probably recall, our free cash flow tends to be very heavy in Q3 and in Q4. So not included in our guide. As we resume it in the second half of the year, there might be some benefit. I think the benefit will be much more meaningful in 2025 than it will be in 2024."
},
{
"speaker": "Andrew Obin",
"content": "And just a follow-up on Viessmann. What's your ability if -- for whatever reason, second half orders do not pick up as you expected, what's your ability to accelerate restructuring at Viessmann? Because I guess you guys kept the outlook for restructuring flat versus last quarter. Are you gated or limited in any way what you -- on the timing what you can do in Germany? Are there levers on cost at Viessmann that you can still pull in '24?"
},
{
"speaker": "David Gitlin",
"content": "Yes. Andrew, I have to say I've been so proud of Thomas and the team working with the central apps folks at Carrier to be incredibly and appropriately aggressive on cost. And if you look at the actions that Thomas has taken, what's been very important for that -- for our 12,000 new colleagues at Viessmann that fully understand this is it has nothing to do with the combination with Carrier. It's all actions that business would have taken because of the overall market conditions."
},
{
"speaker": "",
"content": "So they've been very aggressive on all elements of takeout of cost, not just on basic G&A, but they've been aggressive on materials, logistics costs, value engineering, which is part of the benefit and insourcing part of the benefit of coming together with Carrier. And they're going to continue to take cost."
},
{
"speaker": "",
"content": "So there's a lot of levers that, that business can and will pull to take costs out of the business. There are certain kind of natural limitations in the agreement that we had with them, but those are not things that are in any way going to affect the ability for that business to take the appropriate cost actions."
},
{
"speaker": "Andrew Obin",
"content": "So when you talk about cost synergies, that excludes whatever actions, as you have alluded, Viessmann would have taken these actions, regardless given the market conditions? Is that the fair point that there's $200 million by year 3, we have, but at the same time, Viessmann can accelerate internal cost control given the market conditions? Is that the right way to think about it? Sorry."
},
{
"speaker": "David Gitlin",
"content": "I think it's a fair description, Andrew. I -- look, I think cost synergies, we have a very specific definition we use. It's cost that's taken out because of the combination. So there's a bunch of examples of that where we both buy from the same supplier, and we have the ability to go renegotiate with those suppliers or the ability to get more work to certain suppliers."
},
{
"speaker": "",
"content": "We have a whole lot of value engineering between Toshiba, Carrier, GWA and Viessmann. So there's things that cost takeout that we can do because we're now part of the same family. We see it with some of our factory optimization. So yes, there's cost takeout that they're doing on their own, and then there's cost synergies on top of that."
},
{
"speaker": "",
"content": "Yes, thank you. And just to close it out, I want to end by thanking our customers who always support us and our team who is doing a phenomenal job. So thank you also to our investors. And as always, Sam will be available all day for questions. Thank you, all."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day."
}
] |
cat | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Welcome to the fourth quarter 2024 Caterpillar earnings conference call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Alex Kapper. Thank you, and please go ahead."
},
{
"speaker": "Alex Kapper",
"content": "Thank you Audra. Good morning everyone and welcome to Caterpillar’s fourth quarter 2024 earnings call. I’m Alex Kapper, Vice President-elect of Investor Relations. Joining me today are Jim Umpleby, Chairman and CEO; Andrew Bonfield, Chief Financial Officer; Kyle Epley, Senior Vice President of Global Finance Services Division; Ryan Fiedler, Vice President of IR; and Robert Rengel, Senior Director of IR. During our call, we’ll be discussing the fourth quarter earnings release we issued earlier today. You can find our slides, the news release and a webcast recap at investors.caterpillar.com under Events and Presentations. The content of this call is protected by U.S. and international copyright law. Any rebroadcast, retransmission, reproduction or distribution of all or part of this content without Caterpillar’s prior written permission is prohibited. Moving to Slide 2, during our call today, we’ll make forward-looking statements which are subject to risks and uncertainties. We’ll also make assumptions that could cause our actual results to be different than the information we’re sharing with you on this call. Please refer to our recent SEC filings and the forward-looking statements reminder in the news release for details on factors that individually or in aggregate could cause our actual results to vary materially from our forecast. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. On today’s call, we’ll also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate U.S. GAAP numbers, please see the appendix of the earnings call slides. Now let’s advance to Slide 3 and turn the call over to our Chairman and CEO, Jim Umpleby."
},
{
"speaker": "Jim Umpleby",
"content": "Thanks Alex. Good morning everyone. Thank you for joining us. As we close out 2024, I want to thank our global team for their strong execution in delivering another good year. Our results continued to reflect the benefit of the diversity of our end markets and the disciplined execution of our strategy for long term profitable growth. For the year, we delivered record adjusted profit per share and higher adjusted operating profit margin that exceeded the top of our target range. Although our top line decreased in the year, services revenue grew to a record level. We also generated ME&T free cash flow near the top of the target range. Our robust ME&T free cash flow along with our strong balance sheet allowed us to deploy over $10 million to shareholders through share repurchases and dividends during the year. I’ll begin with my perspectives about our performance in the quarter and for the full year. I’ll then provide some insights about our end markets followed by an update on our sustainability journey. For the fourth quarter, sales and revenues were down 5% versus last year, primarily due to lower sales volume. This was slightly below our expectations mainly due to services growing at a slightly slower rate than we expected and some delivery delays in energy and transportation. Services revenues did increase in the quarter compared to 2023. Stronger than expected machine sales to users drove a higher than anticipated dealer inventory reduction which offset each other, resulting in a minimal impact to sales. Fourth quarter adjusted operating profit margin was below our expectations at 18.3%, primarily due to lower volume and an unfavorable mix of products. We achieved quarterly adjusted profit per share of $5.14 and generated $3 billion of ME&T free cash flow. Since last quarter end, our backlog increased by $1.3 billion to $30 billion. For the full year, total sales and revenues were $64.8 billion, a decrease of 3% compared to 2023. Services revenues increased 4% to $24 billion. Adjusted operating profit margin of 20.7% exceeded the top end of the target range, as we expected, and represents a slight improvement from 2023. We achieved record adjusted profit per share in 2024 of $21.90, a 3% increase over 2023. In addition, we generated $9.4 billion of ME&T free cash flow, which was near the top of our target range, as we expected. Since 2019, we have generated approximately $40 billion of ME&T free cash flow, including $10.3 billion in 2024. Our strong and consistent ME&T free cash flow has allowed us to reduce the average number of shares outstanding by approximately 18% since the beginning of 2019. Turning to Slide 4, as I mentioned earlier, sales and revenues declined 5% in the fourth quarter to $16.2 billion. Compared to the fourth quarter of 2023, machine sales to users, which includes construction industries and resource industries, declined by 3% but was better than our expectations. Energy and transportation continued to grow as sales to users increased 2%. Sales to users in construction industries were down 3% year-over-year. In North America, sales to users were slightly lower, but better than we expected. Sales to users grew in residential construction, while non-residential was down slightly. Rental fleet loading was down but in line with expectations, as we described during our last earnings call. Dealers’ rental revenue continued to grow in the quarter. Sales to users declined in EAME and Asia Pacific in line with our expectations. Sales to users in Latin America continued to grow but at a lower rate than we expected. In resource industries, sales to users declined 3%, which was better than we expected. Mining was better than expected due to large mining and off-highway trucks being placed into service earlier than we anticipated. Heavy construction and coring aggregates were in line with expectations. In energy and transportation, sales to users increased by 2%. Power generation sales to users grew 27% as conditions remained favorable for both reciprocating engines and turbines and turbine-related services. Sales to users for reciprocating engines used in oil and gas applications declined primarily due to a challenging comparative to the fourth quarter of 2023. For solar turbines and turbine-related services, fourth quarter sales were down in oil and gas compared to strong shipments in the fourth quarter of 2023. Most of solar’s fourth quarter decline in oil and gas was offset by growth in power generation. Transportation sales to users increased, while industrial declined. Moving to dealer inventory and backlog, in total dealer inventory decreased by $1.3 billion versus the third quarter of 2024. For machines, dealer inventory decreased by $1.6 billion. The decrease was more than we had anticipated due to better than expected sales to users, particularly for construction industries in North America and resource industries. As I mentioned, backlog increased versus the third quarter to $30 billion, led by energy and transportation. This is a $2.5 billion increase versus 2023 year-end. Our backlog remains elevated as a percentage of revenues compared to historical levels. We continue to see strong order activity for both reciprocating engines and power generation and turbines and turbine-related services in both oil and gas and power generation. Turning to Slide 5, I’ll now provide full year highlights. In 2024, we generated sales and revenues of $64.8 billion, down 3% versus last year. This was due to lower sales volume partially offset by favorable price realization. Our adjusted operating profit margin was 20.7%, a 20 basis point increase over 2023 despite lower sales and revenues. Adjusted profit per share in 2024 was $21.90. As I mentioned, services revenue increased to $24 billion in 2024, a 4% increase over 2023. Services continued to grow as we focus on making our customers successful. Working with our dealers, we are leveraging over 1.5 million connected reporting assets and digital tools. Our Cat digital tools allow customers to more efficiently improve uptime, manage their fleets, and transact on our ecommerce platforms. For example, this year we launched an internal generative AI solution designed to optimize the creation of intelligent leads, which we call Prioritize Service Events, or PSEs. This tool significantly reduces the time and effort required for service recommendations, helping customers avoid unplanned downtime by clearly identifying the recommended repair options and timing for customers. In 2024, we delivered more than two-thirds of new equipment with a customer value agreement, which remains an important part of our services growth initiatives. We also experienced better than expected growth in our ecommerce platforms and have focused on improving our customer on-boarding to include key digital products. Also in 2024, we saw record usage of Vision Link, our equipment management application, on-boarding and activating thousands of new customers throughout the year. Services growth remains resilient despite the decline in our overall top line. We continued to execute our various services initiatives as we strive towards our aspirational target of $28 billion in services revenues. Moving to Slide 6, we generated robust ME&T free cash flow of $9.4 billion for the full year. We deployed $10.3 billion to shareholders through $7.7 billion of share repurchases and $2.6 billion of dividends paid. We remain proud of our dividend aristocrat status as we have paid higher annual dividends for 31 consecutive years. We continue to expect to return substantially all ME&T free cash flow to shareholders over time through dividends and share repurchases. Now on Slide 7, I’ll describe our expectations moving forward. Overall, we currently anticipate 2025 sales and revenues to be slightly lower compared to 2024. In 2025, we expect continued strength in energy and transportation to mostly offset lower sales in construction industries and resource industries. We also expect services revenues to grow in 2025, including growth across all three primary segments. We currently expect machine dealer inventory to end 2025 at similar levels to year-end 2024. Full year adjusted operating profit margin is expected to be lower than 2024, but it is anticipated to be in the top half of the target range based on the corresponding level of sales and revenues. Finally, we expect ME&T free cash flow to be in the top half of our target range of $5 billion to $10 billion. Now I’ll discuss our outlook for key end markets, starting with construction industries. In North America, we expect moderately lower sales to users in 2025 versus last year. Construction spend in North America remains healthy, primarily driven by large multi-year projects and government-related infrastructure investments supported by funding from the IIJA. Although we anticipate the combined non-residential and residential construction spend to remain similar to 2024 levels, our current planning assumptions reflect lower demand for new equipment. We also expect lower dealer rental fleet loading compared to 2024, although dealer revenue is expected to grow. Overall, we remain positive about the medium and longer term outlook in North America. In Asia Pacific outside of China, we expect soft economic conditions to continue into 2025. We anticipate China to remain at relatively low levels for the above-10 ton excavator industry. In EAME, we anticipate weak economic conditions in Europe will continue and a healthy level of construction activity in Africa and the Middle East. Construction activity in Latin America is expected to decline moderately. We also anticipate the ongoing benefit of our services initiatives will positively impact construction industries in 2025. Moving to resource industries, we anticipate lower sales to users in 2025 compared to last year, partially offset by higher services revenues including robust rebuild activity. Customers continue to display capital discipline, although key commodities remain above investment thresholds. Customer product utilization remains high. The number of parked trucks remains relatively low. The age of the fleet remains elevated and our autonomous solutions continue to see strong customer acceptance. We continue to believe the energy transition will support increased commodity demand over time, expanding our total addressable market and providing further opportunities for long term profitable growth. Moving to energy and transportation, demand is expected to remain strong in power generation, and we expect growth for both Cat reciprocating engines and solar turbines. Overall strength in power generation for both prime and backup power applications continues to be driven by increasing energy demand to support data center growth related to cloud computing and generative AI. Through continued focus on improving manufacturing efficiencies, along with initial stages of our investment to increase large engine output capacity, we expect growth in reciprocating engines for power generation in 2025. We also expect growth in solar turbines for power generation driven by increased customer demand. For oil and gas, after a flat year in 2024, we expect moderate growth in 2025. We expect reciprocating engines and services to be slightly down in 2025 due to continuing capital discipline by our customers, industry consolidation, and efficiency improvements in our customers’ operations. Solar turbines’ oil and gas backlog remains strong, and we see continued healthy order and inquiry activity. We expect growth for turbines and turbine-related services in oil and gas. Demand for our products in industrial applications is expected to remain at a relatively low level, similar to 2024. In transportation, we anticipate full year growth driven by rail services. Moving to Slide 8, I’ll now provide an update on our sustainability journey. Caterpillar’s legacy of sustainable innovation spans nearly a century. Throughout that time, we have provided products and services that improve the quality of life and the environment while helping customers fulfill society’s need for infrastructure in a sustainable way. Earlier this month, Caterpillar kicked off its year-long centennial celebration at CES 2025 with the theme, The Next Hundred Years: Experience What’s Possible. We showcased our continuous investment in the core technologies of autonomy, alternative fuels, connectivity and digital, and electrification. Our ability to provide these solutions reflects investments of more than $30 billion in R&D over the past 20 years to deliver best-in-class innovation. Taking center stage at the Caterpillar CES exhibit was a Cat 972 wheel loader retrofitted to be an extended range electrified machine hybrid technical demonstrator. The demonstrator can run fully battery electric with zero exhaust emissions for several hours. It has an on-board generator and charger that enables full day uptime without requiring an investment in direct current, or DC charging infrastructure. In initial testing, the demonstrator maintains or exceeds the performance of a Cat 972 internal combustion machine while providing customers with the benefits of a hybrid system. With that, I’ll turn it over to Andrew."
},
{
"speaker": "Andrew Bonfield",
"content": "Thank you Jim, and good morning everyone. I’ll begin with a summary of the fourth quarter and then provide more detailed comments, including some on the performance of the segments. Next, I’ll discuss the balance sheet and free cash flow before concluding with comments on our high level assumptions for 2025, as well as expectations for the first quarter. Beginning on Slide 9, sales and revenues were $16.2 billion, a 5% decrease versus the prior year. As Jim mentioned, sales were slightly lower than we had anticipated, which together with unfavorable mix resulted in lower than expected margins for the quarter. Adjusted operating profit was $3 billion and our adjusted operating profit margin was 18.3%. Profit per share was $5.78 in the fourth quarter compared to $5.28 in the fourth quarter of last year. Adjusted profit per share was $5.14 in the quarter, a 2% decrease compared to $5.23 last year. Adjusted profit per share excluded a discrete tax benefit of $0.46 for a tax law change related to currency translation. Mark to market gains of $0.23 for the re-measurement of pension and other post-employment plans was also excluded, in addition to restructuring costs of $0.05 in the quarter. Other income expense was $185 million favorable versus the prior year, mostly driven by a positive currency impact related to ME&T balance sheet translation, which compared to a negative impact in the fourth quarter last year. As I have mentioned previously, we do not anticipate currency translation movements, so the positive impact on the fourth quarter of 2024 helped to offset the impact of operating profit being lower than expected. Excluding discrete items, the provision for income taxes in the fourth quarter of 2024 reflected a global annual effective tax rate of 22.2%. This was slightly lower than we had expected a quarter ago and benefited the quarter by $0.09. Finally, the year-over-year impact from the reduction in the average number of shares outstanding, primarily due to share repurchases, resulted in a favorable impact on adjusted profit per share of approximately $0.24 as compared to the fourth quarter of 2023. Moving onto Slide 10, I’ll discuss the top line results for the fourth quarter. Sales and revenues decreased by 5% compared to the prior year, primarily impacted by lower sales volume. Price was unfavorable year-over-year and about in line with what we had expected. Lower volume was driven by the impact from changes in dealer inventories and a 2% year-over-year decrease in total sales to users. Total machine dealer inventory decreased by $1.6 billion in the quarter compared to $1.4 billion decrease in the prior year. The decrease in machine dealer inventory was larger than we had expected, and it’s mostly a function of higher than anticipated sales to users across both construction industries in North America and resource industries. Service revenues increased in the quarter compared to 2023. As I mentioned, the sales decrease in the quarter was slightly larger than we had anticipated. This was mostly due to services growing at a slightly slower rate than we had expected and some delivery delays in energy and transportation. Moving to operating profit on Slide 11, operating profit in the fourth quarter decreased by 7% to $2.9 billion. Adjusted operating profit decreased by 8% to $3 billion mainly due to the profit impact of lower than expected sales volume. As I mentioned, for the fourth quarter the adjusted operating profit margin was 18.3%, a 60 basis point decrease compared to the prior year. This was lower than we had anticipated mainly due to a lower than expected sales volume and the impact of unfavorable mix. On Slide 12, construction industry sales decreased by 8% in the fourth quarter to $6 billion. This was slightly below our expectations on lower than anticipated volume. Compared to the prior year, the 8% sales decrease was primarily due to unfavorable price realization and lower sales volume. The decrease in sales volume was mainly driven by lower sales of equipment to end users and dealers reducing their inventory by slightly more than they did during the fourth quarter of 2023. By region, construction industry sales in North America decreased by 14%. In Latin America, sales increased by 6%. Sales in the EAME region decreased by 1%, and Asia Pacific sales decreased by 2%. Fourth quarter profit for construction industries was $1.2 billion, a 24% decrease versus the prior year. This was primarily due to unfavorable price realization as a result of the impact of the post-sales merchandising programs that we discussed with you in October. The segment’s margin of 19.6% was a decrease of 390 basis points versus the prior year. The margin was lower than we had anticipated, primarily impacted by lower volume and unfavorable mix. Manufacturing costs were also unfavorable versus our expectations, principally due to a headwind from cost absorption as our inventory in construction industries declined. Turning to Slide 13, resource industry sales decreased by 9% in the fourth quarter to $3 billion. This was below our expectations mainly due to services growing at a slightly lower rate than we had anticipated. As we compare to the prior year, the 9% sales decrease was primarily due to lower sales volume mainly driven by the impact from changes in dealer inventories. Dealer inventory decreased more in the fourth quarter of 2024 than it did in the fourth quarter of 2023. Fourth quarter profit for resource industries decreased by 22% versus the prior year to $466 million. This was mainly due to the profit impact of lower sales volume. The segment’s margin of 15.7% was a decrease of 280 basis points versus the prior year. This was lower than we had anticipated, primarily due to lower volume. Now on Slide 14, energy and transportation sales of $7.6 billion were about flat versus the prior year. Sales were slightly below our expectations to a lower than expected services growth rate, largely in oil and gas, and the timing of deliveries of international locomotives. Compared to the prior year, sales were roughly flat as the impact of lower sales volume was mostly offset by favorable price realization. By application, power generation sales increased by 22%, transportation sales were lower by 1%, oil and gas sales decreased by 14%, and industrial sales decreased by 14%. Fourth quarter profit for energy and transportation increased by 3% versus the prior year to $1.5 billion. The increase was primarily due to favorable price realization partially offset by the profit impact of lower sales volume. The segment’s margin of 19.3% was an increase of 70 basis points versus the prior year. This was lower than we had anticipated, primarily due to lower than expected volume and an unfavorable mix of products. Moving to Slide 15, financial products revenues increased by 4% versus the prior year to about $1 billion, primarily due to higher average earning assets in North America and higher average financing rates across all regions, except North America. Segment profit decreased by 29% to $166 million. This was mainly due to an unfavorable impact from equities securities in addition to lower margin and a higher provision for credit losses. Our customers’ financial health remains strong. Past dues were 1.56% in the quarter, down 23 basis points versus the prior year and our lowest level since 2005. The allowance rate was 0.91%, remaining near historic lows. Business activity at Cat Financial remains healthy. Retail credit applications increased and our retail new business volume grew by 3% versus the prior year. This was our highest level since 2012, supported by attractive finance packages for customers choosing to buy Caterpillar equipment. We continue to see proportionately more of our sales financed through Cat Financial; in addition, demand for used equipment remains healthy and inventories remain at low levels. Conversion rates were above historical averages as customers choose to buy equipment at the end of their lease term. Moving onto Slide 16, we continue to generate strong ME&T free cash flow. The $9.4 billion in 2024 was near the top end of our target range and just slightly lower than the prior year despite a larger payment for short term incentive compensation and higher capital expenditure. CapEx for the year was about $2 billion, which was in line with our expectations. Moving to capital deployment, in 2024 we returned $10.3 billion to shareholders through repurchased stock and dividends. On share repurchases, we deployed $7.7 billion as we continue to fulfill our objective to be in the market on a more consistent basis. Our balance sheet remains strong with an enterprise cash balance of $6.9 billion. In addition, we hold $2 billion in slightly longer dated liquid marketable securities to improve yields on that cash. Now on Slide 17, let me start with a high level overview of our expectations for the full year. We expect a slight decrease in sales for 2025 with an unfavorable impact from both volume and price. Due to the impact of post-sales merchandising programs, price realization should account for about a 1% decrease in sales for the full year. On margins, the impact of price together with high depreciation costs due to the investments we are making should result in adjusted operating profit margins being in the top half of the target range with the expected level of sales, rather than being above the top end of the range, as occurred in 2024. Our margin targets are progressive, so while we would expect volume to have an impact on absolute margins, our target is adjusted for lower sales. We expect a slight headwind in other income and expense in 2025 primarily due to lower interest income, mostly due to lower interest rates, as well as the absence of the positive currency benefit from ME&T balance sheet translation that occurred in 2024. As I mentioned, we do not anticipate translation movements in our expectations. We expect restructuring costs of approximately $150 million to $200 million in 2025. We anticipate a global annual effective tax rate of 23% for 2025, excluding discrete items. While the impact of the share buyback should be positive, we expect to have less ME&T free cash flow to deploy in 2025. This implies a less favorable impact to profit per share in 2025 as compared to 2024. By segment, lower sales in construction industries and resource industries will be partially offset by sales growth in energy and transportation. For construction industries, we expect lower sales in 2025 based on the outlook Jim described and unfavorable price realization. In resource industries, we anticipate slightly lower sales versus 2024 driven by unfavorable price realization and slightly lower volume. Higher volumes and favorable price in energy and transportation should drive sales growth, though sales remain constrained until the benefits of the investments we are making in large engines begin to flow through beyond 2025. We also anticipate another year of services growth in each of our primary segments. Currently, we do not anticipate a significant change in dealer inventory in machines by the end of 2025. Moving onto ME&T free cash flow, we expect to be in the top half of our target range of $5 billion to $10 billion. The first quarter of 2025 will be impacted by a $1.4 billion cash outflow related to the payout of last year’s incentive compensation. We anticipate CapEx of about $2.5 billion in 2025 as we continue to make disciplined investments that are right for our business, governed by a focus on growing absolute OPACC [ph] dollars. This includes the multi-year capital investment to expand our large engine volume output capability that we mentioned last year. Turning to Slide 18, to assist with your modeling, I’ll provide some color on the first quarter, starting with the top line. We expect lower sales versus the prior year. For perspective, in a typical year we see our lowest sales in the first quarter of the year. In 2025, we anticipate that trend to continue to be more pronounced as sales in the first quarter should account for a lower percentage of full year sales than is typical by about 100 basis points. This decrease is mainly due to our expectations for dealer inventory movements and price, which primarily impacts machines. Energy and transportation is expected to show normal seasonality with sales growing throughout the year. Let me explain. Although dealers did reduce machine inventory significantly in the fourth quarter, they remain around the top end of the range as we enter 2025. This compares with dealer inventories in construction industries being towards the middle of the range at the beginning of 2024. As a result, we expect them to build correspondingly less inventory during the first quarter than the $1.1 billion that they built in the first quarter of 2024. As we expect dealer inventory to be about flat by year end, we should see a tailwind to sales in the fourth quarter as we don’t expect a similar machine dealer inventory change as we have seen in the last two years. We also expect unfavorable price realization for machines in the first quarter due to the impact of post-sales merchandising programs. We would expect these price impacts to be greater for machines in the first half of the year as the noticeable impact of post-sales merchandising programs started in the third quarter of 2024, making for an easier comparison in the second half. To pull together the impact by segment, we anticipate lower sales in construction industries in the first quarter, impacted by lower sales to users, the headwind from changes in dealer inventory and price, the impact of which should be similar to what we saw in the fourth quarter of 2024. In resource industries in the first quarter, we expect lower sales volume versus the prior year, impacted by lower volume and unfavorable price realization. In energy and transportation, we anticipate similar sales in the first quarter versus the prior year as continued strength in power generation is about offset by lower oil and gas and transportation sales. Price should be positive for energy and transportation. Now I’ll provide some color on first quarter margin expectations. Though enterprise margins are typically stronger in the first quarter compared to with the remaining quarters of the year, we do not expect this seasonal trend to occur in 2025. Compared to the prior year, we anticipate a lower enterprise adjusted operating profit margin in the first quarter due primarily to lower than usual volume and price. Volume is impacted by the lower build of machine dealer inventory and slightly lower sales to users for machines. Unfavorable price realization for machines is principally due to the factors I’ve discussed previously, which will be partially offset by favorable price in energy and transportation. We expect there will be improvement in first quarter margins offsetting the volume impact in the first quarter due to stronger volume in the fourth quarter than is typical. By segment, in the first quarter in construction industries, we anticipate lower margins compared to the prior year due primarily to lower volume and price. We do not expect to see the margin benefit we typically see in the first quarter of the year as compared to the fourth quarter of the prior year, which is generally in the range of 100 to 200 basis points. Again, some of this will be offset in the fourth quarter as volume is favorable and price more neutral. In resource industries, we anticipate lower margin in the first quarter compared to the prior year, mainly due to lower volume and unfavorable price realization. In energy and transportation, we expect slightly lower margin versus the prior year as favorable price realization is more than offset by higher manufacturing costs and unfavorable mix impacts. Again, as a reminder, this detail is provided to help you model the first quarter and does not impact our expectations for the full year that I set out earlier, which is a slight decrease in sales and revenues for the year and margins in the top half of the target range. Turning to Slide 19, let me summarize. Adjusted profit per share of $21.90 exceeded last year’s record by 3%. This was our third straight year with record adjusted profit per share. Adjusted operating profit margin of 20.7% exceeded the top of our target range. ME&T free cash flow of $9.4 billion was near the top of the target range of $5 billion to $10 billion. For 2025, while we expect a slight drop in sales, we expect to be in the top half of the adjusted operating profit margin range and the top half of the ME&T free cash flow target range, and we anticipate another year of services growth. We continue to execute our strategy for long term profitable growth, and with that, we’ll take your questions."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question and answer session. [Operator instructions] Your first question comes from the line of Steven Volkmann with Jefferies."
},
{
"speaker": "Steven Volkmann",
"content": "Hello, good morning everybody. I guess I’ll dive in, if I could since its timely, just Jim, how are you seeing the data center business now? There’s obviously some concern about what that’s going to look like longer term. I know you’re adding some capacity. Can you just discuss any changes in your view relative to data center demand?"
},
{
"speaker": "Jim Umpleby",
"content": "Yes, we continue to see strong demand for both our reciprocating engines and our gas turbines, just in conversations with customers. It’s really all about how quickly can you increase capacity for your reciprocating engines and how quickly can you get us our large gas turbines, so we’re very encouraged by what we see happening in the marketplace. Many customers are planning orders with us over multiple years to ensure that we can meet their needs, and as a reminder, we said that with the investments we’re making in our large reciprocating engines, we are expanding capacity by about 125% over 2023 - that will happen over the next several years, and with solar, we have a new product, the Titan 350. We’re very encouraged by the acceptance in the market that we’re seeing for that product, and of course a lot of it is being driven by data centers, so again still very, very positive from our perspective."
},
{
"speaker": "Steven Volkmann",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We’ll go next to Michael Feniger at Bank of America."
},
{
"speaker": "Andrew Bonfield",
"content": "Hi Michael."
},
{
"speaker": "Michael Feniger",
"content": "Morning guys. Thanks for taking my question. For dealers, to see the inventory, I think in 2023 machines built $700 million for the full year, ’24 inventory is down $700 million. I know you guys are thinking North America construction end user is down a little bit on ’25, so how do you get comfortable with where those dealer inventories are going to stay the same on the machine side, and did anything changed post election in terms of the views around inventories, because I think there were some comments that the retail sales end users was a little bit better than expected in terms of how it’s informing your view on ’25. Thanks everyone."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, so as you correctly point out, we did see a dealer inventory build for machines in 2023. Most of that, actually, was in resource industries rather than construction industries, and in fact most of the decline this year, year-over-year actually, is in resource industries rather than construction industries, so that’s part of the balance. As we know with resource industries, a lot of that is around timing of commissioning. We did see better than we expected commissioning in the fourth quarter which will have some impact on the first quarter of 2025, but that was a positive as dealers were able to deliver more machines to customers, particularly on the RI side. Overall on the CI side, based on our conversations--obviously we engage in conversations with dealers, dealers are independent businesses, they determine what level of inventory they hold, they base that on their expectations for the outlook for the markets. Obviously our expectation, based on what we’re seeing today is, as you know, that not all of our end markets are exactly in sync as we think about from a CI perspective, and based on our conversations, we don’t expect a material reduction in dealer inventory as we go through the year. Yes, we did see [indiscernible] were slightly better in North America than we expected in the fourth quarter - that is probably one of the first times we’ve actually seen that trend, and there may be some benefit from some of our post-sales merchandising programs, but we’re not calling that for 2025 yet. We still think that’s somewhere we need a lot of work still to be seen to make sure that we’re actually seeing that continue to flow through."
},
{
"speaker": "Operator",
"content": "We’ll move next to Rob Wertheimer at Melius Research."
},
{
"speaker": "Rob Wertheimer",
"content": "Hi, good morning and thank you. My question is on you have a large and diverse oil and gas business, and I’m wondering if you could characterize, especially if you will on gas compression, kind of where you think you are in the cycle. Obviously we’ve had Europe, we’ve had Russia, we’ve had lots of different demand shifting around, and there may be other growth areas - [indiscernible], etc. I just wonder if you could give a little bit of an outlook on oil and gas. Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yes, certainly. We are expecting moderate growth in 2025 for oil and gas in total. For recip, we expect engine services to be slightly down for the year, really driven by gas compression and well servicing. We did see some order pick-up in recip gas compression in late 2024. On the solar turbine side, very healthy backlog, healthy order intake and inquiry activity. We do expect growth in oil and gas in the year. We are seeing, to your specific question about gas compression, solar does have a--there’s a lot of activity around gas transmission, gas compression particularly in the United States - many pipeline customers are adding compression to existing pipelines, so again that business is quite strong, and a lot of quotation activity as well."
},
{
"speaker": "Rob Wertheimer",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We’ll go next to David Raso at Evercore ISI."
},
{
"speaker": "Andrew Bonfield",
"content": "Hi David."
},
{
"speaker": "David Raso",
"content": "Hi everybody, thanks for the time. I’m curious - obviously trying to think about margins for ’25 for the segments, and I was a little surprised by price cost being negative. The manufacturing cost had been a positive year-over-year, all of a sudden the comp gets harder, right - that’s why the fourth quarter wasn’t going to be as easy, but to see the cost up, I noticed you called out E&T, but does that imply CI and RI manufacturing costs were still a benefit year-over-year, and all the cost is in E&T? Maybe if you can just provide that kind of framework from the fourth quarter to how to think about full year ’25 price cost."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes David, if you recall, actually in my comments I did call out within CI negative absorption in the fourth quarter as we did reduce CI inventory, so manufacturing costs were also negative in CI. In E&T, most of that was a function, actually, of putting more labor in the factories to get more machines out the door, or more engines out the door at the end of the year, and that obviously reflects the demand we’re seeing. Obviously, remember that we are--you know, we are still trying to build up capacity particularly on the large engine side, and that really is what’s driving that in particular. On material costs, our expectations are that material costs will decline in 2025; however, there are some offsets within manufacturing costs which go the other way. Some of that relates to volume and absorption as a result of that, which means we don’t get the cost price offset that we’ve had in previous years. Most of that is the reason and the rationale by segment for that. So yes, material costs will be favorable but manufacturing costs will be broadly in line with our expectations. Remember also, other things come in, mix and so forth as well, and finally just one thing to remember, the depreciation I called out, actually most of that is within manufacturing costs as well."
},
{
"speaker": "Operator",
"content": "We’ll go next to Jerry Revich at Goldman Sachs."
},
{
"speaker": "Jerry Revich",
"content": "Yes, hi. Good morning everyone."
},
{
"speaker": "Andrew Bonfield",
"content": "Morning Jerry."
},
{
"speaker": "Jerry Revich",
"content": "Jim, Andrew, I’m wondering if you could just talk about your solar turbine lead times, and how are you thinking about potentially adding additional roofline capacity for turbines specifically? We’re hearing optimism on the Titan 350 from the customer base, and assuming what we saw earlier this week is a blip on the radar, I’m just wondering how are you thinking about capacity for that range of product."
},
{
"speaker": "Jim Umpleby",
"content": "Yes, as I mentioned earlier, we’re seeing strong backlog and strong inquiry and order activity for solar, for both power generation and gas compression. We can increase capacity without building new factories, since you used the roofline--mentioned the roofline in your question, so certainly there are things that we can do within our facilities. One is just increasingly manufacture, and you can do things like add an additional test cell to an existing facility, maybe add an engine build pit - things like that. One of the big issues, of course, is working with suppliers to ensure that we get enough components from suppliers, and of course just given the strength in the business, there’s a lot of companies out there working with those same suppliers, so that is--that can be a bit of a limiting factor. But in terms of actual investments required to increase capacity, based on what we see coming, we don’t see a need to build a brand-new factory or anything like that."
},
{
"speaker": "Operator",
"content": "We’ll move next to Chad Dillard at Bernstein."
},
{
"speaker": "Chad Dillard",
"content": "Hey, good morning guys. Thanks for taking my question."
},
{
"speaker": "Jim Umpleby",
"content": "Hi Chad."
},
{
"speaker": "Chad Dillard",
"content": "Hey, how are you? My question is on the ’25 operating profit guide. You’re guiding to the top end of the range for a given level of revenue for the full year. You’ve been guiding that way, I think for the last year and actually have been hitting it, so I guess what would give you--what do you think would drive you to bring that guide back to the midpoint - is it price cost normalizing, and in that same vein, how are you thinking about the evolution of price cost to ’25? When does that pressure peak and comps get easier?"
},
{
"speaker": "Jim Umpleby",
"content": "Maybe I’ll start and then I’ll kick it over to Andrew. Firstly, I believe what we said is we expect to be in that top half of the range for margins for 2025, and of course our key measure here for our team is to grow absolute OPACC dollars because we believe that mostly closely aligns with TS over time - of course, OPACC being operating capital after capital charge, so given the return on the capital that we invest, and so again a reminder, what we expect for 2025 is to be in the top half of the range. With that, I’ll turn it over to Andrew."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, and so on the price realization point, this really is relating to the post sales merchandising programs that we discussed a little bit in the third quarter. I’d remind you just that, as I explained in the third quarter, that will take about a year to flow through, and that relates to the fact that obviously in a world where demand is normalizing and supply is less constrained, obviously we make--we have merchandising programs to offer customers particularly things like buying down interest rates. As we’ve said before, that’s also an attractive option for us because obviously we get some margin benefit from that within Cat Financial over the term of the financing deal. What that does mean, though, and as you saw from the Cat Financial numbers, new business volume is very high - actually, their share is up, so effectively over time we’ll recover a little bit through Cat Financial but we will have some margin pressure in the short term from those, as those programs normalize. That mostly impacts machines, mostly impacts the first quarter--first and second quarters, first half of the year. Once we get past Q3, we’ll be past that, and actually then return probably much more to the normal evolution of price cost, which obviously we always try and work to make sure we can offset the two."
},
{
"speaker": "Operator",
"content": "We’ll move to our next question from Jamie Cook at Truist Securities."
},
{
"speaker": "Jamie Cook",
"content": "Hi, good morning. My question relates to E&T. I guess first, you called out delays in shipments, I think in the fourth quarter. Can you just give us color on that - you know, how big that was and when that hits in terms of 2025? Then I was also surprised just your top line growth wasn’t better in 2024, so how do we think about top line growth in 2025, any incremental capacity coming online and how that helps your top line? Just any color there on how much your, I guess, top line and E&T was constrained in 2025 because of lack of capacity. Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "I’ll answer the second part of the question first, and I’ll kick it to Andrew for the first part. As we’ve mentioned, we’re making that investment to increase our capacity in large reciprocating engines by 125% - that takes some time. I think we’ve talked about a four-year period to increase that capacity, so it does take time. We did not expect that to be complete and to have an impact on 2024, and that’s the case. We could in fact ship more if we could build more, but we’re working hard to increase that capacity."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, and as regards the fourth quarter, most of the impact, as I indicated in my comments, was relating to services, particularly in oil and gas. We’ll need to see how that pans out as we go through the first quarter. With regards to the OE side, most of that was international locomotives, and that should hit early in the first half of 2025; and overall, just to remind you, we do expect E&T sales growth in 2025."
},
{
"speaker": "Operator",
"content": "We’ll go next to Mig Dobre at Baird."
},
{
"speaker": "Mig Dobre",
"content": "Thank you, good morning. Andrew, just a very quick clarification on your comments for CI. At least as I heard it, as I understood it, the relative pressure that we’ll see in Q1 might be associated with this segment, so can you give us a sense for how you see this segment revenue and margin progressing sequentially, so relative to what you had in the fourth quarter? Thank you."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, so obviously normally what you would see in CI is a first quarter benefit on sales and revenues, mainly due to dealer inventory builds. The last couple of years, that’s been around a billion dollars. We expect that to be significantly less in the first quarter of this year. Correspondingly, we’ve actually seen quite a significant dealer inventory reduction in the fourth quarter - that will be a little bit less, so this is really just a non-operating--actually as we look at underlying sales to users, they will be pretty much in line throughout the whole of the year and will be down slightly for the full year, so that is the underlying characteristics on the top line. The other overlay is really around price. Price will impact the first half. Impact from price, as you saw in the--for CI in the fourth quarter was around $300 million. That will be the impact, the estimated impact on the first quarter; and obviously as we go through the rest of the year and particularly in the second half, the comps become easier and that will actually neutralize as we get into the second half. It’s really just--overall, just really a timing issue related to dealer inventory mostly and the timing of price. When you take those two things out, effectively sales to users should actually be broadly much the same, first half to second half. There is no demand change we’re expecting as we go through the year."
},
{
"speaker": "Operator",
"content": "Next we’ll move to Tami Zakaria at JP Morgan."
},
{
"speaker": "Tami Zakaria",
"content": "Hi, good morning. The order growth in the fourth quarter, I’m curious, how did construction and resources orders do sequentially in the quarter versus the third quarter? It seems like E&T was strong, but would love any directional commentary on the other two segments, if you’re able to provide."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, so Tami, overall E&T was the major driver. We did see some improvement in orders in resource industries particularly related to some large contracts that we’ve announced previously; and then in CI, it was broadly flat for the quarter year-over-year."
},
{
"speaker": "Operator",
"content": "We’ll go next to Tim Thein at Raymond James."
},
{
"speaker": "Tim Thein",
"content": "Thank you, good morning. Maybe Andrew, just back to the--you had mentioned within the commentary around CI, the issue of inventory absorption or the headwind from it. As you think about Cat more broadly, should we in an environment where the top line is slightly lower, should we think about that as a headwind more broadly for Cat as a whole in ’25, just given where inventory levels are for the company? Is that something we should be factoring in, in terms of that discussion around material cost, or is it less of a headwind as you think about the margin outlook? Thank you."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes Tim, thanks. I think, as I tried to indicate to David, there are other factors within manufacturing costs which go the other way - absorption will be one of them, slightly going against, obviously, because our intention would be effectively to reduce volume next year, which will impact our rate of absorption and potentially inventory as well. Inventory is a little bit of a more difficult subject. Just to remind you, we are a very large complex company, we have hundreds of products that we hold inventory for, and not all those products have exactly the same lead time. Some of the longer lead time projects are where we are strongest at the moment, things like solar and also large engines, and so some of those may actually continue to build inventory, where we may see some inventory trimming with CI, for example, with slightly lower volumes and also RI as we go through the year. It’s going to be a little bit of a mixed bag, but there may be some impact on absorption and that was built into the fact that obviously we’re not going to see favorability from material costs coming through, manufacturing cost added to the depreciation I talked about a moment ago as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from Angel Castillo at Morgan Stanley."
},
{
"speaker": "Angel Castillo",
"content": "Hi, good morning. Thanks for taking my question. Just wanted to maybe go into the competitive environment a little bit more as you think about the first quarter, continuing to see some of the flow through of the merchandise programs that you mentioned. I guess as we evolve into the second half, I get the comps getting easier. I guess maybe what gives you confidence, though, that the pricing and competitive environment doesn’t worsen, and maybe if you could overlay on that just any views on Trump policies and implications on construction activity in the U.S., and whether--you know, how you see that impacting demand overall."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, so on the merchandising programs, some of that is actually within our control. It’s not just--but obviously our focus is actually growing absolute OPACC dollars, remind you, so we don’t necessarily focus on margin per product. But obviously we’ll take that into account, and pricing takes into account the value we provide customers and a lot of other things. Obviously this is relating to--the price we’re talking about is relating to the merchandising programs, and we don’t expect those to change much from where we have them today. In fact, actually in a lower interest rate environment, actually they will become less of the total, so it may actually be the opposite if interest rates do start to fall as we go through the year, based on that buying down of interest rates."
},
{
"speaker": "Jim Umpleby",
"content": "Yes, and just in terms of the administration, certainly if the push for deregulation and other kinds of changes from a regulatory perspective helps increase economic growth, particularly in the United States, that should be a positive again. We’ll have to see how that all plays out, but that certainly has the potential to be positive for us."
},
{
"speaker": "Operator",
"content": "Next we’ll move to Kristen Owen at Oppenheimer."
},
{
"speaker": "Kristen Owen",
"content": "Morning, thank you for the question. I wanted to come back to the margin target guidance coming in at the upper half of the range. You did make some adjustments to that margin target when we were at the height of the supply chain dislocation. Just given the strong performance since then, the outlook even inclusive of that negative price impact, I’m wondering how we should think about this range? Is it still valid, or should we be actually thinking about an upward shift in that range over time? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yes, again as we think about 2025, we’re talking about being in the top half of that range, and so certainly for this year, we’re not anticipating changing it. Again, just as a reminder, as I mentioned earlier, our driver here is really absolute OPACC dollars, because that most closely, we believe, corresponds to increased TSR over time, and so what we try to do is give investors that guide to give you a sense of where we’ll be, and we make various investments to grow our business profitably for ’25. You know, we said we’ll be in the top half of the range, and as we always do, a year from now we’ll reassess and let you know what we think for 2026."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, and Kristen, just the other point to always remember is our margin targets are very progressive at the top end of the range. Margins have to--effectively margin is round about 40% at the top end of that target range, which is well above our average gross margin for our products across the whole, so it does require a lot of operating leverage. That is one of the reasons again why we took into account the fact that, while performance has been strong, we’re back in the range now and we still think that actually is a valid range to work with."
},
{
"speaker": "Operator",
"content": "We’ll go next to Steven Fisher at UBS."
},
{
"speaker": "Steven Fisher",
"content": "Thanks, good morning. I know it’s still very early to really understand exactly all the policies coming out of the administration, but wanted to ask a little bit about tariffs, if it hasn’t been asked already. Curious about how you’re thinking about contingency plans and strategies for managing tariffs on the products that you import from China into the U.S. I know generally you have a strategy of producing for local, but I think there’s maybe some products coming in from China. Just curious how you’re thinking about the contingency plans and strategies for that. Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yes, I’ll give that a shot. Certainly it’s going to take time to see how this plays out, there’s certainly a lot of discussions going on around tariffs, and we’ll have to see what actually gets put into place in the end. We are a global manufacturer but our largest manufacturing presence is in the United States, and we are a net exporter outside of the U.S., and that positions us pretty well versus many other companies out there. Having said that, as you say, we do tend to try to produce in region for region, but yes, some products and components particularly move around. But as you can imagine, it’s something we keep a close eye on and we’ll deal with it. We’ve been around 100 years and we’ve seen many different administrations with different attitudes on these issues, and we’ll deal with it. But again, the fact that we have such a large U.S. manufacturing presence, I think positions us pretty well."
},
{
"speaker": "Alex Kapper",
"content": "Audra, we have time for one more question."
},
{
"speaker": "Operator",
"content": "Today’s final question comes from the line of Kyle Menges from Citi."
},
{
"speaker": "Kyle Menges",
"content": "Thanks for taking the question. I was hoping if you could provide a little bit more color on what you’re seeing in RI. You talked about some order improvement in 4Q. How are customer conversations progressing and orders so far in 1Q, and maybe just talk a little bit about some of the pricing actions you’re taking in RI - I think you said it would be negative in 1Q, so would just love to hear some color on those items. Thanks."
},
{
"speaker": "Jim Umpleby",
"content": "You know certainly, as I mentioned earlier, our customers continue to display capital discipline, but we are encouraged by the fact that the key commodities that our products help our customers produce remain above investment thresholds, and some of the things we look at to get a gauge of what’s happening in the industry, we look at product utilization, the hours that are being put on our machines, and those are high. The number of parked trucks is relatively flow, and the age of the fleet is relatively elevated as well. Again, we’re continuing to invest in our autonomous solutions and we continue to see strong customer acceptance of that. If you stop and think about some of the things that are happening, we talked about data center build-outs and all the rest - I mean, again you think about commodities like copper, that should be a positive for that over time. Having said that, again our customers are displaying capital discipline in terms of price."
},
{
"speaker": "Andrew Bonfield",
"content": "We do expect some marginally negative impact in the first quarter, as we said, and that would be mostly due to the fact that obviously we are also putting merchandising programs particularly where we think about things like heavy construction, coring and aggregates are the major areas that will be affected there."
},
{
"speaker": "Jim Umpleby",
"content": "Okay, great. Well, I just want to thank everyone again for joining us. We always appreciate your questions. I’d like to once again thank our team for their strong performance in 2024, delivering record adjusted profit per share and strong ME&T free cash flow. We’ve been around 100 years, and so as we kick off our centennial year this year, we certainly remain committed to serving our customers. We’ll continue to execute our strategy and invest for long term profitable growth. With that, I’ll turn it over to Alex."
},
{
"speaker": "Alex Kapper",
"content": "Thank you Jim, Andrew and everyone who joined us today. A replay of our call will be available online later this morning. We’ll also post a transcript on our Investor Relations website as soon as it’s available. You’ll also find our fourth quarter results video with our CFO and the SEC filing with our sales to users data. Click on investors.caterpillar.com and then click on Financials to vie those materials. Finally, I’d like to thank Ryan for his support through our transition, and I wish him the best as he moves onto another role in Caterpillar. If you have any questions, please reach out to me or Rob Rengel. The Investor Relations general phone number is 309-675-4549. Now let’s turn it back to Audra to conclude our call."
},
{
"speaker": "Operator",
"content": "That concludes today’s call. Thank you for joining. You may all disconnect."
}
] |
cat | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Welcome to the Third Quarter 2024 Caterpillar Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Fiedler. Please go ahead."
},
{
"speaker": "Ryan Fiedler",
"content": "Thanks, Audra. Good morning, everyone, and welcome to Caterpillar's third quarter of 2024 earnings call. I'm Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim Umpleby, Chairman and CEO; Andrew Bonfield, Chief Financial Officer; Kyle Epley, Senior Vice President of the Global Finance Services Division; Alex Kapper, Vice President-Elect of IR; and Rob Rengel, Senior Director of IR. During our call, we'll be discussing the third quarter earnings release we issued earlier today. You can find our slides, the news release, and a webcast recap at investors.caterpillar.com under Events & Presentations. The content of this call is protected by US and international copyright law. Any rebroadcast, retransmission, reproduction or distribution of all or part of this content without Caterpillar's prior written permission is prohibited. Moving to Slide 2. During our call today, we'll make forward-looking statements, which are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to be different than the information we're sharing with you on this call. Please refer to our recent SEC filings and the forward-looking statements reminder in the news release for details on factors that, individually or in aggregate, could cause our actual results to vary materially from our forecast. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. On today's call, we'll also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate US GAAP numbers, please see the appendix of the earnings call slides. Now, let's turn to Slide 3 and turn the call over to our Chairman and CEO, Jim Umpleby."
},
{
"speaker": "Jim Umpleby",
"content": "Thanks, Ryan. Good morning, everyone. Thank you for joining us. As we close out the third quarter, I want to thank our global team for another good quarter as our results reflect the benefit of the diversity of our end markets. We delivered strong adjusted operating profit margin and adjusted profit per share, which were consistent with our expectations, although our top-line was lower than we anticipated. We also generated ME&T free cash flow of $2.7 billion in the third quarter. Our robust ME&T free cash flow, along with our strong balance sheet, allowed us to deploy over $9 billion to shareholders through share repurchases and dividends during the first three quarters of the year, including $1.5 billion this quarter. We continue to remain disciplined in the execution of our strategy for long-term profitable growth. I'll begin with my perspectives about our performance in the quarter and will provide an update on our full year expectations. I'll then provide some insights about our end markets, followed by an update on our strategy and sustainability journey. Moving to quarterly results. Sales and revenues were down 4% in the third quarter versus last year, below our expectations due to the impact of lower-than-expected sales to users in Construction Industries and timing of deliveries in Resource Industries and Energy & Transportation. Services increased in the quarter compared to 2023. Adjusted operating profit margin was generally in line with our expectations at 20%. We achieved quarterly adjusted profit per share of $5.17, in line with our expectations at the time of the last earnings call. In addition, our backlog increased slightly to $28.7 billion and remains at a very healthy level. For the full year, although we updated our expectations since our last earnings call to reflect sales being slightly below our prior estimate, our expected adjusted operating profit margin is unchanged and remains above the top of the range. Also, our expectation for adjusted profit per share is unchanged. We are increasing our expectations for ME&T free cash flow and now anticipate it will be near the top of our target range of $5 billion to $10 billion. Turning to Slide 4. In the third quarter of 2024, sales and revenues declined 4% to $16.1 billion due to lower sales volume. Compared to the third quarter of 2023, overall sales to users decreased 6%. For Machines, which includes Construction Industries and Resource Industries, sales to users declined by 10%, which was below our expectations. Energy & Transportation continued to grow as sales to users increased 5%. Sales to users in Construction Industries were down 7% year-over-year. In North America, sales to users were down primarily due to lower rental fleet loading and the absence of a large pipeline deal in the third quarter of 2023. Excluding these two items, sales to users were about flat versus the prior year. Compared to our expectations, sales to users were lower than expected, impacted by rental fleet loading. Our dealers' rental revenue continued to grow in the quarter. Sales to users declined in EAME, primarily due to ongoing weakness in construction activity in Europe. Sales to users in Asia Pacific declined, while Latin America increased. In Resource Industries, sales to users declined 18%, generally in line with our expectations versus a strong third quarter in 2023. Mining, as well as heavy construction, and quarry and aggregates were lower, mainly due to softness we previously discussed for two products, articulated trucks and off-highway trucks. In Energy & Transportation, sales to users increased by 5%, and we continue to see growth in all applications except industrial. Power generation sales to users grew strongly as market conditions remained favorable for both reciprocating engines and solar turbines and turbine-related services. Oil and gas sales to users benefited from strong sales of turbines and turbine-related services. For reciprocating engines in oil and gas applications, sales to users were higher for gas compression but lower in well servicing. Transportation sales to users increased, while industrial declined as we expected. Our results continue to reflect the benefit of the diversity of our end markets, as well as the disciplined execution of our strategy for long-term profitable growth. Moving to dealer inventory and our backlog. In total, dealer inventory increased by $400 million versus the second quarter of 2024. For Machines, dealer inventory increased by $100 million, slightly more than we had anticipated. Looking ahead to the fourth quarter, our current planning assumptions forecast a reduction in machine dealer inventory, and we expect machine dealer inventory to end the year around the same level as year-end 2023. Dealers are independent businesses and make stocking decisions across a wide range of products based on multiple factors across the product portfolio. While machine dealer inventory is currently around the top end of the typical range, we remain comfortable with the overall level of dealer inventory. As I mentioned, backlog increased slightly versus the second quarter to $28.7 billion. Energy & Transportation increased as we continue to see strong demand for solar turbines in oil and gas and power generation, as well as strong demand for reciprocating engines for power generation. Moving to Slide 5, we generated robust ME&T free cash flow of $2.7 billion in the third quarter and $6.4 billion in the first three quarters of 2024. As I mentioned, year-to-date, we deployed more than $9 billion to shareholders through share repurchases and dividends. We remain proud of our dividend aristocrat status and continue to expect to return substantially all ME&T free cash flow to shareholders over time through dividends and share repurchases. Now, on Slide 6, I'll describe our expectations for our three primary segments moving forward. In Construction Industries, we expect lower sales to users in the fourth quarter, but remain positive about the longer-term demand outlook. During our August earnings call, we noted a lower level of rental fleet loading in North America, which continued into the third quarter, and we now expect the trend to persist in the fourth quarter. Although we have lowered our expectations for sales to users in the fourth quarter, primarily due to lower rental fleet loading, dealer rental revenue continues to grow. In addition, government-related infrastructure projects are expected to remain healthy, supported by funding yet to be spent from the IIJA. In Asia Pacific, outside of China, we expect soft economic conditions to continue. We anticipate demand in China will remain at a relatively low level for the above 10-ton excavator industry. In EAME, we anticipate that weak economic conditions in Europe will continue, partially offset by continued healthy construction demand in the Middle East. Construction activity in Latin America remains healthy, and we are expecting modest growth to continue. In addition, we expect the ongoing benefit of our services initiatives will positively impact Construction Industries. Next, I'll discuss Resource Industries. After strong performance in 2023 in mining as well as heavy construction and quarry and aggregates, we continue to anticipate lower machine volume in the fourth quarter of 2024 versus last year. However, the rate of decline for sales to users in the fourth quarter is expected to moderate versus the previous quarters. We expect to see higher services revenues, including robust rebuild activity. Customer product utilization remains high, the number of parked trucks remains relatively low, the age of the fleet remains elevated, and our autonomous solutions continue to see strong customer acceptance. Customers continue to display capital discipline. However, we continue to believe the energy transition will support increased commodity demand over time, expanding our total addressable market and providing further opportunities for long-term profitable growth. Moving to Energy & Transportation. For power generation, demand is expected to remain strong, and we expect robust growth in the fourth quarter and full year sales for both reciprocating engines and solar turbines. Overall strength in power generation continues to be driven by data center growth related to cloud computing and generative AI, and we expect this trend to continue. In oil and gas, in total, we continue to expect a stronger year overall in 2024 versus 2023. For solar turbines used in oil and gas applications, we expect a strong fourth quarter, but sales are expected to be lower than the fourth quarter of 2023 due to the timing of deliveries. The increase in power generation at solar will mostly offset solar's decline in oil and gas, so we expect solar's total sales in the fourth quarter to be roughly flat compared to last year. Solar has a strong backlog as well as healthy order and inquiry activity, and we continue to expect full year growth for solar in oil and gas. After a strong 2023, we expect reciprocating engine sales in oil and gas to be slightly down this year, primarily due to ongoing softness in well servicing. We still expect gas compression to be up for the full year. However, we expect it to soften in the near term as equipment lead times have normalized. As we had previously mentioned, we can leverage our large engine platforms across a variety of applications. Based on current market conditions and well servicing applications, we are able to serve additional power generation demand as we continue to meet oil and gas customer needs while optimizing our overall large engine capacity. Industrial demand has continued to remain at a relatively low level compared to 2023. In transportation, we anticipate full year growth in both rail services and marine applications. Moving to Slide 7, now, I'll provide an update on our strategy and sustainability journey. In February of 2024, we announced a multiyear capital investment in our large reciprocating engine division to approximately double output capability compared to 2023 for new engines and aftermarket parts. Based on increasing expectations of future demand growth, today, we are announcing an additional multiyear investment to further expand our large engine volume output capability to more than 125% compared to 2023. As I mentioned, we leverage these large engines across a variety of applications, including data centers, oil and gas, large mining trucks, and distributed power generation. Moving on to sustainability. We continue to invest in new product, technologies and services to help our customers achieve their climate-related objectives. In September, we unveiled an innovative solution to help solve one of the most complex aspects of the mining industry's energy transition, energy management. Cat Dynamic Energy Transfer, or DET, is a fully Caterpillar developed system that can transfer energy to both diesel electric and battery electric large mining trucks while they are working around them on-site. It can also charge batteries while operating with increased speed on grade, improving operational efficiency and machine uptime. Cat DET is comprised of a series of integrated elements, including a power module that converts energy from a mine site's power source, an electrified rail system to transmit the energy, and a machine system to transfer the energy to the truck's powertrain. Cat DET will integrate with the Cat MineStar Command for hauling solution, merging autonomy and electrification technologies to provide a holistic site solution. We believe mine sites will benefit from enhanced efficiency with the integration of electrification and automation. When combined, these technologies will help miners achieve production targets, while simultaneously managing energy demands. This example highlights how we leverage our industry-leading technology through an integrated approach across our portfolio to help our customers build a better, more sustainable world. With that, I'll turn it over to Andrew."
},
{
"speaker": "Andrew Bonfield",
"content": "Thank you, Jim, and good morning, everyone. As usual, I'll begin with a high-level summary of the third quarter, and then provide more detailed comments, including the performance of the segments. I'll then, discuss the balance sheet and free cash flow, before concluding with comments on our assumptions for the full year and the fourth quarter. Beginning on Slide 8, although sales and revenues were lower than we had expected, our adjusted operating profit margin was 20.0%, generally in line with what we had anticipated. Adjusted profit per share was in line with our expectations despite adjusted operating profit being impacted by the lower sales and revenues. I will highlight a few of the moving parts in a moment. As Jim mentioned, our full year margin expectations remain unchanged, and we continue to anticipate the adjusted operating profit margin will be above the top end of the target range despite the slightly lower outlook for the top-line. Our expectations for adjusted profit per share remain unchanged versus our expectations at the time of our last earnings call. Also, we have increased our expectations for ME&T free cash flow for the year, which we now anticipate will be near the top of our $5 billion to $10 billion target range. In the third quarter, sales and revenues of $16.1 billion decreased by 4% compared to the prior year. The adjusted operating profit margin of 20.0% was 80 basis points lower when compared to the prior year. Profit per share was $5.06 in the third quarter compared to $5.45 in the third quarter of last year. Restructuring costs were $0.11 in the quarter versus $0.07 in the prior year. Adjusted profit per share was $5.17 in the quarter compared to $5.52 last year. Other income and expense was $119 million headwind versus the prior year, mostly driven by an unfavorable currency impact related to ME&T balance sheet translation. We do not forecast the impact of foreign currency translation on our adjusted profit per share, so this acted as a headwind compared to our expectations for the quarter. Excluding discrete items, the provision for income taxes in the third quarter in both 2023 and 2024 reflected a global annual effective tax rate of 22.5%. We recorded a discrete tax benefit, which had an $0.11 favorable impact within the quarter. We do not anticipate discrete items. Finally, the year-over-year impact from the reduction in the average number of shares outstanding, primarily due to share repurchases, resulted in a favorable impact on adjusted profit per share of approximately $0.26 as compared to the third quarter 2023. This was slightly better than we had expected. Moving to Slide 9, I'll discuss our top-line results for the third quarter. Sales and revenues decreased by 4% compared to the prior year, primarily impacted by lower sales volume as a result of lower sales to users and impacts from changes in dealer inventories. Total sales to users decreased by 6% as a 10% decrease from Machines was partially offset by a 5% increase for Energy & Transportation. The impact from changes in total dealer inventories acted as a sales headwind of about $200 million in the quarter. For Machines-only, dealer inventory increased by about $100 million, a smaller increase than the $400 million increase in the prior year, but slightly above our expectations of being flattish to slightly lower. Service revenues increased versus the prior year, as we had anticipated. Moving to operating profit on Slide 10. Operating profit in the third quarter decreased by 9% to $3.1 billion. Adjusted operating profit decreased by 8% to $3.2 billion, mainly due to the impact of lower sales volume, partially offset by favorable price realization and manufacturing costs. Since early 2022, price realization has been a strong -- has been strong and often exceeded our expectations. Over the past several quarters, we have highlighted that price will begin to moderate in the second half of this year. In the third quarter, this moderation began to occur as price realization was lower than previous quarters and generally in line with our expectations. As I mentioned, for the third quarter, the adjusted operating profit margin was 20.0%, which was generally in line with our expectations. By segment, margin in Construction Industries and Resource Industries was slightly below our expectations on lower volume, while Energy & Transportation was about in line. Financial products had a slightly stronger quarter than we had expected. On Slide 11, Construction Industries sales decreased by 9% in the third quarter to $6.3 billion, slightly below our expectations. The decrease versus the prior year was primarily due to lower sales volume and unfavorable price realization. The decrease in sales volume was mainly driven by lower sales of equipment to end users. Changes in dealer inventories also acted as a slight headwind to sales. By region, Construction Industries sales in North America decreased by 11%; in Latin America, sales increased by 19%; sales in the EAME region decreased by 15%; in Asia Pacific, sales declined by 12%. Third quarter profit for Construction Industries was $1.5 billion, a 20% decrease versus the prior year. This is mainly due to the profit impact of lower sales volume and unfavorable price realization. The segment's margin of 23.4% was a decrease of 300 basis points versus the prior year. Turning to Slide 12, Resource Industries sales decreased by 10% in the third quarter to $3.0 billion, which was slightly point below our expectations. The decline versus the prior year was primarily due to lower sales volume, mainly driven by lower sales of equipment to end users given a challenging comparison to the prior year. Third quarter profit for Resource Industries decreased by 15% versus the prior year to $619 million. This was mainly due to the profit impact of lower sales volume. The segment's margin of 20.4% was a decrease of 140 basis points versus the prior year. Now, on Slide 13, Energy & Transportation sales increased by 5% in the third quarter to $7.2 billion, slightly lower than we had expected, driven by the timing of deliveries. The increase versus the prior year was primarily due to favorable price realization and higher sales volume, including higher intersegment sales. By application, power generation sales increased by 26%, transportation sales were higher by 3%, oil and gas sales decreased by 1%, and industrial sales decreased by 16%. Third quarter profit for Energy & Transportation increased by 21% versus the prior year to $1.4 billion. The increase was mainly due to favorable price realization. The segment's margin of 19.9% was an increase of 270 basis points versus the prior year. Moving to Slide 14, financial products revenues increased by 6% to about $1 billion, primarily due to higher average earning assets driven by North America and higher average financing rates across all regions. Segment profit increased by 21% to $246 million. This is mainly due to a favorable impact from equity securities and a lower provision for credit losses. Our customers' financial health is strong. Past dues remain near historic lows of 1.74% in the quarter, down 22 basis points versus the prior year. Our allowance rate was 0.87%, our lowest on record. Business activity at Cat Financial remains healthy. Our retail new business volume increased by 17% versus the prior year, supported by our financing packages for customers choosing to buy Caterpillar equipment. Though Caterpillar's retail machine sales volume was lower, proportionately more sales have been financed through Cat Financial, which highlights the attractiveness of the financing options we are offering to our customers. We also continue to see healthy demand for used equipment and inventories remain at low levels. Conversion rates are also strong as customers choose to buy equipment at the end of their lease term. Moving on to Slide 15, we generated about $2.7 billion in ME&T free cash flow in the third quarter and deployed about $1.5 billion in share repurchases and dividends. Our balance sheet remains strong with an enterprise cash balance of $5.6 billion. In addition, we hold $1.8 billion in slightly longer dated liquid marketable securities to improve yields on that cash. Now, on Slide 16, I will share our high-level assumptions for the full year. For the full year, we have updated our outlook to reflect sales and revenues that are slightly lower than our expectations at the time of our last earnings call, driven by lower-than-expected third quarter sales and an update to our expectations for dealer rental fleet loading in Construction Industries. We continue to anticipate services growth in 2024. As I mentioned earlier, our full year expectations for adjusted operating profit margin and adjusted profit per share remain unchanged compared to our last earnings call. We continue to expect adjusted operating profit margin to be above the top end of the target range. In addition, we are increasing our expectations for ME&T free cash flow for the year, which we now anticipate to be near the top of our $5 billion to $10 billion target range. To assist you with your modeling for the full year, we now anticipate CapEx of around $2 billion and restructuring costs of approximately $400 million. Our expectation for the global annual effective tax rate, excluding discrete items, remains at 22.5%. Turning to Slide 17, I'll provide a few comments on the fourth quarter, starting with the top-line. We expect slightly lower sales and revenues in the fourth quarter compared to the prior year, impacted by lower machine sales to users versus a strong comparison. On machine dealer inventory, our planning assumptions include the expectation that dealers will reduce their inventories in the fourth quarter while balancing their need to be prepared for 2025. The magnitude of the decline for machine dealer inventory is expected to be less than the $1.4 billion decrease we saw in the fourth quarter of 2023. For perspective, we expect machine dealer inventory to end the year around the same level as year-end 2023. Also, the ongoing benefit of our services initiatives is expected to positively impact sales in the fourth quarter. By segment, in the fourth quarter, compared to the prior year, we anticipate a sales decrease in Construction Industries. This is impacted by lower sales to users, which Jim mentioned, along with unfavorable price realization. In Resource Industries, we expect slightly lower sales, impacted by lower sales to users versus a strong fourth quarter of 2023. In Energy & Transportation, we anticipate slightly higher sales versus the prior year, supported by power generation. Enterprise margin in the fourth quarter is expected to trend lower compared to the third quarter, following the typical seasonable pattern. However, versus the prior year, we expect a modestly higher adjusted operating profit margin despite lower sales. We anticipate favorable manufacturing costs and lower SG&A and R&D expenses will more than offset the profit impact of lower sales volume. Lower SG&A and R&D expenses are primarily driven by the benefit of lower short-term incentive compensation versus a high expense in the prior year quarter. Price realization for Machines is expected to trend lower as the pricing environment continues to normalize, though price in Energy & Transportation should act as a partial offset. Regarding price expectations for Machines, it is important to note that discounts to dealers occur through post sales merchandising programs, which impact our results over time. This includes financing support from Cat Financial, which is an effective way of supporting our customers, and we recover a portion of that support over the life of the deal. Let me explain. Based on the current level of price discounting support, we reserve the anticipated payments to dealers for these merchandising programs. At times, there is a lag between the timing of the invoice of the dealer and when the dealer invoices the customer, which impacts the reserve. Over the next few quarters, we expect the impact from these merchandising programs to drive a headwind to Machine price realization as we continue to adjust the reserve to reflect the current level of price discounting support. By segment, in the fourth quarter, in Construction Industries, we anticipate lower margin compared to the prior year primarily due to unfavorable price realization, partially offset by favorable manufacturing costs. In Resource Industries, we anticipate lower margin in the fourth quarter compared to the prior year, mainly due to lower volume and prioritization of strategic investments around services growth and AACE, which is autonomy, alternative fuels, connectivity and digital, and electrification. Favorable manufacturing costs should act as a partial offset. In Energy & Transportation, we expect a higher margin versus the prior year, primarily impacted by favorable price realization. So, turning to Slide 18, let me summarize. Although sales and revenues were lower than we had expected, adjusted operating profit margin and adjusted profit per share were generally in line with our expectations. We now anticipate our top-line for the full year will be slightly below our prior estimate. Our backlog increased slightly and remains at a very healthy level. Our expectations for full year adjusted operating profit margin and adjusted profit per share remain unchanged compared to a quarter ago. We continue to expect adjusted operating profit margin to be above the top end of the target range for the full year based on our expected sales levels. We are now increasing our expectations for ME&T free cash flow, which we anticipate to be near the top of our target range for the full year. Our team executed well in the quarter, and our results continue to benefit -- to reflect the benefit of the diversity of our end markets and the disciplined execution of our strategy for long-term profitable growth. And with that, we'll now take your questions."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question-and-answer session. [Operator Instructions] We'll take our first question from Jerry Revich at Goldman Sachs."
},
{
"speaker": "Jerry Revich",
"content": "Yes. Hi. Good morning, everyone."
},
{
"speaker": "Jim Umpleby",
"content": "Good morning, Jerry."
},
{
"speaker": "Jerry Revich",
"content": "Andrew -- hi. I'm wondering if we could just take a step back. Your margin performance this year is really outstanding relative to the long-term targets. And as you see it, is this level of outperformance sustainable or should we take the pricing headwinds that we spoke about in the prepared remarks to mean that you folks are evaluating the optimal balance between margins and market share?"
},
{
"speaker": "Jim Umpleby",
"content": "Well, Jerry, just as a reminder, our primary measure of profitable growth is increasing absolute OPACC dollars. That's something we're very focused on. Obviously, we're always focused on being competitive in the various markets that we serve, and of course, we serve a diverse group of industries around the world. So, what's happening in one market with one segment is it can be very different than what's happening in another segment just from a competitive perspective. So, again, we're focused on remaining competitive. We do provide margin targets, obviously, to give investors and analysts a sense of where we'll be around margins, and we'll continue to do that. So, again, we're driving to remain competitive, we're driving to increase absolute OPACC dollars, and you can use our margin target ranges to give a sense of where we expect to be."
},
{
"speaker": "Operator",
"content": "We'll move next to Tami Zakaria at JPMorgan."
},
{
"speaker": "Jim Umpleby",
"content": "Good morning, Tami."
},
{
"speaker": "Tami Zakaria",
"content": "Hi. Good morning, Team Caterpillar. Hope you're doing well. My question is on the Resource Industries segment. Volumes in that segment has been down for about a year now, and I think you said the rate of decline you expect to get better in the fourth quarter. I'm curious, how are you planning for this segment for 2025? Do you expect demand -- or sales to stabilize near term or it could get better or maybe stay weak for a few more quarters?"
},
{
"speaker": "Jim Umpleby",
"content": "Well, thanks for your question. I mean, the full year drop, as we talked about in previous calls, is really primarily due to a couple of products, articulated trucks and off-highway trucks. And we had a strong backlog there that we had to work our way through, and that's created a comp issue for us in Resource Industries this year. Having said that, obviously, we're not going to give guidance around 2025. We'll talk about 2025 in January, but certainly, we continue to be quite bullish on the long-term aspects for mining just given all the commodities that need to be produced to support the energy transition. Our mining customers use our products to produce those products, things like copper. So, our customers are displaying capital discipline, but we certainly are bullish about the long term. We do expect higher services revenues, because the utilization of our products is quite high. The age of the fleet is relatively elevated and the number of parked trucks is relatively low. So, those are all positive things. One of the things that we also see is a lot of inquiry activity and order activity around large mining trucks, so we're pleased at that. So that's one of the things that also is a reason for optimism as well."
},
{
"speaker": "Operator",
"content": "Next, we'll move to Angel Castillo at Morgan Stanley."
},
{
"speaker": "Angel Castillo",
"content": "Hi, good morning. Thanks for taking my question. I was wondering if you could expand maybe a little bit..."
},
{
"speaker": "Jim Umpleby",
"content": "Hi, Angel."
},
{
"speaker": "Angel Castillo",
"content": "Good morning. I was wondering if you could expand a little bit more on what you're hearing from your dealers and customers around in terms of Construction Industries, particularly in terms of orders, how is that kind of shaking out for that segment specifically? And then more so qualitatively what you're hearing into 2025 in terms of sentiment and kind of inclinations to buy kind of heading into that year versus the macro that remains a little bit uncertain?"
},
{
"speaker": "Jim Umpleby",
"content": "Yeah. Well, a couple of things. Firstly, in the quarter, as I mentioned earlier, the primary reasons for the decline quarter-to-quarter was based on lower rental fleet loading by our dealers. And, of course, it's important to note that our dealers' rental revenue continues to increase, so it's really an issue of them having lower loading into their rental fleets. In addition to that, we had a large pipeline deal in the third quarter of last year, which obviously didn't reoccur, and that created an issue as well. I mean, from a positive perspective, we expect government-related infrastructure to remain healthy. I mean, if we look at some facts from ARTBA, which is the American Road and Transportation Builders Association, they noted that, only 27% of the $348 billion in total on IIJA funding has been spent as of August of 2024. About 47% of it's been committed, and only 27% of it's been spent. So that's quite healthy as well. So, there's a lot of infrastructure activity out there that our dealers are working with our -- their customers to help support. So, we feel good about that as well."
},
{
"speaker": "Operator",
"content": "We'll go next to Jamie Cook at Truist Securities."
},
{
"speaker": "Jamie Cook",
"content": "Hi. Good morning. And I'm sorry, I'm flipping between multiple calls, but, Jim, I think you said during the prepared remarks that you guys are adding incremental large engine capacity relative to your previous announcement. So, I guess my question is, is there any way you can frame the capital investment? And more important, what you think the longer-term revenue opportunity for Caterpillar as you continue to increase capacity here? And then, sort of what does that imply for margins for this segment? Again, we're adding a lot of capacity, but the margins are below Resource and Construction. So, should margins be structurally higher as the volumes ramp? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Thanks for your question, Jamie, and we haven't quantified the amount of capital investment in that capacity increase, but we did talk about the fact that we expect with this incremental investment that we will have increased our large engine volume output capability to more than 25% -- 125% compared to 2023. And, of course, those engines are used across a wide variety of applications, and certainly, what's driving the demand today is data centers. We sell backup generators sets for data centers, but we're also quite excited about the opportunity going forward for what we call distributed generation. Data centers, of course, don't just create an opportunity for us for backup generator sets, but, of course, the base load requirements on the grid is going up as well because of data centers, and there's much been written about that. And so, just given the fact that there's been relative underinvestment in traditional power plants over the last few years, the fact that more renewables have been added to the grid, which are intermittent in nature, and the fact that now we have data centers increasing baseload requirements on the grid, we think that creates an opportunity for us for both our gas turbine generator sets and our reciprocating engine generator sets in what we call distributed power applications distributed across the grid, and our gas turbines and gensets can burn a wide variety of fuels, natural gas, biofuels, hydrogen blends. So, we're quite excited about that long-term opportunity that is starting to manifest itself. And your question about margins, certainly, you saw a nice margin increase quarter-to-quarter in Energy & Transportation, and just because of mix and because of increased volume and just the fact that business should be higher, again, we have the opportunity to increase margins in Energy & Transportation going forward, but I'm not going to quantify that at this point. But certainly, it's an opportunity."
},
{
"speaker": "Operator",
"content": "We'll take our next question from David Raso at Evercore ISI."
},
{
"speaker": "David Raso",
"content": "Hi. Thank you. Yeah, looking, as everybody, more bread crumbs for 2025. My question, I guess, two pieces. The comment about the drag, right, the lag of discounting for CI, it'll show itself more as some of those orders get shipped into '25. Can you give us a sense of just where we stand right now? Let's assume no further deterioration maybe in CI pricing. But what we're booking right now with those discounts, what is the most acute, like, period in '25 that that shows up? Like, essentially, it's how long are these orders out for? Is this second quarter, third quarter next year, that should be the most acute drag from the incremental discounting right now? And then, on the positive side, you kind of just said you didn't want to quantify it, but the investments in E&T, the large engines, which I know also go to large mining trucks, but let's think of it as E&T in particular right now, is there any way to think about regular throughput improvement? Any capacity additions that can show up in '25 to give us a sense of at least your throughput capability '25 versus '24? Just some order of magnitude? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yeah. Thanks for your question, David. So, one of the things we talked about when we announced the initial investment to increase our large engine capacity is that would increase over a four-year period, and so we haven't laid it out year-by-year, and it's -- again, it's a four-year increase. So, I'm afraid I'm not going to be able to answer your question to give a sense of additional output for 2025. And I'll let Andrew answer your question about margins."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. So, on the impact of pricing, this is one of those accounting quirks that we sometimes have. The way it works, David, is the accrual is done on a historic 12-month basis to build up the reserve. So potentially, this could act -- impact us for several quarters. It is -- as the merchandising programs increase, you then have the amount that's in inventory that you have to effectively catch up on over time, and that's done over a 12-month period. So, generally, it will be for the next several quarters, but we are starting to see the merchandising programs hit more normal levels now, and, obviously, that creates a little bit of a headwind on price. I will probably quantify it a little bit more when we get to 2025 guidance for you in January."
},
{
"speaker": "Operator",
"content": "Next, we'll go to Michael Feniger at Bank of America."
},
{
"speaker": "Michael Feniger",
"content": "Hey, everyone. Thank you for taking my question. I would just love to get a sense of -- on the oil and gas side, obviously, retail sales were up a little bit. You talked about the differentiation of what you're seeing in terms of the recip side and well services, maybe gas compression, some of the other areas. Just when we look into 2025, if we see more LNG permitting in the Gulf, is that positive for the solar business? Do we need a higher nat gas price? Obviously, the oil price has been kind of stuck in a range. So, just curious how we're thinking with oil and gas being very strong and up in '24. You kind of made some comments on Q4. What do we kind of think about the bread crumbs for '25 for that business? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "So again, I'll resist giving the guidance for 2025, but I'll just give you some color around the industry. Certainly, we mentioned the fact that well servicing continued to be a bit weak. Gas compression for recip for Cat oil and gas, we expect to be up for the total year, but a bit of softening in the fourth quarter. On solar turbines and oil and gas, the business is quite strong, a lot of booking activity, a lot of quotation activity, both for gas compression, but also for international projects as well. So again, solar business quite robust, and I've described the recip. It remains to be seen, obviously, if LNG exports then are again -- start again, if that permitting process starts again, I would think certainly, medium to long term, that'd be a positive for us."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Kristen Owen at Oppenheimer & Company."
},
{
"speaker": "Kristen Owen",
"content": "Great. Thank you for taking the question. Jim, I wanted to come back to the CI competitive dynamics, particularly in North America. I mean, you've called out this re-fleeting issue a couple of quarters in a row now, but you are at the higher end of the inventory range. Just wondering, can you help us understand how much maybe incremental international competition you're seeing, given the depreciation at the yen and just continued disappointment in China activity? Is there anything you're seeing on a shift in the competitive landscape there?"
},
{
"speaker": "Jim Umpleby",
"content": "Well, certainly, we're very focused on remaining competitive and the competitive situation continually changes. So, I could -- every year I've been in this job and before that, the competitive situation always changes, but we are quite confident in our ability to continue to compete. We continue to invest in new technologies, to allow -- as an example, to allow operators to more effectively operate their machines, as an example, taking a less experienced operator and through technology, allowing them to operate more like an experienced operator. We continue to invest in our digital capabilities. Our dealers continue to invest in their capabilities as well. So, we're quite confident in our ability to continue to compete and be successful. The competitive situation, there are currency changes that occur and you're right, the yen has been relatively weak and that for a period of time, can create a bit of a tailwind for a competitor, but those things change over time as currencies change. But, again, what we're really focused on is providing that long-term value to our customers by continuing to invest in things like technology, our digital capabilities, service capabilities, and all the rest."
},
{
"speaker": "Andrew Bonfield",
"content": "And can I just make a comment on your comment about the higher end of the inventory range? I mean, one of the things just to remember is dealer inventory is a complex, thing. We have 150 dealers around the world. We have three business segments. We have lots of different products. There are some actual product lines where, actually, dealers holding more inventory would actually be a good thing from a competitive perspective, not necessarily always reducing. So, it's not necessarily without them burning it down. We obviously, work with them through that process where they do need to think about a deal inventory reduction, and that's why we're anticipating in the fourth quarter. But there are also some business segments where, actually, at times, we would like dealers probably to hold a little bit more for competitive reasons as well."
},
{
"speaker": "Operator",
"content": "We'll go next to Steven Fisher at UBS."
},
{
"speaker": "Steven Fisher",
"content": "Thanks. Good morning. Jim, you mentioned the four-year process on power gen capacity expansion, but the power gen growth actually accelerated to about 26% year-over-year from 15% in Q2. So, with being at capacity on some of the bigger projects -- products, can you talk about what drove that acceleration and, to what extent is that maybe a function of shifting some of your oil and gas engines into power gen? And should we expect some sort of quarter-to-quarter fluctuations in that rate of growth in power gen going forward based on comps and how you are able to shift capacity around? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yeah. Just to be -- thanks for your question. Just to be clear, when we ship a generator set to an oil and gas customer or for an oil and gas application, we count that as oil and gas, not power generation, just to be clear. So, a variety of reasons for the increase. Certainly, of course, as I mentioned in my prepared remarks, we do have the ability to reallocate if the demand for oil and gas is not there and we have excess capacity. We can shift those engines from oil and gas to power generation and back and forth depending on the needs of our customers. So that's there. Solar power generation, again, that solar business and power generation is also increasing, and that also has an impact on it as well. And we've been, of course, working in our reciprocating engine facilities to increase capacity. Yes, the major impact will come later because of the big capital investment we're making, but we're working on increasing throughput and getting more out of our existing facilities as well as the demand goes up."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Kyle Menges of Citigroup."
},
{
"speaker": "Kyle Menges",
"content": "Thanks for taking the question. I was hoping if you could discuss inventories a little bit more. So, this planned reduction in in dealer inventories in 4Q, is that enough to make you guys feel pretty good about machine inventories heading into next year? And then, it'd also be helpful just to hear your thoughts on used inventories. Sounds like they remain at low levels, but are you seeing used tick up a little bit? And is there any cause for concern that used inventories could become an issue in 2025?"
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. So, first of all, let me mention on used. As we say, used inventory levels actually remain at pretty low levels based on history. They had ticked up slightly. Obviously, pricing has become a little bit lower, but pricing still is actually okay from a Cat Financial perspective. So, no concern at this point around used inventory at all from an overall perspective. With regards to dealer inventory, obviously, we work closely with our dealers through what we call our S&OP process. That's our sales and operations planning process. We go down by dealer, by product, really to understand what their expectations, what their requirements are, what their ordering needs are. That's part of a way of us helping to manage the factories and production efficiently. At this point in time, we expect that reduction we see to bring about the inventory overall to about flat year-over-year. That seems to be the right level based on what we're hearing from dealers at this stage. I don't see any reason, at this point in time, that there would be a need to reduce them significantly more, but, obviously, that's a discussion process that will occur through 2025. But, obviously, we are ready and prepared to manage and work and manage production accordingly. With regards to -- as I made the point a moment ago, there are some product lines where actually dealers really could hold more inventory. So, got to be very, very careful about looking at it as a holistic, but, overall, we're very comfortable with the total level and expectations for the year-end."
},
{
"speaker": "Operator",
"content": "We'll go next to Chad Dillard at Bernstein."
},
{
"speaker": "Chad Dillard",
"content": "Hey. Good morning, all. So..."
},
{
"speaker": "Andrew Bonfield",
"content": "Hi, Chad."
},
{
"speaker": "Chad Dillard",
"content": "I wanted to revisit -- hey. How you guys doing? So I just wanted to revisit the comments about pricing in CI. So first, just want to understand, like, when do you actually expect, like, the max pricing pressure? And then secondly, if we think about the other side of the ledger, the cost side, you have fuel coming down. It sounds like you're easing on SG&A and then R&D costs. So, just trying to think through whether you'll be able to offset some of that pricing pressure with some improved costs."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. So, let me just, first of all, come back to the overall. If you actually look at our overall gross margins for the quarter, gross margins were about flat despite low volume. So, we have been able to find offsets. Some of that obviously is with positive price within E&T, and some of that is lower manufacturing costs. So, there are always -- and that's part of the benefit of having a broad portfolio of businesses. We are able to manage that appropriately. Obviously, we are looking at commodity input costs, and, obviously, working from a procurement perspective. Always remind you that there's always a lag. It's never because of the contracting that we do. We often don't necessarily buy at spot prices. We buy at contracted prices, which may even be lower than spot. So, all of those things are factors which feed in, takes a little bit of time for that to fall through. With regards to the pricing pressure, immediately already, the merchandising programs we put in place are flowing through to the P&L within CI, so that's immediate. The point I was talking about was the lag impact on the reserve we have, which is really just a balance sheet impact, which impacts -- that will impact over the next several quarters. We'll give you a little bit more update of that when we get to January."
},
{
"speaker": "Operator",
"content": "Next, we'll go to Tim Thein at Raymond James."
},
{
"speaker": "Tim Thein",
"content": "Thank you. Good morning. Jim, I was hoping you could maybe give some color on the backlog and the orders which were pretty strong in the quarter and just in terms of maybe a key driver or two of or kind of what's behind that. And I guess, more significantly, I'm just curious if the -- I presume you're going to highlight data centers as part of that. And is there a shift in terms of how you think -- or how we should think about ultimately the delivery -- the timing of those deliveries in that, given the tightness in capacity? I presume some of your bigger data center customers are looking to secure capacity further out. So, anyway, so just the question around the maybe the driver of the orders and then should we think about any change in terms of the ultimate delivery cadence of those orders? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yeah. Thanks for your question. So, the backlog increase in Energy & Transportation was quite robust and that more than offset a decrease in backlog for Machines. And of course, it's not surprising that the backlog for Machines went down in anticipation of the machine dealer inventory reduction that we previously talked about in the fourth quarter. So, the backlog increase in Energy & Transportation being driven a lot by, of course, by power generation for recip, also being driven by robust orders in solar turbines for both oil and gas and recip. So that's really what's behind it. And so certainly, typically lead times for solar is eight to 12 months typically for recip and power generation. We're working hard to meet the demands of our customers there, but we do have orders going out 18, 24 months on the outside for power generation and recip."
},
{
"speaker": "Operator",
"content": "Next, we'll move to Mig Dobre at Baird."
},
{
"speaker": "Mig Dobre",
"content": "Yes. Thank you. And just to follow-up on Tim's question, is there a way to maybe quantify what percentage of the backlog is deliverable here in the next 12 months? And I'm also curious, given the fact that the lead times are what they are in power gen, how are competitive dynamics, you versus your competitors, in that part of the business? Is there somebody else out there maybe with better lead times than you? Can you gain share if you improve your lead times faster than others? Appreciate some thoughts on that."
},
{
"speaker": "Jim Umpleby",
"content": "You bet. Generally, overall, the way we think about it is about 75% of our backlog is expected to be sold within 12 months. That's a general number for total. As I mentioned, some of the large engine orders are out a bit more than that. Certainly, if we can produce more engines, we can sell more engines for power generation, recip engines. That's certainly the case. And again, just given the strength that we see in that market is obviously why we decided to make an incremental investment in our capability to increase engines and parts. So, again, the business is quite strong. It's very, very encouraging."
},
{
"speaker": "Operator",
"content": "Next, we'll go to Jairam Nathan at Daiwa."
},
{
"speaker": "Jairam Nathan",
"content": "Yeah. Hi. Thanks for taking my question. I just wanted to go over some of your position in China. There's a lot of talk about stimulus, not sure how helpful it could be. But, if you could just remind us of your market position there, the freshness products a little bit?"
},
{
"speaker": "Jim Umpleby",
"content": "Yeah. Certainly. So, as we've discussed previously, for a long period of time, we talked about China being roughly 10% -- 5% to 10% of our consolidated sales and revenues. It's certainly been less than that the last couple of years, and the continue -- the market itself continues to be quite weak. And so, it is below that 5% again this year. So, it's a relatively small piece of our total enterprise sales. Certainly, we have a significant presence in China in terms of facilities and we've integrated our supply chain suppliers, manufacturing and local leadership as well and dealers. And but again, the market is, in fact, quite depressed and we have it. And this is a reminder, for us, that market is primarily excavators above 10-ton. And so, people have asked about the stimulus. We certainly -- it's too early for us to have seen any impact of that, and we have not."
},
{
"speaker": "Ryan Fiedler",
"content": "Audra, we have time for one more question."
},
{
"speaker": "Operator",
"content": "And today's final question comes from the line of Rob Wertheimer with Melius Research."
},
{
"speaker": "Rob Wertheimer",
"content": "Thank you. Good morning. So I wanted to follow-up. Last quarter, you kind of touched on expanding opportunities at solar turbines and power gen. And in today's call, I mean, you mentioned some of the strong demand you're seeing in the recip side and capacity expansion, et cetera. On Renova's call, they had some strong trends in narrow derivative turbines, which I think are probably still a little bit above your power range. But I wonder if you might just talk about this business and the opportunity you're seeing in the power gen segment for solar. What that means? Does it mean behind the gated data center? Does it mean data centers? What is the opportunity you're seeing? And then, you've expanded capacity in recips. Do you have room to grow in turbines, or would you -- is the opportunity big enough that you're thinking about expanding there, too? Just a general overview. Thanks."
},
{
"speaker": "Jim Umpleby",
"content": "Yes. Thanks, Rob. So certainly, we are seeing an increase in business in -- for power generation and solar turbines. It's -- we're selling trailerized units now and it's being driven by a whole variety of factors. One of the things that we're doing is selling into some rental fleets, where rental fleets are positioning themselves to help satisfy what they believe will be increased electricity demand across the grid and primarily in North America. And sometimes those units will be rented to a utility, sometimes they'll be rented to a data center, but there's a whole variety of uses for that. So, we are seeing an increase in power generation at solar. Solar is not out of capacity. They certainly have the ability to continue to increase their production. And one of the things you might be aware of is that we are in the process of introducing a newer, larger gas turbine for solar turbines. It's our largest jet called the Titan 350, and that really will allow us to compete in some areas that we have not been able to compete in the past -- compete for in the past because we just didn't have a turbine that was large enough. And so, we're quite excited about that new product. It's early days in terms of just starting to get those shipped, but we are quite encouraged by the amount of customer interest and discussions we're having with our customers about that new product. So again, that's something that's very exciting for us. Okay. With that, I just want to thank everyone for joining us and certainly appreciate your questions. Just want to thank by again, thanking our global team for delivering strong adjusted operating profit margin and adjusted profit per share, and again, while generating robust ME&T free cash flow. And as we discussed today, our results continue to reflect the benefit of the diversity of our end markets as well as the execution of our strategy for long-term profitable growth. Again, thank you for your time."
},
{
"speaker": "Ryan Fiedler",
"content": "Thank you, Jim, Andrew, and everyone who joined us today. A replay of our call will be available online later this morning. We'll also post a transcript to our Investor Relations website as soon as it's available. You'll also find the third quarter results video with our CFO and an SEC filing with our sales to users data. Click on investors.caterpillar.com, then click on Financials to view those materials. If you have any questions, please reach out to Alex, Rob, or me. The Investor Relations general phone number is 309-675-4549. And now, we'll turn the call back to Audra to conclude."
},
{
"speaker": "Operator",
"content": "Thank you. That does conclude our call. Thank you for joining. You may all disconnect."
}
] |
cat | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Welcome to the Second Quarter 2024 Caterpillar Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Fiedler. Thank you. Please go ahead."
},
{
"speaker": "Ryan Fiedler",
"content": "Thank you, Audra, and good morning, everyone, and welcome to Caterpillar's second quarter of 2024 earnings call. I'm Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim Umpleby, Chairman and CEO ; Andrew Bonfield, Chief Financial Officer ; Kyle Epley, Senior Vice President of the Global Finance Services Division; and Rob Rengel, Senior Director of IR. During our call, we'll be discussing the first quarter earnings release we issued earlier today. You can find our slides, the news release, and a webcast recap at investors.caterpillar.com under Events and Presentations. The content of this call is protected by US and international copyright law. Any rebroadcast, retransmission, reproduction or distribution of all or part of this content without Caterpillar's prior written permission is prohibited. Moving to Slide 2. During our call today, we'll make forward-looking statements which are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to be different than the information we're sharing with you on this call. Please refer to our recent SEC filings and the forward-looking statements reminder in the news release for details on factors that, individually or in aggregate, could cause our actual results to vary materially from our forecast. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. On today's call, we'll also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate US GAAP numbers, please see the appendix of the earnings call slides. Now let's turn to Slide 3 and turn the call over to our Chairman and CEO, Jim Umpleby."
},
{
"speaker": "James Umpleby",
"content": "Thanks, Ryan. Good morning, everyone. Thank you for joining us. I'd like to start by thanking our global team for their strong execution in the first half of the year. In the second quarter, we achieved higher adjusted operating profit margin, record adjusted profit per share and generated robust ME&T free cash flow. Our results continue to reflect the benefit of the diversity of our end-markets as well as the disciplined execution of our strategy for long-term profitable growth. I'll begin with my perspectives about our performance in the quarter and we'll provide an update on our full year expectations. I'll then provide some insights about our end-markets, followed by an update on our sustainability journey. Moving to quarterly results. Sales and revenues were down 4% in the second quarter versus last year, slightly below our expectations. Services increased in the quarter. Our adjusted operating profit increased to $3.7 billion, a record. Adjusted operating profit margin was better than we expected and improved to 22.4% up 110 basis points versus last year. We achieved a record quarterly adjusted profit per share of $5.99, up 8%. We also generated $2.5 billion of ME&T free cash flow in the quarter. In addition, our backlog increased to $28.6 billion, up $700 million versus the first quarter of 2024. Before I get into the detail of the quarter and outlook for our segments, I'll update our expectations for the full year based on our first half results. Earlier in the year, we estimated that sales and revenues would be broadly similar for the full year. For the first half, the top-line came in marginally below our expectations and ended 2% below the prior year. We now anticipate our sales and revenues will decline at a roughly similar rate in the second half versus the prior year, in-part due to our latest assumptions for dealer inventory, principally into Resource Industries. Overall sales to users and construction industries are running slightly lower than we anticipated, partially offset by stronger-than-expected sales in Energy and Transportation. Service revenues continue to grow. Although sales and revenues have been marginally below our expectations, adjusted operating profit margins have been stronger than we anticipated. Earlier in the year, we expected our adjusted operating profit margin to be in the top half of the target range at the corresponding level of sales. Due to the strength of our performance in the first half of the year, we now expect overall adjusted operating profit margins to be above the top of the target range for the full year. For the second half, we expect adjusted operating profit margins to be better than we previously anticipated or about flat to the second half of 2023, which Andrew will describe. The strength of our performance to date and our improved second half adjusted operating profit margin expectations give us confidence to guide above our target range. Overall, our expectations for full year adjusted operating profit and adjusted profit per share are now higher than it was during our last earnings call. We also anticipate that ME&T free cash flow will remain in the top half of the free cash flow target range. Turning to Slide 4 and our second quarter results. In the second quarter of 2024, sales and revenues declined 4% to $16.7 billion. Sales volume declined slightly more than we expected, while price realization, including geographic mix was better than we anticipated. Dealer inventory also declined in the second quarter. Compared to the second quarter of 2023, overall sales to users decreased 3%, slightly below expectations. For machines, which includes Construction Industries and Resource Industries, sales to users declined by 8%, slightly more than expected. Energy and transportation continued to show strength as sales to users increased 10%. Sales to users in Construction Industries were down 5%. In North America, sales to users were slightly lower than anticipated, primarily due to weaker than expected rental fleet loading. Government related infrastructure projects remained healthy. Residential sales to users in North America were up as demand for new housing remained resilient. Sales to users declined in the EAME, primarily due to weakness in Europe relating to residential construction and economic conditions. Sales to users in Asia Pacific declined, while Latin America increased. In Resource Industries, sales to users declined 15%, a slightly smaller decline than we expected versus a very strong second quarter in 2023. Mining as well as heavy construction and quarry and aggregates were lower, mainly due to softness we previously discussed for two products, articulated trucks and off-highway trucks. In Energy and Transportation, despite the ongoing weakness in industrial, sales to users increased by 10% as we continue to see strength across most applications. Oil and gas sales to users benefited from strong sales of turbines and turbine related services. We also saw increased sales of reciprocating engines into gas compression, while well servicing oil and gas applications were lower. Power generation sales to users grew as market conditions remained favorable, including strong data center growth. Transportation sales to users increased, while industrial declined as expected from the strong levels last year. Our results continue to reflect the benefit of the diversity of our end-markets as well as the disciplined execution of our strategy for long-term profitable growth. Moving to dealer inventory. In total, dealer inventory decreased by $200 million versus the first quarter. For machines, dealer inventory decreased by $400 million and remains within our typical range. As I mentioned, backlog increased to $28.6 billion, up $700 million versus the first quarter of 2024. Energy & Transportation drove the increase as we continue to see strong demand for solar turbines and reciprocating engines for power generation. Adjusted operating profit margin increased to 22.4% in the second quarter, a 110 basis point increase over last year, which was better than we anticipated. Margin exceeded our expectations, primarily due to lower than expected manufacturing costs and slightly better than expected price. Moving to Slide 5, we generated ME&T free cash flow of $2.5 billion in the second quarter. We deployed more than $1.8 billion of cash for share repurchases and about $600 million in dividends in the second quarter. In June, we announced an additional $20 billion share repurchase authorization with no expiration date. We remain committed to consistent share repurchases. Since 2019, when we communicated our intention to return substantially all ME&T free cash flow to shareholders over time, our net share count has decreased by approximately 18%. In addition, we increased our dividend by 8% in the second quarter, which is our fourth straight year of a high single-digit quarterly increase. We remain proud of our Dividend Aristocrat status and continue to expect to return substantially all ME&T free cash to shareholders over time through dividends and share repurchases. Now on Slide 6. I'll describe our expectations for our three primary segments moving forward. In Construction Industries, after a record 2023, sales to users in the second half are now expected to decline slightly versus last year. In North America, we now anticipate slightly lower construction industry sales to users for full year 2024 than we did previously, primarily due to weaker than expected rental fleet loading. Government related infrastructure projects are expected to remain healthy. In Asia Pacific, outside of China, we still expect soft economic conditions to continue. We anticipate demand in China will remain at a relatively low level for the above 10 ton excavator industry. In the EAME, we anticipate that weak economic conditions in Europe will continue, somewhat offset by continued healthy construction demand in the Middle East. Construction activity in Latin America remains mixed, but overall, we are expecting modest growth. In addition, we are expecting the ongoing benefit of our services initiatives will positively impact Construction Industries. Next, I'll discuss Resource Industries. After strong performance in 2023 in mining as well as heavy construction, in quarry and aggregates, we continue to anticipate lower machine volume versus last year, primarily due to off-highway and articulated trucks. We currently anticipate a decrease in Resource Industries dealer inventories in 2024 versus a slight increase last year. We expect to see higher services revenues, including robust rebuild activity. Customer product utilization remains high, the number of parked trucks remains low and the age of the fleet remains elevated and our autonomous solutions continue to see strong customer acceptance. Customers continue to display capital discipline, however, we continue to believe the energy transition will support increased commodity demand over time, expanding our total addressable market and providing further opportunities for long-term profitable growth. Moving to Energy & Transportation. In oil and gas, in total, we expect a stronger year overall in 2024 versus last year. After a strong 2023, we expect reciprocating engine sales in oil and gas to be flat to slightly down, primarily due to ongoing softness in well servicing. We still expect gas compression to be up for the full year, however, we expect it to soften in the second half. For solar turbines, we continue to expect volume growth in the second half as our backlog remains strong for oil and gas. CAT reciprocating engine and solar turbine demand for power generation is expected to remain strong, largely due to continued data center growth relating to cloud computing and Generative AI. Industrial demand is expected to remain at a relatively low level compared to 2023 in the second half. In Transportation, we anticipate growth as the year progresses in both high speed marine and rail services. Moving to Slide 7. I'll provide an update on our sustainability journey. We are contributing to a reduced carbon future and continue to invest in new products, technologies and services to help our customers achieve their climate related objectives. In April, Caterpillar and Vale signed an agreement to test battery-electric large mining trucks as well as to conduct studies on ethanol powered trucks. Progress has been made on both initiatives since the agreement was signed, including conducting a joint study on a dual-fuel solution for haul trucks operating on ethanol and diesel fuel. We are supporting Vale's sustainability objectives. In June, we added CAT CG260 Gas Generator sets to our portfolio of commercially available power solutions capable of running on hydrogen fuel. Previously, our portfolio with this capability ranged from 400 KW to 2,500 KW. The addition of the CG260 now provides up to 4,500 KW of electric power for continuous, prime and load management requirements and is approved to operate on gas containing up to 25% hydrogen by volume. Caterpillar offers retrofit kits to upgrade CG260 Generator sets already installed with these same hydrogen capabilities. In addition to our hydrogen capabilities and reciprocating engines, solar turbines has been a leader with its ability to burn a wide variety of fuels, including hydrogen, natural gas and biofuels. Today, Caterpillar has a large and growing lineup of technologies to support customers in their sustainability journey. These two examples highlight how we are helping our customers build a better, more sustainable world. With that, I'll turn it over to Andrew."
},
{
"speaker": "Andrew Bonfield",
"content": "Thank you, Jim, and good morning, everyone. I'll begin with a high level summary of the quarter. Then I'll provide more detailed comments on our second quarter results, including the performance of the segments. Next, I'll discuss the balance sheet and free cash flow and then conclude with comments on our assumptions for the remainder of the year. Beginning on Slide 8. Although sales and revenues were slightly below our expectations, we had strong operating performance in the quarter, including higher adjusted operating profit margin and record adjusted profit per share, both of which were stronger than we had anticipated. Sales and revenues of $16.7 billion decreased by about 4% compared to the prior year. Adjusted operating profit increased by 2% to $3.7 billion. And the adjusted operating profit margin was 22.4%, an increase of 110 basis points versus the prior year. Profit per share was $5.48 in the second quarter compared to $5.67 in the second quarter of last year. Adjusted profit per share increased by 8% to $5.99 in the quarter compared to $5.55 last year. Adjusted profit per share excluded restructuring costs of $0.51 per share mainly due to a loss on the divestiture of two non-US entities. This compares to restructuring costs of $0.05 per share and a discrete deferred tax benefit of $0.17 per share, which were both excluded in the second quarter of 2023. Other income of $155 million for the quarter was a $28 million benefit versus the prior year and was primarily driven by favorable impacts from commodity hedges. The provision for income taxes in the second quarter, excluding discrete items, reflected a global annual effective tax rate of 22.5% compared with 23% in the second quarter of 2023. Finally, the year-over-year impact from the reduction in the average number of shares outstanding primarily due to share repurchases over the past year had a favorable impact on adjusted profit per share of approximately $0.29. Moving on to Slide 9. I'll discuss our top line results in the second quarter. Sales and revenues decreased by 4% compared to the prior year as lower volume was partially offset by favorable price realization. Lower volume was mainly driven by the impact from the changes in dealer inventories. As you may recall, we anticipated a sales decline this quarter versus last year as an atypical dealer inventory increase in the second quarter of 2023 made for a challenging comparison. To explain, dealer inventory decreased by about $200 million in the second quarter. In comparison, we saw an increase of $600 million in the second quarter of last year. For machines only, dealer inventory followed the typical seasonal trend this quarter with a decrease of $400 million as compared to a $200 million increase in the second quarter of last year. Sales were slightly below our expectations due to lower-than-expected volume being partially offset by better-than-expected price realization, including geographic mix. Moving to operating profit on Slide 10. Operating profit in the second quarter decreased by 5% to $3.5 billion. This included a $227 million unfavorable impact from higher restructuring costs. Adjusted operating profit increased by 2% to $3.7 billion. Price realization benefited the quarter while the profit impact of lower sales volume acted as a partial offset. The adjusted operating profit margin of 22.4% improved by 110 basis points versus the prior year. Margins were better than we expected mainly due to favorable manufacturing costs, product mix and price. Versus our expectation, price was slightly better than we anticipated driven by Energy & Transportation. On Slide 11, Construction Industries sales decreased by 7% in the second quarter to $6.7 billion. This is primarily due to lower sales volume, partially offset by favorable price realization. Sales volume was impacted by unfavorable changes in dealer inventories. Dealer inventory was about flat in the second quarter of 2024 versus an increase in the second quarter of last year. Lower sales to users also impacted volume. Sales in Construction Industries were lower than we had anticipated due to lower-than-expected rental fleet loading in North America and continued weakness in Europe. By region, sales in North America were about flat and Latin America sales increased by 20%. Sales in the EAME region decreased by 27%. In Asia Pacific, sales declined by 15%. Second quarter profit for Construction Industries was $1.7 billion, a 3% decrease versus the prior year. This was mainly due to lower sales volume, partially offset by favorable price realization, which benefited from geographic mix effects. Favorable manufacturing costs provided some tailwind as well largely reflecting lower material costs. The segment's margin of 26.1% was an increase of 90 basis points versus last year. Margin was better than we had expected primarily due to a favorable product mix and the timing of planned SG&A and R&D spend. Price was in line with our expectations. Turning to Slide 12. Resource Industries sales decreased by 10% in the second quarter to $3.2 billion, which was about in line with our expectations. The decline was primarily due to lower sales volume, partially offset by favorable price realization. Sales volume was impacted by changes in dealer inventories as dealer inventory decreased more during the second quarter of 2024 than during the second quarter of last year. In addition, we saw lower sales to users in the segment as anticipated given the challenging comparison. Second quarter profit for Resource Industries decreased by 3% versus the prior year to $718 million. This is mainly due to lower sales volume, partially offset by favorable impacts from price realization and manufacturing costs, including lower freight. The segment's margin of 22.4% was an increase of 160 basis points versus last year. Margin was better than we had expected mainly driven by the timing of planned SG&A and R&D spend and a favorable product mix. Now on Slide 13. Energy & Transportation sales increased by 2% in the second quarter to $7.3 billion. The increase was due to favorable price realization, which was partially offset by lower sales volume driven by industrial, which declined in line with our expectations. The segment sales were slightly better than we had anticipated primarily driven by price. By application, power generation sales increased by 15%. Transportation sales were higher by 7%. Oil and gas sales improved by 4%, while industrial sales decreased by 21%. Second quarter profit for Energy & Transportation increased by 20% versus the prior year to $1.5 billion. The increase was primarily due to favorable price. The segment's margin of 20.8% was an increase of 320 basis points versus the prior year. Margin was significantly stronger than we had anticipated due to better price and lower-than-expected manufacturing costs, which largely reflected favorable inventory absorption, lower freight and lower material costs. Moving to Slide 14. Financial Products revenues increased by 9% to about $1 billion primarily due to higher average financing rates across all regions and higher average earning assets in North America. Segment profit decreased by 5% to $227 million. This was mainly due to a higher provision for credit losses, which largely reflected the absence of a nonrecurring reserve release from the prior year. The portfolio remains healthy as past dues of 1.74% on near historic lows and reflect a 41 basis point improvement compared to the prior year. In addition, the allowance rate was 0.89% our lowest rate on record. Business activity remains healthy as new business volume increased versus the prior year primarily driven by North America. We also continue to see healthy demand for used equipment where inventories remain close to historical low levels. Moving on to Slide 15. We generated $2.5 billion in ME&T free cash flow in the second quarter and we expect our full year free cash flow to be in the top half of our annual target range of between $7.5 billion to $10 billion. Our expectations for CapEx remain between $2 billion and $2.5 billion for the year. On share repurchases, the more than $1.8 billion deployed in the second quarter included a $1 billion accelerated share repurchase agreement. Approximately 75% of those shares were delivered to the company upfront with the balance to be delivered when the agreement is terminated prior to year-end. Note that we also had an ME&T bond maturity of $1 billion in the second quarter. And given our healthy liquidity position, we did not issue new bonds. Our balance sheet remains strong with an enterprise cash balance of $4.3 billion. In addition, we hold $1.8 billion in slightly longer-dated liquid marketable securities to improve yields on that cash. Now on Slides 16 and 17, I will show our high-level assumptions for the remainder of the year. As Jim mentioned, we now anticipate sales and revenues to be slightly lower this year versus the record 2023 level. This compares to our previous expectation for broadly similar sales. This change reflects an updated assumption of a slight reduction in machine dealer inventory, primarily in Resource Industries and lower-than-expected sales to users in Construction Industries mainly due to lower rental fleet loading in North America. Now specific to our second half assumptions. We typically see higher sales in the second half as compared to the first and we expect sales to follow that normal seasonable trend this year. As compared to the prior year, we now anticipate slightly lower sales in the second half driven by lower machine sales to users. Changes in dealer inventories and machines are expected to have a nominal impact as the decrease in the second half of this year should be similar to the decrease observed in the second half of 2023, which was about $1 billion. However, note that machine dealer inventory changes will impact the quarters differently as we expect a sales headwind in the third quarter as dealers built their inventories in the third quarter of 2023 and a sales tailwind in the fourth quarter due to a smaller inventory decline than the prior year. Finally, we continue to anticipate services growth in the second half of the year as we strive to achieve our 2026 target of $28 billion in services revenues. Moving on to our margin expectations. As Jim mentioned, the strength of our first half performance combined with the more favorable expectations for the second half mean that we now anticipate overall adjusted operating profit margin to be above the top end of the target range for the full year. Specific to second half margins, despite higher sales, we do expect lower margins versus the first half, which follows a typical seasonable trend. However, keep in mind that first half margins were at record levels and the magnitude of the second half decline may be slightly larger than is typical. As compared to the prior year, we expect our adjusted operating profit margin in the second half will be similar to the prior year level. While we anticipate some favorability in manufacturing costs on improved operational efficiencies, we do expect slightly lower volumes and a slight headwind from price in the second half versus a year ago. On price, the impact of lapping the increases taken in the second half of 2023 means that the benefit in the second half of this year will be significantly lower. In addition, we expect that improved availability across the industry will result in the normalization of the pricing environment. To assist you with your modeling for the full year, please note that we now anticipate restructuring costs of around $450 million and that our expectations for the annual effective tax rate, excluding discrete items, remains at 22.5%. Now on Slide 18. I'll provide a few comments on the third quarter, starting on the top line. We expect slightly lower sales and revenues in the third quarter compared to the prior year as we anticipate a dealer inventory headwind for machines, which will impact volumes. We expect dealer inventory machines to be flattish to slightly lower in the third quarter as is typical, which compares to the atypical $400 million increase in the prior year. We also anticipate lower machine sales to users versus a strong comparison. We expect flattish price realization in the third quarter versus the prior year due to the normalization that I mentioned a moment ago. We also anticipate that the ongoing benefit of our service initiatives will positively impact sales in the third quarter. By segment in the third quarter compared to the prior year, we anticipate lower sales in Construction Industries primarily due to a headwind from changes in dealer inventories. In Resource Industries, we expect lower sales as sales to users are impacted by a challenging comparison similar to that which we have observed in the first two quarters of this year. In Energy & Transportation, we anticipate higher sales versus the prior year, supported by strengthen in power generation, oil and gas and transportation. Lower sales in industrial should act as a partial offset. For enterprise margins in the third quarter, we expect similar adjusted operating profit margin compared to the prior year as we anticipate lower volume will be offset primarily by favorable manufacturing costs. By segment in the third quarter, in Construction Industries, we anticipate lower margin compared to the prior year on lower volume and slightly unfavorable price realization. Favorable manufacturing costs should act as a partial offset. For Resource Industries, we anticipate slightly lower margins in the third quarter compared to the prior year due to unfavorable volume and higher SG&A and R&D spend. In Energy & Transportation, we expect a higher margin versus the prior year and stronger volumes and favorable price realization. So turning to Slide 19, let me summarize. Strong execution and operating performance continued in the second quarter. Higher adjusted operating profit margin of 22.4% offset the decrease in sales and revenues and led to a record adjusted profit per share of $5.99. We now expect overall adjusted operating profit margin to be above the top end of the target range for the full year based on our expected sales levels, which should now be slightly lower than levels in 2023. The net of these factors leads to our current expectation for higher adjusted operating profit and adjusted profit per share as compared to what we contemplated at the beginning of the year. ME&T free cash flow generation was $2.5 billion in the quarter. We continue to expect to be in the top half of our target range for the full year. We have deployed $7.6 billion to shareholders through share repurchases and dividends in the first half of 2024. We continue to execute our strategy for long-term profitable growth. And with that we'll take your questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Chad Dillard from Bernstein. Your line is open."
},
{
"speaker": "Chad Dillard",
"content": "Hi. Good morning, everyone."
},
{
"speaker": "James Umpleby",
"content": "Good morning, Chad."
},
{
"speaker": "Andrew Bonfield",
"content": "Good morning, Chad"
},
{
"speaker": "Chad Dillard",
"content": "So I was hoping you could unpack a little bit more the price cost dynamics as we look through the second half of the year. Can you just like walk through like a segment basis in an enterprise, how to think about that? And at least for the second half do you think price cost will be positive?"
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. So, overall, so let me start. Obviously, for the full year, price will exceed increases in manufacturing costs. As we look out in the second half of the year, we do expect price to moderate as we've consistently said. However, we are seeing some favorability in manufacturing costs as we saw in the second quarter and we expect that to continue. There will be a continued normalization, particularly in construction of the pricing environment as availability improves and across the industry as a whole. We expect price to be positive in Energy & Transportation in the second half. And that will offset any weakness that we may see in Construction Industries. So, overall, as I just pointed out in my comments, we do expect favorability in manufacturing costs and that will offset actually the volume decline that we expect impact on margins in the third quarter."
},
{
"speaker": "Operator",
"content": "We'll move next to Jamie Cook at Truist Securities."
},
{
"speaker": "Jamie Cook",
"content": "Hi. Good morning and congrats on a nice quarter."
},
{
"speaker": "James Umpleby",
"content": "Thanks, Jamie."
},
{
"speaker": "Jamie Cook",
"content": "I guess my question -- my question pertains to E&T and the E&T margin strength in the quarter. Can you help, I mean, given, again, Jim, the capacity investments you're making in that business, how we think about the E&T margin potential over the long-term relative to Construction and Resource, given you're adding capacity there? And sort of where should we be, Jim, as we're exiting the year? How do we think about the incremental capacity that's coming online just trying to figure out how that helps potentially 2025 and 2026. Thanks."
},
{
"speaker": "James Umpleby",
"content": "Well, thank you, Jamie, for your question. And then as you noted, we are adding capacity to increase our capability to build both large engines and part of those large engines. But it's a multiyear project and that project will take some time to play out. So it's not a 12-month program. It lasts longer than that, it takes some time. Having said that, the demand for large engines and for solar turbines for both oil and gas and power generation continues to be quite strong. So the margin increase that you saw is a reflection of higher volume, better price and also better mix as well quite frankly. So again, is there a potential for margin expansion over time in Energy & Transportation? There certainly is that possibility. Again, a lot of it will depend upon mix and again our ability to increase our capacity in large engines, which we're working very hard to do. But again, the good news is that, again, back to that power generation market is quite strong. And one of the things we're also bullish about that's possibly a bit farther out is just the opportunity for distributed generation. As more renewables are added to the grid, as there's more grid instability issues, it creates an opportunity for us, we believe, to sell both reciprocating engines and gas turbines and distributed power generation applications distributed throughout the grid. And we're very excited about that opportunity. One of the things also to keep in mind is we have a strong backlog. And the backlog increase that we reported today, of course, E&T was a big part of that. And that includes both solar turbines and our large engines."
},
{
"speaker": "Operator",
"content": "We'll move next to Steve Volkmann at Jefferies."
},
{
"speaker": "Stephen Volkmann",
"content": "Great. Good morning, guys. Thanks for taking the question. Pivoting maybe to Construction Industries. I think you both mentioned lower-than-expected rental fleet loading in the quarter as one of the trends that you called out. And I'm curious if that is -- if you view that as sort of a timing issue and maybe you can give us a sense of where you think the rental fleets are and how much kind of update and refleeting needs to be done there?"
},
{
"speaker": "James Umpleby",
"content": "Certainly. We're willing to start with this is dealer rental income was actually up for the quarter. And dealers are independent businesses and of course make their own decisions about what kind of machines and how many machines they put into their rental fleets. And there's a whole variety of things they look at there. They think about interest rates, obviously, and they think about other aspects. But we are continuing to be bullish on what we see as an opportunity around rental and we're working closely with our dealers to help them increase their rental business over time."
},
{
"speaker": "Operator",
"content": "Our next question comes from Robert Wertheimer at Melius Research."
},
{
"speaker": "Robert Wertheimer",
"content": "Hi. Good morning, everybody. I also wanted to circle around to E&T, where as you see the rise of data centers, I guess, the critical nature of that power backup is rising. An important question is going to be around mix and margin in the E&T segment. Is there any oil and gas, obviously, you're running, it's a great business, it's a high margin, high mix as well. Is there any anticipated mix impact if power gen kind of replaces some of the strength we've seen in oil and gas? And then more broadly, Jim, I think you mentioned kind of solar turbines in power gen. I think you've had historical strength in like combined heat and power and things like that. Is that market for solar turbines expanding visibly already in power gen to more and more applications? And I'll stop there. Thanks."
},
{
"speaker": "James Umpleby",
"content": "Thank you, Rob. So to answer the last part of your question first. So on solar, we have seen some pretty interesting applications for solar that you're right, traditionally over the last 30 years. So there's been a lot of combined heat and power applications for solar. But as an example, we relatively recently sold some solar gas turbines in a power generation application for continuous duty for a data center in Ireland. And that's something that, again, we wouldn't have seen 20 years ago. So there are some more opportunities. And as I mentioned earlier, as we think about distributed generation for both recip and gas turbines and, again, our engines and turbines burn a whole variety of fuels, natural gas, biofuels, hydrogen blends and all the rest. We do see an increased opportunity for those distributed power generation opportunities over time. And we think that's a secular growth trend again that we're very excited about. As you think about Energy & Transportation, there's a lot of components there. So when you asked the question about kind of mix in oil and gas versus power generation, generally, we do quite well margin wise in our large engine. So that's something that we're quite excited about, the opportunities that we see moving forward. Of course, solar is a very good business as well. So again there's a lot of things there to think about not just power generation and oil and gas. But as we think about Energy & Transportation moving forward and our ability to again to grow that business and achieve strong margins, we feel quite good."
},
{
"speaker": "Operator",
"content": "We'll move next to David Raso at Evercore ISI."
},
{
"speaker": "David Raso",
"content": "Hi. Thank you for the time. I was curious, the retail sales machines, it sounds like you're expecting to be down again in the second half of the year. But anything you're hearing from the dealers to sort of be thoughtful about when you would expect retail machines, retail sales to pick back-up? Is there any indication from the order book or backlog within CI and RI? And with that also where do you expect the dealer inventory to end the year on machines? Thank you."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. So let me start and help unpack that a little bit. So on the retail sales, two factors, obviously, retail sales in the quarter, one which was in North America. And most of that was actually rental fleet that does go into retail sales, but it actually is rental fleet loading by dealers. So that was most of that. And then Europe itself as well, which was still softer than we expect. Overall, our expectation now part of the reason why we've reduced our estimates for retail sales for the year is mostly due to that rental fleet loading. Our expectations are that although as Jim said, dealer rental revenue is still growing nicely, they will not load their fleet as much as we had originally expected at the beginning of the year, and that's relatively moderate. Overall on dealer inventory, as I said at the beginning of the year, as you know, dealer inventory is very complex, David. It's multiple segments, multiple business units, multiple dealers. And dealers are independent businesses. We expected the dealer inventory to be about flat for the year. We now expect a small reduction of machine dealer inventory, almost all of that will be in Resource Industries, which, as you know, is more a function of commissioning rather than anything else. And, overall, we expect to end the year with dealer inventory on the CI side about flattish and comfortably within the typical range that we talk about in three to four months."
},
{
"speaker": "Operator",
"content": "We'll go next to Michael Feniger at Bank of America."
},
{
"speaker": "Michael Feniger",
"content": "Thank you for taking my question. I'm curious when you look at your different segments, if we're entering a lower interest rate environment, a Fed easing cycle, where do you see -- what segments kind of reacting to a lower rate environment first? And just basically following up on that with the construction side with your response to David. Just is the assumption with your comfortability on the inventories, is that assuming that dealer retail sales gets better by the end of the year or is assuming where we are today? Thank you."
},
{
"speaker": "James Umpleby",
"content": "Maybe I'll start and then I'll kick it over to Andrew just to talk about interest rates a bit. So if you stop and think about our business, there are certain aspects that are not as sensitive to interest rate movements and think about the build-out in data centers around power generation, oil and gas generally and government infrastructure as well. We talked a lot about in our previous calls the regulatory environment that has been supporting build-out in North America and we still feel good about that. And obviously that is less interest rate-sensitive. The parts of our business that are more interest rate sensitive, think about someone building possibly a warehouse in North America and needs construction equipment for that. Those kinds of activities do tend to be more interest rate-sensitive. So if interest rates come down, that certainly has the possibility to improve that business. And then I'll let Andrew."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. Just on the dealer inventory thing, just a reminder, obviously, from today to the end of the year, we expect a reduction in machine dealer inventory, as I talked about, which is in line with our normal seasonal trend. Overall, effectively, our assumption of flattish dealer inventory in CI and remaining within the typical range implies is based on our expectations of retail sales. And there's always a forward-looking retail sales expectation rather than a backward-looking retail sales expectation."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Jerry Revich at Goldman Sachs."
},
{
"speaker": "Jerry Revich",
"content": "Yes, hi. Good morning, everyone."
},
{
"speaker": "James Umpleby",
"content": "Hi, Jerry."
},
{
"speaker": "Andrew Bonfield",
"content": "Hi, Jerry."
},
{
"speaker": "Jerry Revich",
"content": "Hi, Jim, Andrew. I'm wondering if you could just talk about what your prospect list looks like in Resource Industries based on industry and your competitor data. Looks like we've hit an air pocket in terms of orders. And obviously, deliveries have been weaker, and we've seen destock. Based on what you're seeing from your customers, when do you expect looking to reaccelerate for mining trucks and other equipment?"
},
{
"speaker": "James Umpleby",
"content": "Thanks for your question, Jerry. As I mentioned earlier, there's a lot of positives in mining. Certainly, the utilization of our equipment is high. The number of parked trucks is relatively low. We expect robust service activity. Having said that, our customers are displaying capital discipline. But at the same time, one of the things to keep in mind is, one of the reasons that we saw lower sales is that we had kind of a backlog of a couple of products that we talked about in our prepared remarks, articulated trucks and off-highway trucks. And as we worked our way through that, that created a relative comp issue that you're seeing today. But having said that, certainly, there's a lot of interest in commodities such as copper. And we've seen areas of strength and things like large mining trucks and that activity as well, and that's positive. And we remain bullish about mining, just thinking about the energy transition and all of the commodities that our customers will use our products to produce. So again, we're not too concerned about just a quarterly deviation. What we're really focused on is more the medium and long-term over time and we remain quite bullish on the mining business."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Tami Zakaria at JPMorgan."
},
{
"speaker": "Tami Zakaria",
"content": "Hey, good morning. Thank you so much. So my question is more longer term focused rather than this quarter or year. So can you help us frame how to think about Caterpillar's current portfolio of products that play into the data center market aside from backup generators? Are there any other products maybe related to micro grids or anything else to call out where you see an opportunity? And related to that, besides E&T as a segment, do data centers provide opportunities for any product or services within CI or RI as well over the medium to long-term?"
},
{
"speaker": "James Umpleby",
"content": "We do believe. Thanks for your question. We do believe that the data center build-out creates opportunities in many areas across our business. So you mentioned backup generators. That's, obviously, that's an opportunity, which is here today that we're dealing with. In addition, I mentioned earlier the fact that data centers is increasing power generation requirements. So in the United States, I have the stats right, electricity demand was flat between, I think, between 2007 and 2022 and now it's starting to increase. And of course, our customers use our products to produce the commodities to satisfy that increase in electricity demand. In addition to that, I talked about the fact that both our reciprocated engines and our gas turbines we believe have the opportunity to be used in what we call distributed power generation applications. And a lot of that, again, is tied back to that data center build-out as electricity demand in the developed world continues to increase. And of course, in the developing world, as standards of living increase, power generation demands go up as well. And again, that's an opportunity for us as our customers use our products to produce the commodities to satisfy that increasing demand. In addition to that, yes, we do provide micro grids in our power generation organization. We work with customers to set up micro grids. That's one of the things that we do have the ability to do and we're pretty uniquely positioned just given our portfolio of products to help our customers do that. Also as you think about data center build-out, well, of course, that requires construction machinery as well and that helps our construction equipment business. And then, of course, thinking about copper and the other commodities that need to be produced to also support what's happening with increased power generation requirements that helps RI. So I believe that the data center build-out helps a whole variety of products across our portfolio."
},
{
"speaker": "Operator",
"content": "We'll move next to Mig Dobre at Baird."
},
{
"speaker": "Mircea Dobre",
"content": "Thank you. Good morning, everyone. Just a quick follow-up on construction pricing. I guess it sounds like you expect a little bit of erosion here, but maybe we can get some insight in terms of the magnitude. I'm looking back at 2016, that's the last year where I think we saw two, three percentage points. Is that kind of a fair expectation to have going forward? And how do you think about used prices in this market and the potential impact that might have as we think about 2025 even? Thank you."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes, Mig. So absolutely will not be that sort of level of magnitude. We obviously see a normal element of competitive positioning, which obviously impacts pricing. Obviously, we don't expect list price changes. This will be really about customer-by-customer discussions. On the impact of used market, the used market obviously has had some impact, has seen some erosion of price. Actually, quite interestingly, where that impacts us more is around Cat Financial. And actually although used prices are coming down, they are still relatively high compared to historic levels, and inventories are very low. So we are not expecting that to impact us. The other area, obviously, does impact used prices would be around rental fleet. And obviously that and higher interest rates are having some impact on rental fleet loading as we talked about already in the call."
},
{
"speaker": "Operator",
"content": "We'll go next to Kyle Menges of Citi."
},
{
"speaker": "Kyle Menges",
"content": "Thank you and good morning, guys."
},
{
"speaker": "Andrew Bonfield",
"content": "Hey, Kyle."
},
{
"speaker": "Kyle Menges",
"content": "It'd be helpful just to hear a little bit more about the rental fleet loading kind of changing your expectations there for the second half of the year. I am curious just to parse out just what is kind of demand-related like softening demand in the second half versus you trying to manage the rental fleets versus kind of dealers trying to pushing back a little bit about taking fleet. Just would love to hear kind of what's driving that. Thank you."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. So obviously, as Jim mentioned, rental -- dealer rental revenue is actually increasing positively as we expected for the year and that's driven by the level of activity. Our assumption when we started the planning year was the dealer fleet loading would be a certain number. It is slightly less than that and that's why we have taken it down. It is more around the fact that they are not loading their fleets quite as quickly and they're managing their fleet. That's what they do. They're independent businesses. They make decisions around how much fleet, how they move the fleet out into the market as well. And remember also, when you talk about rental fleet, particularly around things like heavy rents, heavy rents are effectively a long -- actually almost a rent to buy. And often that market is dependent on the customer choice as well. So it's not just the dealer here. You also have the customer at the other end of that equation as well as to when the timing when they make their final purchase. So a lot of those things, so it's a little bit complex, and therefore, is not one size fits all. But generally, we're still very comfortable, as Jim said, with the opportunity in front of the dealers on the rental side, and we're very positive about the long-term outlook."
},
{
"speaker": "James Umpleby",
"content": "And maybe just to add in, we want our dealers to have a profitable, growing rental business. And utilization is an important part of that. So it's not a situation where we're encouraging to take more equipment than they need. We don't want them to take more equipment from us than they need. We want them to have a growing, profitable rental business. And we believe that's a growing opportunity for them and for us over time. And again, there will be quarterly deviations in terms of how much equipment they decide to take into the rental fleet. The point is it's a growing growth opportunity for both us and our dealers. And we're very supportive and are helping them with a variety of tools, whether it's digital tools and also other methodologies to help them grow their rental business."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. Just again just contextualizing sort of from a size perspective because I think sometimes things seem a little bit bigger. Just to remind you, then in terms of CI, this is still a relatively small number, but it is what is driving some of that change in our outlook, which again is relatively modest. So just before people start worrying that it's a bigger element and a bigger number than it really is. Remember, OEM sales, about 40% of our revenues come from services across the business. Only about 60% is original equipment. And again that does vary by segment. And North America is not 100% of CI sales either."
},
{
"speaker": "Operator",
"content": "We'll move next to Steven Fisher at UBS."
},
{
"speaker": "Steven Fisher",
"content": "Thanks. Good morning. You mentioned, Jim, the gas compression is starting to soften a little bit. Curious just kind of where you are in the backlog there? Do you expect your sales in gas compression actually be down year-over-year in the second half? And maybe what visibility do you have to rebuilding the backlog there and what it might take? Is it a next round of big LNG projects or how do we think about that? Thank you."
},
{
"speaker": "James Umpleby",
"content": "Yes. So we do expect for the year, I believe, I said that we expect gas compression year-over-year to be higher. So higher in 2024 than 2023. We did say we expected a bit of softening in the second half, but still, again, gas compression higher in 2024 total than in 2023. You asked about backlog. Again, we do have quite a strong backlog in our large engines across and our gas turbines around E&T. So again we feel good about that as well. And the comment we made about gas compression that was really recip oil and gas. We expected to soften in the second half of the year, but it didn't. Solar turbines, it also serves oil and gas. And our comment was about recent engines in oil and gas. And again a lot of strength in E&T overall."
},
{
"speaker": "Operator",
"content": "We'll go next to Angel Castillo at Morgan Stanley."
},
{
"speaker": "Angel Castillo",
"content": "Hi. Good morning. Thanks for taking my question. Just wanted to maybe unpack the backlog dynamic around CI if you could give us a little bit more color. So kind of a three-part question. One, what were the orders in the second quarter for CI? Two, kind of on the backlog. What's kind of the coverage that you have at this point versus your historical levels, just given that we had a pretty strong demand over a number of years? And then kind of lastly, just can you talk about kind of the price margin mix within that backlog as we kind of have visibility now looking forward versus maybe what was in there before?"
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. So Angel, we obviously do not break down backlog by segment. So that's just a point. I would say to you, though, we did have a high level of orders in the second quarter in CI of 2023. Part of that was, if you remember, we did see a dealer inventory build in the third quarter. Some of that was ahead of an engine switchover. So it's not a -- it is down year-over-year, but that is partly because of the comparison we actually -- as a result of that change in the NPI last year, the new product introduction. Again, similarly, mix varies across the businesses. And obviously there are different parts of our business which are more profitable than others. And you did see -- we do see favorable product mix in CI. And obviously that does remain -- that is a function of what products are being sold and in what proportion. With regards to the backlog, I mean, the backlog for CI reflects availability. And as you know, availability now is pretty good. And that lies in about our 13 week time period, which we would consider to be about the norm of three months."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Tim Thein at Raymond James."
},
{
"speaker": "Timothy Thein",
"content": "Great. Thank you. Good morning. Jim, maybe a question for you just on -- another CI related one, just on the balance between market share and pricing and just thinking, obviously, over the long-term, PINS a very important concept for Cat. And just thinking about how you and tied in with that, the ambition to grow services. Just thinking as to -- as the market first time and some time now we're dealing with kind of free flowing supply and maybe a little bit more competition and capital directed at North America, just how you balance -- how are you and the dealers balance that, again, motivation to grow PINS while also kind of balancing that price equation. Thank you."
},
{
"speaker": "James Umpleby",
"content": "Yes, certainly PINS are very important to us, and we make pricing decisions based on a whole variety of inputs. Obviously, we look at our input costs, we look at our competitive situation. And we're continually working to add more value to our customers. So it's not just a price situation. Price is important and we need to remain competitive. But again we have some real advantages, we believe. One is our dealer network, again, one of our most significant competitive advantages. We have a distribution network that none of our competitors have. In addition to that, we continue to invest significantly in technology to help our customers be more successful. All the tools that we're putting into our machines to, for example, allow our customer to hire a relatively inexperienced operator and have them operate a machine like a pro who's been at it for many years. So again, there's a lot that goes into that, a lot of investments in services capabilities, a lot of investments in technology as well. But certainly, yes, we recognize PINS are important as it helps seed the market for future services growth and it's something we're very focused on."
},
{
"speaker": "Ryan Fiedler",
"content": "Hey, Audra, we have time for one more question."
},
{
"speaker": "Operator",
"content": "Thank you. Today's final question comes from the line of Nicole DeBlase from Deutsche Bank."
},
{
"speaker": "Nicole DeBlase",
"content": "Yeah, thanks. Good morning, guys."
},
{
"speaker": "James Umpleby",
"content": "Good morning, Nicole."
},
{
"speaker": "Andrew Bonfield",
"content": "Hi, Nicole."
},
{
"speaker": "Nicole DeBlase",
"content": "Just a couple of follow-ups on CI. I guess I was kind of surprised by the strength in Latin America this quarter, a big year-on-year growth. Can you just talk a little bit about the drivers there and also what you're seeing in EAME? And is there any signs of life in Europe or are things just kind of bouncing along the bottom there? Thank you."
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. So Nicole, on Latin America, actually Brazil was strong, which is an important market for us and that was part of the reason for the strength. So that was good. And obviously, we'll keep an eye out and hope that, that continues as we go through the remainder of the year and looking forward. Europe, as we indicated, has been a problem. It's been a problem. I think most of our competitors have made similar comments as well. It does seem to be a little bit on the bottom. Obviously, it's depending what happens there, obviously, you've seen the ECB cut rates. There is, for example, today in the UK that we talked about construction -- actually growth in construction this last month. So hopefully, it is starting to pick up, but our assumption really is that it doesn't pick up that quickly for the remainder of the year."
},
{
"speaker": "James Umpleby",
"content": "All right. With that, we'll just thank you all for your questions. We greatly appreciate it. I want to just close by thanking our global team for their strong execution in the first half of the year and achieved higher adjusted operating profit margin, record adjusted profit per share and strong ME&T free cash flow. And our results continue to reflect the benefit of the diversity of our end-markets as well as our disciplined execution of our strategy for long-term profitable growth. With that, I'll turn it back to Ryan."
},
{
"speaker": "Ryan Fiedler",
"content": "Thanks, Jim, Andrew and everyone who joined us today. A replay of our call will be available online later this morning. We'll also post a transcript on our Investor Relations website as soon as it's available. You'll also find the second quarter results video with our CFO and an SEC filing with our sales to users data. Click on investors.caterpillar.com and then click on Financials to view those materials. If you have any questions, just please reach out to Rob or me. The Investor Relations general phone number is 309-675-4549. Now let's turn the call back to Audra to conclude our call."
},
{
"speaker": "Operator",
"content": "Thank you. That concludes our call for today. Thank you for joining. You may all disconnect."
}
] |
cat | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Welcome to the First Quarter 2024 Caterpillar Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Fiedler. Thank you. Please go ahead."
},
{
"speaker": "Ryan Fiedler",
"content": "Thanks, Audra. Good morning, everyone. Welcome to Caterpillar's first quarter of 2024 earnings call. I'm Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim Umpleby, Chairman and CEO; Andrew Bonfield, Chief Financial Officer; Kyle Epley, Senior Vice President of the Global Finance Services Division; and Rob Rengel, Senior Director of IR. During our call, we'll be discussing the first quarter earnings release we issued earlier today. You can find our slides, the news release, and a webcast recap at investors.caterpillar.com under Events and Presentations. The content of this call is protected by U.S. and international copyright law. Any rebroadcast, retransmission, reproduction, or distribution of all or part of this content without Caterpillar's prior written permission is prohibited. Moving to slide two. During our call today, we'll make forward-looking statements which are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to be different than the information we're sharing with you on this call. Please refer to the recent SEC filings and the forward-looking statements reminder in the news release for details on factors that, individually or in aggregate, could cause our actual results to vary materially from our forecast. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. On today's call, we'll also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate U.S. GAAP numbers, please see the appendix of the earnings call slides. Now I'll turn the call over to our Chairman and CEO, Jim Umpleby."
},
{
"speaker": "Jim Umpleby",
"content": "Thanks, Ryan. Good morning, everyone. Thank you for joining us. I'd like to start by thanking our global team for delivering another strong quarter, including higher adjusted operating profit margin, record adjusted profit per share, and strong ME&T free cash flow. Our strong balance sheet and ME&T free cash flow allowed us to deploy a record $5.1 billion of cash for share repurchases and dividends in the first quarter. Our results reflect a continuation of healthy demand for our products and services across most of our end markets. We remain focused on executing our strategy and continue to invest for long-term profitable growth. I'll begin with my perspectives about our performance in the quarter. I'll then provide some insights about our end markets, followed by an update on our sustainability journey. It was another strong quarter. Sales and revenues were about flat in the quarter versus last year, broadly in line with our expectations. Services revenues increased in the quarter. Our adjusted operating profit increased by 5% to $3.5 billion. Adjusted operating profit margin was slightly better than we expected and improved to 22.2% up a 110 basis points versus last year. We achieved a record adjusted profit per share of $5.60 up 14%. We also generated strong ME&T free cash flow in the quarter of $1.3 billion. In addition, our backlog increased to $27.9 billion up $400 million versus the fourth quarter of 2023. We continue to expect 2024 sales and revenues to be broadly similar to the record 2023 level. We have revised our full year 2024 segment expectations to reflect a slightly stronger top line in Energy & Transportation offset by softening in the European market for Construction Industries. We anticipate services to be higher in 2024 as we strive to achieve our 2026 target of $28 billion. For the year, we continue to expect adjusted operating profit margin and ME&T free cash flow to be in the top half of our target ranges. Turning to slide four. In the first quarter of 2024 sales and revenues remained about flat at $15.8 billion. Compared to our expectations, sales volume was slightly lower while price realization, including geographic mix, was better than we anticipated. Compared to the first quarter of 2023, overall sales to users decreased by 5%. This was slightly lower than we expected, mainly due to weakness in Europe for Construction Industries. Energy & Transportation continued to show strength, where sales to users increased 9%. For machines, which includes Construction Industries and Resource Industries, sales to users declined by 9%. Focusing on Construction Industries, sales to users were down 5%. In North America, our largest geographic region for Construction Industries, sales to users increased as expected, and demand remained healthy for both non-residential and residential construction. Construction projects, as well as government related infrastructure, continue to benefit non-residential demand. Although residential sales to users in North America were down slightly, demand for new housing remained strong. Sales to users declined in EAME primarily due to weakness in Europe related to residential construction and economic conditions. Latin America and Asia Pacific sales to users also saw some declines. In Resource Industries, sales to users declined 17% in the first quarter compared to a very strong first quarter in 2023. Mining, as well as heavy construction and quarry and aggregates were lower, mainly due to softness in off-highway and articulated trucks that we mentioned during our last earnings call. In Energy & Transportation, sales to users increased by 9%. Oil and gas sales to users benefited from strong sales of turbines and turbine-related services. We also saw increased sales of reciprocating engines in the gas compression and well servicing oil and gas applications. Power generation sales to users grew as market conditions remained favorable, including strong data center growth. Transportation sales to users increased while industrial declined as we expected from strong levels last year. In total, dealer inventory increased by $1.4 billion versus the fourth quarter. For machines, dealer inventory increased by $1.1 billion, which was slightly higher than our expectations, largely due to sales to users being modestly lower than anticipated. The increase in machine dealer inventory is consistent with normal seasonal patterns of which Construction Industries products accounted for the majority of the increase. The total level of machine dealer inventory is comfortably within the typical range. As I mentioned, backlog increased to $27.9 billion, up $400 million versus the fourth quarter of 2023, led by Energy & Transportation. Backlog remains elevated as a percentage of revenues compared to historical levels. Adjusted operating profit margin increased to 22.2% in the first quarter, a 110 basis point increase over last year, which was slightly better than we anticipated. This was primarily due to better than expected manufacturing costs, mainly related to freight. Moving to slide five. We generated strong ME&T free cash flow of $1.3 billion in the first quarter. We deployed $5.1 billion of cash for share repurchases and dividends in the first quarter, including the initiation of a $3.5 billion accelerated share repurchase program which may last up to nine months. We remain proud of our Dividend Aristocrat status and continue to expect to return substantially all ME&T free cash flow to shareholders over time through dividends and share repurchases. Now on slide six, I'll describe our expectations moving forward. We expect a continuation of healthy demand across most of our end markets for our products and services. We continue to anticipate 2024 sales and revenues to be broadly similar to the record 2023 level. As I mentioned, we expect services to continue to grow in 2024. We currently do not anticipate a significant change in dealer inventory in machines in 2024, compared to a $700 million increase in 2023. This is expected to be a headwind to sales in 2024. As a reminder, dealers are independent businesses and manage their own inventories. The vast majority of dealer inventories in Energy & Transportation are backed by firm customer orders. The timing of these products being recognized as sales to users is impacted by dealer packaging and commissioning, which is why it is difficult to predict dealer inventory in E&T. This is why we have become more explicit about the differentiation between machine dealer inventory and total dealer inventory. As I mentioned, we anticipate that our 2024 results will be within the top half of our target ranges for both adjusted operating profit margin and ME&T free cash flow. Our strong results continue to reflect the diversity of our end markets, as well as the disciplined execution of our strategy for profitable growth. Now, I'll discuss our outlook for key end markets starting with Construction Industries. In North America, after a very strong 2023, we continue to expect demand in the region will remain healthy in 2024 for both non-residential and residential construction. We anticipate non-residential construction to remain at similar levels to slightly higher demand levels compared to last year due to construction projects, as well as government related infrastructure. Residential construction demand is expected to be flat to slightly down versus last year, which remains strong in comparison to historical levels. In Asia Pacific, outside of China, we are seeing some softening in economic conditions. We anticipate demand in China will remain at a relatively low level for the above 10-ton excavator industry. In EAME, we anticipate that weak economic conditions in Europe will continue, somewhat offset by strong construction activity in the Middle East. Construction activity in Latin America remains mixed, but overall, we are expecting modest growth. In addition, we expect the ongoing benefit of our services initiatives will positively impact Construction Industries in 2024. Next, I'll discuss Resource Industries. After strong performance in 2023 in mining, as well as heavy construction and quarry and aggregates, we anticipate lower machine volume versus last year, primarily due to off-highway and articulated trucks. In addition, we anticipate a small decrease in resource industry dealer inventories during 2024 versus a slight increase last year. While we continue to see a high level of quoting activity overall, we anticipate lower order rates as customers display capital discipline. We expect to see higher services revenues, including robust rebuild activity. Customer product utilization remains high, the number of parked trucks remains low, and the age of the fleet remains elevated, and our autonomous solutions continue to see strong customer acceptance. We continue to believe the energy transition will support increased commodity demand over time, expanding our total addressable market, and providing further opportunities for long-term profitable growth. Moving to Energy & Transportation. In oil and gas, we expect reciprocating engines and services to be about flat after strong 2023 performance. We expect reciprocating gas compression demand to be higher in 2024 than it was in 2023. While servicing demand in North America is expected to soften, Cat reciprocating engine demand for power generation is expected to remain strong, largely due to continued data center growth relating to Cloud Computing and Generative AI. Last quarter, I mentioned we are making a multi-year capital investment in our large reciprocating engine division, including increasing capacity for both new engines and aftermarket parts. This investment will approximately double output for large engines and aftermarket parts as compared to 2023. We leverage these large engines across a variety of applications, including data centers, oil and gas, large mining trucks, and distributed power generation. For Solar Turbines, our backlog and quoting activity both remain strong for oil and gas and power generation. As we said previously, industrial demand is expected to soften relative to a strong 2023. In transportation, we anticipate high-speed marine to increase as customers continue to upgrade aging fleets. Moving to slide seven, I'll provide an update on our sustainability journey. We are contributing to a reduced carbon future and continue to invest in new products technologies and services, to help our customers achieve their climate related objectives. In January we announced the signing of an electrification strategic agreement with CRH to advance the deployment of Caterpillar‘s Zero-Exhaust Emissions Solutions. CRH is the number one aggregate producer in North America and the first company in that industry to sign such an agreement with Caterpillar. The agreement is focused on accelerating the deployment of Caterpillar’s 70-ton to 100-ton class battery electric off-highway trucks and charging solutions at a CRH site in North America. Through the agreement CRH will participate in Caterpillar’s early learner program for battery electric off-highway trucks. In February Caterpillar oil and gas announced the launch of the Cat Hybrid Energy Storage Solution to help drillers and operators cut fuel consumption, lower total cost of ownership and reduce emissions in oil and gas operations. The custom designed energy storage system stores excess power from the job site and then discharges it as needed. In a hybrid system that combines the Cat Hybrid Energy Storage Solution in a natural gas fuel generator set, the transient response is even quicker than a conventional diesel only rigs. Depending upon site configuration the Hybrid Energy Storage Solution has proven to deliver up to 30% fuel cost savings with natural gas, 85% fuel cost savings with fuel gas, and up to an 80% reduction in nitrogen oxides. Carbon dioxide equivalent reductions up to 11% and 7% are possible with natural gas and fuel gas respectively. In addition, we look forward to issuing our 19th Annual Sustainability Report in May. The material in our report reinforce our ongoing commitment to sustainability. With that I'll turn it over to Andrew."
},
{
"speaker": "Andrew Bonfield",
"content": "Thank you, Jim. Good morning everyone. I'll begin by commenting on the first quarter results, including the performance of our segments. Then I'll discuss the balance sheet and ME&T free cash flow before concluding with a few comments on the full year and our assumptions for the second quarter. Beginning on slide eight. Our operating performance was strong with both adjusted operating profit margin and adjusted profit per share, being better than we had expected. Sales and revenues of $15.8 billion were about flat compared to the prior year, broadly in line with our expectations. Adjusted operating profit increased by 5% to $3.5 billion and the adjusted operating profit margin was 22.2% an increase of 110 basis points versus the prior year which was slightly better than we had expected. Profit per share was $5.75 in the first quarter, compared to $3.74 in the first quarter of last year Adjusted profit per share increased by 14% to $5.60 in the first quarter, compared to $4.91 last year. Adjusted profit per share excluded net restructuring income of $0.15 per share, this compares to restructuring expense of $1.17 which was excluded in the first quarter of 2023. Other income of $156 million for the quarter, was higher than the first quarter of 2023 by $124 million, this primary related to favorable ME&T balance sheet translation. The provision for income taxes in the first quarter excluding discrete items, reflected a global annual effective tax rate of 22.5% compared with 23% in the first quarter of 2023. Included in profit per share and adjusted profit per share was a benefit of $38 million or $0.08 for a discrete tax item related to stock based compensation. A comparable benefit of $32 million or $0.06 per share was included in the first quarter of 2023. The year-over-year impact of a reduction in the number of shares primarily due to share repurchases over the past year, had a favorable impact on adjusted profit per share of approximately $0.24. This included a favorable impact from the initial shares we received, from the $3.5 billion accelerated share repurchase agreement that Jim mentioned earlier. Before, I move on you will have seen some additional detail on earnings release segment commentaries. We continue to highlight the primary drivers of year-over-year changes in sales and profit by segment, as we have done previously, but in addition we are now also quantifying those significant variances. You will also find some additional information on historical dealer inventory, including at the machines level in the appendix of today's slides Moving to slide nine. I'll discuss our top line results in the first quarter. Sales remained about flat compared to the prior year, as lower volume was largely offset by favorable price realization. The decline in volume was primarily due to lower sales to users. As Jim mentioned, the 5% decrease in sales to users was slightly more than our expectations, mainly driven by weakness in Europe for Construction Industries. Changes in total dealer inventories did not have a significant impact on sales, as the increase of $1.4 billion in the quarter was similar to the increase last year. As Jim mentioned, the $1.1 billion increase for machines was slightly higher than we had anticipated, primarily as sales to users were modestly lower than we had expected. As compared to our expectations for the quarter, sales were broadly in line. Sales volume was slightly lower than we had anticipated, while price realization, including geographic mix, was better than we had expected. By segment, sales in Construction Industries were lower than we had anticipated, while sales in Energy & Transportation exceeded our expectations. Resource Industry sales were about in line. Moving to operating profit on Slide 10. The first quarter operating profit increased by 29% to $3.5 billion. As a reminder, the prior year included a $586 million charge that arose from the divestiture of the company's long-haul business. Adjusted operating profit increased by 5% to $3.5 billion. Price realization benefited the quarter, while lower sales volume acted as a partial offset. The adjusted operating profit margin of 22.2% improved by 110 basis points versus the prior year. Margins were slightly better than we had anticipated, mainly due to favorable manufacturing costs, as freight costs were lower than we had expected. Price, including a benefit from geographic mix, was also better than we had anticipated. Now on slide 11, I'll review segment performance, starting with Construction Industries. Sales decreased by 5% in the first quarter to $6.4 billion, primarily due to lower sales volume, partially offset by favorable price realization. Sales were slightly lower than we had anticipated. Sales in North America increased by 6% in the quarter. In the EAME region, sales fell by 25%, and in particular, Europe was lower than we had anticipated, impacted by weakness in residential construction and economic conditions. In Latin America, sales decreased by 1%. In Asia Pacific, sales decreased by 14%. First quarter profit for Construction Industries was $1.8 billion, a slight decrease versus the prior year. The decrease was mainly due to lower sales volume, partially offset by favorable price realization and manufacturing costs. The segments margin of 27.5% was an increase of 100 basis points versus the last year. This was better than we had expected due to favorable manufacturing costs, which largely reflected lower freight costs. Turning to slide 12, Resource Industries sales decreased by 7% in the first quarter to $3.2 billion, which was about in line with our expectations. The decrease was primarily due to lower sales volume, partially offset by favorable price realization. The decrease in sales volume was mainly driven by lower sales of equipment to end users, which Jim explained. First quarter profit for Resource Industries decreased by 4% versus the prior year to $730 million. The decrease was mainly due to lower sales volume, partially offset by favorable price realization. The segments margin of 22.9% was an increase of 60 basis points versus last year. This is better than we had expected on stronger price and favorable manufacturing costs, driven mainly by lower freight costs. Now on slide 13, Energy & Transportation sales increased by 7% in the first quarter to $6.7 billion. The increase was primarily due to higher sales volume and favorable price. Sales were stronger than we had expected, mostly due to increased deliveries of large engines. By application, power generation sales increased by 26%, oil and gas sales improved by 19%, transportation sales were higher by 9%, while industrial sales decreased by 21%. First quarter profit for Energy & Transportation increased by 23% versus the prior year to $1.3 billion. The increase was primarily due to favorable price realization. The segments margin of 19.5% was an increase of 260 basis points versus the prior year. The margin was significantly stronger than we had anticipated due to lower than expected manufacturing costs, higher volume, and better price. Moving to slide 14, Financial Products revenues increased by 10% to $991 million, primarily due to higher average financing rates across all regions and higher average net earning assets in North America. Segment profit was strong, increasing by 26% to $293 million. The increase was mainly due to an insurance settlement and a favorable impact from equity securities. Our portfolio continues to perform well as past dues remain near historic lows at 1.78%, a 22 basis point improvement compared to the first quarter of 2023. This is the lowest first quarter past dues since 2006. In addition, the allowance rate was our lowest on record at 1.01%. Business activity remains strong as new business volume increased versus the prior year, primarily driven by North America. We continue to see strong demand for used equipment and inventories remain close to historically low levels, with just slight increases over recent quarters. Moving on to slide 15. As Jim mentioned, our ME&T free cash flow remains strong. We generated $1.3 billion in the quarter after taking into account the $1.7 billion payments made for 2023 short-term incentive compensation and CapEx spend of about $500 million. Spend for both short-term incentive compensation and CapEx was higher than it was in the first quarter of 2023. For the full year, we expect to be in the top half of our ME&T free cash flow target range, which correlates to between $7.5 billion and $10 billion. We still expect to spend between $2 billion and $2.5 billion in CapEx, and we will continue to prioritize investments around AACE, which is autonomy, alternative fuels, connectivity, and digital and electrification. Moving to capital deployment. We continue to expect to return substantially all our ME&T free cash flow to shareholders over time through dividends and share repurchases. Of the record $5.1 billion of cash deployed in the first quarter, share repurchase spend was $4.5 billion, including the $3.5 billion accelerated share repurchase, or ASR. The $3.5 billion were deployed in the first quarter, and the ASR agreement may last for up to nine months. The ASR provides us with favorable pricing as compared to shorter-term ASRs, which we have carried out previously, which makes it more attractive. Price is finally determined relative to the volume-weighted average price, or VWAP, over the duration of the agreement. Approximately 70% of the shares were delivered to the company up front, but the balance calculated when the agreement is terminated based on the actual average VWAP. As a reminder, our objective is to be in the market on a more consistent basis with share repurchases, so this is a great mechanism for us to use. As I mentioned, our balance sheet remains strong. We have ample liquidity with an enterprise cash balance of $5 billion, and we hold an additional $2.2 billion in slightly longer-dated liquid marketable securities to improve yields on that cash. Moving to slide 16, I will share our high-level assumptions for the full year. As compared to a quarter ago, our assumptions for the full year generally remain unchanged. On the top line, we anticipate broadly similar sales and revenues as compared to the record 2023 level, consistent with what we mentioned last quarter. Although our top-level sales expectations remain the same, segment inputs have shifted a bit. We now see a slightly stronger top line in Energy & Transportation after a strong first quarter, while our expectations have been tampered slightly in Construction Industries due to economic conditions in the European market. We continue to expect slightly favorable price realization versus the prior year. Our expectations on dealer inventory also remain unchanged. We currently do not expect a significant change in dealer inventory of machines in 2024 compared to a $700 million increase in 2023. This is expected to be a headwind to sales. We also continue to anticipate another year of services growth across each of our primary segments as we strive to achieve our 2026 target of $28 billion in services revenues. At the segment level, we now expect Construction Industries sales to users to be slightly lower compared to 2023 due to the softer economic conditions in Europe. We expect demand in North America to remain at healthy levels, as Jim discussed. We also anticipate changes in dealer inventory to act as a headwind to Construction Industries sales in 2024. We expect sales service revenues to be positive versus the prior year. In Resource Industries, we continue to expect lower sales impacted by lower machine volume, primarily in off-highway and articulated trucks, where the comparison versus the prior year is challenging. We anticipate changes in dealer inventory to act as a headwind to sales in this segment as well. In Energy & Transportation, our 2024 sales expectations have increased slightly after the strong first quarter. We continue to see strong demand for reciprocating engines in power generation, as well as healthy order and quoting activity for Solar Turbines for both oil and gas and power generation. This supports our improved optimism for higher sales in Energy & Transportation in 2024. Also, as typical seasonality would suggest, we expect to see some sales ramp in Energy & Transportation as we move through the full year. On full year adjusted operating profit margin, we continue to expect to be in the top half of the margin target range at our expected sales levels. As I mentioned last quarter, we expect a relatively small pricing benefit to be weighted towards the first half of the year, given carryover from increases in the second half of last year. We now expect flattish manufacturing costs this year versus the prior year, as we anticipate more favorable freight costs, although the unfavorable impact from cost absorption could act as a partial offset. As I mentioned a quarter ago, given better availability this year, we anticipate shipping a more normal mix of products this year. We anticipate this dynamic may act as a slight headwind to margins. SG&A and R&D expenses are expected to ramp through the remainder of the year as we continue to invest in strategic initiatives aimed at future long-term profitable growth. This will be offset by the benefit of lower short-term incentive compensation. In addition, from a segment perspective, keep in mind that margins in Construction Industries tend to trend lower as the year progresses. Finally, we continue to anticipate restructuring costs of $300 million to $450 million this year, and our expectation for annual effective tax rate, excluding discrete items, is now 22.5%. Now on slide 17, I'll discuss our expectations for the second quarter, starting with the top line. We expect lower sales in the second quarter compared to the prior year, as we anticipate a headwind due to changes in dealer inventory of machines which will impact volumes. We expect dealer inventory of machines to decline this quarter in line with normal seasonal trends, versus the atypical $200 million increase that occurred in the second quarter of 2023. However, we anticipate a continuation of healthy demand across most of our end markets for our products and services, and prices expected to remain positive year-over-year. Following the typical seasonable pattern, we do expect higher sales in the second quarter as compared to the first. By segment compared to the prior year, we anticipate lower sales in Construction Industries as we expect changes in dealer inventory to act as a headwind. Favorable price should that provide a partial offset. We expect lower sales in resource industries versus the prior year, driven by lower volume, partially offset by favorable price. In Energy & Transportation, we anticipate similar sales versus the prior year. On enterprise margins in the second quarter, we expect the adjusted operating profit margin to be similar to the prior year, and lower versus the first quarter, following the typical seasonable pattern. As compared to the prior year, we could expect that price will remain favorable from the continued carryover benefit from increases taken in the second half of 2023. We expect flattish manufacturing costs compared to the prior year, as favorable freight is expected to offset the impacts of unfavorable cost absorption. We also anticipate an increase in SG&A and R&D expenses related to strategic investments, although this will be offset by lower short-term incentive compensation. By segment, in both Construction Industries and Resource Industries, we expect similar margins in the second quarter compared to the prior year, as we expect favorable price to be offset by lower volume. In Energy & Transportation, we expect a higher margin versus the prior year on better price and favorable mix. Unfavorable manufacturing costs and SG&A and R&D spend related to strategic investments are expected to act as a partial offset in this segment. Note that we expect a headwind to enterprise margins and corporate costs in the quarter, where we anticipate unfavorable year-over-year impacts from timing differences. So turning to slide 18, let me summarize. The strong operating performance continued in this quarter, with the adjusted operating profit margin at 22.2%, and record adjusted profit per share of $5.60. We deployed a record $5.1 billion of cash per share repurchases and dividends in the quarter. Our assumptions for the full year remain similar, and we expect to be in the top half of our target ranges for both adjusted operating profit margin and ME&T free cash flow. We continue to execute our strategy for the long-term profitable growth. And with that, we'll take your questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll take our first question from Tami Zakaria at JP Morgan."
},
{
"speaker": "Tami Zakaria",
"content": "Hi, good morning. Thank you so much."
},
{
"speaker": "Jim Umpleby",
"content": "Good morning, Tami."
},
{
"speaker": "Tami Zakaria",
"content": "Hi. How are you? So, nice margin performance in the quarter, and hence my question is around margins you guided for the second quarter. So if sales are expected to be lower year-over-year, I'm assuming volumes are down too. So what essentially would help margins remain relatively flattish? Is it price? I know you mentioned some factors, but just wanted more color. Is it price cost? Is it some cost-savings initiatives or is it something else that's going on? So, any color there would be helpful."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. So, at the moment there are two factors. One, which is obviously price, will still be positive in the second quarter, and that will help overall margins and will help to offset the impact of lower volume. Also, we do expect to see some flattening of manufacturing costs versus the prior year, mostly because of freight. We would expect the benefit of lower freight costs to offset the impact of cost absorption, which may occur in the quarter, so those are two factors. And then we will expect the increase in investments we're making behind our strategic investments and SG&A and R&D, to be offset by lower short-term incentive compensation expense. So those are all the moving parts, but overall as we said, we expect margins to be about flat year-over-year in the second quarter versus second quarter of 2023."
},
{
"speaker": "Operator",
"content": "We'll move next to Michael Feniger at Bank of America."
},
{
"speaker": "Michael Feniger",
"content": "Great. Thanks for taking my question. I know your guiding Q2 sales to be lower year-over-year, and the full year to be broadly similar. So maybe you could give us some context of what's driving that second half, that slight pick-up. Is it deliveries in a certain market like E&T? And is your expectations that end-user dealer retail sales which pulled back in Q1, do you think that's the low point for the year and that starts to improve through the year to match that full year guide? Any context there would be helpful?"
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. So overall as we said, really what's happening in Q2 is principally the impact on lower volume will be around the impact of dealer inventory movements, particularly on the machine side. Last year, as I said, we actually had a very atypical build in the second quarter. As you know, the historic trend is always during selling season to see, particularly on the CI side, dealer inventory to decrease. So that was really the main driver. Overall, as we've indicated for the year, we still expect healthy volume in North America in CI. We do have some impact now on Europe. That means we now expect CI STUs to be slightly lower year-over-year. We are seeing that offset though by expected sales growth in energy and transportation, where we're seeing more positivity than we've seen. As far as STUs are concerned, obviously the first quarter was impacted by those, principally the European conditions which we mentioned a moment ago. Overall, we're still very comfortable, but the overall guide we've made for the year, which is sales and revenues, will be broadly flat with 2023."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Jamie Cook at Truist Securities."
},
{
"speaker": "Jamie Cook",
"content": "Hey. Good morning, everyone. Nice quarter. Jim, I guess my question, under your leadership, I think the earnings power of Caterpillar has far exceeded anyone's expectation, and a lot of that was driven by the O&E business model and your focus on profitable growth. At the same time, you've been allocating capital to higher return products right, that's part of the strategy. At the same time, you are talking about doubling, I think you said your large engine capacity to meet demand for data centers and this is, now your lower – at this point it's your lower margin segment. So I guess understanding right now with ME&T, we have investment in AACE and capacity. But like over time, why shouldn't E&T margins structurally be higher than the other two segments, in particular given where construction margins are right now? I'm just wondering if the market under appreciates where E&T margins can go, given the capacity additions you are talking about. Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Jamie, it's a good question. One of the things to keep in mind is that many of the investments we're making, a lot of electrification in other areas, the costs are absorbed in energy and transportation, so that's one of the things that has an impact on the margin of the total segment. And as you quite rightly mentioned, we're very focused on investing in areas that represent the best opportunities for future profitable growth. And as we look at the margin opportunities around large engines, that's certainly an area that very much deserves our investment, in both capital and expense and management attention as well. So certainly, as you know, our primary measure of profitable growth is absolute OPACC dollars, and we're trying to increase that. Having said that, we provided our margin targets and we said we'd be in the upper half of the range. But again, we're investing in areas that represent very good opportunities for profitable growth, and that includes large engines. So I'm not saying that margins won't come up in E&T. Again, the one thing to keep in mind here is that a lot of costs go into that segment that really benefits some of the other segments."
},
{
"speaker": "Operator",
"content": "We'll move next to David Raso at Evercore ISI."
},
{
"speaker": "David Raso",
"content": "Hi, thank you for the time. I think some of the concern around the second half of the year, sales having to be positive to offset the first half being down, it would be helpful if you can give us a little sense of the implied orders for the quarter actually did turn slightly positive year-over-year. Can you give us any color that you can around sort of what moved in the backlog sequentially, E&T, CI, RI, just so we can get a sense of, was the order improvement year-over-year solely E&T? Was there any order improvement year-over-year in RI and CI, just to maybe build more confidence in the second half of the year sales growth? And of course, any color around some of the E&T orders. You get the impression some are very long-dated orders. Just trying to get a sense of that order flow in E&T, how soon can those orders show up in revenues? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "David, let me answer the last part of your question first. So, in terms of E&T, about 80% of our total CAT backlog is expected to be sold within 12 months, and we don't put orders into the – we don't put things into the backlog unless we have a firm customer order. So we work really closely with our customers, as an example with customers that are looking for large engines for data centers, and we have a sense going out multiple years of what it is they want, but we don't put any of that into the backlog until they give us a firm order. So, it doesn't – our backlog doesn't go out as far as you might think. So I'll start with that and then I'll turn it over to Andrew for the first part of your question."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. And Dave, your fact on the implied order rate is correct. Yes, the implied orders are up year-over-year. Obviously, that is one of the factors which gives us confidence as we look out and also relative strength of the backlog gives us a lot of confidence within the business lines where they are. As regards to backlog, obviously most of the increase has been in E&T as you would expect, given that those are the businesses now which is showing more strength relatively versus CI and RI, and that just is reflected in that order positioning as we go out."
},
{
"speaker": "Operator",
"content": "We'll go next to Rob Wertheimer at Melius Research."
},
{
"speaker": "Rob Wertheimer",
"content": "Hi. My question is around CAT's capabilities in Power Gen and data centers and so forth and how that may or may not be changing with the rise of AI and kind of massive increases in scale of data centers. I guess specifically, I understand that your investment in large research is probably partially targeted at that. My impression is that historically, solar turbines were more combined heat and power in Power Gen. I don't know whether they've served the data center market. I'm curious as to whether you now have an opportunity as those data centers are bigger to sell turbines into it and just your general sense of how the world is changing. Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Thank you, Rob. We are very excited about what we view as a secular growth opportunity around data centers, both in terms of increasing base power loads, but also the specific opportunities to serve those data centers. So as you probably know, traditionally we have provided reciprocating generative sets as backup for those data centers. But what you say is very correct. That business is changing, and I believe that we are uniquely positioned, because we have a combination of both gas turbines and research that burn a whole variety of fuels. And so we have had some projects now where we've shipped gas turbines, to provide prime power for data centers, because in some places when data centers want to go into a geographic area, the utility can't handle the load of those, and when in fact there's natural gas available, we've seen situations where a customer will take gas turbines, install those, burn natural gas to produce their own base power for the data centers. In addition to that then, there's also the reciprocating engine gen sets as backup if something were to happen. But typically again, we are seeing a change, you are right. The market's changing, and we're very excited about that opportunity."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Chad Dillard at Bernstein."
},
{
"speaker": "Chad Dillard",
"content": "Hi. Good morning, guys."
},
{
"speaker": "Jim Umpleby",
"content": "Good morning, Chad."
},
{
"speaker": "Chad Dillard",
"content": "So, good morning. So, my question for you is on E&T. Just trying to understand, where the lead times or what the lead times are, specifically in Power Gen. And then, just like how long it will take to get your capacity expansion online, and just how to think about, just like when you can actually ramp the revenues there."
},
{
"speaker": "Jim Umpleby",
"content": "Yeah. So, we're starting to make – again, we started to make those capacity investments, and those – that capacity is expected to ramp up over the next four years, so it's gradually phased in. So that'll happen over a four-year period. In terms of E&T, obviously I mentioned that Solar Turbines has strong quotation and order activity as well, and they have the ability certainly to increase their production. So again, the capacity in large engines, the investment that we specifically mentioned, is expected to gradually phase up over the next four years."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah, and just a quick point to make. Obviously Power Gen is the fastest-growing business today within energy and transportation, just to note. And actually, as a percentage of E&T sales, it has gone up from 25% in the first quarter of last year to 29% this year. So it is an area of exciting opportunity, even before we build the capacity, and obviously an area where there's potential for further growth as well."
},
{
"speaker": "Jim Umpleby",
"content": "And maybe just one add-on. You know one of the beauties about our business model – we're making this capacity investment in large engines, but those large engines just don't have the ability to serve the power generation market. I mean they serve a whole variety of markets, so those same large engines are used for oil and gas. They are used for large mining trucks. They are used for data center backup. But we also believe there's an opportunity over time for distributed generation as well. So again, we're making this capital investment not just based on one opportunity in the marketplace, but upon multiple opportunities in different industries. And again, we think that diversity of our end-market opportunities is one that really makes this an excellent investment."
},
{
"speaker": "Operator",
"content": "And we'll move to our next question from Jerry Revich at Goldman Sachs."
},
{
"speaker": "Jerry Revich",
"content": "Yes, hi. Good morning, everyone."
},
{
"speaker": "Jim Umpleby",
"content": "Good morning, Jerry."
},
{
"speaker": "Jerry Revich",
"content": "Jim, Andrew, I'm wondering if you could just talk about in construction industries, in prior cycles the industry has passed through lower input costs in terms of lower prices to customers when input costs have declined. In the first quarter we saw a nice price cost spread on the positive side for you folks here. I'm wondering to what extent do you think for you folks in the industry, could we see that price cost gap continue to widen since the industry has taken a more disciplined approach in cutting production sooner relative to the soft spot that you mentioned in your prepared remarks?"
},
{
"speaker": "Andrew Bonfield",
"content": "Yes. So Jerry, as we've indicated, obviously price has been favorable, but we expect the benefit of favorable price to moderate as the year progresses and that obviously holds true for CI as it does for the other segments. And that really will obviously mean that the benefits on margin expansion will become much, much tougher for CI, as particularly as you get into the second half of the year where you won't see that spread. We do see manufacturing costs being broadly flattish, and part of the reason for that is because of the favorability of freight, which is more than offsetting the impact of cost absorption. So overall, we've obviously taken the approach that where we have got the benefit of price, we will obviously be trying to hold that as best as we can obviously. And we've been, as you rightly pointed out, we’ve been pretty disciplined about making sure that we have cut production, like for example in the excavators that you saw in the fourth quarter, where we do see softness or weakness in the market."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Stephen Volkmann at Jefferies."
},
{
"speaker": "Stephen Volkmann",
"content": "Great. Good morning, guys. I'm wondering if we could tack back to the dealer inventory commentary. I want to make sure I understand that right, because that seems to be a bit of a focus for the market this morning. I think if I'm not mistaken, that the dealers did build a little more than you expected in the first quarter. I'm curious why that might be. And if you can provide some sense of how much of that total 1.4 kind of has a customer name on it, and I guess the bottom line is, why don't you worry that that's kind of an inventory build that sort of makes things less bullish going forward? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "The reason the dealer inventory increased a bit more than we expected is primarily due to the softness in European construction. It was – that really is the reason for that, that build in dealer inventory. The dealer inventory is well within our typical range, comfortably within what we consider a typical range. So we are not concerned about it."
},
{
"speaker": "Andrew Bonfield",
"content": "And just the other bit of granularity which we tried to give and just is about spilling out between machine and dealer inventory and dealer inventory as a whole. Principally because obviously in energy and transportation, it is that most of that inventory as we said previously, and also within resource industries, over 70% of that is backed by firm customer orders. It's not really inventory sitting on a dealer's lot waiting. Often it's a city getting ready for commissioning, and that is part of the reason for that. Overall, as Jim reiterated and just to reiterate, we are comfortably within the range on machine dealer inventory. We do expect for the year that inventory level to be about flat year-over-year. That's our expectation and then planning assumption at the moment."
},
{
"speaker": "Operator",
"content": "We'll move to our next question from Mig Dobre at Baird."
},
{
"speaker": "Mig Dobre",
"content": "Yes, thank you. Good morning."
},
{
"speaker": "Jim Umpleby",
"content": "Hi, Meg."
},
{
"speaker": "Mig Dobre",
"content": "Hi. Maybe we can talk a little bit about resource industries. I guess one of the things that stood out to me was the pretty significant decline in dealer deliveries in this segment, and I'm curious in mining specifically, what's going on there? Are you actually starting to see maybe a pullback in demand from your customers? Is the investment cycle maturing there or is this just sort of a temporary aberration?"
},
{
"speaker": "Jim Umpleby",
"content": "Yeah, so we had expected some softness certainly in RI this year and we talked about that, I believe in our first quarter call, so a number of things. First of all, on the positive side, the number of parked trucks, and there's some indices that we look at to really judge the health of the mining industry and so some positives. The number of parked trucks is relatively low. The utilization of our customers’ products, of our products by our customers is high, and the age of the fleet is relatively elevated, so those are positive things. Having said that, our customers are displaying capital discipline. Not surprising, just given what's happened in the economic conditions around the world, but those indices really do bode well for us. In addition to that, we've seen great strength, great acceptance of our autonomous solutions. So those have been accepted well also. We expect a robust rebuild activity this year, because our products are being used so extensively by our customers. So again, really, I think it's just really mostly a function of a bit of a dealer inventory change and also our customers displaying capital discipline."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah, and just to add to that a little bit, just to remind you that the first quarter of 2023 was very strong and actually the highest level of STUs in resource industries for over 10 years at the time. So that was a significant factor. Secondly, as we talked about, there are two product lines, where because of supply chain there was a backlog which was used up principally in 2023, off-highway trucks and also articulated trucks. Just as an FYI, large mining trucks are still growing, which I know is one of the factors that many of you look at. So there was no issue there at all with regards to that."
},
{
"speaker": "A - Jim Umpleby",
"content": "And again, you think about just the market changing, we're still very bullish on the fact longer term that we believe the energy transition will support increased commodity demand over time. That'll expand our total addressable market and provide us further opportunities for long-term profitable growth. Just think about everything that has to happen for EVs. There's no way around that being accomplished without our customers producing more commodities, and of course, they use our products to produce those additional commodities."
},
{
"speaker": "Operator",
"content": "We'll go next to Angel Castillo at Morgan Stanley."
},
{
"speaker": "Angel Castillo",
"content": "Hi, good morning and thanks for taking my question. Just wanted to clarify, going back to North America CI in the second quarter, you talked about seeing continued kind of healthy demand there. But just wanted to clarify, as we think about kind of dealer inventories coming down in the second quarter, and you also have a little bit of tougher comps there as you think about retail sales. When we kind of look at retail sales for the second quarter of this year, just to clarify, is that expected to be still positive or do you expect that to turn kind of modestly negative? And as you kind of talk about that and provide more color on that, could you also talk about what you are seeing in April, in terms of kind of quarter-to-date trends in retail sales?"
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah, as I think we've indicated overall, for the full year, we expect CI revenues to be, STUs to be slightly negative for the full year. The first quarter, in January we said we thought they would be about flat for the full year. So that does imply some acceleration through the year in order to get back to that sort of – to be just slightly negative. With regards to trends in April, look we're not going to talk about what's happening. I mean, as is always the case, quarter-on-quarter you see changes, which can relate to commissioning and all sorts of number of factors, but we're comfortable with that full year forecast for CI."
},
{
"speaker": "A - Jim Umpleby",
"content": "And North America is our strongest, largest geographic area for CI. And as we said earlier, we certainly expect demand in North America to remain healthy. We've got – we expect it to be flat to slightly higher in non-residential, flat to slightly down. So again, in that North American market, which is so important to us, business continues to be strong."
},
{
"speaker": "Operator",
"content": "Our next question comes from Kristen Owen at Oppenheimer."
},
{
"speaker": "Kristen Owen",
"content": "Great. Thank you for taking the question. I wanted to ask about capital allocation here, just given the ASR that you put in place. You've bought back more shares than historically you do in a year. I appreciate that that is in line with the ME&T free cash flow deployment, but your stock is also at all-time highs. So just wondering how we should think about intrinsic value at this stage and how to weigh that ASR versus, say, dividend increase."
},
{
"speaker": "Andrew Bonfield",
"content": "Yeah. So obviously as you know, we have both a dividend policy as well as a share buyback policy. As far as the dividend is concerned, we have one more year of our high single digits. That's a board decision which will probably be made around June time, and then after that we'll probably come back and look at what the future policy will be. Remember, the objective is to pay out no more than 60% to 65% of free cash flow in a low environment for the dividend. So that will be part of our – that comes into part of the policy and the way we look at that. With regards to intrinsic value, obviously as is always the case, yes, we do take into account intrinsic value, and that decision has been made as part of the longer term ASR, obviously. But remind you that the benefit of the ASR is really around the fact that you are in the market more consistently. We don't try and market time. We are really just trying to be in the market consistently to return that cash to shareholders. Overall, we believe that's the best approach, but we're very comfortable with putting that in place. Audra, we have time for one more question."
},
{
"speaker": "Operator",
"content": "Thank you. That question comes from Nicole DeBlase at Deutsche Bank."
},
{
"speaker": "Nicole DeBlase",
"content": "Yeah, thanks. Good morning, guys. I also wanted to focus on CI. So a lot of discussion obviously about Europe kind of being the problem child this quarter. I guess, are you guys seeing as you kind of progress through the quarter, some signs of stabilization or is there risk that Europe could still get worse? And then I guess also like, with dealer inventories being up and not being the driver, are you concerned about the level of dealer inventories in Europe CI specifically? Thank you."
},
{
"speaker": "Jim Umpleby",
"content": "Yeah, firstly, as I mentioned earlier, we believe that dealer inventory is comfortably within what we would consider the typical range. When we think about EAME, we talked about construction weakness in Europe, but also there's strength in the Middle East, a lot of construction activity in the Middle East. So again, that provides a bit of a buffer there to the total EAME region. And again, I keep coming back to North America as our largest, most important region for CI and the fact that non-residential construction is underpinned by those government infrastructure projects, which again is a very positive thing for us. So I think it's an important thing to keep in mind as you think about CI."
},
{
"speaker": "Jim Umpleby",
"content": "All right. Well again, thank you for joining us and we certainly appreciate all your questions. I'd like to just close by thanking our global team for their strong performance in the first quarter, including higher adjusted operating profit margin, record adjusted profit per share and strong EM&T free cash flow. Our strong results continue to reflect the diversity of our end markets, as well as the disciplined execution of our strategy for long term profitable growth. With that, I'll turn it back to Ryan."
},
{
"speaker": "Ryan Fiedler",
"content": "Thanks Jim, Andrew, and everyone who joined us today. A replay of our call will be available online later this morning. We'll also post a transcript on our Investor Relations website as soon as it's available. You'll also find our first quarter results video with our CFO and an SEC filing with our sales to users data. Click on investors.caterpillar.com and then click on financials to view those materials. If you have any questions, please reach out to Rob or me. Now let's turn the call back to Audra to conclude our call."
},
{
"speaker": "Operator",
"content": "Thank you. And that does conclude our call. Thank you for joining. You may all now disconnect."
}
] |
cb | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Thank you for standing by, and welcome to the Chubb Limited 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 ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again press the star, one. Thank you. I’d now like to turn the call over to Karen Beyer, Senior Vice President, Investor Relations. You may begin."
},
{
"speaker": "Karen Beyer",
"content": "Thank you and welcome to our December 31, 2024 fourth quarter and year-end earnings conference call. Our report today will contain forward-looking statements, including statements relating to company performance, pricing and business mix, growth opportunities, and economic and market conditions which are subject to risks and uncertainties, and actual results may differ materially. Please see our recent SEC filings, earnings release and financial supplement, which are available on our website at investors.chubb.com for more information on factors that could affect these matters. We will also refer today to non-GAAP financial measures, reconciliations of which to the most directly comparable GAAP measures and related details are provided in our earnings press release and financial supplement. Now I’d like to introduce our speakers. First, we have Evan Greenberg, Chairman and Chief Executive Officer, followed by Peter Enns, our Chief Financial Officer, and then we’ll take your questions. Also with us to assist with your questions this morning are several members of our management team. It’s now my pleasure to turn the call over to Evan."
},
{
"speaker": "Evan Greenberg",
"content": "Good morning. Before I begin, I want to take a moment to speak about the terrible tragedy surrounding the California wildfires - the live lost and tremendous loss of property, a major disaster still unfolding. Our job and the role we play in society is to support our policyholders. Our colleagues have been on the ground, supported by Chubb colleagues throughout the U.S., endeavoring to assist those clients who have lost property, been displaced from their homes and businesses, and had their lives severely disrupted. While it doesn’t erase the enormous difficulty they have and will continue to experience, we’re doing all we can in small and big ways to ease their burden. Our thoughts are with those who have suffered, and our gratitude goes to those firefighters and emergency workers who serve tirelessly. From a financial perspective, our current estimate of the cost of supporting our customers and helping them recover and rebuild from their catastrophe is $1.5 billion net pre-tax and is a first quarter 2025 event. Now turning to our results for the fourth quarter ’24, which you have all seen, we had a great quarter which contributed to an outstanding year; in fact, the best in our company’s history. For the quarter, record P&C underwriting income with a world-class combined ratio of 85.7, together with another quarter of record investment income led to core operating income of $2.5 billion. Operating earnings were up 9.4% on a pre-tax basis or 10.5% per share, though after tax they were distorted by the one-time tax benefit we received last year. Looking through that, operating income was up over 7.5% after tax. Global P&C premium revenue, which excludes agriculture, grew 6.7% in the quarter with good contributions from our P&C businesses globally of North America and overseas general. Premiums in our life insurance division grew 8.5% constant dollars. For the year, we generated operating income of $9.1 billion, up 11.5% adjusted for the one-time tax benefit and 13% on a per-share basis. Looking more broadly, over the past three years core operating income has grown over 65% and is nearly double the amount from pre-COVID 2019. All three major sources of income for our company produced record results last year. P&C underwriting income of $5.9 billion was up over 7% with a published combined ratio of 86.6. Adjusted net investment income grew 19.3% to $6.4 billion, and life insurance income topped $1 billion. For the year, we grew global P&C premiums 9.9% and life premiums 18.5% in constant dollars. Shareholder returns were strong. Our core operating ROE was about 14% and our return on tangible equity was 21.6. Per-share book and tangible book value grew 8.8 and 14.1 respectively. Our results top and bottom line continue to demonstrate the broad and diversified nature of the company and the consistency of contributions from our businesses around the world - North America, Asia, Europe, Latin America, both commercial and consumer. As we look forward to 2025, we have good momentum and are optimistic about the year ahead, both top and bottom line, cat losses and FX notwithstanding. Returning to the quarter, our underwriting performance was outstanding while absorbing a more normal level of cat losses. P&C underwriting income was $1.6 billion and the current accident year combined ratio excluding cats was 82.2%, more than two points better than prior year and also a record result. Our prior year’s reserve development in the quarter and for the year was $213 million and $856 million respectively, and speaks to the strength of reserves and conservative nature of our loss reserving practices. On the asset side, we’re investment managers, our other business, and we had another excellent quarter in terms of performance. Our invested assets now stands at $151 billion, and it will continue to grow. For the quarter, adjusted net investment income was a record $1.7 billion, up 13.7%. Our fixed income portfolio yield is 5% versus 4.8% a year ago, and our current new money rate is averaging 5.6%. Peter will have more to say about financial items. Turning to growth, pricing and the rate environment, again global P&C premiums increased 6.7% in the quarter, with commercial up 6.4% and consumer up 7.5%. All regions of the world contributed favorably. Life premiums grew 8.5%. In terms of the commercial P&C rate environment, market trends or themes were consistent with those of the previous quarter. Property has grown more competitive and large account shared and layered at E&S while pricing was favorable. Casualty is stable or firming, depending on the class, and overall pricing is ahead of loss cost tracking. Financial lines, particularly D&O and employment practices liability is where more competition is reaching for market share at the expense of current accident year underwriting margins. Overall, market conditions are favorable and we see good growth opportunity for over 80% of our global P&C business, commercial and consumer, as well as for our life business. North America and overseas general, Asia, Europe and Latin America, each with many areas of favorable growth opportunity. Our middle market and small commercial businesses globally, our U.S. E&S business, our U.S. high net worth business, global A&H and life, international personal lines, our digital business and specialty businesses such as our growing climate plus business. Now turning to the quarter, let me give you some more color by division. Beginning with North America, premiums excluding agriculture were up 6.3% and consisted of 10% growth in personal insurance and 5.1% growth in commercial, with P&C lines up 7.2% and financial lines down 2.9%. We had another strong quarter for new business, up over 22% versus prior year, and our renewal retention on a policy count basis was 90.4%. These again speak to the reasonably disciplined tone of the market and our excellent operating performance. Premiums in our major account and specialty division increased 4.6% with P&C up 5.8% and financial lines down 1.7%. Within major and specialty, our Westchester E&S business grew 8%. Premiums at our middle market division increased 6.2% with P&C up 10% and financial lines down 5%. Pricing for property and casualty excluding financial lines and comp was up 9.9% with rates up 8.2% and exposure change of 1.6%. Financial lines pricing was down 3.3% with rates down 3.6%. In workers comp, which includes both primary comp and large account risk management, pricing was up 4.7% with rates up 2.5% and exposure up 2.1%. Breaking down P&C pricing further, property pricing was up 6.9% with rates up 3.5% and exposure change of 3.3%. Casualty pricing in North America was up 12.7% with rates up 11.8% and exposure up 0.8%. Loss costs in North America remained stable - no change and in line with what we contemplate in our loss PICs. Our North America commercial lines business ran an amazing 83.9% published combined ratio for the year - again, an amazing result. In agriculture, where we are the market leader, our crop underwriting results this quarter were excellent, and we finished the year with $354 million in underwriting profit. Premiums were down from prior year due to lower commodity prices and the formulas for risk sharing with the government. On the consumer side of North America, our high net worth personal lines business had another outstanding quarter with premium growth of 10%, including new business growth of 34%. Premiums in our true high net worth segments, a group that seeks our brand for the differentiated coverage and service we are known for, grew 17.6%. Our home owners pricing was up over 12% in the quarter and ahead of loss cost trends, which remained steady. For the year, we ran an outstanding 83.6% combined ratio in our high net worth personal lines business. Turning to our international general insurance operations, premiums in the quarter for our retail business were up 7.7% with commercial lines up 10.3% and consumer up 4.7%. From a region of the world perspective, Asia Pac led the way with premiums up 12.2%. Europe grew 8.2%, including growth of 12% on the continent. Latin America grew just 2.5% and was impacted by foreign exchange. If you adjust for that, Latin America was up 11.5% in constant dollars. In our international retail commercial business, P&C pricing was up 3.7% and financial lines pricing was down more than 6%. Premiums in our London wholesale business were essentially flat. They were up 1.1% with prices down 4% as the London market continued to grow more competitive. For the year, our overseas general business ran an excellent 86.4 combined ratio. Our global reinsurance business had a strong quarter with premium growth of about 20% and finished the year with premiums up 32% and a combined ratio of 85.9, reflecting a more disciplined reinsurance market, both property and pockets of casualty. In our international life business, which is fundamentally Asia, premiums and deposits were up over 26% in constant dollar. In combined insurance company, our U.S. worksite business grew 17.8%. Our life division finished the year with pre-tax income of $1.1 billion, which was ahead of what we originally projected for the year. We have good momentum in our life business, which continues to build. In summary, we had a great quarter and a great year. While we’re in the risk business and there’s plenty of uncertainty in the world, we’re confident that our ability to continue growing operating earnings and EPS at a double-digit rate, cats and FX notwithstanding. Our earnings growth will come from three sources: P&C underwriting, investment income, and life income. Now I’ll turn the call back over to Peter."
},
{
"speaker": "Peter Enns",
"content": "Thank you Evan, and good morning. As you just heard, we concluded the year with another strong quarter, contributing to record full-year results across our three primary sources of earnings. Our balance sheet finished the year in an exceptionally strong position with book value of $64 billion and total invested assets of $151 billion. The quarter and full year produced adjusted operating cash flow of $4.2 billion and a record $15.9 billion respectively. It’s also worth noting that during the quarter, AM Best affirmed our company’s rating and stable outlook, and in January S&P affirmed our rating and stable outlook. During the quarter, we returned $1.1 billion of capital to shareholders, including $725 million in share repurchases and $367 million in dividends. We returned $3.5 billion in total for the year, including $2 billion in share repurchases and $1.5 billion in dividends, which represented approximately 38% of our full year core operating earnings. The average share price on repurchases for the year was $269.23. Book value for the quarter and the year was adversely impacted by unrealized mark to market losses on our high quality fixed income portfolio due to interest rate changes, which we expect to amortize back to par over time, as well as foreign exchange losses. Book and tangible book value per share excluding AOCI grew 2.9% and 4.3% respectively for the quarter, and 10.8% and 15.4% respectively for the year. Our core operating return on tangible equity for the quarter and year was 22% and 21.6% respectively, while our core operating ROE for the quarter and year was 14.3% and 13.9%. Turning to investments, our A-rated portfolio, which now has an average book yield of 5%, produced adjusted net investment income of $1.69 billion, which included approximately $25 million of higher than normal income from private equity. We expect our quarterly adjusted net investment income to have a run rate between $1.67 billion and $1.75 billion over the next six months. Regarding underwriting results, the quarter included pre-tax catastrophe losses of $607 million, of which $309 million was from Hurricane Milton and $140 million from Hurricane Helene. The remaining balance was principally from weather related events split 31% in the U.S. and 69% international. Prior period development in the quarter in our active companies was a favorable $352 million pre-tax with favorable development split 17% in long tail lines, primarily from general casualty, and 83% in short tail lines, primarily from property and agriculture. Our corporate runoff portfolio had adverse development of $139 million, primarily asbestos related. Our paid to incurred ratio for the year was 83%. Our core effective tax rate was 18.2% for the quarter and 17.5% for the year, which are below our previously guided range due to shifts in mix of income. We expect our annual core operating effective tax rate for 2025 to be in the range of 19% to 19.5%, including the transition cash tax benefit provided on the adoption of the new Bermuda income tax. I’ll now turn the call back over to Karen."
},
{
"speaker": "Karen Beyer",
"content": "Thank you. At this point, we’ll be happy to take your questions."
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question and answer session. [Operator instructions] Your first question comes from the line of Brian Meredith from UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"content": "Yes, thank you. A couple questions here for me. Evan, I’m wondering if you can dig into a little bit the Cal fire loss estimate that you’ve given out there. Does it include assessments, subrogation, kind of ground up? Maybe give us a little context on how we should be thinking about the $1.5 billion number."
},
{
"speaker": "Evan Greenberg",
"content": "Yes. First of all, it’s a ground-up number. It’s our own losses. We don’t go off of what we imagine as a total industry wildfire loss and a market share - this is our number that our adjusters on the ground have been able to estimate property by property. It does include an assessment for--our projection of an assessment from the fair [ph] plan, and we don’t take credit in ours for subrogation."
},
{
"speaker": "Brian Meredith",
"content": "That’s helpful, thank you. Then my second question, Evan, I’m just curious, looking at 2025, still getting some solid growth in commercial lines, call it mid to high single digit organic growth here in premium. But if you think of 2025, is that kind of a good number to target organically, and then is this kind of the period that we’re looking at, that maybe you should start looking a little bit more at inorganic growth opportunities?"
},
{
"speaker": "Evan Greenberg",
"content": "I love you, Brian. Yes, you know, I don’t give--we don’t give guidance on forward-looking, but your first statement--you know, your logic sounds pretty decent to me. I didn’t say it, you said it. As for inorganic growth, money is not burning a hole in our pocket and, as you know, it’s opportunistic and it’s in support of our organic strategies, and it’s got to be the right thing at the right price. We’re always looking."
},
{
"speaker": "Brian Meredith",
"content": "Great, appreciate it."
},
{
"speaker": "Evan Greenberg",
"content": "You’re welcome."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of David Motemaden from Evercore ISI. Your line is open."
},
{
"speaker": "David Motemaden",
"content": "Hey, good morning. I had a question on the--for Peter and Evan on the favorable long tail reserve development, the 17% of the 350 or so on the active companies. It sounds like that was driven by general casualty. That’s a bit of a change versus what you guys have experienced over the last several quarters, so I’m wondering if you could elaborate on the favorable development that you’re seeing there, because that’s quite different than what you and others have been reporting, and any clarity on what sort of accident year it’s coming from too would be helpful."
},
{
"speaker": "Evan Greenberg",
"content": "Well, I’m going to correct your mental model to begin with. Our casualty, we study different portfolios of casualty each quarter. Some casualty portfolios, we have taken reserve strengthening, some portfolios we’ve taken no action, some portfolios we’ve had reserve releases, and there has not been a consistency per quarter except the consistency is the portfolios is we study each quarter, and so a cohort of casualty we studied this quarter had favorable development given the reserve strength in that portfolio."
},
{
"speaker": "David Motemaden",
"content": "Got it, helpful. Thank you for that. Then maybe--you know, obviously strong results in North America commercial, that included a little bit of a headwind from the structured transactions too. Could you--of that 40 basis point headwind, could you just help me think about the impact that had on the loss ratio and how we should think about the durability of that loss ratio going forward?"
},
{
"speaker": "Evan Greenberg",
"content": "You’re saying on structured transaction, what’s its impact in the quarter on loss ratio?"
},
{
"speaker": "David Motemaden",
"content": "Yes."
},
{
"speaker": "Evan Greenberg",
"content": "Structured transactions typically run off favorable. Now, we don’t break down the pieces and going to give you each--you know, the component of that exactly, but they--what you should know is they run a higher loss ratio than the average portfolio does."
},
{
"speaker": "David Motemaden",
"content": "Got it, okay. Thank you."
},
{
"speaker": "Evan Greenberg",
"content": "David, does that help you?"
},
{
"speaker": "David Motemaden",
"content": "Yes, yes, that does help. I mean, I guess you guys had given the 40 basis points just on the total combined ratio. I guess I can just use that, sort of as a placeholder for what sort of impact that may have had on the--maybe a little bit bigger on the loss ratio, maybe [indiscernible]."
},
{
"speaker": "Evan Greenberg",
"content": "We don’t have it at hand, but it’s probably--you know, it’s in the range, okay?"
},
{
"speaker": "David Motemaden",
"content": "Got it, understood. That’s helpful. Thank you."
},
{
"speaker": "Evan Greenberg",
"content": "It’s a fucking basis point, so it’s easy for me to tell you you’re in the range. I mean, it could be 10 basis points up or do, but we’ll take it offline with you and help you."
},
{
"speaker": "David Motemaden",
"content": "Thanks."
},
{
"speaker": "Evan Greenberg",
"content": "You’re welcome."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Gregory Peters from Raymond James. Your line is open."
},
{
"speaker": "Greg Peters",
"content": "Well, good morning everyone. Evan, in response to Brian’s question, you said you love him. I don’t recall you ever saying you love a sell-side analyst, so the new year’s definitely starting off good for us!"
},
{
"speaker": "Evan Greenberg",
"content": "Don’t mess it up, Greg!"
},
{
"speaker": "Greg Peters",
"content": "All right. I’m sure I can. Anyway, in your press release, you say you’re growing operating earnings and EPS at a double-digit rate. You talk about the three buckets - PC, investment income and life insurance, so maybe you can, from a big picture perspective, unpack life insurance and talk about where you see the growth coming next year--or this year, I should say, ’25, and how it might compare with how the growth came out for ’24."
},
{
"speaker": "Evan Greenberg",
"content": "Yes, you know, there was a lot of consolidation impact on the life income in the ’23 year and a little bit of noise in ’24. There was one-time stuff in ’23, so to look through the underlying growth rate of that, it produced a really solid double-digit growth rate in income. When I looked through it, it was in that 12% to 14% range. When I look forward, I see that continuing and even strengthening. We have good momentum, and it’s obviously Asia, and it’s both north Asia and it’s Southeast Asia. Our business in Korea, while the revenue growth is not overly exciting, the margin of that business continues to expand and our overall income is growing. It’s a ballast of the business. It’s supported by then faster--countries that are growing much more quickly - Hong Kong, Taiwan, China now growing more quickly for us, and each of those producing improved margin and therefore faster income growth. Southeast Asia, with Vietnam and Thailand, they had slower growth this past year, and they’re accelerating as we go forward. Finally, we have two other businesses in Indonesia and in New Zealand that are good businesses, picking up momentum. It’s in direct response marketing, it’s in agency, and over 60% of the business, about 70% of it is really accident and health and risk-based type products, and the rest is very conservatively structured savings-related products, because people in Asia, you have two themes, you have an aging population in the north that requires a certain kind of savings and health-related product, and then you have people in Southeast Asia, where it’s a younger population, family oriented, there are no social safety nets, and so they rely on these kinds of products much more than they do in other parts of the world. I’ll remind you, unlike many regions of the world, these parts of Asia are growing, particularly Southeast Asia. The economic growth is multiples of what we’re seeing in the West, and that just means a rising middle class."
},
{
"speaker": "Greg Peters",
"content": "Thanks for the perspective and detail. I guess pivoting to the other bucket, which is PC, it seems like the broader market is producing some pretty good results relative to longer term averages, and we’re hearing about increased competition across a broader set of lines of business, even you, in your comments, talked about financial lines, so maybe you could spend a minute and give us some perspective on how you think where we are in the cycle and how Chubb is going to be positioned to come out of it."
},
{
"speaker": "Evan Greenberg",
"content": "Yes, it goes to my comment, about 80% of the business growth, and where you therefore see the pockets of competition. As a backdrop and in the way you think about cycles--and I’ve been thinking about this for a while, we’re in a more inflationary period in the insurance industry, and it’s a prolonged one, than we have seen in a very long time. We went through decades of really relatively low inflation, on the short tail class side virtually pretty flat, and on the long tail side, there’s always been pockets but it was running at a lower level. We’re in a period of sustained inflation, so to just stay in place, rates have to move. It doesn’t mean margins improve if they just keep pace with loss costs, so a certain amount of industry growth is just to reflect inflation. The competition, it’s increasing in shared and large account business, so first large account will grow more slowly because you have a couple of lines of business where competition increases - property, shared and layered property, but it’s well priced and it doesn’t mean that there’s a decrease in margin. It means that to retain business, you become a bit more competitive, it’s harder to grow. More want that business, so you’re not going to see growth but you’re going to see good results from all we’re imagining as we go forward. E&S property, same thing. Financial lines in large account, same thing; and then primary casualty is not a real growth business, but it’s a ballast that supports growth of many other lines for large account, so large account, not so much. In middle market and small commercial, growth opportunity, and it’s a growth opportunity across many segments. By the way, there’s certain secular change taking place in that business, and by the way, it’s not simply in the United States, it’s global; and then the consumer lines business from high net worth to personal lines outside the United States to our accident and health businesses, particularly with middle class in Asia and in Latin America on both the life side and the non-life side, when I add it all up--anyway. Does that give you a sense?"
},
{
"speaker": "Greg Peters",
"content": "Yes, it does. What did you mean by the secular change comment?"
},
{
"speaker": "Evan Greenberg",
"content": "When you--particularly in middle market in the United States, I’ll take that as an example, with all of the change in climate and cat activity, and with the change in the legal environment around the trial bar and social inflation, regional and mutuals have a harder time. They’re not equipped with the data, with the balance sheet, with the depth of business in reinsurance relationships to be able to--and with the technology to be able to compete the same way. That over time is shifting market share, and it advantages a few larger players."
},
{
"speaker": "Greg Peters",
"content": "That makes sense. Thanks for the answers."
},
{
"speaker": "Evan Greenberg",
"content": "You’re welcome."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Meyer Shields from KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"content": "Great, thank you. Good morning. First, I was hoping you could walk us through any changes to your reinsurance purchasing at January 1."
},
{
"speaker": "Evan Greenberg",
"content": "None."
},
{
"speaker": "Meyer Shields",
"content": "Okay, that’s pretty easy. The second, I don’t know if this is significant, but--"
},
{
"speaker": "Evan Greenberg",
"content": "Yes, I would have done--it did nothing [indiscernible]."
},
{
"speaker": "Meyer Shields",
"content": "That’s fine, makes [indiscernible] there. There was a little bit of an uptick in administrative expenses in North America commercial, and I was hoping you could walk us through that. I don’t know if it’s incentive compensation or something else."
},
{
"speaker": "Evan Greenberg",
"content": "A little uptick in what in North America?"
},
{
"speaker": "Meyer Shields",
"content": "The admin expenses."
},
{
"speaker": "Evan Greenberg",
"content": "No, it’s just--oh my God, it’s 0.1%. It’s just noise."
},
{
"speaker": "Meyer Shields",
"content": "Okay."
},
{
"speaker": "Evan Greenberg",
"content": "Meyer--"
},
{
"speaker": "Meyer Shields",
"content": "I’m sorry, go ahead?"
},
{
"speaker": "Evan Greenberg",
"content": "[Indiscernible]"
},
{
"speaker": "Meyer Shields",
"content": "Yes, I was looking for dollars, not the percentage."
},
{
"speaker": "Evan Greenberg",
"content": "No, it’s just--it’s just--no, nothing. It’s just variability in the quarter."
},
{
"speaker": "Meyer Shields",
"content": "Okay, perfect. Thank you so much."
},
{
"speaker": "Evan Greenberg",
"content": "There’s not a trend in that."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Mike Zaremski from BMO. Your line is open."
},
{
"speaker": "Mike Zaremski",
"content": "Hey, morning. First is a follow-up to your insights about the secular change in the U.S. middle market space. If I think through your comments in the past, Evan, you’ve said that Chubb has aspirations to move more down market, and your definition of mid market or small market might be also different than some of the peers. But just curious if you’re painting a picture that Chubb’s competitive advantages are growing versus some of its peers, would you still have aspirations to do kind of inorganic things in the small midmarket space in the U.S., or less so as time goes on?"
},
{
"speaker": "Evan Greenberg",
"content": "Our focus is on organic SME - small and middle market, and it’s organic. That is our focus and has been our focus. Anything that’s inorganic is simply opportunistic, and that’s not our focus. It’s opportunistic."
},
{
"speaker": "Mike Zaremski",
"content": "Okay, and lastly switching gears, on the investment portfolio, there’s been a bit of an increase in equities over the last couple quarters - we’re up to about $9 billion. Anything changing there in terms of over the next year, you expect to see a different mix shift in the investment portfolio? Thanks."
},
{
"speaker": "Peter Enns",
"content": "Mike, it’s Peter. First off, that specific $5 billion shift relates to us actually moving about $5 million of investment-grade corporates into a fund for, call it investment efficiency purposes between different entities. The underlying is still investment-grade fixed income, but because of GAAP, we have to show it as equity, so there’s no underlying change in that. In terms of the going forward, we’ve spoken about our strategy--you’ll see it in the investor presentation, there will be a change in investment allocation, slight change which we put out there in that investor deck."
},
{
"speaker": "Mike Zaremski",
"content": "Thank you Peter."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Andrew Kligerman from TD Cowen. Your line is open."
},
{
"speaker": "Andrew Kligerman",
"content": "Thank you, good morning. Evan, in casualty lines, you mentioned the 12% rate increase for North America - that sounds really solid. But in reinsurance, you said there were pockets of strength, and I’m hearing overall in reinsurance casualty, there’s a lot of softness going on. One, why the disconnect; and two, what are those pockets of weakness in casualty reinsurance?"
},
{
"speaker": "Evan Greenberg",
"content": "No, I said there’s pockets of opportunity in reinsurance casualty. You have to be very select, and I’m not going to go into more detail than that; but let’s be clear, we have not been significant, by any means, reinsurance casualty writers, and in fact we shrank and shrank and shrank over quite a number of years because we didn’t see the market producing an underwriting profit. We see select--you know, the market is stressed in reinsurance casualty, and we see--you know, we see selective pockets. I’m not going to overstate it."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it."
},
{
"speaker": "Evan Greenberg",
"content": "Relative to travel, it’s not big money."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it, got it. Then with regard to the financial lines--"
},
{
"speaker": "Evan Greenberg",
"content": "[Indiscernible] it’s opportunistic trades [indiscernible]."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it. Then with regard to financial lines, it looks like that’s the area where you’re seeing premiums decline across the board. It’s been about three years now of continuous decline, particularly in public D&O. What is it that players like about it, that they continue to go after it and you just don’t think it’s good business at this point?"
},
{
"speaker": "Evan Greenberg",
"content": "Well, we love the business. It’s the pricing."
},
{
"speaker": "Andrew Kligerman",
"content": "Yes."
},
{
"speaker": "Evan Greenberg",
"content": "You know, look - during the pandemic, there was a significant drop-off in securities class actions and in other forms of loss - let’s call it employment practices liability during the financial crisis, so those years are producing favorable results. The head fake around it, which is why I used the words, current accident year, is in terms of loss, the number of securities class actions, the frequency of loss is reverting back to the mean. In some areas, like employment practices, in fact frequency of loss is increasing pretty quickly. Severity of loss continues to trend, and so I think what they don’t see or they ignore is what’s coming about current accident year margins and pressure. We know this. We have a big book of this business, and Chubb is a leader in this business across classes, and so we--we’re patient. We know how to ebb and flow in a period, so it’s--you know, it’s not something you like looking at, but on the other hand we’ve got plenty of other tables to play."
},
{
"speaker": "Andrew Kligerman",
"content": "Makes a lot of sense, thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Alex Scott from Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"content": "Hey, good morning. First one I had for you all is on sort of the fallout from what we’re going to see in California from the wildfires, and I guess specifically, what will your approach be to the market going forward? Will you have to make any changes in the way you approach that market, and just interested in any thoughts you have on what needs to be done to sort of stabilize the insurance market there."
},
{
"speaker": "Evan Greenberg",
"content": "Yes, thank you for that question. Look - California is a difficult market for insurance companies, and it has only become more difficult over time. The state along with the pressure it receives from consumer advocacy groups suppresses the ability to charge a fair price for the risk and tailored coverages to improve availability and affordability of insurance for the citizens of the state. Insurers are unable to generate a reasonable risk-adjusted return commensurate with the risk of ensuring natural perils such as wildfire and the cost in California associated with reconstruction following a disaster. This suppression of pricing signals, which are rising, encourages more risk taking by individuals and businesses as to where they choose to live or work, and it encourages less risk management or loss mitigation activity, and they’re part as well by federal and state and local governments, who all have a hand in loss mitigation activity that actually is occurring, or not occurring. In a word, economics incent behaviors, and California is impacting those economic signals. As insurers have reduced their exposures in the state, the state has offered more under-priced coverage through its own insurer of last resort. Frankly, it’s an unsustainable model, and one way or the other, the citizens of the state pay the price for coverage. California is not alone in this regard, but it certainly stands out. We’ve been shrinking our exposure in California for some time; for example, in the area where the wildfires occurred, our exposure has been reduced by over 50%. We’re not going to write insurance where we cannot achieve a reasonable risk-adjusted return for taking the risk."
},
{
"speaker": "Alex Scott",
"content": "That’s really helpful. Maybe just a follow-on question to that, would you expect what’s going on in California and sort of the fallout from that to affect property pricing more broadly? I mean, it seems like the world’s becoming a riskier place and certainly price adequacy has seemed pretty good in property and other areas, but will this be enough to change thinking, whether at the primary or reinsurance level, in your view?"
},
{
"speaker": "Evan Greenberg",
"content": "You know, it’s too early to tell. I don’t know yet. As the loss, the magnitude of this loss emerges and grows, more of it begins to find its way to reinsurance balance sheets and to other balance sheets, and that’s going to be the question, is what is the ultimate size of the loss and where does it end up? That will give us--that will determine whether it has a broader impact on overall property pricing, which in my judgment overall is adequate. This is a reminder of why the industry needs to maintain pricing adequacy."
},
{
"speaker": "Alex Scott",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Elyse Greenspan from Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. My first question, can you guys provide, I guess, what the current excess capital drag on your ROE is?"
},
{
"speaker": "Evan Greenberg",
"content": "I’m sorry--?"
},
{
"speaker": "Peter Enns",
"content": "The current excess capita ROE drag. Yes, we haven’t disclosed that in a while, Elyse; and again, how we’re thinking about things, consistent with what we talked about in our investor presentation, is looking at our capital as also a source of investment as we gradually and incrementally increase our asset allocation towards alts. That’s just starting, so I’ll say right now, looking at the year behind us, it will be in a range similar to, call it a year ago that we discussed and people backward computed, so. It was in the range of ROE looking backwards of around 2% on ROE and 6% on ROTE."
},
{
"speaker": "Elyse Greenspan",
"content": "That’s helpful. Then my second question, you provided tax guidance, and I think you had said that it considers some transition cash tax benefit from Bermuda. I had also thought that there was some--the potential for some reversals of the DTAs that were set up, so I’m assuming--I think that might not take place this year, but it might be a couple years out. Are you guys just assuming there’s no change in the DTA structure of what was set up a year ago?"
},
{
"speaker": "Peter Enns",
"content": "Yes Elyse, from an accounting perspective, it’s based on Bermuda law, and Bermuda law isn’t expected to change. If it changes, we’d have to look at it. OECD came out with some administrative guidance a couple of weeks ago that has to be reviewed and see how it applies. As you may have seen, the new administration has come through with saying they’re not going to participate in the global minimum tax of OECD and are vacating on that basis, so we have a sense of where--we have a very clear sense of where we are for ’25 and ’26, and one thing we know is longer term, it’s very uncertain, particularly with the new administration along with China, India, and some other very large countries not being involved at all as well."
},
{
"speaker": "Evan Greenberg",
"content": "It never involved Swiss law--"
},
{
"speaker": "Peter Enns",
"content": "Swiss law, yes."
},
{
"speaker": "Evan Greenberg",
"content": "Yes, it’s messy."
},
{
"speaker": "Elyse Greenspan",
"content": "Then on--I’ll throw one in for Evan. You guys have been talking about competition in financial lines for some time, and obviously pulled back there. Do you--what do you think it takes, I guess, for things to get better there? Is there something--are you not expecting conditions, I guess, to change at any point in the near term?"
},
{
"speaker": "Evan Greenberg",
"content": "I think there’s some--I think as losses emerge and it re-normalizes, that will be an ameliorating factor."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay, thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Yaron Kinar from Jefferies. Your line is open."
},
{
"speaker": "Yaron Kinar",
"content": "Thank you, good morning. Evan, at the risk of maybe changing your sentiment around the sell-side analysts here so quickly, I do want to go back to something I asked last quarter with regards to North America commercial premium growth, which was 2% on a gross premium basis. I’m just trying to reconcile that with the pricing environment, which seems to be ahead of that, and the opportunities that you’re seeing and the appetite that you have. Maybe you can walk us through the puts and takes there."
},
{
"speaker": "Evan Greenberg",
"content": "I’m not sure what you--can you be more clear?"
},
{
"speaker": "Yaron Kinar",
"content": "Sure. Your premium growth, gross premium growth was 2%. I think the pricing environment in North America P&C, if we take the bits and pieces of pricing that you offered, is north of that. It seems to also be a bit of raw trend--"
},
{
"speaker": "Evan Greenberg",
"content": "I think you have to start with net premium growth, not gross premium growth. Net premium growth--"
},
{
"speaker": "Yaron Kinar",
"content": "Why would that be?"
},
{
"speaker": "Evan Greenberg",
"content": "Well, because net--gross premium growth has too many distortions of transactions that we do, that frankly distort that number, large transactions, where it may be a self-insured program or it’s a structured program, so gross has puts and calls based on the premium flows with our clients. If you get to a middle market business, it’s more steady; but when you have large account and then you have gross line, even in E&S business with a client, that’s what makes a lot of noise and a lot of difference. You’re never going to get there. You have to start at net premium. Now, I could just tell you that, and I’m giving you that as an explanation, not as a--this is nothing to debate."
},
{
"speaker": "Yaron Kinar",
"content": "Fair enough, and if we take the net premium growth, which was 5%, versus roughly 7% pricing?"
},
{
"speaker": "Evan Greenberg",
"content": "Well, it’s a mix of--there’s a mix of business, there is a retention. It doesn’t translate directly, it never does. You start with a retention rate, you then have to add new business, you have to do it line by line and the mix of it, so you’ll hear overall pricing, but now take overall pricing and you have to adjust for the mix of business. When you’re trying to translate to revenue [indiscernible]. If you want, offline we will give you a simple math lesson of that and take you through it."
},
{
"speaker": "Yaron Kinar",
"content": "Great, I’m always--"
},
{
"speaker": "Evan Greenberg",
"content": "I don’t mean a lesson in a bad way. We’ll take you through and give you some--you know, maybe another way to help you think about it."
},
{
"speaker": "Yaron Kinar",
"content": "Great, always eager to learn. Thank you."
},
{
"speaker": "Evan Greenberg",
"content": "You got it."
},
{
"speaker": "Operator",
"content": "That concludes our question and answer session. I will now turn the call back over to Karen Beyer for closing remarks."
},
{
"speaker": "Karen Beyer",
"content": "Thank you everyone for joining us today, and if you have any follow-up questions still, we’ll be around to take your call. Enjoy the day, thank you."
},
{
"speaker": "Operator",
"content": "This concludes today’s conference call. Thank you for your participation. You may now disconnect."
}
] |
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